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P. 1
TEN GREAT ECONOMIC MYTHS

TEN GREAT ECONOMIC MYTHS

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Published by: Mises Fan on Oct 07, 2012
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The
FreeMarket
TEN
GREAT
ECONOMICMYTHS
PartI
byMurrayN.
Rothbard
Our
country
is
beset
by
alarge
number
of
economicmyths
that
distort
public
thinking
on
important
problems
and
leadus
to
accept
unsound
and
dangerous
government
policies.
Here
are
ten
of
the
mostdangerous
of
these
mythsand
an
analysis
ofwhat
is
wrong
withthem.
Myth
#1
Deficitsarethecause
of
inflation;deficitshave
nothing
todo
with
inflation.
In
recent
decadeswe
always
have
had
federaldeficits.
The
invariableresponse
oftheparty
out
of
power,
whicheverit
maybe,
is
todenounce
those
deficitsas
being
the
cause
ofourchronic
inflation.
And
the
invariableresponse
of
what'
ever
party
is
in
power
has
beento
claim
that
deficits
havenothingtodowith
inflation.
Both
opposing
statements
are
myths.
Deficits
mean
that
the
federal
government
is
spendingmore
than
it
is
taking
inin
taxes.
Those
deficits
canbe
financed
in
two
ways.If
they
are
financedby
sellingTreasury
bondsto
the
public,
thenthe
deficitsare
not
inflationary.
No
new
money
is
created;people
and
institutions
simply
draw
downtheir
bank
deposits
to
pay
for
the
bonds,
andthe
Treasuryspends
that
money.
Money
has
simply
beentrans,
ferredfrom
the
public
to
the
Treasury,
andthenthe
money
is
spent
on
other
members
of
the
public.
On
theotherhand,the
deficit
may
be
financed
by
selling
bondsto
the
banking
system.If
that
occurs,
the
banks
create
new
moneyby
creating
new
bank
deposits
and
using
themtobuy
the
bonds.
The
new
money,
in
the
form
of
bank
deposits,
is
then
spentby
the
Treasury,
and
thereby
enters
<><
~.
permanently
intothe
spendingstream
of
the
economy,raisingprices
and
causinginflation.Byacomplexprocess,
the
FederalReserveenables
the
banksto
create
the
new
moneyby
generating
bank
reserves
ofone,tenth
that
Professor
MurrayRothbardandDirector
LewRockwell
atthe
MisesInstitute's
GoldStandard
Conference.
amount.Thus,ifbanks
are
tobuy
$100billion
of
new
bondsto
finance
the
deficit,
the
Fedbuys
approximately$10bil,lion
of
old
Treasury
bonds.This
purchase
increases
bank
reserves
by
$10billion,allowing
thebankstopyramid
the
creation
of
new
bank
deposits
or
moneyby
ten
times
that
amount.Inshort,thegovernment
and
thebanking
systemit
controlsin
effect
"print"new
moneyto
pay
for
the
federaldeficit.
Thus,
deficitsare
inflationary
totheextent
that
they
arefinanced
bythebanking
system;
they
are
not
inflationary
totheextentthey
are
underwrittenby
the
public.
Some
policymakers
pointto
the
1982,83
period,
when
deficitswereaccelerating
and
inflation
was
abating,
asastatistical"proof"
that
deficits
and
inflation
have
no
relation
toeach
other.
This
is
no
proofat
all.
Generalprice
changes
are
determinedby
two
factors:
the
supplyof,
andthe
de,
mand
for,money.
During
1982,83
the
Fedcreatednew
moneyat
avery
high
rate,
approximately
at
15
percentperannum.
Much
of
this
wentto
finance
the
expanding
deficit.
But
on
theotherhand,the
severedepression
of
thosetwo
(Continued
on
page2.)
1
 
