Nullification and Gun Control

27 Feb

Cover page of Tom Wood's book on Nullification

Cover page of Tom Wood’s book on Nullification

Sheriffs in the Utah state of the United States have refused to implement any federal policy restricting gun ownership. In a letter to Barrack Obama, the Utah Sheriffs’ Association, consisting of 28 out of 29 Utah sheriffs, have declared that,

We respect the Office of the President of the United States of America. But, make no mistake, as the duly-elected sheriffs of our respective counties, we will enforce the rights guaranteed to our citizens by the Constitution. No federal official will be permitted to descend upon our constituents and take from them what the Bill of Rights—in particular Amendment II—has given them. (emphasis mine)

A similar situation in India might look like an association of Police officers refusing to implement a Government directive (either state or central) because they think it is against the spirit of the Indian constitution. To take a specific example, maybe the Police officers in Tamil Nadu refusing to enforce the State ban on Vishwaroopam because they believe it violates freedom of speech. I am not an expert on the Indian constitution, but my guess would be that such a move would clearly be unconstitutional. Police officers in India s are law enforcers and cannot choose whether to implement a law passed by the Indian parliament.

In a similar vein, the letter written by the Utah sheriffs may seem completely outrageous. But in the case of the United States, refusal to enforce a federal law may have constitutional backing through the right of nullification. Tom Woods defines nullification as,

 State nullification is the idea that the states can and must refuse to enforce unconstitutional federal laws.

Woods traces the power of the state governments to nullify unconstitutional federal laws to Virginia and Kentucky Resolutions, drafted by James Madison (a key Founding Father of the US, the fourth American President and “Father of Constitution”) and Thomas Jefferson (another key Founding Father and principal author of the American Declaration of Independence) in 1798.

The Utah sheriffs have come together to protect the rights guaranteed to US citizens under the Second Amendment to the US Constitution, which says,

A well regulated militia, being necessary to the security of a free state, the right of the people to keep and bear arms, shall not be infringed.

The debate on nullification and the second amendment  in the blogoshpere is ideologically charged. The libertarians invoke the concept of nullification to question Obama’s move to restrict gun ownership in the US, while the liberals question the validity of nullification and resort to the Supremacy Clause, which the federal government has previously used to strike down conflicting state laws.

Any which way, it will be interesting to see how things unfold.

Raise that unemployment now

19 Feb

Sipping my morning cup of tea, I came across a horrifying article by Paul Krugman titled “Raise that wage now.” In the article, Krugman seconds Obama’s proposal in his State of the Union address to raise the minimum wage by 24% in the US. I knew immediately that this would have opened a can of worms with the blogosphere debating this in full swing. Here’s a short clip on what Milton Friedman had to say about minimum wages,

 

Don Boudreaux at Cafe Hayek has a good compilation of some libertarian links against raising the minimum wages. You can read them here.

Since so much has been written on this, and I think the title of this post is clear on where I stand on this debate, I thought of posting two cartoon strips on this topic.

PayneMinWage

Source

BDAQWwuCAAEKNtb (1)

Source

Its a wonderful life with capitalism

30 Oct

Let my country awake…

15 Aug

Where the mind is without fear and the head is held high;
Where knowledge is free;
Where the world has not been broken up into fragments by narrow domestic walls;
Where words come out from the depth of truth;
Where tireless striving stretches its arms towards perfection:
Where the clear stream of reason has not lost its way into the dreary desert sand of dead habit;
Where the mind is lead forward by thee into ever-widening thought and action —
Into that heaven of freedom, my Father, let my country awake.
~ Rabindranath Tagore ~

Free markets and Government

11 Aug

F.A. Hayek in The Road to Serfdom,

To create conditions in which competition will be as effective as possible, to supplement it where it cannot be made effective, to provide the services which, in the words of Adam Smith, “though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expense to any individual  or small number of individuals”, these tasks provide indeed a wide and unquestioned field for state activity. In no system that could be rationally defended would the state just do nothing. (emphasis added)

To summarize, free markets does not mean no government. This may seem like an obvious fact, but a lot of heartburn between interventionists and free marketers will be avoided if we keep the above in mind.

