Tuesday, March 31, 2009

Some Cool Graphs

If you are interested in economics and like looking at graphs, then you'll love this page at the Mises Institute web site.

The page is full of various graphs, roughly divided into the following categories: Current prices, monetary trends, interest rates, macrotrends, and federal budget.

If you feel overwhelmed by the sheer number of graphs or don't know what most of them represent, never fear. In December '08 Jeffrey Tucker interviewed Mark Thornton, senior fellow at the Mises Institute, to walk through the page and explain what each of the graphs means. Along the way, Thornton also provided commentary on how some of the graphs relate to the current financial meltdown as well as previous recessions. It's quite educational. Click on one of the links below.

Current Market Conditions - Mark Thornton Explains the Mises Institute's "Markets and Data" Web Page (12/15/2008)
Audio Stream / MP3

Sunday, March 29, 2009

Would the Big Guys Still Buy Out All the Little Guys in a Free Market?

I frequently discuss free market economics with my friends. A few of them are free market advocates like I am, but we still ask each other tough, critical questions from time to time. Sometimes we are just playing devil's advocate, but other times we honestly don't know the answer. In one recent discussion I had, one of my friends (a supporter of free markets) asked a good question to which he did not have an answer. I'll paraphrase what he said:

"I understand how government intervention is often used to concentrate wealth in the hands of the politically well-connected. But I still have lingering doubts that a totally free market would prevent wealth from becoming ever more concentrated in the hands of the wealthiest and most powerful people. For example, look what happens to most successful start-up companies. A big competitor inevitably comes along and offers to buy out their business for such an attractive sum that it would be crazy to refuse. So the big guys can just buy out all of the little guys to eliminate the competition and maintain their monopolies, can't they?"

I started to respond but stopped in mid-sentence when I realized I didn't have an answer to the question. My friend had stumped me. A small seed of doubt regarding totally free markets had been planted in the back of my mind.

A few weeks went by. I continued to read books and articles by Austrian economists and libertarian scholars, keeping an eye out for something -- anything -- that might address the hard question my friend had asked. Finally, today as I was reading Thomas Woods's new book Meltdown, a passage on page 48 jumped out at me:

In the wake of the Enron scandal and the dot-com boom and bust, Congress passed Sarbanes-Oxley, a regulatory act that well-established firms came to welcome since they knew it would give them a competitive advantage against newcomers. They had no idea how much. The most recent estimated annual cost to implement it in a public corporation is $3.5 million.

So how does this $3.5 million cost of implementing the Sarbanes-Oxley regulations apply to small businesses choosing to sell out to their much larger competitors? Woods quotes Michael S. Malone from a 2006 Wall Street Journal article:

"The closer you look at Sarbanes-Oxley," writes [Malone], "the more you realize it is almost perfectly designed to crush new business creation.... [$3.5 million is] pocket change for a Fortune 500 company, [but] the entire annual profit of a newly public firm. Is it really any wonder that smart entrepreneurs look for a corporate sugar daddy instead of an IPO?" Add to that Regulation FD ("Fair Disclosure") and the new rules on stock option valuation, and the result is that "fewer new companies are going public; economic power is being concentrated in the hands of fewer companies; competition is reduced; new wealth is less widely distributed; the rich are getting richer; fewer talented people want to join entrepreneurial ventures; and corporate boards are getting stupider and more paranoid." That could be why the biggest, most established firms typically seem to favor additional regulatory burdens. Expect to hear them joining the chorus today, solemnly informing us how sadly necessary additional regulation is.

In other words, one of the main reasons so many entrepreneurial ventures sell out to the big guys rather than "go public" and compete with them is because government regulations have made "going public" prohibitively expensive.

This is a perverse effect of the government on the economy that few people understand. The mountains of government regulations burdening our economy disproportionately harm the small businesses, not the big ones, because the costs of complying with them are typically fixed rather than proportional to a business' size. And in addition to that regulatory strangulation, small businesses must also prepare themselves to do legal battle at any time with large corporations and their teams of highly paid lawyers over "intellectual property" and other anti-competitive schemes -- not an inexpensive undertaking for a small business, to be sure.

The little guys sell out to the big guys not because our economic system is inherently rigged against them, but because our government has made it so through incessant regulation and interference.

Saturday, March 28, 2009

The Cheapest Inflation Hedge

After mentioning some key points from Peter Schiff's 2007 book Crash Proof: How to Profit from the Coming Economic Collapse, I got to thinking about what the cheapest way to save in foreign currencies or physical gold would be. After discussing the matter with a friend, I decided to compare three methods: (1) buying and selling shares of the Merk Hard Currency Fund through a discount broker (many offer free mutual fund transactions), (2) buying and selling "digital gold" through GoldMoney.com, and (3) buying and selling physical gold bullion coins at the local dealer and storing them in a safe deposit box. I didn't consider gold Exchange Traded Funds (ETFs) since I've heard sketchy things about them.

I chose GoldMoney.com as a representative "digital gold" currency since it appears to be fairly legit and is growing in popularity. Basically, when you purchase gold through GoldMoney, they allocate the gold to you (earmark it) and let you choose a secure storage vault from their list. For transactions below $10,000, they sell gold at 2.5% above spot and purchase it at spot, and they charge a yearly fee of 0.2% for storage.

For physical gold bullion coins, I have seen recent buy/sell spreads of around 4%, so for a conservative representative value I assumed 5% on average. In my calculations, I treated the buy/sell spread as a purchase fee of 5% with no sale fee. For storage, I assumed a small safe deposit box at a flat cost of $20 per year.

The first step was to summarize the fees and expenses for each of the three strategies.

Table 1. Fees and expenses for dollar-hedging strategies

The next step was to calculate the total cost per year for each strategy, given various average balances and average rates of transactions. For each average balance and average rate of transactions, I calculated which of the three methods was the least costly over the course of a year (ignoring taxes). The results are presented in the following table:

Table 2. Minimum yearly costs for dollar-hedging strategies

From Table 2, we can see that there is no clear winner in all cases. For a small balance and frequent transactions, the Merk Hard Currency Fund is the winner (however, frequent buying and selling of a mutual fund often results in penalties, and Merk's prospectus warns against it, so maybe it's not really a winner). For balances greater than about $10,000 and a rate of transactions less than about $5,000 per year, physical gold coins are the way to go. For situations intermediate between those two, "digital gold" through GoldMoney.com is the least costly.

