Unquestionably, one of the most effective forms of communication is a thoughtful letter written to a person in answer to his own question.
The staff members of the Foundation for Economic Education write thousands of such letters each year. Some of these are, in effect, short articles on “general interest” subjects not fully covered in previous FEE publications.
A selection of these letters—slightly edited to eliminate extraneous references—will be published in this section from time to time.

Causes of Depressions

Dear Mr. H:

To help in answering your question about the causes of depressions, copies of several articles are being sent to you under separate cover. Perhaps the most extensive and thorough study of the subject has been made by Dr. Ludwig von Mises, and you will find a copy of one of his speeches, Economic Planning, in the package. If you are interested in pursuing this subject further, I would suggest that you take a look at his major work, Human Action (Yale University Press, 1949), especially Chapter XX, which deals with “Interest, Credit Expansion and the Trade Cycle.” Meanwhile, I shall attempt a few brief words of explanation on this subject, myself.

All persons make mistakes from time to time. No person is omniscient. No one can foresee with absolute certainty new inventions or discoveries which will make past methods and products obsolete. Everyone may make mistakes in judgment. Probably many persons bought buggies, in the belief that the horseless carriage was just a passing fancy. An individual who buys a black-and-white television set today gambles on the possibility that color television will not become available commercially until he has received his “money’s worth” from his purchase.

Businessmen make mistakes too. Because world conditions are ever-changing—are in a constant state of flux—businessmen must make decisions every day. And every decision results in action which may be “right” or “wrong” from the businessman’s point of view. Every step in the wrong direction is a crisis in the life of some particular individual. Under the conditions of a free market, where the law of supply and demand functions without interference, each worker, each businessman, learns very quickly if he has made a mistake. Each wrong guess hurts him Nit causes him financial loss. Perhaps it may be a minor mistake, soon rectified. But, however minor, he finds it expensive, and he tries to correct it as soon as possible. Every day, millions of daily crises occur in the lives of millions of persons. Unless something happens to interfere with their estimates as to the future or to upset the plans of these millions of people, they each tend to counteract and correct their individual errors, if possible, before they develop into serious crises, so that, unfortunate as these mistakes may be for the persons involved, the ups and downs of business are soon remedied.

You will say you have heard all this before—that this doesn’t answer your question about the “Great Depression” of 1929 to 1932 plus! I remember how astonished I was when I started studying these matters several years ago to learn that the stock market boom of the 1920′s, the crash, and the depression were NOT due to the failures of businessmen, but to the interference, by government, with the mechanism outlined above.

All through the 1920′s the federal government, through the Federal Reserve Banks, was controlling the interest rate. (And the Federal Reserve Banks control interest rates in this country today.) The men who were making these decisions in the 1920′s were just as liable to error as any other human being. They were not omniscient supermen. The principal mistake they made was due to a perfectly logical situation. They wanted to keep the government interest payment low—they wanted to help out the poor Europeans who had suffered in the war (World War I) and they wanted people, the voters, in this country to feel prosperous, to have plenty of money to spend, so that they would send the politicians-in-power back to office. (And the voters did just this in 1924, and again in 1928.)

Under the influence of their politically-appointed Board of Governors, the Federal Reserve Banks lowered the rate of interest during the 1920′s below the market rate, i.e., they lowered it below what it would have been if they hadn’t intervened, so that people wanted to borrow more at the new low rate than they would have at the market rate of interest. Demand for credit increased.

In order to meet the demand without raising the rate of interest, the Federal Reserve Banks, with the aid of government, created money and/or credit artificially. (In a free market, no one can borrow money unless someone else has accumulated savings. But when it is possible to loan money or grant credit from a newly created supply of money or credit, the amount people can borrow is no longer limited by the amount other people have saved.) The fact that money was comparatively cheap to borrow in the 1920′s created the impression that there were more capital goods and factors of production available for expanding production than there actually were. The businessmen made their plans as if the available credit and money were an indication of the amount of savings which had been accumulated, whereas in fact, the only difference was that the supply of money and credit had been increased. The businessmen were making their calculations on the basis of a rate of interest which was not the market rate—their calculations were founded on falsified information.

People in the 1920′s, pleased at the comparative cheapness of borrowing, borrowed more money than they would have if it had been more expensive. Some used this money to bid up stock market prices others to buy things on the installment plan. Some businessmen used this money to plan additions to their factories and others to start big real estate developments, etc. Because people had more money, while the supply of goods that they were trying to buy with the money was the same—they bid the prices of goods up, and up, and up. As businessmen found that their plans for expansion were going to cost more than they had anticipated, due to the increase in prices, they borrowed still more money from the banks. And so the spiral of easy money bidding up prices made it necessary for the banks to create still more money and credit. Although the banks did increase the interest rate somewhat for the loans they trade in the 1920′s, the rate was still below the market rate—it was still cheaper than it would have been, in view of the increased supply of money and credit, if the banks and the government had not intervened.