A Guide to the Gold Standard

7 Jul

April 1933, the US goes off the gold standard

The April 20, 1933 edition of the The New York Times read, “GOLD STANDARD DROPPED TEMPORARILY TO AID PRICES AND OUR WORLD POSITION; BILL READY FOR CONTROLLED INFLATION.”

The temporary suspension of the gold standard turned out to be anything but temporary, which reminds me of a Milton Friedman quote, “Nothing is so permanent as a temporary government program.”

The purpose of this post is to show that it is technically possible to implement a gold standard today. Many criticisms against the gold standard claim that it is not possible to shift to a gold standard. These criticisms range from – the money supply will fall, there will be chaos if many agencies control money supply, there is not enough gold in the world to shift to a gold standard. These criticisms are baseless and betray an understanding of what money really is.

Once we have clarified  (hopefully) that it is technically possible to implement a gold standard, whether we should shift to a gold standard is an altogether different question. So, the way to argue against the gold standard is to debate along ideological lines. If someone argues that we should not implement the gold standard because the government should control the money supply, that’s fine. The nature of the debate then  boils down to whether the government should control the money supply or not. However, if one argues against the gold standard saying that it is not possible to implement the same, the debate does not stand any merit.

I myself am guilty of the same misunderstandings that I attempt to clarify through this post. On 4 December , 2010, I had put a post in this blog with the title In defense of fiat moneyMuch of what you will read in this post will directly contradict what was argued earlier.

What is so special about gold?

First and foremost, the Austrian economists do not support the gold standard because it has some mystical properties. As our economy moved from barter to exchange based on money, gold came to be widely accepted as the best medium of exchange. This was because gold satisfied the many qualities of a good medium of exchange, like acceptability, durability, portability, homogeneity, scarcity.

Murray Rothbard in his book, What has the government done to our money, says

Historically, many different goods have been used as media (medium of exchange): tobacco in colonial Virginia, sugar in the West Indies, salt in Abyssinia, cattle in ancient Greece, nails in Scotland, copper in ancient Egypt, and grain, beads, tea, cowrie shells, and fishhooks. Through the centuries, two commodities, gold and silver, have emerged as money in the free competition of the market, and have displaced the other commodities.

Thus, the Austrians support the gold standard as gold is what the market accepted as money before the government monopolized the money supply. It is not for any economist to decide what commodity should be used as money. Our monetary history suggests that gold was established by the market as the best form of money. In case some other commodity had been established as money, we would have been arguing for a monetary system based on a different commodity.

What is the Gold Standard?

Simply put, a gold standard means a monetary system based on the commodity gold. Does this mean you will have to carry gold bars in trucks to make payment for buying real estate? No. You can make payments in paper receipts which will be redeemable in gold. Who has the obligation to redeem the paper receipts for gold? Obviously, the entity who has issued the receipts; which brings us to a very contentious question – who has the right to issue such redeemable paper receipts?

In a gold standard, anybody who has gold can issue such receipts. Suppose the government has gold reserves of 1 tonne. It can issue its own paper receipts, say the ‘dollar’ and define it as equal to 1 gram of gold. This will allow the government to issue 1 million dollars. Similarly, anyone can take out their own paper receipts. If you have 1 tonne of gold, you can take out your own receipts, and label it ‘rupiya’ and define it as 1 kg of gold. This will allow you to print 1000 rupiya. You can take this rupiya to the market and buy goods and services.

Will the market accept your rupiyas as payment? That will depend on your credibility in the market. Say you went to purchase a car and it costs 1 kg gold. You can use your one rupiya to buy the car. The car dealer can later knock at your door and ask you to redeem your one rupiya for 1 kg gold. If you do not redeem your rupiya, your credibility declines, and in the future, market participants may refuse to accept rupiyas.

Does this mean you will starve to death with nobody willing to sell you food? Of course not. Even if the credibility of your rupiya has gone for a toss, you can always turn in your gold to the government and receive dollar in exchange. Or you could turn over your gold to a bank whose currency is widely accepted by the public. Or, you could simply melt your gold into smaller units and use it directly for exchange.

