Roger Farmer’s Prosperity for All

I have just read a review copy of Roger Farmer’s new book Prosperity for All, which distills many of Roger’s very interesting ideas into a form which, though readable, is still challenging — at least, it was for me. There is a lot that I like and agree with in Roger’s book, and the fact that he is a UCLA economist, though he came to UCLA after my departure, is certainly a point in his favor. So I will begin by mentioning some of the things that I really liked about Roger’s book.

What I like most is that he recognizes that beliefs are fundamental, which is almost exactly what I meant when I wrote this post (“Expectations Are Fundamental”) five years ago. The point I wanted to make is that the idea that there is some fundamental existential reality that economic agents try — and, if they are rational, will — perceive is a gross and misleading oversimplification, because expectations themselves are part of reality. In a world in which expectations are fundamental, the Keynesian beauty-contest theory of expectations and stock prices (described in chapter 12 of The General Theory) is not absurd as it is widely considered to be believers in the efficient market hypothesis. The almost universal unprofitability of simple trading rules or algorithms is not inconsistent with a market process in which the causality between prices and expectations goes in both directions, in which case anticipating expectations is no less rational than anticipating future cash flows.

One of the treats of reading this book is Farmer’s recollections of his time as a graduate student at Penn in the early 1980s when David Cass, Karl Shell, and Costas Azariadis were developing their theory of sunspot equilibrium in which expectations are self-fulfilling, an idea skillfully deployed by Roger to revise the basic New Keynesian model and re-orient it along a very different path from the standard New Keynesian one. I am sympathetic to that reorientation, and the main reason for that re-orientation is that Roger rejects the idea that there is a unique equilibrium to which the economy automatically reverts, albeit somewhat more slowly than if speeded along by the appropriate monetary policy, on its own. The notion that there is a unique equilibrium to which the economy automatically reverts is an assumption with no basis in theory or experience. The most that the natural-rate hypothesis can tell us is that if an economy is operating at its natural rate of unemployment, monetary expansion cannot permanently reduce the rate of unemployment below that natural rate. Eventually — once economic agents come to expect that the monetary expansion and the correspondingly higher rate of inflation will be maintained indefinitely — the unemployment rate must revert to the natural rate. But the natural-rate hypothesis does not tell us that monetary expansion cannot reduce unemployment when the actual unemployment rate exceeds the natural rate, although it is often misinterpreted as making that assertion.

In his book, Roger takes the anti-natural-rate argument a step further, asserting that the natural rate of unemployment rate is not unique. There is actually a range of unemployment rates at which the economy can permanently remain; which of those alternative natural rates the economy winds up at depends on the expectations held by the public about nominal future income. The higher expected future income, the greater consumption spending and, consequently, the greater employment. Things are a bit more complicated than I have just described them, because Roger also believes that consumption depends not on current income but on wealth. However, in the very simplified model with which Roger operates, wealth depends on expectations about future income. The more optimistic people are about their income-earning opportunities, the higher asset values; the higher asset values, the wealthier the public, and the greater consumption spending. The relationship between current income and expected future income is what Roger calls the belief function.

Thus, Roger juxtaposes a simple New Keynesian model against his own monetary model. The New Keynesian model consists of 1) an investment equals saving equilibrium condition (IS curve) describing the optimal consumption/savings decision of the representative individual as a locus of combinations of expected real interest rates and real income, based on the assumed rate of time preference of the representative individual, expected future income, and expected future inflation; 2) a Taylor rule describing how the monetary authority sets its nominal interest rate as a function of inflation and the output gap and its target (natural) nominal interest rate; 3) a short-run Phillips Curve that expresses actual inflation as a function of expected future inflation and the output gap. The three basic equations allow three endogenous variables, inflation, real income and the nominal rate of interest to be determined. The IS curve represents equilibrium combinations of real income and real interest rates; the Taylor rule determines a nominal interest rate; given the nominal rate determined by the Taylor rule, the IS curve can be redrawn to represent equilibrium combinations of real income and inflation. The intersection of the redrawn IS curve with the Phillips curve determines the inflation rate and real income.

Roger doesn’t like the New Keynesian model because he rejects the notion of a unique equilibrium with a unique natural rate of unemployment, a notion that I have argued is theoretically unfounded. Roger dismisses the natural-rate hypothesis on empirical grounds, the frequent observations of persistently high rates of unemployment being inconsistent with the idea that there are economic forces causing unemployment to revert back to the natural rate. Two responses to this empirical anomaly are possible: 1) the natural rate of unemployment is unstable, so that the observed persistence of high unemployment reflect increases in the underlying but unobservable natural rate of unemployment; 2) the adverse economic shocks that produce high unemployment are persistent, with unemployment returning to a natural level only after the adverse shocks have ceased. In the absence of independent empirical tests of the hypothesis that the natural rate of unemployment has changed, or of the hypothesis that adverse shocks causing unemployment to rise above the natural rate are persistent, neither of these responses is plausible, much less persuasive.

So Roger recasts the basic New Keynesian model in a very different form. While maintaining the Taylor Rule, he rewrites the IS curve so that it describes a relationship between the nominal interest rate and the expected growth of nominal income given the assumed rate of time preference, and in place of the Phillips Curve, he substitutes his belief function, which says that the expected growth of nominal income in the next period equals the current rate of growth. The IS curve and the Taylor Rule provide two steady state equations in three variables, nominal income growth, nominal interest rate and inflation, so that the rate of inflation is left undetermined. Once the belief function specifies the expected rate of growth of nominal income, the nominal interest rate consistent with expected nominal-income growth is determined. Since the belief function tells us only that the expected nominal-income growth equals the current rate of nominal-income growth, any change in nominal-income growth persists into the next period.

At any rate, Roger’s policy proposal is not to change the interest-rate rule followed by the monetary authority, but to propose a rule whereby the monetary authority influences the public’s expectations of nominal-income growth. The greater expected nominal-income growth, the greater wealth, and the greater consumption expenditures. The greater consumption expenditures, the greater income and employment. Expectations are self-fulfilling. Roger therefore advocates a policy by which the government buys and sells a stock-market index fund in order to keep overall wealth at a level that will generate enough consumption expenditures to support maximum sustainable employment.

This is a quick summary of some of the main substantive arguments that Roger makes in his book, and I hope that I have not misrepresented them too badly. As I have already said, I very much sympathize with his criticism of the New Keynesian model, and I agree with nearly all of his criticisms. I also agree wholeheartedly with his emphasis on the importance of expectations and on self-fulfilling character of expectations. Nevertheless, I have to admit that I have trouble taking Roger’s own monetary model and his policy proposal for stabilizing a broad index of equity prices over time seriously. And the reason I am so skeptical about Roger’s model and his policy recommendation is that his model, which does after all bear at least a family resemblance to the simple New Keynesian model, strikes me as being far too simplified to be credible as a representation of a real-world economy. His model, like the New Keynesian model, is an intertemporal model with neither money nor real capital, and the idea that there is an interest rate in such model is, though theoretically defensible, not very plausible. There may be a sequence of periods in such a model in which some form of intertemporal exchange takes place, but without explicitly introducing at least one good that is carried over from period to period, the extent of intertemporal trading is limited and devoid of the arbitrage constraints inherent in a system in which real assets are held from one period to the next.

So I am very skeptical about any macroeconomic model with no market for real assets so that the interest rate interacts with asset values and expected future prices in such a way that the existing stock of durable assets is willingly held over time. The simple New Keynesian model in which there is no money and no durable assets, but simply bonds whose existence is difficult to rationalize in the absence of money or durable assets, does not strike me as a sound foundation for making macroeconomic policy. An interest rate may exist in such a model, but such a model strikes me as woefully inadequate for macroeconomic policy analysis. And although Roger has certainly offered some interesting improvements on the simple New Keynesian model, I would not be willing to rely on Roger’s monetary model for the sweeping policy and institutional recommendations that he proposes, especially his proposal for stabilizing the long-run growth path of a broad index of stock prices.

This is an important point, so I will try to restate it within a wider context. Modern macroeconomics, of which Roger’s model is one of the more interesting examples, flatters itself by claiming to be grounded in the secure microfoundations of the Arrow-Debreu-McKenzie general equilibrium model. But the great achievement of the ADM model was to show the logical possibility of an equilibrium of the independently formulated, optimizing plans of an unlimited number of economic agents producing and trading an unlimited number of commodities over an unlimited number of time periods.

To prove the mutual consistency of such a decentralized decision-making process coordinated by a system of equilibrium prices was a remarkable intellectual achievement. Modern macroeconomics deceptively trades on the prestige of this achievement in claiming to be founded on the ADM general-equilibrium model; the claim is at best misleading, because modern macroeconomics collapses the multiplicity of goods, services, and assets into a single non-durable commodity, so that the only relevant plan the agents in the modern macromodel are called upon to make is a decision about how much to spend in the current period given a shared utility function and a shared production technology for the single output. In the process, all the hard work performed by the ADM general-equilibrium model in explaining how a system of competitive prices could achieve an equilibrium of the complex independent — but interdependent — intertemporal plans of a multitude of decision-makers is effectively discarded and disregarded.

This approach to macroeconomics is not microfounded, but its opposite. The approach relies on the assumption that all but a very small set of microeconomic issues are irrelevant to macroeconomics. Now it is legitimate for macroeconomics to disregard many microeconomic issues, but the assumption that there is continuous microeconomic coordination, apart from the handful of potential imperfections on which modern macroeconomics chooses to focus is not legitimate. In particular, to collapse the entire economy into a single output, implies that all the separate markets encompassed by an actual economy are in equilibrium and that the equilibrium is maintained over time. For that equilibrium to be maintained over time, agents must formulate correct expectations of all the individual relative prices that prevail in those markets over time. The ADM model sidestepped that expectational problem by assuming that a full set of current and forward markets exists in the initial period and that all the agents participating in the economy are present and endowed with wealth enabling them to trade in the initial period. Under those rather demanding assumptions, if an equilibrium price vector covering all current and future markets is arrived at, the optimizing agents will formulate a set of mutually consistent optimal plans conditional on that vector of equilibrium prices so that all the optimal plans can and will be carried out as time happily unfolds for as long as the agents continue in their blissful existence.