2
(Continued
from
page
1.)
thosetwo
yearsincreased
thedemand
for
money
(Le.low,
ered
the
desire
to
spendmoney
on
goods),
in
response
tothe
severebusinesslosses.
This
temporarily
compensatingin,
crease
inthedemand
for
money
does
not
make
deficits
any
the
lessinflationary.
In
fact,asrecoveryproceeds,
spending
willpick
up
andthedemand
for
money
willfall,
andthe
spending
ofthe
new
money
willaccelerateinflation.
Myth
#2
Deficitsdo
not
haveacrowding-outeffect
on
privateinvestment.
In
recent
years
therehasbeen
an
understandableworryover
the
low
rate
of
saving
and
investment
intheUnited
States.
One
worry
is
that
the
enormous
federaldeficitswill
divert
savings
to
unproductivegovernmentspending
and
thereby
crowd
out
productiveinvestment,
generating
ever,greater
long,run
problems
in
advancingoreven
maintain'
ing
the
living
standards
ofthe
public.
Administration
spokesmen
haveonce
again
attempted
torebut
thischarge
by
statistics.
In
1982,83,
they
declare,deficitswere
high
and
increasing,while
interest
ratesfell,
thereby
indicating
that
deficits
have
no
crowding,out
effect.
Thisargumentonce
againshows
the
fallacy
of
trying
to
refutelogic
with
statistics.
Interest
ratesfellbecause
ofthe
drop
of
business
borrowing
in
arecession."Real"
interest
rates(interestrates
minus
the
inflation
rate)stayed
unprece,dentedly
high,
however
-
partly
because
most
of
usexpect
renewedheavy
inflation,
partly
because
of
the
crowding,out
effect.
Inany
case,statistics
cannot
refutelogic;
and
logictellsus
that
ifsavingsgo
into
governmentbonds,there
willnecessarily
be
lesssavingsavailablefor
productiveinvest'
ment
than
there
would
havebeen,
and
interest
rateswill
behigher
than
theywouldhave
beenwithoutthe
deficits.Ifdeficitsare
financed
bythe
public,
then
this
diversion
of
savings
intogovernment
projects
is
direct
and
palpable.If
the
deficitsare
financed
by
bank
inflation,
then
the
diver'
sion
is
indirect,
the
crowding,outnowtaking
place
by
the
new
money"printed"by
the
governmentcompeting
forresources
witholdmoney
saved
by
the
public.
Milton
Friedman
tries
torebutthe
crowding,out
effect
of
deficits
by
claiming
that
all
government
spending,
not
just
deficits,equallycrowds
out
private
savings
and
investment.
It
is
true
that
moneysiphoned
off
by
taxes
could
also
have
gone
into
private
savings
and
investment.But
deficits
have
afargreater
crowding,out
effect
than
overallspending,sincedeficits
financedby
the
publicobviously
tap
savings
and
savingsalone,whereastaxes
reduce
the
public's
con,
sumption
aswellassavings.
Thus,
deficits,
whichever
way
youlook
at
them,
causegrave
economic
problems.If
they
are
financed
by
thebank,
ingsystem,
they
areinflationary.
Buteven
if
they
are
financed
by
the
public,
they
willstillcauseseverecrowding
out
effects,
diverting
much,needed
savings
from
productive
private
investment
to
wasteful
government
projects.
And,
furthermore,
the
greater
the
deficits
the
greater
the
perma
nent
incometax
burden
on
theAmerican
people
to
pay
for
themounting
interestpayments,
a
problem
aggravatedby
the
highinterest
rates
broughtabout
byinflationary
defi,cits.
Myth
#3
Taxincreasesareacurefordeficits.
Those
people
who
are
properlyworried
about
the
deficit
unfortunately
offer
an
unacceptable
solution:increasingtaxes.
Curing
deficits
by
raisingtaxes
is
equivalentto
curing
someone's
bronchitisbyshooting
him.
The
"cure"
is
farworse
than
the
disease.
For
one
reason,
as
many
critics
have
pointed
out,
raisingtaxessimplygives
the
governmentmore
money,
and
so
the
politicians
and
bureaucrats
arelikely
to
reactby
rais
.
expenditures
stillfurther.
Parkinson
saiditall
in
hisfamous"Law":
"Expenditures
rise
to
meet
income:'If
the
govern
ment
is
willing
to
have,
say,a20
percent
deficit,itwill
handle
high
revenues
by
raising
spending
still
more
tomaintainthe
same
proportionof
deficit.
Butevenapart
fromthis
shrewdjudgmentin
politicalpsychology,
whyshouldanyone
believe
that
a
tax
is
better
than
a
higher
price?
It
is
true
that
inflation
is
aform
oftaxation,inwhich
the
government
and
other-earlyreceivers
of
new
money
areable
to
expropriate
the
members
ofthe
publicwhose
income
rises
laterin
the
process
of
inflation.
But,
at
least
with
inflation,peoplearestill
reaping
some
ofthe
benefits
of
exchange.If
bread
rises
to
$10aloaf,this
is
unfortunate,
but
at
least
you
can
still
eat
the
bread.But
iftaxesgo
up,
yourmoney
is
expropriated
for
the
benefit
of
politicians
and
bureaucrats,
and
you
areleft
with
no
service
or
benefit.
The
only
result
is
that
the
producers'money
is
confiscatedfor
the
benefit
of
a
bureaucracy
that
adds
insult
to
injuryby
using
partof
that
confiscated
money
to
push
the
public
around.
No,the
only
sound
cure
fordeficits
is
asimple
but
vir,tually
unmentioned
one:
cutthe
federal
budget.
Howand
where?
Anywhere
and
everywhere.
I.
 