The point I am trying to make here is that in a free market gold standard, the market will decide the paper receipts or currency that will be used. Will there be multitude currencies and chaos? No. History suggests that the market will eventually settle to a few different types of paper receipts. Maybe, only dollars will be used or maybe, currencies issued by certain trust worthy banks will be used. (It may be mentioned here that currency issued by different banks will not be a problem, just as having savings account at different banks is not a problem. Inter bank transactions can take place through a clearing house, as is presently done.)

Paper currency issued by different participants in the gold standard are simply receipts for a claim towards gold. As gold is the real money in a gold standard, we stumble on an important question. Who has the right to mine gold? Well, no points for guessing, but obviously the Austrian reply to this question will be – its a free market, everybody has the right to mine gold.

Suppose you want to buy a car, which costs 1 kg gold. You have two choices – either you can mine 1 kg gold and pay for your car, or you can choose to work somewhere and get 1 kg of gold as wages. Which option you choose depends on which activity will demand the least effort from your side – this is similar to saying which activity is preferable to you. Similary, a mining company will mine gold till the time it is profitable for it to do so. It may seem that in a gold standard, private  mining companies will earn super normal profits and will become masters of the universe. This is not true.

An example will clarify.

Assume a mining company can hire laborers for 1 kg gold per day to work on its gold mines, and each laborer can mine 5 kg of gold per day. Can such a situation arise in a free market? Of course not. Why would anyone accept 1 kg gold in payment for extracting 5 kg of gold? One can argue here that independently (without machinery of the mining company), the laborer will be unable to mine gold, and hence he may accept a lower payment that the value of gold he produces. Even then, what prohibits another company which can buy machinery and hire laborers to start mining operations? Eventually, as long as mining gold remains a profitable activity, the supply of gold will keep on increasing, adding to the existing supply of gold stock in the economy. Eventually, the “price” of gold (in terms of its purchasing power in buying goods and services) will fall to match the cost of extracting gold and we reach a sort of “steady state” supply of gold.

As we can see above, the supply of gold, which is to say the supply of money in a gold standard, is determined by the market. It is important to mention here that the initial stock of gold, as well as the addition to gold stock through mining, are irrelevant from the point of view of operation of the gold standard.

We can take a stylized example of an economy to understand the above point.

Assume an economy which produces only one good – say 1000 units of X. Assume the initial stock of gold in this economy is 1000 kgs and gold is the accepted medium of exchange. This 1000 kgs of gold is split between two market participants, say A and B, equally – 500 kgs each. What will be the price of one unit of X in this economy? X will cost 1 kg gold, and both A and B can buy 500 units each of X. Now, in the same example, assume that the initial stock of gold, which is split evenly between X and Y, is 1 kg. The price of one unit of X will be 1 gm and A and B can both still buy 500 units each of X. Now assume that because of a certain technological innovation, it has become easier to mine gold and the stock of gold in the economy increases to 2000 kgs. Ceteris paribus, the price of one unit of X increases to 2 kgs of gold and A and B can both still buy 500 units of each.

In a fiat money economy, the way to think about this is to imagine that one morning when you wake up, you are told that an extra “zero” has been added to all monetary denominations. So Rs 10 is now Rs 100. What used to cost Rs 10 before will now cost Rs 100. Similarly, if you were earning Rs 10 before, you will now earn Rs 100. In real terms, nothing changes. By adding an extra zero, we have increased the monetary base in an economy ten times. If the initial stock of money in an economy was Rs 10 lakh, it is now Rs 100 lakh. In real terms, nothing changes. In nominal terms, the purchasing power of rupee has fallen – what you could previously buy with Rs 10 will now cost Rs 100.

What is important is real consumption of goods and services. Money is simply used to exchange goods and services. If there is a huge initial pile of gold, prices will be quoted in tonnes or million tonnes. If we have very limited supply of gold, prices will be quoted in grams or milligrams. We can use any unit we want, it couldn’t matter less.

Can we shift to a Gold standard today?

Yes we can. Most of the criticisms against the gold standard have already been addressed above. We saw how in a free market gold standard, even though everybody has the right to issue currency, there is no chaos or dooms day. The market will choose as currency the paper receipts which have the highest credibility for redemption in gold. In fact, the term ‘dollar’ originated from coins which earned a reputation for their quality.