Keep in mind, however, that in these calculations I made a few assumptions that may not always be true, and I only compared one factor (yearly expenses) among the strategies. Obviously, there are other factors to consider. For example, the total cost to accumulate one's balance to begin with might be important if you don't plan to maintain the balance for more than a few years. Another example is that a lot of people are hesitant to buy "digital gold" that is stored in someone else's vault, no matter how legit the operation appears to be. The feeling of security and empowerment that comes from possessing physical gold -- at home, in a safe deposit box, buried somewhere in a treasure chest, whatever -- surely places a psychological premium over alternative dollar-hedging strategies in uncertain times. When you hold gold in your own hand, nobody can steal it from you without starting a hell of a fight. By contrast, all the Federal Reserve has to do to steal U.S. dollars from you is print more of them.

Bottom line: Saving money in a basket of "hard" foreign currencies probably isn't a bad idea, but it's likely more expensive than simply buying and selling gold. And isn't gold the hardest currency by definition, anyways? In the long run, how could gold fail to appreciate against any fiat currency?

Monday, March 23, 2009

The Morality of the Free Market

After listening to hundreds of podcasts offered by the Mises Institute and LewRockwell.com over the course of six months or more, I have finally encountered one that I can say is, without a doubt, my favorite one so far.

It is an hour-long speech given by a rabbi named Daniel Lapin at the 2009 Austrian Scholars Conference in Auburn, Alabama. In it, he discusses the morality of making money in a free market. He speaks from a Judeo-Christian perspective, emphasizing Judaism.

There is something about Rabbi Lapin's speech that grabbed hold of me and wouldn't let go. He is an excellent speaker, but that isn't it entirely. I think it's because I'm interdisciplinary at heart, and Lapin's speech is refreshingly interdisciplinary. It bridges the gap between Austro-Libertarian theory and Judeo-Christian wisdom in what I think is a beautiful and coherent way.

A common misperception among Republicans and other non-libertarian conservatives is that libertarianism is inherently hedonistic, greedy, and devoid of morals. To be sure, some libertarians are greedy or hedonistic. But as Rabbi Lapin explains, there is nothing inherently contradictory between freedom and morality in the Judeo-Christian tradition. To the contrary, morality has everything to do with freedom.

When you get a few spare moments, take the time to listen to Rabbi Lapin's excellent speech. I think you'll be glad you did:

Daniel Lapin: It's Moral to Make Money in the Market

Sunday, March 22, 2009

Crash Proof

I try to remain open minded enough to consider convincing evidence or arguments seriously, even if they contradict something I believe or think I know. Peter Schiff's 2007 book Crash Proof is a good example.

Peter Schiff is an open and enthusiastic advocate of Austrian economics and is the president of Euro Pacific Capital Inc., a brokerage firm that specializes in trading foreign securities. He is well known in the Austro-Libertarian community, and is becoming better known in the mainstream media, because he not only successfully predicted the crash of the housing bubble well before it happened, he has also earned a large fortune based on his accurate financial foresight.

In my March 6th post I wrote that rather than shy away from the U.S. stock market in response to the Dow tumbling by 50%, we should instead view the resultingly cheap stocks as a great bargain akin to the 50%-off or buy-one-get-one-free sales we've been seeing lately in the consumer goods sectors. When one wants to buy something, I argued, isn't it better for that person if the thing -- even if it's stock -- is cheap rather than expensive? Although I still think that fundamental rule is sound, and Schiff agrees with it, Crash Proof solidly argues that in a world where reality and public opinion are often painfully at odds with each other, time-tested investment strategies (of the sort found in most investment classics published by Wall Street) sometimes need to be modified in response to widespread insanity.

The particular insanity Schiff writes about in Crash Proof is the combination of the U.S. trade deficit, budget deficit, and national debt (especially when unfunded liabilities such as Social Security are included). The U.S. has rapidly gone from the world's largest creditor nation to its largest debtor nation, and in the process our manufacturing base has almost completely disappeared. Plus, U.S. citizens used to have one of the highest savings rates in the world but are now the world's biggest spenders with a near-zero savings rate.

Schiff explains that economic growth requires capital accumulation by businesses, which requires savings by consumers. The Austrian perspective is that saving is a tradeoff between present and future consumption. When people save, they consume less today in order to consume more in the future, and this sends a signal to the market that production capacity should be increased to meet the higher demand that will be created in the future as the people spend their savings. The market signal is sent in the form of lower interest rates created by the wider availability of loans to businesses as a result of increased savings. Businesses use these loans to accumulate capital, which they then use to expand and improve their operations. That ultimately results in more and cheaper consumer goods, i.e., a higher standard of living. We thus see that in a free market, the individual virtues of thrift and saving create greater prosperity for all. If a country's national savings rate is negative or close to zero, its economy is therefore not growing -- it is shrinking. Such is the case for the U.S. and its debt-ridden citizens.

As for the U.S.'s huge trade deficit, Schiff points out the Austrian observation that a country ultimately "pays" for its imports not with money, but with its exports. The reason for this is that ultimately the money Country A pays for goods from Country B comes back to it when Country B (or some other country that has purchased that money) uses it to purchase goods from Country A. If a country has zero balance of trade, it means that it exports roughly as much stuff as it imports (in terms of units of money). By contrast, a country that exports more stuff than it imports (i.e., it largely "imports" money) has a positive balance of trade, and a country that exports less stuff than it imports (i.e., it largely "exports" money) has a negative balance of trade. The U.S. has a negative balance of trade -- a big-time trade deficit -- because our manufacturing base that used to produce exportable goods has gradually disappeared. By contrast, our biggest trading partner, China, has a positive balance of trade -- a trade surplus -- due largely to their impressive manufacturing base. In effect, the U.S. is getting a "free ride" since China has not yet traded in all those dollars for actual goods. When it eventually decides to do that, all those dollars coming back to the U.S. in search of goods will bid prices up into the stratosphere. And this is in addition to all the new money reserves that U.S. banks have gotten from the Fed but haven't used as a base of an inflationary credit pyramid yet.