However, without a complete set of current and forward markets, achieving the full equilibrium of the ADM model requires that agents formulate consistent expectations of the future prices that will be realized only over the course of time not in the initial period. Roy Radner, who extended the ADM model to accommodate the case of incomplete markets, called such a sequential equilibrium, an equilibrium of plans, prices and expectations. The sequential equilibrium described by Radner has the property that expectations are rational, but the assumption of rational expectations for all future prices over a sequence of future time periods is so unbelievably outlandish as an approximation to reality — sort of like the assumption that it could be 76 degrees fahrenheit in Washington DC in February — that to build that assumption into a macroeconomic model is an absurdity of mind-boggling proportions. But that is precisely what modern macroeconomics, in both its Real Business Cycle and New Keynesian incarnations, has done.

If instead of the sequential equilibrium of plans, prices and expectations, one tries to model an economy in which the price expectations of agents can be inconsistent, while prices adjust within any period to clear markets – the method of temporary equilibrium first described by Hicks in Value and Capital – one can begin to develop a richer conception of how a macroeconomic system can be subject to the financial disturbances, and financial crises to which modern macroeconomies are occasionally, if not routinely, vulnerable. But that would require a reorientation, if not a repudiation, of the path on which macroeconomics has been resolutely marching for nigh on forty years. In his 1984 paper “Consistent Temporary Equilibrium,” published in a volume edited by J. P. Fitoussi, C. J. Bliss made a start on developing such a macroeconomic theory.

There are few economists better equipped than Roger Farmer to lead macroeconomics onto a new and more productive path. He has not done so in this book, but I am hoping that, in his next one, he will.

A Tutorial for Judy Shelton on the ABCs of Currency Manipulation

Currency manipulation has become a favorite bugbear of critics of both monetary policy and trade policy. Some claim that countries depress their exchange rates to give their exporters an unfair advantage in foreign markets and to insulate their domestic producers from foreign competition. Others claim that using monetary policy as a way to stimulate aggregate demand is necessarily a form of currency manipulation, because monetary expansion causes the currency whose supply is being expanded to depreciate against other currencies, making monetary expansion, ipso facto, a form of currency manipulation.

As I have already explained in a number of posts (e.g., here, here, and here) a theoretically respectable case can be made for the possibility that currency manipulation can be used as a form of covert protectionism without imposing either tariffs, quotas or obviously protectionist measures to favor the producers of one country against their foreign competitors. All of this was explained by the eminent international trade theorist Max Corden  over 30 years ago in a famous paper (“Exchange Rate Protection”). But to be able to make a credible case that currency manipulation is being practiced, it has to be shown that currency depreciation has been coupled with a restrictive monetary policy – either by reducing the supply of, or by increasing the demand for, base money. The charge that monetary expansion is ever a form of currency manipulation is therefore suspect on its face, and those who make accusations that countries are engaging in currency manipulation rarely bother to support the charge with evidence that currency deprection is being coupled with a restrictive monetary policy.

So it was no surprise to see in Tuesday’s Wall Street Journal that monetary-policy entrepreneur Dr. Judy Shelton has written another one of her screeds promoting the gold standard, in which, showing no awareness of the necessary conditions for currency manipulation, she assures us that a) currency manipulation is a real problem and b) that restoring the gold standard would solve it.

Certainly the rules regarding international exchange-rate arrangements are not working. Monetary integrity was the key to making Bretton Woods institutions work when they were created after World War II to prevent future breakdowns in world order due to trade. The international monetary system, devised in 1944, was based on fixed exchange rates linked to a gold-convertible dollar.

No such system exists today. And no real leader can aspire to champion both the logic and the morality of free trade without confronting the practice that undermines both: currency manipulation.

Ahem, pray tell, which rules relating to exchange-rate arrangements does Dr. Shelton believe are not working? She doesn’t cite any. And, what, on earth does “monetary integrity” even mean, and what does that high-minded, but totally amorphous, concept have to do with the rules of exchange-rate arrangements that aren’t working?

Dr. Shelton mentions “monetary integrity” in the context of the Bretton Woods system, a system based — well, sort of — on fixed exchange rates, forgetting – or choosing not — to acknowledge that, under the Bretton Woods system, exchange rates were also unilaterally adjustable by participating countries. Not only were they adjustable, but currency devaluations were implemented on numerous occasions as a strategy for export promotion, the most notorious example being Britain’s 30% devaluation of sterling in 1949, just five years after the Bretton Woods agreement had been signed. Indeed, many other countries, including West Germany, Italy, and Japan, also had chronically undervalued currencies under the Bretton Woods system, as did France after it rejoined the gold standard in 1926 at a devalued rate deliberately chosen to ensure that its export industries would enjoy a competitive advantage.

The key point to keep in mind is that for a country to gain a competitive advantage by lowering its exchange rate, it has to prevent the automatic tendency of international price arbitrage and corresponding flows of money to eliminate competitive advantages arising from movements in exchange rates. If a depreciated exchange rate gives rise to an export surplus, a corresponding inflow of foreign funds to finance the export surplus will eventually either drive the exchange rate back toward its old level, thereby reducing or eliminating the initial depreciation, or, if the lower rate is maintained, the cash inflow will accumulate in reserve holdings of the central bank. Unless the central bank is willing to accept a continuing accumulation of foreign-exchange reserves, the increased domestic demand and monetary expansion associated with the export surplus will lead to a corresponding rise in domestic prices, wages and incomes, thereby reducing or eliminating the competitive advantage created by the depressed exchange rate. Thus, unless the central bank is willing to accumulate foreign-exchange reserves without limit, or can create an increased demand by private banks and the public to hold additional cash, thereby creating a chronic excess demand for money that can be satisfied only by a continuing export surplus, a permanently reduced foreign-exchange rate creates only a transitory competitive advantage.

I don’t say that currency manipulation is not possible. It is not only possible, but we know that currency manipulation has been practiced. But currency manipulation can occur under a fixed-exchange rate regime as well as under flexible exchange-rate regimes, as demonstrated by the conduct of the Bank of France from 1926 to 1935 while it was operating under a gold standard. And the most egregious recent example of currency manipulation was undertaken by the Chinese central bank when it effectively pegged the yuan to the dollar at a fixed rate. Keeping its exchange rate fixed against the dollar was precisely the offense that the currency-manipulation police accused the Chinese of committing.

When governments manipulate exchange rates to affect currency markets, they undermine the honest efforts of countries that wish to compete fairly in the global marketplace. Supply and demand are distorted by artificial prices conveyed through contrived exchange rates. Businesses fail as legitimately earned profits become currency losses.

It is no wonder that appeals to free trade prompt cynicism among those who realize the game is rigged against them. Opposing the Trans-Pacific Partnership in June 2015, Rep. Debbie Dingell (D., Mich.) explained: “We can compete with anybody in the world. We build the best product. But we can’t compete with the Bank of Japan or the Japanese government.”

In other words, central banks provide useful cover for currency manipulation. Japan’s answer to the charge that it manipulates its currency for trade purposes is that movements in the exchange rate are driven by monetary policy aimed at domestic inflation and employment objectives. But there’s no denying that one of the primary “arrows” of Japan’s economic strategy under Prime Minister Shinzo Abe, starting in late 2012, was to use radical quantitative easing to boost the “competitiveness” of Japan’s exports. Over the next three years, the yen fell against the U.S. dollar by some 40%.

That sounds horrible, but Dr. Shelton conveniently forgets – or declines – to acknowledge that in September 2012, the yen had reached its post-war high against the dollar. Moreover, between September 2012 and September 2015, the trade weighted US dollar index in terms of major currencies rose by almost 25%, so most of the depreciation of the yen against the dollar reflected dollar appreciation rather than yen depreciation.

Now as I pointed out in a post in 2013 about Japan, there really were reasons to suspect that the Japanese were engaging in currency manipulation even though Japan’s rapid accumulation of foreign exchange reserves that began in 2009 came to a halt in 2012 before the Bank of Japan launched its quantitative easing program. I have not kept up on what policies the Bank of Japan has been following, so I am not going to venture an opinion about whether Japan is or is not a currency manipulator. But the evidence that Dr. Shelton is providing to support her charge is simply useless and irrelevant.

Last April, U.S. Treasury Secretary Jacob Lew cautioned Japan against using currency depreciation to gain a trade advantage and he placed the country on a the“monitoring list” of potential currency manipulators. But in response, Japanese Finance Minister Taro Aso threatened to raise the bar, saying he was “prepared to undertake intervention” in the foreign-exchange market.

Obviously, the US government responds to pressures from domestic interests harmed by Japanese competition. Whether such back and forth between the American Treasury Secretary and his Japanese counterpart signifies anything beyond routine grandstanding I am not in a position to say.

China has long been intervening directly in the foreign-exchange market to manipulate the value of its currency. The People’s Bank of China announces a daily midpoint for the acceptable exchange rate between the yuan and the dollar, and then does not allow its currency to move more than 2% from the target price. When the value of the yuan starts to edge higher than the desired exchange rate, China’s government buys dollars to push it back down. When the yuan starts to drift lower than the desired rate, it sells off dollar reserves to buy back its own currency.

China’s government has reserves that amount to nearly $3 trillion. According to Mr. Lew, the U.S. should mute its criticism because China has spent nearly $1 trillion to cushion the yuan’s fall over the last 2½ years or so. In a veiled reproach to Mr. Trump’s intention to label China a currency manipulator, Mr. Lew said it was “analytically dangerous” to equate China’s current intervention policies with its earlier efforts to devalue its currency for purposes of gaining a trade advantage. China, he noted, would only be open to criticism that is “intellectually sound.”