Murray Rothbard in his book, What has the government done to our money:

The dollar began as the generally applied name of an ounce weight of silver coined by a Bohemian Count named Schlick, in the sixteenth century. The Count of Schlick lived in Joachim’s Valley or Jaochimsthal. The Count’s coins earned a great reputation for their uniformity and fineness, and they were widely called “Joachim’s thalers,” or, finally, “thaler.” The name “dollar” eventually emerged from “thaler.”

We also saw how the initial stock of gold or increase/decrease in supply of gold pose no difficulties in the technical operation of the gold standard. These are not merely assertions but facts that can be verified by studying monetary history.

Though we have implicitly addressed the criticism that there is not enough gold to shift to a gold standard, lets discuss this again through an example.

Assume an economy is running on gold standard. The gold reserves in this economy is 1000 kg and a dollar is defined as 10 kg of gold. Thus, there are 100 dollars in this economy. Now, the government abolishes the gold standard and monopolizes the function of issuing currency in the economy. With the link between the dollar and gold reserves broken, the government is now free to print dollars without any corresponding increase in gold reserves. Ten years later, the supply of dollars in the economy has increased to 1000 dollars.

If the government wants to re-introduce the gold standard, with the initial stock of gold reserves (1000 kg ) and the inflated supply of  1000 dollars, the dollar will have to redefined from being equal to 10 kg of gold to 1 kg of gold. We can shift back to the gold standard with the same initial gold reserves but an inflated paper money supply. The question of insufficient gold reserves does not arise. Ludwig Von Mises had remarked that an ounce of gold is sufficient to run a gold standard. I think we can appreciate the significance of this quote in the context of the above example.

We now need to address a final point before closing this post. Lets continue with the above example.

Before the government redefines the dollar as being equal to 1 kg of gold, the “price” of gold observed in the fiat economy will be lower than this rate, i.e., the dollar will be overvalued and gold undervalued. This is to be expected as under a fiat money system, the supply of dollars increase as a much faster rate than the supply of gold reserves. Gold has to be mined from the depths of the earth while money can be printed in bulk effortlessly. In our example, assume the price of gold in the fiat economy is half a dollar for 1 kg of gold. This creates a confusion that we need  2000 kgs of gold to convert the 1000 dollars into gold and shift to a gold standard. Since the gold reserves are only 1000 kgs, there must be “insufficient gold.” As we have seen, this betrays an understanding that money is not an independent entity, but a unit of account. The dollar simply has to be redefined to “equate” the available gold reserves with the existing supply of paper money.

When the government redefines the dollar as 1 kg of gold, immediately we see that gold has “appreciated” and the dollar has “depreciated.” 1 kg of gold previously used to fetch you half a dollar. After the introduction of the gold standard and the redefined dollar, 1 kg of gold will fetch you 1 dollar.

If you are a gold mining company (or individual) and were previously selling a kg of gold for half a dollar, you can now exchange the same for one dollar. If it was profitable to sell a kg of gold at half a dollar, its two times more profitable to sell a kg of gold for a dollar. This will lead to more companies (or individuals) engaging in gold mining. This process will continue until rampant mining bids up the cost of gold mining to such an extent that the profit return on gold mining falls to the return observed in other industries. The laws of normal profit which apply to any other industry in a free market economy will apply in the mining industry too.

Why did the Gold standard collapse?

If indeed the gold standard is a workable solution, why did it collapse? To answer this question, we will have to take a voyage through the monetary history of the world. We can keep this topic for a future blog post. Suffice it is to say here that the gold standard did not meet its demise because of any inherent flaws.

Indeed, the gold standard did not collapse – it was abandoned by the government.

——–

A single blog post cannot do justice to a topic as wide as monetary systems. I intend to write more on this in the future. In case you are not convinced regarding some points or feel that more clarity is required, please feel free to drop a comment and I will try to elaborate further.

Day 1 of Robert Wenzel’s 30-day reading list

27 Jun

Henry Stuart Hazlitt (November 28, 1894 – July 9, 1993) was an American economist, philosopher, literary critic and journalist for such publications as The Wall Street Journal, The Nation, The American Mercury, Newsweek, and The New York Times, and he has been recognized as a leading interpreter of economic issues from the perspective of American conservatism and libertarianism – Wikipedia

As per my previous post, I have set out on a task to go through Robert Wenzel’s 30 readings prescribed for an introduction to the Austrian school. The below are my thoughts on the first reading, ‘The Task Confronting Libertarians’ by Henry Hazlitt.