So why does creditor China continue to give debtor U.S. a veritable free ride? There may be a variety of reasons, but the biggest one appears to be that the U.S. dollar enjoys special status as the world's reserve currency since the U.S.'s repudiation of the Bretton Woods Agreement in 1971. As long as the dollar remains the reserve currency, China has reasons to accept them in exchange for its exports and hold onto them. However, there is no reason to think that the U.S. dollar will be the world's reserve currency forever. Given how recklessly the U.S. government has been running the printing presses since late 2008 to bail out American corporations in the wake of the financial panic, combined with our nation's sky-high trade and budget deficits and near-zero savings rate, the U.S. dollar appears to be on its way out. And given that a number of "common-sense" investment strategies (e.g., as outlined in investing-for-the-average-Joe type books) depend totally on the U.S. dollar remaining the world's reserve currency, it just might benefit us to reconsider our basic approach to investing.

Schiff suggests a three-pronged strategy to minimize one's exposure to the effect of the tanking U.S. dollar:

  • Invest in foreign stocks: If the U.S. dollar crashes, all business that deal in U.S. dollars (including all U.S. businesses) will crash with it. Select only foreign stocks of companies that do most of their business in foreign currencies rather than U.S. dollars. Choose conservatively by selecting stocks that have sound fundamentals (sound management, reasonable P/E ratio, etc.) and high yields paid in foreign currencies. Especially conservative sectors are energy/oil/gas utilities, commercial real estate, commodities, and natural resources. If investing in a mutual fund, make sure it is unhedged for "currency risk" since that "risk" is the very reason we want to invest in the fund in the first place. The biggest currency risk right now is not that the foreign currency will tank, but rather that the U.S. dollar will. Forget the mainstream warnings about "political risk" whenever investing in established foreign stocks is mentioned. The biggest political risk our investments face right now is from our own government. Schiff suggests that 70-90% of one's investment portfolio should consist of conservative foreign stocks (the rest would be in gold -- see next bullet).
  • Invest in gold: Aside from the fact that gold is the soundest money there is, and that its price is bound to increase dramatically as the government and banks print U.S. dollars like mad, Schiff also points out some more interesting reasons for investing in the yellow metal. One of them is that he thinks people are going to start moving to gold standards after the U.S. dollar collapses, and this might create political pressure for governments to follow suit. If that happens, gold will command a premium above its bullion price by virtue of its being used widely as legal money. Another reason is that the Internet and debit cards make transacting with precious metals easier than it has ever been in the past. Interestingly, despite his enthusiasm for gold investing, he warns that a bubble in mining stocks similar to the dot-com bubble may occur. Schiff suggests that 10-30% of one's investment portfolio should be in gold-related investments such as physical gold and shares of gold mining stock.
  • Stay liquid: If the U.S. dollar tanks, it will be important to have savings not only to handle emergency expenses, but also to take advantage of great bargains that are likely to pop up during the turmoil. Save three to six months' living expenses in U.S. dollars in case of emergencies, but any additional savings that will not be needed immediately should go into foreign currencies to avoid the effects of the declining U.S. dollar. Schiff recommends a diversified mix of relatively sound foreign currencies ("relative" being the operative word), such as can be found in foreign money market funds like the Merck Hard Currency Fund. He also suggests possibly saving money at institutions actually located in foreign countries so that if unbearable conditions force one to leave the U.S., one will have money waiting at the new location. In conditions that bad, it is unlikely that the U.S. government would let citizens leave the country with anything more than the shirt on their back. Everything else would probably be confiscated.

Schiff's advice in Crash Proof is a bit extreme, but I cannot deny that we are living through a rather extreme situation. On the one hand, investment advisors usually point out that the saying, "This time it's different" is one of the most dangerous sentiments in finance, as well as one that is not supported by most historical evidence. I fully agree, but let's not forget that history repeats itself in more than just one way. Mainstream advisors say things like, "The U.S. dollar will not collapse, because previous financial panics have not caused it to do so. History repeats itself, so we'll be fine." To that I respond: "In previous financial panics, government was more limited and our national and personal debt was much lower. This time we have a perfect storm forming around the U.S. dollar, and yet you expect it to survive? Many other paper currencies from the past have been hyperinflated away by governments printing money in a panic, just like our government is doing right now. History repeats itself, so we will not be fine."

If the thrift, discipline, and love of freedom of the American people is simply laying dormant within us and can be reawakened, the U.S. economy will recover and return to greatness someday. But as Schiff convincingly argues, that recovery is not likely to occur as quickly as the Fed-engineered false "recovery" we saw at the end of the dot-com debacle. The reality is that the true engine of economic growth in the U.S. -- a strong manufacturing base, thrifty citizens, and limited government -- has been destroyed over several decades and will take many years to rebuild, if it is rebuilt at all.

Before the American house of cards crashes down completely, might it be worth considering Schiff's advice? It may not be a bad idea to position oneself to survive the demise of the U.S. dollar by investing in conservative foreign stocks and gold and saving cash in foreign currencies.

Thursday, March 19, 2009

A Clarification Regarding Hyperinflation

In my post yesterday, I was not implying that every single aspect of our economic situation today is comparable to that of Weimar Germany in the 1920s. I was simply using that particular historical example for its convenient ability to conjure up in people's minds the image of people pushing around wheelbarrows full of paper money. Lest one make the mistake of thinking that I chose 1920s Weimar Germany as the only example of hyperinflation in history, allow me to clarify.