Whether China is propping up exchange rates or holding them down, manipulation is manipulation and should not be overlooked. To be intellectually consistent, one must acknowledge that the distortions induced by government intervention in the foreign-exchange market affect both trade and capital flows. A country that props up the value of its currency against the dollar may have strategic goals for investing in U.S. assets.

Far from being intellectually consistent, Dr. Shelton is rushing headlong into intellectual incoherence. She has latched on to the mantra of “currency manipulation,” and she will not let go. How does Dr. Shelton imagine that the fixed exchange rates of the Bretton Woods era, for which she so fervently pines, were maintained?

I have no idea what she might be thinking, but the answer is that they were maintained by intervention into currency markets to keep exchange rates from deviating by more than a minimal amount from their target rates. So precisely the behavior that, under the Bretton Woods system, she extols wholeheartedly, she condemns mindlessly when now undertaken by the Chinese.

Again, my point is not that the Chinese have not engaged in exchange-rate protection in the past. I have actually suggested in earlier posts to which I have hyperlinked above that the Chinese have engaged in that practice. But that no longer appears to be the case, and Dr. Shelton is clearly unable to provide any evidence that the Chinese are still engaging in that practice.

 [T]he . . . first step [to take] to address this issue [is] by questioning why there aren’t adequate rules in place to keep countries from manipulating their exchange rates.

The next step is to establish a universal set of rules based on monetary sovereignty and discipline that would allow nations to voluntarily participate in a trade agreement that did not permit them to undermine true competition by manipulating exchange rates.

I have actually just offered such a rule in case Dr. Shelton is interested. But I have little hope and no expectation that she is or will be.

The Incoherence and Bad Faith of Antonin Scalia’s Originalism — Updated

UPDATE: I just realized that yesterday I mistakenly published a rough draft of this post instead of the version that I had intended to publish. I apologize for that unforced error.

My previous post about judge-made law was inspired by a comment by Scott Sumner on the post before that about Judge Gorsuch. Well, another commenter, gofx, who commented on the post about judge-made law, has inspired this post. Let’s see how long we can keep this recursive equilibrium going. Here’s what gofx had to say:

David, I think your original post criticizing Gorsuch for a “monumental denial of reality” is confusing a normative statement and a positive statement. Textualists, like Scalia and others try to balance the effects common law, statutory, and executive (administrative) law. Yes, English common law is one of the bases of American law. But even the supreme court placed limits on federal judges creating common law with respect to certain areas of state law (Erie Railroad Co. v. Tompkins). So while common law remains important, judges are no longer the King’s agents attempting to standardize decisions and principles across the realm. Along came democracy, legislatures and executive-branch regulations. There is still plenty of scope for common law, but there is more and more “prescribed” laws and rules.

I agree that there is a problem here with confusing “normative” and “positive” statements about the law and the role of judges in making – or not making – law. But I don’t think that the confusion is mine. This is an important point, which will come up again below. But first, let me quote further from gofx’s comment:

Here is Scalia in “Common Law Courts in a Civil Law System: The Role of United States Federal Courts in Interpreting the Constitution and Laws:”

But though I have no quarrel with the common law and its process, I do question whether the attitude of the common-law judge – the mind-set that asks, “What is the most desirable resolution of this case, and how can any impediments to the achievement of that result be evaded?”– is appropriate for most of the work that I do, and much of the work that state judges do. We live in an age of legislation, and most new law is statutory law. As one legal historian has put it, in modern times “the main business of government, and therefore of law, [is] legislative and executive …. Even private law, so-called, [has been] turning statutory. The lion’s share of the norms and rules that actually govern[} the country [come) out of Congress and the legislatures. . . . The rules of the countless administrative agencies [are] themselves an important, even crucial, source of law.” This is particularly true in the federal courts, where, with a qualification so small it does not bear• mentioning, there is no such thing as common law.”

I am grateful for the reference to this essay based on two lectures given by Scalia in 2010, which I have now read for the first time. The first thing to note about the lecture is that despite his disclaimer about having “no quarrel with the common law and its process,” Scalia adopts an almost uniformly derogatory and disdainful attitude toward the common law and especially toward common-law judges; the disdain, bordering on contempt, is palpable. Here are some examples aside from the one gofx kindly provided:

As I have described, this system of making law by judicial opinion, and making law by distinguishing earlier cases, is what every American law student, what every newborn American lawyer, first sees when he opens his eyes. And the impression remains with him for life. His image of the great judge — the Holmes, the Cardozo — is the man (or woman) who has the intelligence to know what is the best rule of law to govern the case at hand, and then the skill to perform the broken-field running through earlier cases that leaves him free to impose that rule — distinguishing one prior case on his left, straight-arming another one on his right, high-stepping away from another precedent about to tackle him from the rear, until (bravo!) he reaches his goal: good law. That image of the great judge remains with the former law student when he himself becomes a judge, and thus the common-law tradition is passed on and on.

[T]he subject of statutory interpretation deserves study and attention in its own right, as the principal business of lawyers and judges. It will not do to treat the enterprise as simply an inconvenient modern add-on to the judges’ primary role of common-law lawmaking. Indeed, attacking the enterprise with the Mr. Fix-it mentality of the common-law judge is a sure recipe for incompetence and usurpation.

But the Great Divide with regard to constitutional interpretation is not that between Framers’ intent and objective meaning; but rather that between original meaning (whether derived from Framers’ intent or not) and current meaning. The ascendant school of constitutional interpretation affirms the existence of what is called the “living Constitution,” a body of law that (unlike normal statutes) grows and changes from age to age, in order to meet the needs of a changing society. And it is the judges who determine those needs and “find” that changing law. Seems familiar, doesn’t it? Yes, it is the common law returned, but infinitely more powerful than what the old common law ever pretended to be, for now it trumps even the statutes of democratic legislatures.

If you go into a constitutional law class, or study a constitutional-law casebook, or read a brief filed in a constitutional-law case, you will rarely find the discussion addressed to the text of the constitutional provision that is at issue, or to the question of what was the originally understood or even the originally intended meaning of that text. Judges simply ask themselves (as a good common-law judge would) what ought the result to be, and then proceed to the task of distinguishing (or, if necessary, overruling) any prior Supreme Court cases that stand in the way. Should there be (to take one of the less controversial examples) a constitutional right to die? If so, there is. Should there be a constitutional right to reclaim a biological child put out for adoption by the other parent? Again, if so, there is. If it is good, it is so. Never mind the text that we are supposedly construing; we will smuggle these in, if all else fails, under the Due Process Clause (which, as I have described, is textually incapable of containing them). Moreover, what the Constitution meant yesterday it does not necessarily mean today. As our opinions say in the context of our Eighth Amendment jurisprudence (the Cruel and Unusual Punishments Clause), its meaning changes to reflect “the evolving standards of decency that mark the progress of a maturing society.”

This is preeminently a common-law way of making law, and not the way of construing a democratically adopted text. . . . The Constitution, however, even though a democratically adopted text, we formally treat like the common law. What, it is fair to ask, is our justification for doing so?

The apparent reason for Scalia’s disdain for common-law judging is basically that judges, rather than deferring to the popular will expressed through legislation, presume to think that they can somehow figure out what the right, or best, decision is rather than mechanically follow the text of a statute enacted by a democratic legislature. Scalia hates judges who think for themselves, because, by thinking for themselves, they betray an insufferable elitisim instead of dutifully deferring to democratically elected legislators through whom the popular will is faithfully expressed. For Scalia it is the only the popular will that matters, the rights and interests of the litigants appearing before the judge being of little consequence compared to upholding the statutory text, the authoritative articulation of the popular will. Moreover, even if the statutes don’t achieve the right result, the people can at least read the statutes and regulations and know what the law says and how it will be enforced. And how can the people ever know what those high and mighty judges will decide to do next? And we all know — do we not? — the countless hours of their spare time spent in libraries and on-line by the unwashed masses poring over the latest additions to US Code and the Federal Register. Just think how all those long hours devoted to reading the US Code and the Federal Register would be wasted if those arrogant judges could simply ignore the plain meaning of the statutes and regulations and were allowed to use their own judgment in deciding cases.

I will forego, at least for now, indulging my desire to comment on Scalia’s critique of common-law judging. I want to focus instead on the positive case that Scalia makes for his textualist theory of statutory interpretation. To do so, let me quote liberally from Richard Posner’s withering 2012 review of Scalia’s treatise (co-authored by Bryan Garner), Reading the Law: The Interpretation of Legal Texts, which exposes the both the incoherence and the bad faith of Scalia’s textualist arguments. The entire review is worthy of careful study, but I will pick out a few paragraphs that highlight Scalia’s tortured relationship with and attitude toward the common law.

Judges like to say that all they do when they interpret a constitutional or statutory provision is apply, to the facts of the particular case, law that has been given to them. They do not make law: that is the job of legislators, and for the authors and ratifiers of constitutions. They are not Apollo; they are his oracle. They are passive interpreters. Their role is semantic.

The passive view of the judicial role is aggressively defended in a new book by Justice Antonin Scalia and the legal lexicographer Bryan Garner (Reading Law: The Interpretation of Legal Texts, 2012). They advocate what is best described as textual originalism, because they want judges to “look for meaning in the governing text, ascribe to that text the meaning that it has borne from its inception, and reject judicial speculation about both the drafters’ extra-textually derived purposes and the desirability of the fair reading’s anticipated consequences.” This austere interpretive method leads to a heavy emphasis on dictionary meanings, in disregard of a wise warning issued by Judge Frank Easterbrook, who though himself a self-declared textualist advises that “the choice among meanings [of words in statutes] must have a footing more solid than a dictionary—which is a museum of words, an historical catalog rather than a means to decode the work of legislatures.” Scalia and Garner reject (before they later accept) Easterbrook’s warning. Does an ordinance that says that “no person may bring a vehicle into the park” apply to an ambulance that enters the park to save a person’s life? For Scalia and Garner, the answer is yes. After all, an ambulance is a vehicle—any dictionary will tell you that. If the authors of the ordinance wanted to make an exception for ambulances, they should have said so. And perverse results are a small price to pay for the objectivity that textual originalism offers (new dictionaries for new texts, old dictionaries for old ones). But Scalia and Garner later retreat in the ambulance case, and their retreat is consistent with a pattern of equivocation exhibited throughout their book. . . .