Myth
#4
EverytimetheFedtightensthe
money
sup
..
-
••.
V
ply,interestratesrise(orfall);everytimetheFedexpandsthe
money
supply,interestratesrise(orfall).
The
financialpress
now
knows
enough
economics
towatch
weekly
money
supplyfigureslikehawks;
but
they
inevitablyinterpr.etthesefigures
in
a
chaotic
fashion.If
themoney
supplyrises,
this
is
interpreted
asloweringinterestrates
and
inflationary;it
is
also
interpreted,often
inthe
verysamearticle,asraising
interest
rates.
And
viceversa.If
the
Fedtightens
thegrowthof
money,it
is
interpreted
as
both
raising
interest
rates
and
lowering
them.
Sometimesitseems
that
all
Fed
actions,
no
matterhow
contradictory,
must
result
in
raising
interest
rates.Clearly
something
is
very
wrong
here.
The
problemhere
is
that,
as
inthe
case
of
pricelevels,
there
areseveralcausalfactors
operating
on
interest
rates
and
in
differentdirections.If
the
Fed
expands
the
money
supply,itdoesso
by
generating
more
bank
reserves
and
thereby
expanding
the
supply
of
bank
credit
andbank
deposits.
The
expansion
of
credit
necessarily
means
an
increasedsupply
in
the
credit
market
and
hence
alowering
~ . , - .
the
price
of
credit,
ortherate
of
interest.
On
the
other
hand,
if
the
Fedrestricts
the
supply
of
credit
andthe
growth
ofthe
money
supply,this
means
that
the
supply
in
the
credit
market
declines,
and
this
shouldmean
arise
in
interest
rates.
And
this
is
precisely
whathappens
in
the
firstdecade
or
two
ofchronic
inflation.
Fedexpansion
lowers
interest
rates;
Fedtightening
raises
them.But
after
thisperiod,
the
public
and
themarket
begin
tocatch
on
towhat
is
happen
ing.
They
begin
to
realize
that
inflation
is
chronic
because
of
the
systemic
expansion
of
the
money
supply.
When
they
realizethisfact
of
life,
they
willalsorealize
that
inflation
wipes
out
the
creditor
for
the
benefit
ofthe
debtor.
Thus,
if
someonegrants
a
loanat
5%for
one
year,
and
there
is
7%inflationfor
that
year,
the
creditor
loses,
not
gains.
He
loses2%,since
he
gets
paidback
in
dollars
that
are
nowworth
7%less
in
purchasing
power.Correspondingly,
thedebtor
gains
by
inflation.
As
creditorsbegin
tocatchon,they
place
an
inflation
premium
on
the
interest
rate,
and
debtors
will
be
willing
to
pay.
Hence,in
the
long-run
anything
which
fuels
the
expectations
of
inflationwillraiseinflation
premiums
on
0-.
/interest
rates;
and
anything
which
dampens
those
expectationswilllower
those
premiums.
Therefore,
a
Fedtighten
ingwill
now
tend
todampen
inflationaryexpectations
and
lower
interestrates;aFed
expansion
willwhip
upthoseexpectations
again
and
raise
them.
There
aretwo,oppositecausal
chains
at
work.
And
soFed
expansion
orcontractioncan
either
raise
or
lower
interest
rates,
depending
on
which
causal
chain
is
stronger.
Which
will
be
stronger?
There
is
no
way
toknow
forsure.
In
the
earlydecades
of
inflation,
there
is
no
inflationpre
mium;
inthe
laterdecades,
such
asweare
now
in,
there
is.
The
relative
strength
and
reaction
times
depend
onthe
subjectiveexpectations
of
the
public,
and
these
cannot
be
forecast
with
certainty.
And
this
is
one
reasonwhy
economic
forecasts
can
neverbe
madewith
certainty.
Myth
#5
Economists,usingchartsor
high
speed
com
..
putermodels,canaccuratelyforecastthefuture.
The
problem
of
forecasting
interest
ratesillustrates
the
pitfalls
of
forecasting
in
general.Peopleare
contrary
cusseswhosebehavior,
thank
goodness,
cannot
be
forecastprecisely
in
advance.
Their
values,ideas,expectations,
and
knowledge
change
all
the
time,
and
changein
an
unpredict
able
manner.
What
economist,forexample,
could
have
forecast(or
did
forecast)
the
CabbagePatch
Kidcraze
ofthe
Christmas
season
of
1983?
Every
economicquantity,
everyprice,purchase,
or
income
figure
is
theembodiment
of
thousands,
even
millions,
of
unpredictable
choices
by
individuals.
Many
studies,formal
and
informal,
have
beenmade
of
the
record
of
forecasting
by
economists,
and
ithas
been
consistentlyabysmal.Forecasters
oftencomplain
that
theycando
well
enough
as
long
as
currenttrendscontinue;
what
they
have
difficulty
indoing
is
catching
changes
in
trend.
But
of
course
there
is
no
trick
in
extrapolating
currenttrendsinto
the
near
future.You
don't
need
sophisticated
computer
modelsfor
that;
you
cando
it
better
and
far
more
cheaply
by
usingaruler.
The
realtrick
is
precisely
to
forecast
when
and
howtrends
willchange,
and
forecasters
have
been
notoriously
bad
at
that.
No
economist
forecast
thedepthof
the
1981-82depression,
andnone
predicted
thestrength
of
the
1983
boom.
The
next
time
you
areswayed
by
the
jargon
or
seemingexpertise
of
the
economic
forecaster,askyourselfthisquestion:If
hecan
really
predict
the
future
sowell,
why
is
he
wastinghistime
putting
out
newsletters
or
doingconsulting
whenhe
himself
could
be
making
trillions
of
dollars
inthe
stock
and
commodity
markets?
(Continued
on
page4.)
3

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