Here is an alphabetical list of countries, summarized from this Wikipedia page, whose currencies have been destroyed or severely devalued by hyperinflation at least once at some point in history:

Angola (1991-95)
Argentina (1975-91)
Austria (1921-22)
Belarus (1994-2002)
Bolivia (1984-86)
Bosnia-Herzegovina (1993)
Brazil (1986-94)
Bulgaria (1996)
Chile (1971-73)
China (1948-49)
Free City of Danzig (1923)
Georgia (1994)
Germany (1923)
Greece (1944)
Hungary (1944-46)
Israel (1971-86)
Japan (1943-51)
Krajina (1993)
Madagascar (2004-05)
Mozambique (1977-2004)
Nicaragua (1987-90)
Peru (1988-90)
Phillippines (1939-1945)
Poland (1922-24, 1989-91)
Republika Srpska (1993)
Romania (1998-present)
Russia (1921-22, 1991-99)
Turkey (1995-2005)
Ukraine (1993-95)
United States (1775-83, 1861-65)
Yugoslavia (1989-94)
Zaire (1989-96)
Zimbabwe (1980-present)

That last one, Zimbabwe, is an especially good example of hyperinflation since it is still happening at this very moment. On January 16 of this year, Zimbabwe's government issued a $100 trillion paper bill:


I just have to laugh when I witness the utter ignorance of economics displayed by some people when they try to rationalize why hyperinflation must be caused by the free market rather than government. Take this example from Wikipedia describing the "major cause" of Russia's 1992 hyperinflation (Note: I am a huge fan of Wikipedia, it's just that once in a while one inevitably stumbles across questionable statements in its articles):

In 1992, the first year of post-Soviet economic reform, inflation was 2,520%, the major cause being the decontrol of most prices in January.

So decontrol of prices, i.e., free market forces, are what caused the hyperinflation? In other words, as soon as the government stopped controlling prices, those greedy capitalist business owners just started charging whatever the hell they wanted for their goods and services, thus causing prices to soar over 2,500% in a single year?

There's a bit of a problem with that explanation. That 2,500% number doesn't just refer to what business owners in Russia were charging -- by economic logic, it also refers to what consumers in Russia were spending. In order for a voluntary transaction involving money to take place, there must be both a buyer and a seller. A business owner can charge whatever the heck he wants for his stuff, even $100 trillion if he's so inclined. But in order for him to actually get that $100 trillion, he has to find a customer who is not only willing to fork over $100 trillion, but also happens to have $100 trillion. Do you see where I'm going with this? If the price of everything is shooting up by 2,500%, it's not just because businesses are charging ridiculous amounts of money for their stuff. It's also because the consumers have ridiculous amounts of money with which to buy that stuff. Where is all that money coming from? Who prints the money in every country and forces the citizens to use it instead of alternatives like gold and silver coins? I'll give you a hint: it rhymes with "smothernment."

Do you think any country that was ever on a gold standard ever saw "hyperinflation" of its currency, so that its citizens began to push around wheelbarrows full of gold bars and sweep piles of gold coins into the gutter to keep the sidewalks clear? Sounds ridiculous, right? Precisely.

Wednesday, March 18, 2009

Say Bye Bye to the U.S. Dollar

Look at this graph:


It shows what economists call the "monetary base," which in plain English just means the amount of paper money and coins in circulation, plus bank deposits at the Federal Reserve. Banks use their Federal Reserve deposits as a "base" on which to pyramid loans to businesses and consumers.

Look at the gigantic spike near the right-hand side of the graph. Kind of sticks out like a sore thumb, doesn't it? Beginning late last year, the Fed doubled the monetary base within two or three short months. From the graph we can see that the previous doubling of the monetary base took about 14 years.

Enjoy the sales and low prices while they last. At least we have debit cards now, so we won't have to push around wheelbarrows full of paper money like they did in Weimar Germany during their hyperinflation in the 1920s. It'll just be a race to see who can swipe their debit cards the fastest. When the value of the currency falls moment by moment, even seconds can make all the difference.

Sunday, March 15, 2009

Imagine a Private Legal System

My previous blog post concerned the inherent conflict of the tradition of jury "duty" with the Thirteenth Amendment, which prohibits involuntary servitude except for people who have been convicted of a crime. I mentioned the idea of a free-market jury selection process, and understandably I received a couple of questions regarding the viability of a private legal system in the broader sense. In this post I will try to address those questions.

First, I'll digress slightly to point out that libertarianism is by no means a single, undifferentiated political philosophy. Among people who refer to themselves as "libertarian," an entire spectrum exists. At one extreme are mainstream conservatives who merely want to reduce the size and power of government by a vague, but typically moderate, amount -- just reduce a tax here, reject a spending increase there. They still want a government, just one that does not interfere with the free market and our daily lives quite as much as the present one does. At the other extreme are radical conservatives who want to "minimize" government ("minarchy") or abolish it altogether to give way to the free market (anarcho-capitalism). Many minarchists say that the only legitimate functions of government are to provide national defense, police, and courts of law. (Ludwig von Mises, perhaps the most influential Austrian School economist, was a minarchist.) Anarcho-capitalism, on the other hand, holds that there are no legitimate functions of government since the very nature of government -- the initiation of coercive force or the threat thereof -- violates the Non-Aggression Axiom which is the foundation of libertarian political theory. (Murray Rothbard, another of the most influential Austrian School economists, was an anarcho-capitalist.)

Let me be clear that the idea of a private legal system falls at the radical end of the libertarian spectrum -- anarcho-capitalism -- since less radical libertarians think a government legal system is necessary. I cannot present all of the many arguments for and against a free-market legal system in one blog post, so I will attempt to summarize only a few of the major ones. Most of these ideas are taken from Murray Rothbard's libertarian manifesto, For a New Liberty.

Question #1: How can society avoid descending into conflict and chaos in the absence of standardized government courts?

This is typically the first question people ask, but it is far too general to be answered by a specific response. The various aspects of this general question will be addressed in the more specific questions that follow, but for now I'll just point out the contradiction inherent in the position that monopoly is undesirable in most, but not all, areas of life. Why is a monopoly in the farming sector, say, considered a bad thing, yet a monopoly in the legal system is considered a necessity? Is it because courts of law are so important to society? Well, what about farming -- isn't food somewhat important to society? How can we point to two different things that are both important to society, and say that one of them must not allow a monopoly but the other one must have a monopoly?

Question #2: Assuming a private legal system were to exist, how would it be financed?

