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

Published February 7, 2017 Uncategorized 9 Comments

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

Published February 5, 2017 Neil Gorsuch , Ronald Dworkin , Scott Sumner , Uncategorized 14 Comments

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

Published February 2, 2017 Korematsu v. United States , Neil Gorsuch 4 Comments
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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

Published January 31, 2017 dynamic programmng , Jack Hirshleifer , Richard Bellman , Stuart Dreyfus 10 Comments
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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

Published January 22, 2017 bitcoins , fiat money , network effects , William Luther 28 Comments

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

Published January 17, 2017 bitcoins , fiat money 38 Comments
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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

Published January 11, 2017 Constitutional Republic , Enoch Powell 4 Comments
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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 coerced 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

Published January 5, 2017 Hayek , Uncategorized 18 Comments

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.

On Intellectual Scruples

Published January 1, 2017 Uncategorized 12 Comments

Citing Jonathan Chait’s stinging takedown of a remarkably silly assertion by Larry Kudlow that it’s good to have a government run by the super-rich, because the super-rich, already satiated with wealth, are immune to the blandishments that might corrupt the merely rich or upper middle-class, Paul Krugman also skewers Kudlow for a deeper inconsistency in his world-view and that of other devotees of supply-side economics.

What Chait doesn’t note is the special irony of seeing this argument from Kudlow, or indeed any right-wing advocate of supply-side economics. Remember, their whole worldview is based around the claim that cutting taxes on rich people will work economic miracles, because of incentives: let a plutocrat keep more of an extra dollar in income, and he’ll innovate, create jobs, lead us to an earthly paradise in order to get that extra income.

To belabor what should be obvious: either the wealthy care about having more money or they don’t. If lower marginal tax rates are an incentive to produce more, the prospect of personal gain is an incentive to engage in corrupt practices. You can’t go all Ayn Rand/Gordon Gekko on the importance of greed as a motivator while claiming that wealth insulates a man from temptation. . . .

But what’s more interesting and revealing, I think, is the way people like Kudlow for whom incentives are supposedly all suddenly say something completely different when it comes to conflicts of interest.

And this is telling us something significant: namely, that supply-side economic theory is and always was a sham. It was never about the incentives; it was just another excuse to make the rich richer.

I understand why Krugman is annoyed with Kudlow and other supply-siders. Kudlow is clearly being inconsistent. But Krugman forgets that he is a partisan advocate, so, like all advocates, he tailors his arguments to support the momentary interest and needs of the political party, and candidates, and causes with which he has aligned himself. And, like any advocate, he searches for whatever arguments he can find to support his side at a particular moment, without caring too much whether the argument he is making today is consistent with another that he made yesterday, or, for that matter, one he made 5 minutes ago. So it’s certainly fair to conclude that Kudlow doesn’t really understand what he is talking about, or that, lacking intellectual scruples, he will say whatever he thinks will advance the interests of his “team.”

But you can’t infer from Kudlow’s lack of intellectual scruples that everyone who favors reducing marginal tax rates is simply trying to make the super-rich even richer. There is a prima facie plausible argument to be made that reducing marginal tax rates would enhance economic efficiency. So the charge that everyone who advocates reducing marginal tax rates is doing so for venal and reprehensible motives just strikes me as, well, implausible.

I mean is it so hard to imagine that an intelligent person could believe that low marginal rates of taxation would promote economic efficiency and enhance productivity? Not for me at any rate, because I used to share that belief myself. If I hold a different view now than I used to, I don’t think it’s because I have become a better person than I used to be (though I hope I have); it’s because I now have serious doubts that low marginal rates of taxation are necessarily efficiency-enhancing. Those doubts result from my having realized that a lot of income — especially in the highest income brackets — is generated by activities whose private benefits greatly exceed their social benefits — the gains to some reflecting interpersonal transfers rather than increased output — so that low marginal income tax rates may, on balance, reduce overall economic efficiency.