Another interpretive principle that Scalia and Garner approve is the presumption against the implied repeal of state statutes by federal statutes. They base this “on an assumption of what Congress, in our federal system, would or should normally desire.” What Congress would desire? What Congress should desire? Is this textualism, too?

And remember the ambulance case? Having said that the conclusion that an ambulance was forbidden to enter the park even to save a person’s life was entailed by textual originalism and therefore correct, Scalia and Garner remark several hundred pages later that the entry of the ambulance is not prohibited after all, owing to the “common-law defense of necessity,” which they allow to override statutory text. Yet just four pages later they say that except in “select fields such as admiralty law, [federal courts] have no significant common-law powers.” And still elsewhere, tacking back again, they refer approvingly to an opinion by Justice Kennedy (Leegin Creative Leather Products, Inc. v. PSKS, Inc.), which states that “the Sherman Act’s use of ‘restraint of trade’ invokes the common law itself … not merely the static content that the common law had assigned to the term in 1890.” In other words, “restraint of trade” had a specific meaning (and it did: it meant “restraints on alienation”) in 1890 that judges are free to alter in conformity with modern economics—a form of “dynamic” interpretation that should be anathema to Scalia and Garner. A few pages later they say that “federal courts do not possess the lawmaking power of common-law courts,” ignoring not only the antitrust and ambulance cases but also the fact that most of the concepts deployed in federal criminal law—such as mens rea (intent), conspiracy, attempt, self-defense, and necessity—are common law concepts left undefined in criminal statutes.

Scalia and Garner indicate their agreement with a number of old cases that hold that an heir who murders his parents or others from whom he expects to inherit is not disqualified from inheriting despite the common law maxim that no person shall be permitted to profit from his wrongful act. (Notice how common law floats in and out of their analysis, unpredictably.) They say that these cases are “textually correct” though awful, and are happy to note that they have been overruled by statute. Yet just before registering their approval they had applauded the rule that allows the deadlines in statutes of limitations to be “tolled” (delayed) “because of unforeseen events that make compliance impossible.” The tolling rule is not statutory. It is a judicial graft on statutes that do not mention tolling. Scalia and Garner do not explain why that is permissible, but a judicial graft disqualifying a murdering heir is not.

Scalia and Garner defend the canon of construction that counsels judges to avoid interpreting a statute in a way that will render it unconstitutional, declaring that this canon is good “judicial policy.” Judicial policy is the antithesis of textual originalism. They note that “many established principles of interpretation are less plausibly based on a reasonable assessment of meaning than on grounds of policy adopted by the courts”—and they applaud those principles, too. They approve the principle that statutes dealing with the same subject should “if possible be interpreted harmoniously,” a principle they deem “based upon a realistic assessment of what the legislature ought to have meant,” which in turn derives from the “sound principles…that the body of the law should make sense, and…that it is the responsibility of the courts, within the permissible meanings of the text, to make it so” (emphasis added). In other words, judges should be realistic, should impose right reason on legislators, should in short clean up after the legislators.

I would just note in passing that Posner shows that the confusion between normative and positive which gofx in the comment above ascribed to me is obviously running rampant, if not amok, throughout Scalia’s treatise. But Posner’s evisceration of Scalia’s bad faith does not go far enough, because the bad faith extends beyond Scalia’s willingness to invoke (or smuggle in) common-law principles to cover up the gaps in his textualism. Scalia’s whole originalist doctrine that the text of the Constitution should be interpreted according to the original meaning of the text of the Constitution relies on the premise that the judicial interpretations of the Constitution had always been governed by the original meaning that had been universally attributed to the Constitutional text. It was only much later, say, in the middle of the twentieth century, on or about May 17, 1954, that the interpretation of the Constitution was perverted by the reprehensible judges and their academic handmaidens who invented the notion of a living constitution that adjusts to the “evolving standards of decency that mark the progress of a maturing society.” Let me quote once more from Posner’s review:

Scalia and Garner contend that textual originalism was the dominant American method of judicial interpretation until the middle of the twentieth century. The only evidence they provide, however, consists of quotations from judges and jurists, such as William Blackstone, John Marshall, and Oliver Wendell Holmes, who wrote before 1950. Yet none of those illuminati, while respectful of statutory and constitutional text, as any responsible lawyer would be, was a textual originalist. All were, famously, “loose constructionists.”

Scalia and Garner call Blackstone “a thoroughgoing originalist.” They say that “Blackstone made it very clear that original meaning governed.” Yet they quote in support the famous statement in his Commentaries on the Laws of England that “the fairest and most rational method to interpret the will of the legislator, is by exploring his intentions at the time when the law made, by signs the most natural and probable. And these signs are either the words, the context, the subject matter, the effects and consequence, or the spirit and reason of the law” (emphasis mine, except that the first “signs” is emphasized in the original). Blackstone adds that “the most universal and effectual way of discovering the true meaning of a law, when the words are dubious, is by considering the reason and spirit of it; or the cause which moved the legislator to enact it.”

Just so! But, once again, Posner goes too easy on Scalia, because Scalia’s whole premise in his essay on common law courts, to which gofx pointed me, is that the modern theories of Constitutional interpretation so abhorent to Scalia are basically extensions, albeit extreme extensions, of common-law judging in which the judge tries to find the best possible outcome for the case he that he is deciding, unconstrained by any statutory or Constitutional text. It is the lack of subordination by common-law judges to any authoritative legal text with a fixed meaning that they are bound to accept that is the ultimate heresy of which all common-law judges, in Scalia’s eyes, stand convicted. But when the US Constitution was ratified all the judges in America and Britain were common-law judges. And Blackstone’s magisterial Commentaries on the Laws of England was a four-volume paean to the common law of England. So, under Scalia’s own originalist doctrine, the meaning of the judiciary in the US Constitution, written by the Framers under Blackstone’s thrall, was the kind of judging practiced by common-law judges. The judges who interpreted the Constitution for almost two centuries after the Constitution was ratified were common-law judges and they were interpreting the Constitution using the very interpretative methods of common-law judges that Scalia so violently condemns.

Scalia has literally hoisted himself by his own originalist petard. Couldn’t have happened to a finer fellow.

Yes, Judges Do Make Law

Scott Sumner has just written an interesting comment to my previous post in which I criticized a remark made by Judge Gorsuch upon being nominated to fill the vacant seat on the Supreme Court — so interesting, in fact, that I think it is worth responding to him in a separate post.

First, here is the remark made by Judge Gorsuch to which I took exception.

I respect, too, the fact that in our legal order, it is for Congress and not the courts to write new laws. It is the role of judges to apply, not alter, the work of the people’s representatives. A judge who likes every outcome he reaches is very likely a bad judge . . . stretching for results he prefers rather than those the law demands.

I criticized Judge Gorsuch for denying what to me is the obvious fact that judges do make law. They make law, because the incremental effect of each individual decision results in a legal order that is different from the legislation that has been enacted by legislatures. Each decision creates a precedent that must be considered by other judges as they apply and construe the sum total of legislatively enacted statutes in light of, and informed by, the precedents of judges and the legal principles that have guided judges those precedents. Law-making by judges under a common law system — even a common law system in which judges are bound to acknowledge the authority of statutory law — is inevitable for many reasons, one but not the only reason being that statutes will sooner or later have to be applied in circumstances were not foreseen by that legislators who enacted those statutes.

To take an example of Constitutional law off the top of my head: is it an unreasonable search for the police to search the cell phone of someone they have arrested without first getting a search warrant? That’s what the Supreme Court had to decide two years ago in Riley v. California. The answer to that question could not be determined by reading the text of the Fourth Amendment which talks about the people being secure in their “persons, houses, papers, or effects” or doing a historical analysis of what the original understanding of the terms “search” and “seizure” and “papers and effects” was when the Fourth Amendment to the Constitution was enacted. Earlier courts had to decide whether government eavesdropping on phone calls violated the Fourth Amendment. And other courts have had to decide whether collecting meta data about phone calls is a violation. Answers to those legal questions can’t be found by reading the relevant legal text.

Here’s part of the New York Times story about the Supreme Court’s decision in Riley v. Califronia.

In a sweeping victory for privacy rights in the digital age, the Supreme Court on Wednesday unanimously ruled that the police need warrants to search the cellphones of people they arrest.

While the decision will offer protection to the 12 million people arrested every year, many for minor crimes, its impact will most likely be much broader. The ruling almost certainly also applies to searches of tablet and laptop computers, and its reasoning may apply to searches of homes and businesses and of information held by third parties like phone companies.

“This is a bold opinion,” said Orin S. Kerr, a law professor at George Washington University. “It is the first computer-search case, and it says we are in a new digital age. You can’t apply the old rules anymore.”

But he added that old principles required that their contents be protected from routine searches. One of the driving forces behind the American Revolution, Chief Justice Roberts wrote, was revulsion against “general warrants,” which “allowed British officers to rummage through homes in an unrestrained search for evidence of criminal activity.”

“The fact that technology now allows an individual to carry such information in his hand,” the chief justice also wrote, “does not make the information any less worthy of the protection for which the founders fought.”