Hazlitt mentions early in the article that libertarians are a minority, and the task laid before them of defending free markets and civil rights is tremendous. It is important to think over this again. We do not realize how pervasive government intervention has become. We regard many activities as unquestionable prerogative of the government- like issuing currency. A lot of conventional brain washing has to be reversed before it may strike someone – why should the government really control the money supply? It is in this sense that libertarians are a minority- what they question has already been settled by the society in favour of the government.

Hazlitt outlines some basic principles which a libertarian can use to defend the free market ideology. They are a nice summary of some standard criticisms against government intervention.

One simple truth that could be endlessly reiterated, and effectively applied to nine-tenths of the statist proposals now being put forward or enacted in such profusion, is that the government has nothing to give to anybody that it doesn’t first take from somebody else.

Any government expenditure has to be met by taxes. A government may borrow, but borrowings too have to be eventually redeemed by the tax payers. In a paper currency system, the government may print money, but printing money is also financed by a covert ‘inflation tax.’ The bottom line- there is no free lunch. We may clamour for government subsidy on petrol, but its our own money that will be used to finance such a subsidy program.

Hazlitt writes,

Thus, it can be pointed out that the modern welfare state is merely a complicated arrangement by which nobody pays for the education of his own children, but everybody pays for the education of everybody else’s children; by which nobody pays his own medical bills, but everybody pays everybody else’s medical bills; by which nobody provides for his own old-age security, but everybody pays for everybody else’s old-age security; and so on.

As noted before, Bastiat exposed the illusive character of all these welfare schemes more than a century ago in his aphorism: “The State is the great fiction by which everybody tries to live at the expense of everybody else.”

Another line of argument against government intervention would be to question “Instead of what?” This would be the opportunity cost argument against government expenditure. For e.g., a tax financed aid program launched by the government would preempt resources from some other use.

The third basic principle of ‘knowing the consequences’ is what I find the most appealing.

Another very important principle to which the libertarian can constantly appeal is to ask the statists to consider the secondary and long-run consequences of their proposals as well as merely their intended direct and immediate consequences.

Lets take an example. The Indian government recently introduced legislation to reserve 25% seats in private schools for students from disadvantaged sections of the society. The ‘direct and immediate’ consequences of this are so attractive that it looks like a great piece of legislation. After all, what could be wrong in giving disadvantaged students access to top class education facilities? Its only when the ‘secondary and long-run consequences’ of this policy are considered that a different picture emerges. What impact will this move have on the supply of quality schooling in India? Does this legislation redeem the government of improving the state of public schools in villages? How will the quality of education be impacted? What does the historical precedent of reservations suggest – like reservations in India’s higher educational institutes? Has the policy worked there against the stated objectives? One also needs to consider the negative effects of the increase in government confidence to introduce such legislation elsewhere. Tomorrow, will the government legislate that out of 4 seats in a car, one seat has to be reserved for a disadvantaged pedestrian?

There are many such questions. One could go on and on. The bottom line being that government intervention, albeit for a noble cause, can bring the baggage of unintended consequences with it. And whats worse is that such unintended consequences only becomes obvious after close examination.

One could mention here an oft repeated point by Milton Friedman – government policy should be evaluated based on its actual impact, not on the basis of its stated objectives.

My own addition to the Hazlitt’s basic principles on how to defend libertarian views-

Its very simple. Replace the word ‘government’ in an argument with the name of a politician – for starters, you can use Lalu Prasad Yadav.

The poor in a society will be looked after by the government.

The poor in a society will be looked after by Lalu Prasad Yadav.

You will immediately see the difference. The first sentence sounds very credible because it evokes images of a paternal body called ‘government’ which looks after its citizens, much like a shepherd looks after his sheep. However, the government is nothing more than the politicians who constitute the government. In this sense, the word ‘government’ is actually an euphemism – an euphemism for corrupt politicians. A point made evident by the second sentence.