Given the lack of research, or my lack of knowledge about the research, on the gaps between the private and social benefits from a lot of very highly remunerated activities, like various forms of financial trading and speculation, research and development aimed at creating intellectual property, and other forms of investment in winner-take-all activities and enterprises, I have no idea what the socially optimum marginal tax rate really is. I therefore have no definite position either for or against changing marginal tax rates.

But I do understand why someone with a perfectly innocent state of mind could believe that not only the super-rich, but even the least well-off members of society, could potentially benefit from reduced marginal tax rates. If you want to disprove or debunk that belief, the right way to do so is to explain what’s wrong with the straightforward — possibly simplistic — reasoning that says that lowering marginal tax rates enhances economic efficiency; it is not by asserting that such a belief could be held only out of venal motives.

As I said, I do understand, and share, Krugman’s frustration with Kudlow, but I still don’t believe that every supporter of low marginal tax rates is lacking in intellectual scruples. And not only is impugning the motives of everyone that disagrees with you unfair, it degrades an already low level of public discourse even further, and may not even be an effective rhetorical strategy.

Imagining the Gold Standard

Published December 29, 2016 Bank of France , D. H. Robertson , gold standard , Great Depression , Larry White 8 Comments

The Marginal Revolution University has posted a nice little 10-minute video conversation between Scott Sumner and Larry about the gold standard and fiat money, Scott speaking up for fiat money and Larry weighing in on the side of the gold standard. I thought that both Scott and Larry acquitted themselves admirably, but several of the arguments made by Larry seemed to me to require either correction or elaboration. The necessary corrections or elaborations do not strengthen the defense of the gold standard that Larry presents so capably.

Larry begins with a defense of the gold standard against the charge that it caused the Great Depression. As I recently argued in my discussion of a post on the gold standard by Cecchetti and Schoenholtz, it is a bit of an overreach to argue that the Great Depression was the necessary consequence of trying to restore the international gold standard in the 1920s after its collapse at the start of World War I. Had the leading central banks at the time, the Federal Reserve, the Bank of England, and especially the Bank of France, behaved more intelligently, the catastrophe could have been averted, allowing the economic expansion of the 1920s to continue for many more years, thereby averting subsequent catastrophes that resulted from the Great Depression. But the perverse actions taken by those banks in 1928 and 1929 had catastrophic consequences, because of the essential properties of the gold-standard system. The gold standard was the mechanism that transformed stupidity into catastrophe. Not every monetary system would have been capable of accomplishing that hideous transformation.

So while it is altogether fitting and proper to remind everyone that the mistakes that led to catastrophe were the result of choices made by policy makers — choices not required by any binding rules of central-bank conduct imposed by the gold standard — the deflation caused by the gold accumulation of the Bank of France and the Federal Reserve occurred only because the gold standard makes deflation inevitable if there is a sufficiently large increase in the demand for gold. While Larry is correct that the gold standard per se did not require the Bank of France to embark on its insane policy of gold accumulation, it should at least give one pause that the most fervent defenders of that insane policy were people like Ludwig von Mises, F.A. Hayek, Lionel Robbins, and Charles Rist, who were also the most diehard proponents of maintaining the gold standard after the Great Depression started, even holding up the Bank of France as a role model for other central banks to emulate. (To be fair, I should acknowledge that Hayek and Robbins, to Mises’s consternation, later admitted their youthful errors.)

Of course, Larry would say that under the free-banking system that he favors, there would be no possibility that a central bank like the Bank of France could engage in the sort of ruinous policy that triggered the Great Depression. Larry may well be right, but there is also a non-trivial chance that he’s not. I prefer not to take a non-trivial chance of catastrophe.