Now for Scott’s comment:

I don’t see how Gorsuch’s view conflicts with your view. It seems like Gorsuch is saying something like “Judges should not legislate, they should interpret the laws.” And you are saying “the laws are complicated.” Both can be true!

Well, in a sense, maybe, because what judges do is technically not legislation. But they do make law; their opinions determine for the rest of us what we may legally do and what we may not legally do and what rights to expect will be respected  and what rights will not be respected. Judges can even change the plain meaning of a statute in order to uphold a more basic, if unwritten, principle of justice, which,under, the plain meaning of Judge Gorsuch’s remark (“It is the role of judges to apply, not alter, the work of the people’s representatives”) would have to be regarded as an abuse of judicial discretion. The absurdity of what I take to be Gorsuch’s position is beautifully illustrated by the case of Riggs v. Palmer which the late — and truly great — Ronald Dworkin discussed in his magnificent article “Is Law a System of Rules?” aka “The Model of Rules.” Here is the one paragraph in which Dworkin uses the Riggs case to show that judges apply not just specific legal rules (e.g., statutory rules), but also deeper principles that govern how those rules should be applied.

My immediate purpose, however, is to distinguish principles in the generic sense from rules, and I shall start by collecting some examples of the former. The examples I offer are chosen haphazardly; almost any case in a law school casebook would provide examples that would serve as well. In 1889, a New York court, in the famous case of Riggs v. Palmer, had to decide whether an heir named in the will of his grandfather could inherit under that will, even though he had murdered his grandfather to do so. The court began its reasoning with this admission: “It is quite true that statues regulating the making, proof and effect of wills, and the devolution of property, if literally construed [my emphasis], and if their force and effect can in no way and under no circumstances be controlled or modified, give this property to the murderer.” But the court continued to note that “all laws as well as all contracts may be controlled in their operation and effect by general, fundamental maxims of the common law. No one shall be permitted to profit by his own fraud, or to take advantage of his own wrong, or to found any claim upon his own iniquity, or to acquire property by his own crime.” The murderer did not receive his inheritance.

QED. In this case the Common law overruled the statute, and justice prevailed over injustice. Game, set, match to the judge!

Judge Gorsuch on “the Role of Judges” in our Legal System

Neil Gorsuch, nominated this week to fill the vacancy on the Supreme Court left by the demise of Antonin Scalia, is in many respects an impressive Judge on the tenth circuit Court of Appeals, receiving accolades and encomiums not only from his ideological allies but also from legal experts and scholars on the opposite end of the ideological spectrum. Besides a J.D. from Harvard, Gorsuch has a Ph.D. in law from Oxford, having written his doctoral dissertation on assisted suicide and euthanasia, a work subsequently published by Princeton University Press. A scholarly judge, known for well-crafted and lucid opinions, he is likely, if confirmed, to leave a lasting mark on the Supreme Court and on American jurisprudence.

So I was really disappointed, though not really surprised, to find out that Judge Gorsuch, at his public introduction at the White House on Tuesday evening, felt compelled to indulge in an abject ritual obeisance to the prevailing right-wing populist legal ideology, delivering the following willfully ignorant, ahistorical, misrepresentation of the role of judges in our Anglo/American, common law legal system.

I respect, too, the fact that in our legal order, it is for Congress and not the courts to write new laws. It is the role of judges to apply, not alter, the work of the people’s representatives. A judge who likes every outcome he reaches is very likely a bad judge . . . stretching for results he prefers rather than those the law demands.

How someone trained in the law both at Harvard and Oxford could so flagrantly mischaracterize what it is that judges do – a mischacterization of the same ilk as John Roberts’s infamous comparison, as a nominee for Chief Justice testifying before the Senate Judiciary Committee, of judges to baseball umpires calling balls and strikes – when the entire Anglo-American legal system and the whole of its jurisprudence rests on the foundation of the common law, a law made in its entirety by judges deciding cases according to their understanding of the principles of justice and their understanding of how earlier judges had decided similar cases in similar situations, a law that evolved slowly as an organic, living tradition over countless generations and many centuries, is simply beyond my comprehension.

With all due respect to Judge Gorsuch’s impressive legal scholarship, I consider his statement to be a monumental denial of reality, orders of magnitude beyond denying climate change or even evolution. It is a denial of the obvious on the level of a Ph.D. mathematician denying that two plus two equals four. But so ferocious and so intransigent are the demands of current right-wing populist legal ideology that failure to deny obvious historical reality would be regarded as an unpardonable sin and a damnable heresy, more than ample grounds for being rejected to fill a coveted seat on the Supreme Court.

I can almost hear the howls of protest emanating from the Federalist Society, which, in its mission statement, solemnly asserts “that it is emphatically the province and duty of the judiciary to state what the law is, not what it should be.” But what exactly is the meaning of “the law” in that ever-so emphatic pronouncement?

“The law” could mean a specific statute, ordinance, enactment, provision, article, or rule, which, if duly enacted by an appropriate law-making body, has “the force of law.” Or alternatively, “the law” could mean the entire body of law under which a rule of law is said to be in effect. Whether a specific statute, ordinance, enactment, provision, article, or rule exists is a purely factual question, and, for the most part, not a controversial one. When a question of law becomes controversial, it is rarely because people have forgotten the existence of a relevant statute, ordinance, or rule, of whose existence they must be reminded by a judge with a superior memory. Rather the question of law arises, because it is not clear which one of a number of alternative, potentially applicable rules should govern the outcome of the case at hand. And that question of law can rarely be answered – certainly not satisfactorily answered – simply by reminding the litigants that the law says such and such and so and so.

The real challenge confronting the judge – especially an appellate judge – is to determine which of the alternative, potentially applicable rules should determine the outcome of the case. And to answer that question, a judge can’t just look up what the law says, the judge has to consider how the entire legal system, including not just the explicit rules, but all the relevant previous judicial decisions and all the principles embodied in those decisions, comports with the decision that must be rendered. The judge deciding the case has to figure out how to make a ruling that best fits in with all those previous decisions and all their underlying principles. It is that best decision which is what “the law,” considered as an overall system, requires. But if that is what a judge is trying to do, it is simply nonsense – as in absurd and incoherent – to assert that the judge is stating “what the law is, not what it should be.”

To be sure, judges sometimes have to make decisions with which they are personally uncomfortable, judges never being possessed of unlimited discretion to rule as they please. But judging means a weighing of arguments and of conflicting values to arrive at the best possible decision under the circumstances — the decision most consistent with the entire system of law, not just particular statutes, enactments or decisions.

For example, Korematsu v. United States has never formally been overruled or vacated by the US Supreme Court. Under the absurd doctrine of the Federalist Society, that abominable decision, no less than the admirable Marbury v. Madison, is “law.” But under any defensible understanding of what the US legal system actually entails, Korematsu is not law, even though it has, regrettably, not yet been formally expunged from precedents of the Supreme Court. One would hope that Judge Gorsuch will be given an opportunity to opine on the legal status of Korematsu and perhaps other legal abominations which are still available to be invoked as precedent, when he testifies before the Senate Judiciary Committee.

Stuart Dreyfus on Richard Bellman, Dynamic Programming, Quants and Financial Engineering

Last week, looking for some information about the mathematician Richard Bellman who, among other feats and achievements, developed dynamic programming, I came across a film called the Bellman Equation which you can watch on the internet. It was written produced and narrated by Bellman’s grandson, Gabriel Bellman and features among others, Gabriel’s father (Bellman’s son), Gabriel’s aunt (Bellman’s daughter), Bellman’s first and second wives, and numerous friends and colleagues. You learn how brilliant, driven, arrogant, charming, and difficult Bellman was, and how he cast a shadow over the lives of his children and grandchildren. Aside from the stories about his life, his work on the atomic bomb in World War II, his meeting with Einstein when he was a young assistant professor at Princeton, his run-in  with the Julius and Ethel Rosenberg at Los Alamos, and, as a result, with Joe McCarthy. And on top of all the family history, family dynamics, and psychological theorizing, you also get an interesting little account of the intuitive logic underlying the theory of dynamic programming. You can watch it for free with commercials on snagfilms.

But I especially wanted to draw attention to the brief appearance in the video of Bellman’s colleague at Rand Corporation in the 1950s, Stuart Dreyfus, with whom Bellman collaborated in developing the theory of dynamic programming, and with whom Bellman co-wrote Applied Dynamic Programming. At 14:17 into the film, one hears the voice of Stuart Dreyfus saying just before he comes into view on the screen:

The world is full of problems where what is required of the person making eh decision is not to just face a static situation and make one single decision, but to make a sequence of decisions as the situation evolves. If you stop to think about it, almost everything in the world falls in that category. So that is the kind of situation hat dynamic programming addressed. The principle on which it is based is such an intuitively obvious principle that it drives some mathematicians crazy, because it’s really kind of impossible to prove that it’s an intuitive principle, and pure mathematicians don’t like intuition.

Then a few moments later, Dreyfus continues:

So this principle of optimality is: why would you ever make a decision now which puts you into a position one step from now where you couldn’t do as well as [if you were in] some other position? Obviously, you would never do that if you knew the value of these other positions.

And a few moments after that:

The place that [dynamic programming] is used the most upsets me greatly — and I don’t know how Dick would feel — but that’s in the so-called “quants” doing so-called “financial engineering” that designed derivatives that brought down the financial system. That’s all dynamic programming mathematics basically. I have a feeling Dick would have thought that’s immoral. The financial world doesn’t produce any useful thing. It’s just like poker; it’s just a game. You’re taking money away from other people and getting yourself things. And to encourage our graduate students to learn how to apply dynamic programming in that area, I think is a sin.

Allowing for some hyperbole on Dreyfus’s part, I think he is making an important point, a point I’ve made before in several posts about finance. A great deal of the income earned by the financial industry does not represent real output; it represents trading based on gaining information advantages over trading partners. So the more money the financial industry makes from financial engineering, the more money someone else is losing to the financial industry, because every trade has two sides.