But one day some individuals or banks who had money out on loan began to have doubts and they decided to call their loans. And then the troubles started. The doubts were cumulative. Everybody started scrambling to save something from his own business.

Perhaps, you will say, these people who borrowed too much were just individuals who made mistakes, and that is what happens every time anyone loses money, or makes an error in his anticipation of business conditions. But, normally, if one man makes his plans on the basis of an error in judgment, there is another—perhaps his next door neighbor—who plans more correctly in the light of the way things turn out, so that the net effect is that the right estimates and the mistakes in judgments balance out. When almost everybody makes an error in his anticipation of future events, and the errors are almost all wrong in the same direction, there must be a reason. And the reason in 1929 was that the use of money was cheap compared with other things on the market. And the reason the use of money was cheap was because there were regulations that made it cheap. The blame for the Great Depression should be laid, NOT at the feet of the free market economy, but at the door of governmental intervention.

In 1929, there was a depression when the easy money policy of the 1920′s finally came to an end, as all monetary and credit inflations eventually must. In Germany there was a run-away inflation and a complete breakdown of the monetary system in 1923, because the government allowed the inflationary monetary policy to continue. (Although the interest rate in Germany reached 90% in 1923, in view of the inflation it would probably have been several hundred per cent if it had not been suppressed artificially below the market rate! )

When governments interfere to control and regulate the economy in any way, the price of the intervention must be paid sooner or later. Interference with the monetary system is especially vicious because it affects everything in the economy, and also because it is so complicated and difficult to explain that its effects, more often than not, are blamed on other than their true causes. (As you know, business has long borne the blame for the depression of the 1920′s.) If the true causes of the Great Depression of 1929 were more generally known, there would be less eagerness for us to follow the same governmental policies today that were practiced in the 1920′s.

The answer to the world’s problems cannot lie in one single plan, nor in fifty nor a hundred plans, subject to the whims of vote-seeking politicians and fallible human beings. The answer to the world’s problems lies in hundreds of millions of plans, each plan made by one individual working for himself and his family. In order to supply his own needs, he must seek to satisfy the wishes of the consumers who are in the market for his product, or for his labor. And so, in working “selfishly” for himself and his family, he cannot help but contribute to the “general welfare.” The man who succeeds in pleasing the greatest number of consumers, receives their dollar “votes,” and thus acquires the means to expand his business and the opportunity to try to please more consumers; or the chance to purchase the production of others; or to make gifts to his favorite charities.

Among the books which have been written on this subject, The Great Depression by Lionel Rob-bins (The Macmillan Co., New York, 1935), and Economics and the Public Welfare (D. Van Nostrand Co., New York, 1949) by B. M. Anderson, are especially worth-while. Bettina Bien

Bettina Bien is a member of the staff of the Foundation for Economic Education.

What Determines Prices?

Dear Mr. B:

To answer your question about the source of prices is not as simple as it might appear. Perhaps the best way to start is with a brief review of history.

Back in the 18th century, when folks were beginning to crystallize the various ideas about prices, values, costs, and economic matters, Adam Smith, among others, began to search for the reason why goods had certain prices. He realized that a loaf of bread had a price that was, more or less, related to the labor that went into it. And he saw that a pair of shoes had another price, which was also, more or less, connected with the amount of work involved. The conclusion that he came to was that the price at which a product sells is the sum total of the wages and costs that go into its preparation. This was called the “labor theory of value.” Later this idea was adopted by Marx and adapted to his ideas.

As people pondered these matters more and more, a few of these early thinkers soon began to realize that an object’s value was related not only to the work involved, as Adam Smith concluded, but also to its utility. But they ran up against what has been called “the paradox of value,” for they could not explain why a pound of iron, for instance, which has many uses, was worth less than a pound of gold. It took many years for the “marginal utility (subjective) theory of value” to be developed. It was not until after 1870, that this idea began to be clarified. In simple terms this theory means that a hungry man will be willing to pay more for his first meal after a fast, for he gets more “utility” out of it, than he will want to offer at that time for a second, or third meal.

Very briefly, this is the evolution of the theory of value. Today it is recognized that value is not intrinsic, it is not in things. The value of an object depends on the utility of the services expected. In other words, it is subjective, not objective.

A potential purchaser weighs the price of each object he considers buying against the value it has for him personally. Should it be priced higher than he wants to pay, he need not buy it—he may look for a substitute, or go without. The result is that producers and sellers do not always succeed in recouping their costs. The price at which an object is sold on the market is determined by thousands and thousands of individual (subjective) value judgments of purchasers and potential purchasers, not by the costs involved.