Larry, I think, makes at least two other serious misjudgments. First, he argues that the instability of the interwar gold standard can be explained away as the result of central-bank errors – errors, don’t forget, that were endorsed by the most stalwart advocates of the gold standard at the time – and that the relative stability of the pre-World War I gold standard was the result of the absence of the central banks in the US and Canada and some other countries while the central banks in Britain, France and Germany were dutifully following the rules of the game.

As a factual matter, the so-called rules of the game, as I have observed elsewhere (also here), were largely imaginary, and certainly never explicitly agreed upon or considered binding by any monetary authority that ever existed. Moreover, the rules of the game were based on an incorrect theory of the gold standard reflecting the now discredited price-specie-flow mechanism, whereby differences in national price levels under the gold standard triggered gold movements that would be deflationary in countries losing gold and inflationary in countries gaining gold. That is a flatly incorrect understanding of how the international adjustment mechanism worked under the gold standard, because price-level differences large enough to trigger compensatory gold flows are inconsistent with arbitrage opportunities tending to equalize the prices of all tradable goods. And finally, as McCloskey and Zecher demonstrated 40 years ago, the empirical evidence clearly refutes the proposition that gold flows under the gold standard were in any way correlated with national price level differences. (See also this post.) So it is something of a stretch for Larry to attribute the stability of the world economy between 1880 and 1914 either to the absence of central banks in some countries or to the central banks that were then in existence having followed the rules of the game in contrast to the central banks of the interwar period that supposedly flouted those rules.

Focusing on the difference between the supposedly rule-based behavior of central banks under the classical gold standard and the discretionary behavior of central banks in the interwar period, Larry misses the really critical difference between the two periods. The second half of the nineteenth century was a period of peace and stability after the end of the Civil War in America and the short, and one-sided, Franco-Prussian War of 1870. The rapid expansion of the domain of the gold standard between 1870 and 1880 was accomplished relatively easily, but not without significant deflationary pressures that lasted for almost two decades. A gold standard had been operating in Britain and those parts of the world under British control for half a century, and gold had long been, along with silver, one of the two main international monies and had maintained a roughly stable value for at least half a century. Once started, the shift from silver to gold caused a rapid depreciation of silver relative to gold, which itself led the powerful creditor classes in countries still on the silver standard to pressure their governments to shift to gold.

After three and a half decades of stability, the gold standard collapsed almost as soon as World War I started. A non-belligerent for three years, the US alone remained on the gold standard until it prohibited the export of gold upon entry into the war in 1917. But, having amassed an enormous gold hoard during World War I, the US was able to restore convertibility easily after the end of the War. However, gold could not be freely traded even after the war. Restrictions on the ownership and exchange of gold were not eliminated until the early 1920s, so the gold standard did not really function in the US until a free market for gold was restored. But prices had doubled between the start of the war and 1920, while 40% of the world’s gold reserves were held by the US. So it was not the value of gold that determined the value of the U.S. dollar; it was the value of the U.S. dollar — determined by the policy of the Federal Reserve — that determined the value of gold. The kind of system that was operating under the classical gold standard, when gold had a clear known value that had been roughly maintained for half a century or more, did not exist in the 1920s when the world was recreating, essentially from scratch, a new gold standard.

Recreating a gold standard after the enormous shock of World War I was not like flicking a switch. No one knew what the value of gold was or would be, because the value of gold itself depended on a whole range of policy choices that inevitably had to be made by governments and central banks. That was just the nature of the world that existed in the 1920s. You can’t just assume that historical reality away.

Larry would like to think and would like the rest of us to think that it would be easy to recreate a gold standard today. But it would be just as hard to recreate a gold standard today as it was in the 1920s — and just as perilous. As Thomas Aubrey pointed out in a comment on my recent post on the gold standard, Russia and China between them hold about 25% of the world’s gold reserves. Some people complain loudly about Chinese currency manipulation now. How would you like to empower the Chinese and the Russians to manipulate the value of gold under a gold standard?