One possible method of financing would be for people to subscribe voluntarily to a court service, paying a monthly premium and calling upon the court if needed. This would be similar to how insurance companies are financed. Another possible method would be for people simply to pay the private courts a fee whenever they choose to use them, and the convicted criminal or contract-breaker would eventually recompense the plaintiff for that fee. (So if the court finds the accused to be innocent, the plaintiff does not recover the fee. This provides a free-market check against the initiation of frivolous lawsuits, for people will know they are unlikely to recover the court fee unless they have a reasonable case.)

Question #3: Okay, so maybe financing for private courts wouldn't be a problem. But who in their right mind would choose a private court over the credibility and respectability of the public legal system?

Plenty of people already have. The use of private arbitration in lieu of public courts has grown for decades, especially in the insurance industry, a trend that is the exact opposite of what those who argue against private courts say should be happening. Evidently a growing number of people and organizations have found the public courts to be clogged, inefficient, and wasteful, so they are increasingly using the free-market alternative of private arbitration to settle their disputes. Private arbitration businesses have an economic incentive to be as fair and rational as possible. They seek to build a positive reputation for quality in their service just as any other business does.

I would add to Rothbard's explanation that almost every person -- especially every child -- has more than a passing familiarity with this basic libertarian concept of voluntary arbitration. Have two of your friends ever had a silly dispute about something (perhaps an arcane piece of trivia or who was "first") they cannot seem to resolve, and they recognized you as having reasonable knowledge of the topic, so they both agreed to let you arbitrate the dispute by declaring who was correct? One friend probably liked your decision more than the other one did, but if they both considered you knowledgeable on the topic, they most likely respected your decision as "final" in some sense. (One can learn a lot about basic truths of human nature just by watching how children spontaneously interact and organize in the absence of adult direction.)

Question #4: Ah, but who enforces the private arbitrators' decisions? Currently they are enforced by the public courts. Therefore, aren't public courts ultimately required after all?

No, they are not. Private arbitrators' decisions did not become legally binding until 1920, but prior to that year the use of private arbitration had grown rapidly. In fact, in medieval England, the structure of merchant law (which the government's courts handled clumsily and inefficiently) grew up completely in private merchants' courts. From the Middle Ages down to 1920, merchants enforced private arbitration decisions through ostracism and boycott. If a merchant refused to submit to arbitration or ignored a decision, the other merchants published this fact in the trade and refused to deal with the recalcitrant merchant. This typically brought him quickly to his senses. These days, with the Internet and credit ratings, ostracism and boycotting can be even more effective than they ever were in the past.

Question #5: Ostracism and boycott may work to enforce arbitrations in private disputes, but they wouldn't always be appropriate or effective in criminal cases. How would private courts enforce their decisions? Aren't libertarians opposed to the use of physical force?

No, libertarians are not opposed to the use of physical force per se. What they are opposed to is the initiation of physical force. In a criminal case, some sort of physical force has allegedly been initiated by the accused. If the accused is convicted, then enforcing his sentence is not the initiation of force but rather the serving of justice. However, justice can only be served after the accused is convicted. Prior to conviction, any physical force used by private police, judges, or marshals against an accused criminal could later be prosecuted as a crime if the accused is found innocent. In particular, no coercive "subpoena power" would exist. Accused criminals would be notified of their upcoming trial, but they would not be forced to attend (however, showing up would definitely help their case!). In contrast to statist systems, no police and judges in a libertarian society could be granted special immunity to use coercion beyond what other people in the society can use.

Question #6: Given your description of how a private court would enforce its own decisions, wouldn't private courts always tend to convict accused criminals in order to justify any use of physical force by its own marshals and judges -- regardless of whether the accused in fact committed the alleged crime?

No, because just as there is an appeals process in the public court system, a private court system would have one as well. In order to gain credibility with consumers and build a reputation for fairness, private courts would have every incentive to enter agreements with other private courts on a reasonable and fair appeals procedure. The simplest procedure would be to allow the defendant, if convicted in the plaintiff's court, to appeal his case at a court of his own choosing. If that second court also finds him guilty, no more appeals can be made -- the criminal has been convicted. However, if the second court finds him innocent, a third court (agreed upon by both courts beforehand) would act as arbitrator to reach the final decision. Effectively, this would mean that if any two private courts reach the same decision, that decision becomes binding on the guilty. With such an appeals procedure in place, any given court would have even more incentive to render fair and accurate verdicts as consistently as possible. For if the consumers started to notice that a particular private court's decisions were contradicted by arbitrating courts in an unusually large percentage of cases, they would tend to avoid using that court.

Question #7: It sounds like the courts' decisions would all be based largely on custom. But customs can differ by location. How could there be a standard, uniform legal code in a private legal system?

Rothbard explains:

The entire law merchant was developed, not by the State or in State courts, but by private merchant courts. It was only much later that government took over mercantile law from its development in merchants' courts. The same occurred with admiralty law, the entire structure of the law of the sea, shipping, salvages, etc. Here again, the State was not interested, and its jurisdiction did not apply to the high seas; so the shippers themselves took on the task of not only applying, but working out the whole structure of admiralty law in their own private courts. Again, it was only later that the government appropriated admiralty law into its own courts.

He continues:

The major body of Anglo-Saxon law, the justly celebrated common law, was developed over the centuries by competing judges applying time-honored principles rather than the shifting decrees of the State. These principles were not decided upon arbitrarily by any king or legislature; they grew up over the centuries by applying rational -- and very often libertarian -- principles to the cases before them. The idea of following precedent was developed, not as a blind service to the past, but because all the judges of the past had made their decisions in applying the generally accepted common law principles to specific cases and problems. For it was universally held that the judge did not make law (as he often does today); the judge's task, his expertise, was in finding the law in accepted common law principles, and then applying that law to specific cases or to new technological or institutional conditions. The glory of the centuries-long development of the common law is testimony to their success.

In those times, there was no arbitrarily imposed "supreme court" whose decision was binding, nor was precedent (albeit honored) considered automatically binding.

Question #8: But who will appoint the judges to let them perform the task of defining the law?