But this does not mean that the cost of production is not an important factor. Production is discouraged if producers believe that the final consumer will not be willing to pay a high enough price to cover the sum total of his anticipated costs. A producer who guesses well may make a high profit. But if other producers catch on, and start making the same thing, or providing the same service, the demand for the particular type of material or labor required, or for an extra supply of capital, may force up the costs so that they will be above the price the consumer is willing to pay. Producers who don’t guess quite well enough will not make their costs, or will have to cut their margin of profit. Producers who have high costs may be forced out of the business entirely, leaving the field to the more efficient who can produce to sell at a price consumers are willing to pay.

And so back to your original question. We see that those early thinkers who pondered the ideas of Adam Smith were on the right track when they started asking questions about the “utility,” the end use, i.e., the subjective value of a commodity. In the final analysis it is the consumers who actually determine the prices at which goods are sold. The producers and distributors are helpless in the hands of “King Consumer.”

Bettina Bien

Gentlemen:

We believe that the work being done by the Foundation for Economic Education is very worthwhile and deserves our support. However, we are concerned about the apparent duplication of effort in other organizations. Would it not be both more effective and more efficient to combine into one large organization the various smaller groups which appear to have similar purposes? B.

Dear Mr. B:

Your concern raises two fundamental questions:

1.       To what extent is there duplication of effort?

2.       At what point is duplication of effort harmful?

With reference to the first question, I think that many organizations in our field share the same broad objective: to create a wider understanding of liberty and the free market. But that situation is not vitally different from the similarity of objectives in the manufacture of machinery. When each manufacturer sets out to build the most effective machine for a specific purpose, there is bound to be duplication of effort. However, as manufacturers begin to specialize, use different methods, and serve different groups, the extent of duplication is minimized.

In a general way, the same thing holds true in educational effort. We all agree on the overall objective but we differ in editorial content; in the approach to the problem; in directing our effort to various audiences; and in the manner in which we present our findings.

The second question opens up an interesting area of thought. Of course, there is a certain amount of duplication in all fields of endeavor, but is this harmful? If it is, at what point does it become wasteful?

Duplication of effort is necessary if there is to be competition and progress. For instance, take the search for a cure for cancer. Would it be feasible to select just one man or one group of men to do the research? We could certainly concentrate our resources in this group but by preventing the activity of others, we might not discover the cure.

Duplication of effort can be reduced by three means:

1.       The use of force. I think it is generally agreed that this method is subject to abuse.

2.       Cooperative effort. How would this be done? Would you merge all the organizations, the good and bad, the competent and the incompetent? Would this not entail compromise? Would not the most effective organization be weakened by such a merger?

3.       By competition. We preach the benefits of competition and we believe in it even in this field. Furthermore, I think that you and others who are called upon to support these institutions should want competition maintained for this reason: Perhaps one of these organizations will show enough gumption, ingenuity and understanding to make some headway. And if I were you or anyone among the potential supporters, I would put my money on the horse that looks best. That is the only justifiable way I know to weed out the ineffective duplication of effort.

Our task, as we see it, is to seek answers to economic questions and to develop explanations for liberty in a nation where it has been taken for granted so long that it is gradually being taken away. We attempt to supply individuals in all parts of the country—those who can’t spend much time doing the drudgery which is research—with facts and ideas. Our goal is to help those who want to understand liberty—to serve as a catalyst to the independent thinking of those who realize the importance of finding answers to economic problems-to the end that liberty and economics may be understood by many persons and in this way aid in the recovery of our freedom.

The Foundation bids for your support, of course. But we should receive it on no other basis than your conviction that our work merits it.

Enclosed is a pamphlet which attempts to brief the answers to pertinent questions about our institution. Also enclosed is a Donor Form, should you care to use it.

William Johnson

“This donation is better evidence than any words, that your letter was effective.”

B.

William Johnson, Editor of Faith and Freedom was formerly a member of the staff of the Foundation for Economic Education.

Guaranteed Annual Wage

Since most industries lack the reserves to pay employees a year’s income in advance, it follows that industry cannot guarantee an annual wage unless industry is first guaranteed a market for its products.

Are the sponsors of a guaranteed annual wage ready to sponsor guaranteed annual sales? Probably not. For, were they to be logical and do the latter, the absurdity of the former would be obvious. William R. Clark

Have you heard the story about the fishing industry agitating for a guaranteed annual catch? Marshall Olds

“If to please the people, we offer what we ourselves disapprove, how can we afterwards defend our work? Let us raise a standard to which the wise and honest can repair. The event is in the hand of God.”

Attributed to George Washington
during the Constitutional Convention

The Foundation for Economic Education, while nonprofit and nonpolitical, is nonetheless an educational champion of private ownership, the profit and loss system, and limited government. Its studies in economics, political science, and related subjects are available to all. It is responsible to no outside person or group. It is supported only by voluntary donations and the sale of its publications. Additional information on request.