The problem of recreating a gold standard was beautifully described in 1922 by Dennis Robertson in his short classic Money. I have previously posted this passage, but as Herbert Spencer is supposed to have said, “it is only by repeated and varied iteration that alien conceptions can be forced upon reluctant minds.” So, I will once again let Dennis Robertson have the final word on the gold standard.

We can now resume the main thread of our argument. In a gold standard country, whatever the exact device in force for facilitating the maintenance of the standard, the quantity of money is such that its value and that of a defined weight of gold are kept at an equality with one another. It looks therefore as if we could confidently take a step forward, and say that in such a country the quantity of money depends on the world value of gold. Before the war this would have been a true enough statement, and it may come to be true again in the lifetime of those now living: it is worthwhile therefore to consider what, if it be true, are its implications.

The value of gold in its turn depends on the world’s demand for it for all purposes, and on the quantity of it in existence in the world. Gold is demanded not only for use as money and in reserves, but for industrial and decorative purposes, and to be hoarded by the nations of the East : and the fact that it can be absorbed into or ejected from these alternative uses sets a limit to the possible changes in its value which may arise from a change in the demand for it for monetary uses, or from a change in its supply. But from the point of view of any single country, the most important alternative use for gold is its use as money or reserves in other countries; and this becomes on occasion a very important matter, for it means that a gold standard country is liable to be at the mercy of any change in fashion not merely in the methods of decoration or dentistry of its neighbours, but in their methods of paying their bills. For instance, the determination of Germany to acquire a standard money of gold in the [eighteen]’seventies materially restricted the increase of the quantity of money in England.

But alas for the best made pigeon-holes! If we assert that at the present day the quantity of money in every gold standard country, and therefore its value, depends on the world value of gold, we shall be in grave danger of falling once more into Alice’s trouble about the thunder and the lightning. For the world’s demand for gold includes the demand of the particular country which we are considering; and if that country be very large and rich and powerful, the value of gold is not something which she must take as given and settled by forces outside her control, but something which up to a point at least she can affect at will. It is open to such a country to maintain what is in effect an arbitrary standard, and to make the value of gold conform to the value of her money instead of making the value of her money conform to the value of gold. And this she can do while still preserving intact the full trappings of a gold circulation or gold bullion system. For as we have hinted, even where such a system exists it does not by itself constitute an infallible and automatic machine for the preservation of a gold standard. In lesser countries it is still necessary for the monetary authority, by refraining from abuse of the elements of ‘play’ still left in the monetary system, to make the supply of money conform to the gold position: in such a country as we are now considering it is open to the monetary authority, by making full use of these same elements of ‘play,’ to make the supply of money dance to its own sweet pipings.

Now for a number of years, for reasons connected partly with the war and partly with its own inherent strength, the United States has been in such a position as has just been described. More than one-third of the world’s monetary gold is still concentrated in her shores; and she possesses two big elements of ‘play’ in her system — the power of varying considerably in practice the proportion of gold reserves which the Federal Reserve Banks hold against their notes and deposits (p. 47), and the power of substituting for one another two kinds of common money, against one of which the law requires a gold reserve of 100 per cent and against the other only one of 40 per cent (p. 51). Exactly what her monetary aim has been and how far she has attained it, is a difficult question of which more later. At present it is enough for us that she has been deliberately trying to treat gold as a servant and not as a master.

It was for this reason, and for fear that the Red Queen might catch us out, that the definition of a gold standard in the first section of this chapter had to be so carefully framed. For it would be misleading to say that in America the value of money is being kept equal to the value of a defined weight of gold: but it is true even there that the value of money and the value of a defined weight of gold are being kept equal to one another. We are not therefore forced into the inconveniently paradoxical statement that America is not on a gold standard. Nevertheless it is arguable that a truer impression of the state of the world’s monetary affairs would be given by saying that America is on an arbitrary standard, while the rest of the world has climbed back painfully on to a dollar standard.

HT: J. P. Koning

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.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner

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