As the libertarian Italian jurist Bruno Leoni wrote: the people themselves, people who choose the judges with the best reputations and greatest expertise and wisdom:

The appointment of judges is not such a special problem as would be, for example, that of "appointing" physicists or doctors or other kinds of learned and experienced people. The emergence of good professional people in any society is only apparently due to official appointments, if any. It is, in fact, based on a widespread consent on the part of clients, colleagues, and the public at large -- a consent without which no appointment is really effective. Of course, people can be wrong about the true value chosen as being worthy, but these difficulties in their choice are inescapable in any kind of choice.

Question #9: This is all fine and good in theory, but there's no way a private, libertarian legal system would work in the real world. Is there any evidence that this theoretical libertarian nonsense actually works?

Absolutely. I already mentioned the libertarian historical development of merchant law, admiralty law, and Anglo-Saxon common law. But perhaps the most impressive historical example of a society of libertarian law and courts was neglected by historians until relatively recently. And we're not just talking about a society where only the courts and law were libertarian -- we're talking about a society that was completely without a State. It was ancient Celtic Ireland.

Ancient Ireland was libertarian for about a thousand years before it was conquered by England in the seventeenth century. It was by no means a "primitive" society; it was the most advanced, most scholarly, and most civilized society in all of Western Europe for centuries. As Joseph R. Peden, an authority on ancient Irish law, wrote in the Journal of Libertarian Studies in 1977, "There was no legislature, no bailiffs, no police, no public enforcement of justice... There was no trace of State-administered justice."

How's that for evidence that libertarianism can actually work in the real world?

Question #10: Okay, in this single blog post you've won me over to the idea that a private legal system in a libertarian society works in theory and can also work (because it has worked!) in the real world. Where can I learn more about this absolutely fascinating topic?

Outstanding! Start by reading pp. 275-290 from Murray Rothbard's For a New Liberty. It's a free download from the Mises Institute web site. He gives some references and footnotes in that section if you're hungry for further reading. While you're at it, read the whole book. It'll open your mind to a whole new universe of possibilities in political philosophy and economics. Also, I've read one other book titled Complete Liberty by a guy named Wes Bertrand that has sections discussing certain aspects of law in the absence of a State.

Tuesday, March 10, 2009

Jury "Duty" and the Thirteenth Amendment

I had to report for jury selection today. Every single one of the 150+ people sitting with me in the jury room from 8:00 AM to 3:00 PM (when we were dismissed) had pretty much their entire day wasted. No one was called into a courtroom. So I had seven full hours to ponder the nature of our hallowed jury selection system.

The instructor told us that Los Angeles County used to summon jurors based on the registered voter list, but eventually people stopped registering to vote. Now it summons jurors from two lists: (1) registered voters and (2) drivers registered through the DMV. As the Missing Persons' '80s pop song "Walking in L.A." declares, nobody walks in L.A. (nor do most of them use mass transit). So the second list covers most everyone who speaks English -- and a good chunk of the ones who don't. Pretty big selection pool, right? You bet. And yet the instructor told us they usually cycle through the list completely every 12 to 18 months. That's a heck of a lot of court cases -- and a heck of a lot of involuntary servitude!

Wait... involuntary servitude? Slavery? Doesn't the Thirteenth Amendment to the U.S. Constitution guarantee us freedom from that? Indeed it does. Read it yourself:

Neither slavery nor involuntary servitude, except as a punishment for crime where of the party shall have been duly convicted, shall exist within the United States, or any place subject to their jurisdiction.

But how does one reconcile that with Article Three of the U.S. Constitution and the Sixth, Seventh, and Fourteenth Amendments, all of which guarantee or preserve the right to a trial by jury? If the government doesn't force people to serve as jurors, how can those parts of the Constitution be upheld? Simple. People are so used to the existing jury selection system that they forget the government does not necessarily have to force people to serve as jurors.

As Murray Rothbard writes on p. 110 of For a New Liberty:

...there is [a] cornerstone of the judicial system which has unaccountably gone unchallenged, even by libertarians, for far too long. This is compulsory jury service. There is little difference in kind, though obviously a great difference in degree, between compulsory jury duty and conscription; both are enslavement, both compel the individual to perform tasks on the State’s behalf and at the State’s bidding. And both are a function of pay at slave wages. Just as the shortage of voluntary enlistees in the army is a function of a pay scale far below the market wage, so the abysmally low pay for jury service insures that, even if jury “enlistments” were possible, not many would be forthcoming. Furthermore, not only are jurors coerced into attending and serving on juries, but sometimes they are locked behind closed doors for many weeks, and prohibited from reading newspapers. What is this but prison and involuntary servitude for noncriminals?

In other words, why doesn't the government offer to pay jurors a wage that is high enough that the needed number of jurors will voluntarily serve? Is slave labor really necessary? Rothbard continues:

It will be objected that jury service is a highly important civic function, and insures a fair trial which a defendant may not obtain from the judge, especially since the judge is part of the State system and therefore liable to be partial to the prosecutor’s case. Very true, but precisely because the service is so vital, it is particularly important that it be performed by people who do it gladly, and voluntarily. Have we forgotten that free labor is happier and more efficient than slave labor? The abolition of jury-slavery should be a vital plank in any libertarian platform. The judges are not conscripted; neither are the opposing lawyers; and neither should the jurors.

Imagine what jury selection would be like in a free-market, libertarian society. Think of the focus on efficiency and customer satisfaction that exists in the less regulated sectors of the economy. Now apply it to the legal system. Can you imagine walking into a courthouse, greeted not by blank expressions and robotic orders mumbled by condescending government bureaucrats, but by smiles and welcomes offered by private-sector employees who have an economic incentive to treat you with respect? Can you imagine not wasting most of an entire day sitting in a waiting room, but getting selected or dismissed as quickly as possible by employees who have an economic incentive to minimize your time spent waiting (since they are paying you dearly for your time)? And can you imagine not being forced to serve as a juror, but choosing to do it based on the competitive wage offered by the court?

Imagining a different world is the first step towards bringing it into existence.

Friday, March 6, 2009

Buy High and Sell Low?

Down, down, down... the Dow just keeps on falling. The Dow dropped below 7,000 this past week to a 12-year low that represents a 52% drop from its record high in October 2007. Yikes.