Not all trading has this characteristic. A lot of trading involves exchanges that are mutually beneficial, and middlemen that facilitate such trading are contributing to the welfare of society by improving the allocation of goods, services and resources. But trading that takes place in order to exploit an information advantage over a counter-party, and devoting resources to the creation of the information advantages that makes such trading profitable is socially wasteful. That is the intuitive principle insightfully grasped and articulated by Dreyfus.

As I have also pointed out in previous posts (e.g., here, here and here) the principle, intuitively grasped on some level, but not properly articulated or applied by people like Thorstein Veblen, was first correctly explicated by Jack Hirshleifer, who like Bellman and Dreyfus, worked for the Rand Corporation in the 1950s and 1960s, in his classic article “The Private and Social Value of Information and the Reward to Inventive Activity.”

Further Thoughts on Bitcoins, Fiat Moneys, and Network Effects

In a couple of tweets to me and J. P. Koning, William Luther pointed out, I think correctly, that the validity of the backward-induction argument in my previous post explaining why bitcoins, or any fiat currency not made acceptable for discharging tax obligations, cannot retain a positive value requires that there be a terminal date after which bitcoins or fiat currency will no longer be accepted in exchange be known with certainty.

 

But if the terminal date is unknown, the backward-induction argument doesn’t work, because everyone (or at least a sufficient number of people) may assume that there will always be someone else willing to accept their soon-to-be worthless holdings of fiat money in exchange for something valuable. Thus, without a certain terminal date, it is not logically necessary for the value of fiat money to fall to zero immediately, even though everyone realizes that,  at some undetermined future time, its value will fall to zero.

In short, the point is that if enough people think that they will be able to unload their holdings of a fundamentally worthless asset on someone more foolish than they are, a pyramid scheme need not collapse quickly, but may operate successfully for a long time. Uncertainty about the terminal date gives people an incentive to gamble on when the moment of truth will arrive. As long as enough people are willing to take the gamble, the pyramid won’t collapse, even if those people know that it sooner or later it will collapse.

Robert Louis Stevenson described the theory quite nicely in a short story, “The Bottle Imp,” which has inspired a philosophic literature concerning the backward induction argument that is known as the “bottle imp paradox,” (further references in the linked wikipedia entry) and the related related “unexpected hanging paradox,” and the “greater fool theory.”

Although Luther’s point is well-taken, it’s not clear to me that, at least on an informal level, my argument about fiat money is without relevance. Even though a zero value for fiat money is logically necessary, a positive value is not assured. The value of fiat money is indeterminate, and the risk of a collapse of value or a hyperinflation is, would indeed be a constant risk for a pure fiat money if there were no other factors, e.g., acceptability for discharging tax liabilities, operating else to support a positive value. Even if a positive value were maintained for a time, a collapse of value could occur quite suddenly; there could well be a tipping point at which a critical mass of people expecting the value to fall to zero could overwhelm the optimism of those expecting the value to remain remain positive causing a convergence of self-fulfilling expectations of a zero value.

But this is where network effects come into the picture to play a stabilizing role. If network effects are very strong, which they certainly are for a medium of exchange in any advanced market economy, there is a powerful lock-in for most people, because almost all transactions taking place in the economy are carried out by way of a direct or indirect transfer of the medium of exchange. Recontracting in terms of an alternative medium of exchange is not only costly for each individual, but would require an unraveling of the existing infrastructure for carrying out these transactions with little chance of replacing it with a new medium-of-exchange-network infrastructure.

Once transactors have been locked in to the existing medium-of-exchange-network infrastructure, the costs of abandoning the existing medium of exchange may be prohibitive, thereby preventing a switch from the existing medium of exchange, even though people realize that there is a high probability that the medium of exchange will eventually lose its value, the costs to each individual of opting out of the medium-of-exchange network being prohibitive as would be the transactions costs of arriving at a voluntary collective shift to some new medium of exchange.

However, it is possible that small countries whose economies are highly integrated with the economies of neighboring countries, are in a better position to switch from to an alternative currency if the likelihood that the currently used medium of exchange will become worthless increases. So the chances of seeing a sudden collapse of an existing medium of exchange are greater in small open economies than in large, relatively self-contained, economies.

Based on the above reasoning suggests the following preliminary conjecture: the probability that a fiat currency that is not acceptable for discharging tax liabilities could retain a positive value would depend on two factors: a) the strength of network effects, and b) the proportion of users of the existing medium of exchange that have occasion to use an alternative medium of exchange in carrying out their routine transactions.

Shilling for Bitcoins

Bitcoins have been on a wild ride these past several months. After the November 2013 crash which saw the value of bitcoins plummet from over $1000 a coin to less than $300 a coin in just over a year, bitcoins seem to stabilize in a fairly tight range between $250 and $350 until early November 2015 when the price started to climb gradually reaching $730 last July before a brief decline to less than $600 in August, when another sustained price rise commenced. The price rise accelerated in December, and bitcoin price broke the $1000 barrier early in January, reaching $1100 last week before plummeting to less than $800 (a loss of almost of a third in value). Bitcoins have again recovered, climbing back over $900, and now at about $890 as of this writing (11:22pm EST).

In earlier posts (e.g., here and here) I have suggested that bitcoins are a bubble phenomenon, because bitcoins have no fundamental value, their only use being a medium of exchange. Some people believe that all forms of paper or token money, unless associated with some sort of promise or expectation of convertibility into a real asset, are bubbles. The reason why privately issued inconvertible paper money is unlikely to have any value is that people would expect it eventually to have zero value in the future, inasmuch as no one would want to be stuck holding paper money when there is no one left to trade with. The rational expectation that the future value of paper money must go to zero implies, by the mathematical argument known as backward induction, that its value today must be zero. If its value today exceeds zero, then the violation of backward induction, must be termed as a bubble.

That at least is the theory. However, that theory of the worthlessness of paper money applies only to privately issued money, not to government issued money, because government issued money can be given a current value if the government accepts the paper money it issues as payment for tax liability. At peak periods when the public has a net liability to pay taxes to the government, the aggregate outstanding stock of money must have a real value at least as great as the net outstanding aggregate private-sector tax liability to the government.

So I was very interested today to read a post on NADAQ.com “Why Bitcoin Has Value” by David Perry, chief architect for BitcoinStore and author of the Bitcoin blog Coding in My Sleep. Perry deals intelligently with many of the issues that I have raised in my earlier posts, so it will be interesting to try to follow him as he tries to explain why Bitcoins really do have value.

To begin, we really need to understand why anything has value. Fans of post-apocalyptic fiction will often point out that in the end, the only things of real value are those that sustain and defend life. Perhaps they’re right on one level, but with the rise of civilized societies things got a bit more complex, because the things that sustain and defend those societies also gain a certain degree of value. It is in this context that all monies, Bitcoin included, gain their value. Since our societies rely heavily on trade and commerce, anything that facilitates the exchange of goods and services has some degree of value.

In case you missed it, there was a bit of a logical leap there. Things can be valuable either because we are willing to give up something in return for the services we derive from owning them or possessing them, or because we believe that we can exchange them to other people for things that we derive services from owning or possessing them. If something is valuable only because it facilitates trade, you run into the logical problem of backward induction. At some point, far into the future, there will be nobody left to trade with, so the medium of exchange won’t have any more value. Something like gold does have value today because it glitters and people are willing to give up something to be able to derive those glitter services. But a piece of paper? No glitter services from a piece of paper. Of course if the government prints the piece of paper, the piece of paper can serve as a get-out-of-jail card, which some people will be willing to pay a lot for. A bitcoin does not glitter and it won’t get you out of jail.

Imagine, for example, a pre-money marketplace where the barter system is king. Perhaps you’re a fisherman coming to market with the day’s catch and you’re looking to go home with some eggs. Unfortunately for you, the chicken farmer has no use for fish at the moment, so you need to arrange a complex series of exchanges to end up with something the egg seller actually wants. You’ll probably lose a percentage of your fish’s value with each trade, and you also must know the exchange rate of everything with respect to everything else. What a mess.

This is where money saves the day. By agreeing on one intermediate commodity, say, silver coins, two is the maximum number of exchanges anyone has to make. And there’s only one exchange rate for every other commodity that matters: its cost in silver coins.

In truth there is more complexity involved—some things, like your fish, would make very poor money indeed. Fish don’t stay good for very long, they’re not particularly divisible, and depending on the exchange rate, you might have to carry a truly absurd amount of them to make your day’s purchases.

On the other hand, silver coins have their inherent problems too, when traded on extremely large or extremely small scales. This is what is truly valuable about Bitcoin: It’s better money.

Again that same pesky old problem. Silver, like gold, provides services other than serving as money. It has a value independent of being a medium of exchange, so, at the margin, there are people out there who value it as much for its glitter or other real services as other people value it for its services as a medium of exchange. But the only series that a bitcoin provides is that someone out there expects somebody else to accept it in trade. Why makes that a sustainable value rather than a bubble? Just asking, but I’m still waiting for an answer.

It’s been a long time since those first “hard” monies were developed, and today we transact primarily with digital representations of paper currency. We imagine bank vaults filled with stacks of cash, but that’s almost never the case these days—most money exists merely as numbers in a database. There’s nothing wrong with this type of system, either; it works fantastically well in an age where physical presence during a transaction is not a given. The problem is that the system is aging and far too often plagued by incompetence or greed.

Every IT guy knows that from time to time you have to take a drastic step: throw the old system in the trash and build a new one from scratch. Old systems, such as our current monetary system, have been patched so many times they are no longer functioning as efficiently as they should.

We previously patched our problems with gold and silver by introducing paper banknotes. We patched further problems by removing the precious metal backing those banknotes, then patched them again and again to allow wire transfers, credit cards, debit cards, direct deposit and online billpay. All the cornerstones of modern life are just patches on this ancient system.