Today we see financial writers and commentators wailing and gnashing their teeth, grumbling about how the stock market is currently a terrible place for one's investment funds. As we watch the stock market indexes tumble lower and lower, with no end in sight, many of us are inclined to jump on the anti-stock bandwagon. But wait, haven't we seen this before? Wasn't it like this when the dot-com stock bubble burst, too? The conventional wisdom during financial booms is invariably to buy, buy, buy. And the conventional wisdom following bubble-bursts is always to sell, sell, sell. If you think about it, this is just another way of saying that the conventional wisdom is to buy high and sell low. Say what?

Billionaire investing legend Warren Buffett wrote in his 1997 Chairman's letter to the shareholders of Berkshire Hathaway:

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

This means that long-term investors who don't plan to retire within the next few years -- this applies especially to 20- and 30-somethings -- should be happy that the Dow is taking a dive. Not only that, but the lower it goes, the more of it they should buy! Warren Buffett put his money where his mouth is during the 1973-74 bear market, in which he purchased a stake in the Washington Post Company, which subsequently increased in price by a factor of over 100.

Warren Buffett is only one of the many financial titans to have taken advantage of low, low prices during economic panics and depressions. There is a famous quote attributed to 18th century British nobleman Baron Rothschild of the (in)famous Rothschild banking dynasty:

The time to buy is when there's blood in the streets.

The quote is a bit grisly, but it gets the point across. Some people forget that in every transaction -- even during crises -- every seller has a corresponding buyer. When the Dow plunges 52%, that does not mean 52% of the real wealth represented by the stock market has just disappeared. All the shares are still there. All the physical buildings, people, and resources are still there. They have just shifted into a different (usually smaller) set of hands. Wealth has been redistributed. In a panic, the majority of emotion-driven investors sell their stocks to a minority of savvy investors. And those same savvy investors subsequently make a fortune selling those same stocks at a much higher price back to the majority of emotion-driven investors during the next financial boom.

Despite all the wailing about Financial Doomsday, as long as our economy remains capitalist, the stock market is here to stay. As Austrian economist Ludwig von Mises pointed out, there is no capitalism without a stock market. If the stock market disappears, it doesn't matter what you have invested your wealth in -- whether it's bonds, cash, precious metals, or collectable Star Wars action figures -- because that will disappear as well. In the absence of capitalism, the government ultimately owns everything, including you. The death of capitalism is certainly a possibility since the federal government has been nationalizing the U.S. economy in leaps and bounds since the present financial crisis began. But if it happens, it happens -- there is no saving or planning for it.

But if this blatant attack on capitalism by government fails, the stock market will survive. It will eventually bottom out and rise again. It always has and always will. Instead of looking for "safe haven" investments during financial panics, maybe we should consider buying even more stocks as the prices are plunging. The exclamation "What a deal!" doesn't just apply to promotional value meals at McDonald's and after-Thanksgiving sales at Macy's. It applies equally well to stocks after a sharp and emotional market plunge.

Thursday, March 5, 2009

Jury Nullification

A couple of weeks ago I received a jury summons in the mail. Coincidentally, shortly afterwards I listened to a Mises Institute podcast that happened to explain the concept of jury nullification. Either I never learned that concept in school or, if I did, I promptly forgot it. Tonight, I came across this article written by Jacob G. Hornberger that reiterates the concept of jury nullification.

In a nutshell, jury nullification is the power of a juror to decide not only the facts, but also the law, of a case brought before him. This idea appears to be controversial today, but it shouldn't be. What the Constitution means by the right to trial by jury can be clearly understood from what trial by jury meant immediately before the Constitution was ratified. Pages 95-98 of this paper by James Ostrowski provide quotes by Thomas Jefferson, John Adams, Alexander Hamilton, and others which say a jury has the power to decide both the facts and the law of a case. Even John Jay, the first Chief Justice himself, instructed a jury in a 1794 civil case as follows (boldface mine):

[O]n questions of fact, it is the province of the jury, on questions of law, it is the province of the court to decide. But it must be recognized that by the same law, which recognizes this reasonable distribution of jurisdiction, you have nevertheless a right to take upon yourselves to judge of both, and to determine the law as well as the fact in controversy. On this, and on every other occasion, we have no doubt, you [the jury] will pay that respect, which is due to the opinion of the court: For, as on the one hand, it is presumed, that juries are the best judges of facts it is, on the other hand, presumable, that the courts are the best judge of the law. But still both objects are lawfully, within your power of decision.

I find that one of the most interesting aspects of the power of jury nullification (aside from the power itself) is that judges do not inform jurors of it. In fact, judges often mislead jurors into thinking that they have the power to decide only the facts, not the law, of a case. So unless jurors have already been educated outside of court regarding jury nullification, judges leave them ignorant regarding the full extent of their powers. Ostrowski summarizes in the conclusion to his paper:

Jury nullification has gone through the following transformations over the last several hundred years:
  • A practice which subjects jurors to punishment by the court—England, circa 1500.
  • A right which may not be punished—England, circa 1670.
  • A power subject to no judicial review—U.S., 1895.
  • A power about which the court and the lawyers may not inform jurors—U.S., circa, 1980.
  • A practice which subjects jurors to punishment by the court—U.S., 2000.
Modern, sophisticated legal analysis has succeeded in taking our jury system back to medieval England.

I'll certainly have something to think about as my potential jury duty next week approaches. The courts are starting to crack down heavily on jury nullification, despite its advocacy (intelligently and ethically applied, of course) by John Jay, Jefferson, Adams, Hamilton, et al. If I am asked about my views on jury nullification, I plan to be ready with a well-supported answer in favor of it.

Tuesday, March 3, 2009

Speculators Stabilize Prices

One of the most pervasive and persistent economic fallacies -- even among many people who claim to advocate free markets -- is that the speculator disrupts markets by making prices more volatile. In fact, the opposite is true.

In Walter Block's witty and iconoclastic book Defending the Undefendable, in which he puts the free market's most extreme and controversial cases to the test, he makes the following bold claim that I can almost guarantee you never heard in school: "The popular hatred for the speculator is as great a perversion of justice as can be imagined." The surprising reason is that the speculator, despite his selfish attempt to turn a profit by buying low and selling high, actually promotes the public good. Adam Smith described this counterintuitive truth in his 1776 classic The Wealth of Nations:

Every individual endeavors to employ his capital so that its produce may be of the greatest value. He generally neither intends to promote the public interest, nor knows how much he is promoting it. And he intends only his own security, his own gain. He is led in this as if by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it.

The successful speculator is an example of a person who acts in his own selfish interest, yet (usually without knowing or caring) promotes the public good. The frequent objection is that speculators cause prices to rise or become volatile, but the overall effect of speculators is rather to stabilize prices. Walter Block explains using the example of food:

In times of plenty, when food prices are unusually low, the speculator buys. He takes some of the food off the market, thus causing prices to rise. In the lean years which follow, this stored food goes on the market, thus causing prices to fall. Of course, food will be costly during a famine, and the speculator will sell it for more than his original purchase price. But food will not be as costly as it would have been without his activity! (It should be remembered that the speculator does not cause food shortages which are usually the result of crop failures and other natural or man-made disasters.)

Block goes on to emphasize that the effect of the successful speculator on food prices is not to make them more volatile, but rather to level them off. The effect on him is to earn profits: the market's way of compensating him for his valuable service. Effectively, what the speculator does is to relieve other people of certain financial risks and volatility in exchange for a "fee." Block concludes:

Yet instead of honoring the speculator, demagogues and their followers revile him. But prohibiting food speculation has the same effect on society as preventing squirrels from storing up nuts for winter -- it leads to starvation.

He has a point. And the food example can be applied to just about any other commodity or asset. "But what about unsuccessful speculators," you ask? Block points out that the occasional unsuccessful speculator tends to lose his capital due to his lack of predictive skill. Eventually he is forced into another line of work for which he is better suited -- the market weeds him out. "Ah," you say, "but what about the unsuccessful speculators that appear in droves during financial bubbles, masses of lemmings who blindly follow each other into the financial stratosphere until the bubble bursts, at which point most of them lose everything? Surely you aren't trying to tell me that they are promoting the public good!"

Not necessarily. However, given that speculators earn profits by buying low and selling high, we should ask ourselves whether, in financial bubbles, an obscenely large number of otherwise skilled and intelligent speculators start "recklessly" investing capital not because they are collectively insane, but because there is something in the economy that is in fact artificially undervalued (kept below its market price). I asked myself that question, and here is the answer I found: Such an artificially undervalued "something" does exist during financial bubbles. It is bank credit itself -- driven to bargain-basement interest rates and incredibly lax lending standards as a direct result of government intervention.

Many people forget that bank credit, like any other commodity or asset, has a "price": the interest rate. An artificially low interest rate enforced by the Federal Reserve System means "cheap" bank credit, and as we have just seen, speculators are eager to buy things that seem unusually cheap in the hopes of selling them later when their price better reflects reality. So of course speculators (and businesses in their speculative roles) will take out more bank loans than usual during Fed-fueled credit expansions. If the expansion is sustained over a number of years, even the most street-smart speculators who recognize the beginnings of the bubble may have no choice but to play along in order to avoid being forced out of business by their competition. Even the legendary billionaire investor Warren Buffett recently admitted to doing "some dumb things in investments" last year.

Since the Fed so severely distorts our money system, which results in false market signals automatically feeding everyone with the same misleading, overoptimistic information, it should not be a mystery why speculators far and wide appear to become infected by insatiable greed and even collective mania during financial bubbles. In the absence of government intervention, the self-regulating processes of the free market do not sustain such madness and disorder. Only government is capable of such massive failure.

Give the successful speculator a break for once. Better yet, give him a pat on the back. He deserves it.

Investor "Irrationality," Perennial Scapegoat

Forget the Austrian School's logical explanation way back in the 1920s that central banks (such as our very own Fed) are ultimately responsible for boom-bust cycles in the economy.

Expansionary booms and their subsequent depressions are caused not by the Fed's monetary expansion, but by... well, there's really no easy way to say this: they're caused by you. And those irrational emotions of yours. How could you?

The argument that investor psychology has been the main culprit in history's economic manias and their subsequent meltdowns is quite common. It is found in books such as Charles MacKay's Extraordinary Popular Delusions and the Madness of Crowds (1841), John Kenneth Galbraith's The Great Crash of 1929 (1954), Edward Chancellor's Devil Take the Hindmost: A History of Financial Speculation (1999), and Robert Shiller's Irrational Exuberance (2000).

The government loves to blame its own screw-ups on private-sector "irrationality," because human "irrationality" is supposedly the ultimate reason for government's very existence: it must protect us from our wild, uncontrollable, passionate, murderous tendencies.

Perhaps, but isn't the government simply an organization of humans, just as the free market is? Isn't it just as human as any other organization that consists of human members? So what is the real distinction between government and non-government?

I don't dispute for one moment that human emotion can be humorously, and even dangerously, irrational. My day-to-day experiences with other people -- and myself -- are enough to convince me of that basic human truth. So how can I deny that investor psychology plays a critical role in economic manias and depressions? I can't. It most certainly does.

But to ignore the Fed's massive distortion of a key market signal, the interest rate, through its expansion of the money supply and lowering of the interest rate, and then to point the finger at "irrational exuberance" as the main component of economic boom-bust cycles, is like leaving all the windows in one's house open on a hot day, turning on the thermostat, and then blaming the thermostat for wastefully running the air conditioner non-stop. It mistakes a superficial cause for a far more fundamental one.

Investor psychology is powerful, but so are interest rates. They are both "forces" in economics. Leave the free market alone, and interest rates will rise in response to investor optimism fueled by affordable credit. Relatively quickly, the interest rates will rise high enough that optimism becomes tamed and reverses itself before anything resembling an economy-wide "bubble" ever has a chance to form. But as the optimism cools, demand for credit correspondingly drops, which causes interest rates to lower in response. This prevents capital investment from drying up completely, so pessimism does not cause a full-blown depression. Stability, not wild oscillation, is what results from this interplay: a balance between supply of and demand for credit, between future and present consumption, between optimism and reality.