But what would you do if you had the chance to start over? What if you could make purely digital money based on modern technologies to solve modern needs? What if we didn’t need those dusty old systems or the people making absurd profits maintaining them? This is Bitcoin.

Am I missing something? Just what is the defect with the good old dollar that the Bitcoin is improving upon? This sounds like: “it’s better, cuz it’s newer.” That’s not an explanation; it’s just like saying: “it’s better, cuz I say it’s better.”

Bitcoin isn’t another patch, another layer of abstraction added on top of an aging and over-complex system. Bitcoin isn’t another bank or payment processor coming up with new ways to move old dollars. Bitcoin is instead a simple, elegant and modern replacement for the entire concept of money. It has value for exactly the same reason as the paper money in your wallet: It simplifies the exchange of goods and services, not in the antique setting of a barter system bazaar, but in the current setting of modern internet-enabled life.

“But that’s only why it’s useful,” I hear some of you saying. “Why does it actually have value?”

Yes! That’s exactly what I’m saying, and I’m still waiting for an answer.

The two-word answer is one most economists are familiar with: network effect. The network effect is a lovely piece of jargon that refers to the quite commonsense statement that networked products and services tend to have more value when more people use them. The most common example is the telephone. During its early days when few people had access to telephones their utility, and therefore their value, were minimal. Today practically everyone has a phone, so its utility and value is [sic] so high as to be unquestionable. In this way the value of Bitcoin is directly tied to the number of its users and the frequency of their use.

OK, I get that. Just one problem. The dollar has already internalized all those network effects. To get people to switch from dollars to bitcoins, bitcoins would have to offer transactions services that are spectacularly better than those provided by the dollar. What exactly are those spectacularly better transactions services that bitcoins are providing?

Of course Bitcoin’s value stemming from the network effect is not without its own unique difficulties. When the network is still relatively small, each new group’s entry or egress can create massive price fluctuations, resulting in huge profits for early adopters. Unfortunately, this makes Bitcoin look, on the surface, too good to be true—a bit like a Ponzi or pyramid scheme.

Ponzis and pyramids are distinct and different forms of fraud, but they share one thing in common: The first ones in make a lot of money while the last ones in foot the bill. Both feature initial “investors” being paid out directly from new investors’ money. The return is always too good to be true and the gains (for those who actually get gains) are exponential.

The huge increase in value (along with occasional huge drops in value) may be good for early investors, but they are fatal for an aspiring medium of exchange. What you want from a medium of exchange is not a rapidly increasing value, but a nearly (if not necessarily perfectly) stable value. There is no upper limit on the value of a bitcoin and no lower limit. So the bitcoin lacks any mechanism for ensure the stable value that is essential for a well-functioning medium of exchange.

Because Bitcoin’s value has risen so dramatically since its 2009 debut, it seems to fit this sort of a profile at first glance, but then so does every new technology. It’s just not normally the case that we get to invest in this sort of technology and profit as it’s adopted. Imagine being able to invest in the concept of email back in 1965 when some clever hacker at MIT found a way to use primitive multi-user computer systems to pass messages. It might have seemed like a silly waste then, but owning even a tiny percentage of the rights to email today would make one wealthy beyond imagining.

Technologies follow a known adoption curve, which tends to include a period of exponential rise. Bitcoin is no exception. Ponzis and pyramids both create value for their oldest investors by stealing from the new. There’s no economics involved—just theft.

Bitcoin creates value for the old investors and the new by splitting a finite currency supply more ways. That’s not trickery or theft, just good old-fashioned supply and demand at work—a basic and ancient economic principle applied to the world’s newest currency system.

The maximum number of bitcoins is bounded from above, meaning that if it ever did begin to internalize those network effects and the demand for bitcoins did rise, the increased demand would cause its value to skyrocket, which would undermine its suitability as a medium of exchange. The market capitalization of bitcoins hit an all-time high of $15 billion last week. The US monetary base is $3.5 trillion, which is about 230 times the market capitalization of bitcoins. I mean, get real. Bitcoins, by design, are incapable of ever becoming a widely adopted medium of exchange. So even if there were to be a collapse of the dollar — and that outcome may be beyond the capacity of even a Trump Presidency to achieve – it could not be the bitcoin that replaced it as the world’s dominant currency.

La Republique Constitutionelle, C’est Moi

In addition to being popular with the poorly educated, our President-elect also has a committed corps of  highly educated, scholarly supporters. One of the more notable of these is a scholarly type who, writing under the somewhat pretentious pseudonym “Publius Decius Mus” (hereinafter PDM), described the 2016 election as the Flight 93 Election, which seems an odd way to encourage voting for someone, inasmuch as the passengers on flight 93 could not have expected to survive their attack on their hijackers. By implication, a vote for PDM’s choice for President was a vote for national suicide. The suicide committed by the passengers on Flight 93 averted an even greater catastrophe, but what is the larger catastrophe averted by this act of national suicide? But I digress.

Without exactly addressing the peculiarity of the metaphor he used to frame the choice facing voters in 2016, PDM, in a subsequent response to critics, explained that his point was that, although the United States of America might continue to exist if Hillary Clinton were elected President, it would no longer be a Constitutional Republic. A Clinton election, PDM argued, would mean that the country would inevitably continue on its current irreversible path toward an Administrative State ruled by a cadre of faceless bureaucrats and experts unaccountable to the people or their elected representatives.

Thus, in PDM’s view, the outcome of the election has preserved the future of the US as a Constitutional Republic, though, as already noted, that interpretation seems to be belied by the metaphor with which PDM chose to frame the choice presented to voters. At any rate, PDM, while acknowledging that his chosen candidate was an imperfect standard bearer for the cause of Constitutional Republicanism, argued that, by speaking out against the policies of unrestricted immigration, free trade, and military interventionism pursued by all recent administrations, his preferred candidate was the last, best — indeed the only — hope for the preservation of our Constitutional Republic.

The transfer of power to the new administration has not yet taken place, but we have already seen evidence of the commitment of PEOTUS to Constitutional Republicanism. Of course to gauge the commitment, it may help to first have a general idea of the main characteristics of a Constitutional Republic, which we may summarize as follows:

  • The people are sovereign and exercise their sovereignty through a government of elected representatives.
  • The powers exercised by these representatives are limited by a basic law (the Constitution) defining the lawful powers that these representative may exercise.
  • The rights of the people are protected by a rule of law that allows the government to restrict or abridge the rights of citizens only by enacting laws consistent with the Constitution.

But before discussing the attachment of the PEOTUS to Constitutional Republicanism, I want to refer to a post I wrote about six months ago in which I discussed an extraordinary 20th century British politician whose influence, for better or worse, is still felt in Britain, a politician who, in opposing immigration by non-whites, including those already legally residing in Britain, and, in arguing for preserving England/Britain as a legally homogeneous ethnic nation, expressed almost 50 years ago many of the feelings and resentments now animating supporters of PDM’s preferred candidate for President in 2016. That politician was Enoch Powell.

Whatever one might think of Powell — and my own feelings about him are a mixture of admiration and revulsion — he had a genuine commitment to the ideals of personal liberty and the rule of law, though those ideals, as he himself acknowledged, did not rank at the top of his scale of values. I mention Powell in this context because, in criticizing the concept of “voluntary” wage-and-price guidelines to combat inflation – a popular idea in the 1960s and 1970s —  Powell brilliantly described these guidelines as the “rule of the threat of law,” meaning that the government forced businesses and unions to comply with its wishes, not by enacting legislation, thereby requiring compliance by the force of law, but by making it understood, either by explicit statement or by implication, that failure to comply with the guidelines would result in the enactment of legislation requiring compliance under even more onerous terms. This method of achieving policy objectives, by coercing members of the public, not by law, but through open or veiled threats, is the antithesis of the rule of law; it aims at coercing members of the public – businesses and workers – to take actions against their best interests by threatening them with even more unpleasant consequences if they fail to comply with requests or demands of government officials that have no legal standing.

Interestingly, when queried about not having paid taxes in past years, and about having sold products in the US produced overseas, and about having employed foreign workers in domestic construction projects, the PEOTUS pointed out that, in not paying taxes, in selling products in the US produced overseas, and in employing foreign workers on domestic construction projects, he had been in full compliance with the laws of the United States, so that he was only pursuing his own economic self-interest as he, a US citizen, had every right to do. However, the PEOTUS apparently now finds it intolerable that private business firms should make economic decisions in the interests of their owners in the way that he, by his own admission, had done when he ran his own business.

Unless Carrier, GM, and Ford and other businesses do what the PEOTUS wants them to do, they will suffer retribution; non-compliant companies are threatened with a 35% tariff applied on products they manufacture abroad. It is one thing to impose a tariff on imported goods in general; it is quite another to impose a tariff selectively to punish companies for taking actions in the economic interests of their owners of which the PEOTUS disapproves. That is precisely the rule of the threat of law against which Enoch Powell eloquently and rightly warned.

This kind of trampling on the rule of law is not what one would expect to occur in a Constitutional Republic. And remember, that according to PDM, it was with a view to preserving our Constitution Republic that he decided whom to support for President in 2016. So one can’t help wondering if PDM now feels that he has now been vindicated. Perhaps . . . if his idea of a Constitutional Republic approximates the idea of the state held by King Louis XIV.

Wherein Hayek Agrees with DeLong that Just Because You’re Rich, It Doesn’t Mean You Deserve to Be

Recently Brad DeLong expounded on the extent to which the earnings that accrue to individuals do not correspond to the contributions total output that can be ascribed to the personal efforts of those individuals or the contributions made by resources owned by thoe people. Here’s DeLong:

Pascal Lamy: “When the wise man points at the moon, the fool looks at the finger…”

Perhaps in the end the problem is that people want to pretend that they are filling a valuable role in the societal division of labor, and are receiving no more than they earn–than they contribute.

But that is not the case. The value–the societal dividend–is in the accumulated knowledge of humanity and in the painfully constructed networks that make up our value chains.

A “contribution” theory of what a proper distribution of income might be can only be made coherent if there are constant returns to scale in the scarce, priced, owned factors of production. Only then can you divide the pile of resources by giving to each the marginal societal product of their work and of the resources that they own.

That, however, is not the world we live in.

In a world–like the one we live in–of mammoth increasing returns to unowned knowledge and to networks, no individual and no community is especially valuable. Those who receive good livings are those who are lucky–as Carrier’s workers in Indiana have been lucky in living near Carrier’s initial location. It’s not that their contribution to society is large or that their luck is replicable: if it were, they would not care (much) about the departure of Carrier because there would be another productive network that they could fit into a slot in.

All of this “what you deserve” language is tied up with some vague idea that you deserve what you contribute–that what your work adds to the pool of society’s resources is what you deserve.

This illusion is punctured by any recognition that there is a large societal dividend to be distributed, and that the government can distribute it by supplementing (inadequate) market wages determined by your (low) societal marginal product, or by explicitly providing income support or services unconnected with work via social insurance. Instead, the government is supposed to, somehow, via clever redistribution, rearrange the pattern of market power in the economy so that the increasing-returns knowledge- and network-based societal dividend is predistributed in a relatively egalitarian way so that everybody can pretend that their income is just “to each according to his work”, and that they are not heirs and heiresses coupon clipping off of the societal capital of our predecessors’ accumulated knowledge and networks.

On top of this we add: Polanyian disruption of patterns of life–local communities, income levels, industrial specialization–that you believed you had a right to obtain or maintain, and a right to believe that you deserve. But in a market capitalist society, nobody has a right to the preservation of their local communities, to their income levels, or to an occupation in their industrial specialization. In a market capitalist society, those survive only if they pass a market profitability test. And so the only rights that matter are those property rights that at the moment carry with them market power–the combination of the (almost inevitably low) marginal societal products of your skills and the resources you own, plus the (sometimes high) market power that those resources grant to you.

This wish to believe that you are not a moocher is what keeps people from seeing issues of distribution and allocation clearly–and generates hostility to social insurance and to wage supplement policies, for they rip the veil off of the idea that you deserve to be highly paid because you are worth it. You aren’t.

And this ties itself up with regional issues: regional decline can come very quickly whenever a region finds that its key industries have, for whatever reason, lost the market power that diverted its previously substantial share of the knowledge- and network-based societal dividend into the coffers of its firms. The resources cannot be simply redeployed in other industries unless those two have market power to control the direction of a share of the knowledge- and network-based societal dividend. And so communities decline and die. And the social contract–which was supposed to have given you a right to a healthy community–is broken.

As I have said before, humans are, at a very deep and basic level, gift-exchange animals. We create and reinforce our social bonds by establishing patterns of “owing” other people and by “being owed”. We want to enter into reciprocal gift-exchange relationships. We create and reinforce social bonds by giving each other presents. We like to give. We like to receive. We like neither to feel like cheaters nor to feel cheated. We like, instead, to feel embedded in networks of mutual reciprocal obligation. We don’t like being too much on the downside of the gift exchange: to have received much more than we have given in return makes us feel very small. We don’t like being too much on the upside of the gift exchange either: to give and give and give and never receive makes us feel like suckers.

We want to be neither cheaters nor saps.

It is, psychologically, very hard for most of us to feel like we are being takers: that we are consuming more than we are contributing, and are in some way dependent on and recipients of the charity of others. It is also, psychologically, very hard for most of us to feel like we are being saps: that others are laughing at us as they toil not yet consume what we have produced.

And it is on top of this evopsych propensity to be gift-exchange animals–what Adam Smith called our “natural propensity to truck, barter, and exchange”–we have built our complex economic division of labor. We construct property and market exchange–what Adam Smith called our natural propensity “to truck, barter, and exchange” to set and regulate expectations of what the fair, non-cheater non-sap terms of gift-exchange over time are.

We devise money as an institution as a substitute for the trust needed in a gift-exchange relationship, and we thus construct a largely-peaceful global 7.4B-strong highly-productive societal division of labor, built on:

  • assigning things to owners—who thus have both the responsibility for stewardship and the incentive to be good stewards…
  • very large-scale webs of win-win exchange… mediated and regulated by market prices…

There are enormous benefits to arranging things this way. As soon as we enter into a gift-exchange relationship with someone or something we will see again–perhaps often–it will automatically shade over into the friend zone. This is just who we are. And as soon as we think about entering into a gift-exchange relationship with someone, we think better of them. Thus a large and extended division of labor mediated by the market version of gift-exchange is a ver powerful creator of social harmony.

This is what the wise Albert Hirschman called the doux commerce thesis. People, as economists conceive them, are not “Hobbesians” focusing on their narrow personal self-interest, but rather “Lockeians”: believers in live-and-let live, respecting others and their spheres of autonomy, and eager to enter into reciprocal gift-exchange relationships—both one-offs mediated by cash alone and longer-run ones as well.

In an economist’s imagination, people do not enter a butcher’s shop only when armed cap-a-pie and only with armed guards. They do not fear that the butcher will knock him unconscious, take his money, slaughter him, smoke him, and sell him as long pig.

Rather, there is a presumed underlying order of property and ownership that is largely self-enforcing, that requires only a “night watchman” to keep it stable and secure.

Yet to keep the fiction that we are all fairly playing the reciprocal game of gift exchange in a 7.4 billion-strong social network–that we are neither cheaters nor saps–we need to ignore that we are coupon clippers living off of our societal inheritance.

And to do this, we need to do more than (a) set up a framework for the production of stuff, (b) set up a framework for the distribution of stuff, and so (c) create a very dense reciprocal network of interdependencies to create and reinforce our belief that we are all one society.

We need to do so in such a way that people do not see themselves, are not seen as saps–people who are systematically and persistently taken advantage of by others in their societal and market gift-exchange relationships. We need to do so in such a way that people do not see themselves, are not seen as, and are not moochers–people who systematically persistently take advantage of others in their societal and market gift-exchange relationships. We need to do this in the presence of a vast increasing-returns in the knowledge- and network-based societal dividend and in spite of the low societal marginal product of any one of us.

Thus we need to do this via clever redistribution rather than via explicit wage supplements or basic incomes or social insurance that robs people of the illusion that what they receive is what they have earned and what they are worth through their work.

Now I think it is an open question whether it is harder to do the job via predistribution, or to do the job via changing human perceptions to get everybody to understand that

  • no, none of us is worth what we are paid.
  • we are all living, to various extents, off of the dividends from our societal capital
  • those of us who are doing especially well are those of us who have managed to luck into situations in which we have market power–in which the resources we control are (a) scarce, (b) hard to replicate quickly, and (c) help produce things
  • that rich people have a serious jones for right now.

Compare with Hayek’s Law, Legislation and Liberty volume 2, pp. 73-74

It has been argued persuasively that people will tolerate major inequalities of the material positions only if they believe that the different individuals get on the whole what they deserve, that they did in fact support the market order only because (and so long as) they thought that the differences of remuneration corresponded roughly to differences of merit, and that in consequence the maintenance of a free society presupposes the belief that some sort of “social justice” is being done. The market order, however, does not in fact owe its origin to such beliefs, or was originally justified in this manner. This order could develop, after its earlier beginnings had decayed during the middle ages and to some extent been destroyed by the restrictions imposed by authority, when a thousand years of vain efforts to discover substantively just prices or wages were abandoned and the late schoolmen recognized them to be empty formulae and taught instead that the prices determined by just conduct of the parties in the market, i.e., the competitive prices arrived at without fraud, monopoly and violence, was all that justice required. It was from this tradition that John Locke and his contemporaries derived the classical liberal conception of justice for which, as has been rightly said, it was only ‘the way in which competition was carried on, not its results’, that could be just or unjust.

It is unquestionably true that, particularly among those who were very successful in the market order, a belief in a much stronger moral justification of individual success developed, and that, long after the basic principles of such an order had been fully elaborated and approved by catholic moral philosophers, it had in the Anglo-Saxon world received strong support from Calvinist teaching.It certainly is important in the market order (or free enterprise society, misleadingly called ‘capitalism’) that the individuals believe that their well-being depends primarily on their own efforts and decisions. Indeed, few circumstances will do more to make a person energetic and efficient than the belief that it depends chiefly on him whether he will reach the goals he has set himself. For this reason this belief is often encouraged by education and governing opinion — it seems to me, generally much to the benefit of most of the members of society in which it prevails, who will owe many important material and moral improvements to persons guided by it. But it leads not doubt also to an exaggerated confidence in the truth of this generalization which to those who regard themselves (and perhaps are) equally able but have failed must appear as a bitter irony and severe provocation.

It is probably a misfortune that, especially in the USA, popular writers like Samuel Smiles and Horatio Alger, and later the sociologist W. G. Sumner, have defended free enterprise on the ground that it regularly rewards the deserving, and it bodes ill for the future of the market order that this seems to have become the only defence of it which is understood by the general public. That it has largely become the basis of the self-esteem of the businessman often gives him an air of self-righteousness which does not make him more popular. [If only!]

It is therefore a real dilemma to what extent we ought to encourage in the young a belief that when they really try they will succeed, or should rather emphasize that inevitably some unworthy will succeed and some worthy fail — whenever we ought to allow the views of those groups to prevail with whom the over-confidence in the appropriate reward of the able and industrious is strong and who in consequence will do much that benefits the rest, and whether without such partly erroneous beliefs the large number will tolerate actual differences in rewards which will be based only partly on achievement and partly on mere chance.


About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

Enter your email address to follow this blog and receive notifications of new posts by email.

Join 1,282 other followers

Follow Uneasy Money on WordPress.com