Take a simple price ceiling, such as a maximum price for gasoline or maximum rent for Manhattan apartments.  People who support such laws think that somehow those who are selling or renting the good have the power to charge a higher price than what is perceived as fair or just, and that legislating a maximum below what would be charged must therefore protect consumers.  The traditional economic analysis rightly shows how this causes shortages and various other undesirable unintended consequences.

Buyers Limited Too

The point I want to make is that such laws also limit the behavior of buyers (or renters). In a genuinely free market, sellers who wish to maximize profits cannot charge any price they wish. They must be attentive to the intensity of consumer demand at various prices.  Ultimately the price of a given good is high because buyers find the product very valuable.  Price control says, “Sorry, buyers, you cannot express to sellers just how valuable you find this good, and therefore those of you who value it most highly will be unable to gain access to it.”  So rather than view price ceilings as laws to protect hapless buyers from ruthless sellers, we would be more accurate in seeing them as laws that prevent motivated buyers from outcompeting other buyers and communicating to ignorant sellers just how intensely they value the good.

We can make the same argument about price floors, or minimum-price laws such as farm price supports or the minimum wage.  Minimum-wage laws are normally couched in terms of protecting powerless sellers of labor against ruthless buyers, who have so much power, they can drive wages down to near-poverty levels.  Again, we know how the minimum wage causes all kinds of problems, most importantly high levels of unemployment among the least-skilled workers.  (In fact, many early proponents of the minimum wage recognized this, but saw it as a feature not a bug: It was a way to impoverish and eliminate the eugenically undesirable [pdf].)

However, like maximum-price laws, these laws really limit the other side of the market.  A minimum wage does not just prevent employers from “exploiting” workers at “too low” a wage; it also prevents workers from offering their services at wages they think will make them employable.  For lower-skilled workers, a minimum-wage law is effectively a minimum-productivity law that undermines their ability to outcompete other workers by offering to work for less when they can’t produce as much per hour as the minimum wage.  And this is precisely the feature of the law that higher-skilled workers like: It enables them to shut out competition from other workers.

Who Competes?

The key is to remember that market competition is not between buyers and sellers, but rather among buyers and among sellers.  As a result, all laws that limit prices necessarily limit the ability of both sides of the market to compete, regardless of how the law is framed or who its proponents say it will “limit.”  All price controls choke off market communication by preventing the competitive process on each side of transactions from telling the other side how much goods are valued.

The next time someone tells you that price controls or minimum-wage laws put the brakes on powerful firms that sell necessities at too high a price or buy labor at unfairly low wages, don’t believe it.  Those laws limit consumers and workers, especially lower skilled ones, at least as much as they limit powerful firms.

Although the phrase nation-building sounds much more constructive and well-intentioned than the destruction and death that has normally accompanied the use of American military power around the world, attempts to build nations are just as likely to fail.  What the nation-builders overlook is a distinction made by Ludwig von Mises almost 100 years ago:  A nation is not necessarily the same as “the State.”  In his much under-appreciated little book Nation, State, and Economy, Mises argued that “nations” are defined not by geography or by political institutions, but most fundamentally by language and other similar cultural institutions that provide a basis for “mutual understanding.”

Therefore the nation, Mises argues, cannot be understood as a static object that we can manipulate as we wish: “Nations and languages are not unchangeable categories but, rather, provisional results of a process in constant flux;  they change from day to day, and so we see before us a wealth of intermediate forms whose classification requires some pondering.”  Put in the language of F. A. Hayek, nations are spontaneous orders that emerge from the daily choices of people about the language they use and the other ways in which they participate in or withdraw from a variety of cultural forms.  Only the people themselves constitute a “nation” by their own individual choices.

And it is nations constituted this way that make the decision to create a State.  States imposed on nations by princes, Mises argues, are doomed to fail because they normally attempt to eliminate all forms of community that lie between the prince and the people.  If it doesn’t come from the State, it is to be dissolved.  In other words, imposed States dislike and destroy the delicate, complex, and evolved connections that comprise a true nation.

By engaging in nation-building, governments take on a task that is no different in principle from the attempt to plan an economy domestically.  Once we understand that true nations are the unintended consequence of decentralized cultural processes involving the millions of choices of millions of people, the absurdity of trying to build a nation as if it were a child’s toy or even a skyscraper becomes clear.  Once we start to muck around in processes that are complex and whose relevant causal connections are beyond our ability to understand, we are certain to produce unintended and undesirable consequences precisely because we act from the hubris of the planner.

Knowledge Problem

As the economist Chris Coyne points out in his wonderful book, After War, postwar reconstruction (which is one form nation-building has taken) suffers from the same sort of knowledge problem as domestic economic planning.  If Mises and Hayek were right about the impossibility of socialist planning because economies are simply too complex to be surveyed by one mind, then nation-building is equally impossible since the social connections that form shared language and culture are no less daunting in their complexity.  Just as the intervention of economic planners inevitably produces results that run counter to their stated goals, leading them to intervene again to solve those problems, so will nation-building create resistance and new forms of culture and community that frustrate the designs of the builders.  The quagmires of Iraq and Afghanistan are clear evidence for this argument.

Perhaps because of the accidental alliances created by the Cold War, many have forgotten that the classical-liberal tradition is anti-imperialist and cosmopolitan.  Classical liberals have always believed that the best way to encourage national development is through trade in goods, services, and ideas, and not through intervention in the name of helping others.  Nations and cultures cannot be built by even the best-intentioned outsiders – those things emerge and evolve just like the markets that are part of them.  It is but another “fatal conceit” to think that nations were ever built by anyone or that we can today rebuild them.

The spontaneous orders of language and culture that are the defining characteristics of nationhood work best when left to evolve in the directions their citizens take them.  The best we can do to support the emergence of “good” nations is to encourage unhampered social evolution within those nations and to refrain from thinking we can build something better.

Meanwhile, the Obama administration said it would cut by half (on average) the compensation of the highest-paid people at the seven companies still on taxpayer life support: AIG, Bank of America, Citigroup, General Motors, Chrysler, GMAC, and Chrysler Financial.

So here’s the puzzle: Is such government intrusion into the compensation process a good or bad thing?

Before answering, let’s remember that the taxpayers have been compelled to rescue lots of companies, banking and otherwise, over the last two years. The people’s exposure is immense. Neil Barofsky, special inspector general for Treasury’s financial sector rescue, says enormous surprise bailout costs will befall the country in addition to the $159 billion the Congressional Budget Office projects TARP will lose. Barofsky was referring to the cost of government borrowing and the potential cost of rewarding risky behavior.

Besides that, the Fed has been buying up billions of dollars in “toxic” (that is, worthless) mortgage-backed and other paper with money created from thin air. The new money threatens to ignite a monster price inflation when the banks begin to lend it. The impending dissipation of the people’s wealth at the hands of the Fed(eral Bureau of Counterfeiting) is another cost of the bipartisan government bailout of corporate finance. It’ll be a massive tax on the middle and working classes.

Well, then, shouldn’t the government have something to say about what goes on in those companies on the dole, executive pay in particular?

It’s tempting to say yes, but I think the best answer is no. I’m not totally comfortable with that answer, but it seems better than the alternative.

First off, we must reject the propaganda that the Treasury and the Fed are acting as the taxpayers’ agents by taking control of corporate compensation. Nothing can be further from the truth. They are the taxpayers’ adversaries and are only looking out for themselves. After all, they are the ones that exposed the taxpayers to these huge liabilities in the first place.

Moreover, it’s not really the taxpayers’ money the politicians are looking out for. In real terms, it’s now their money by virtue of legal plunder. The Bush administration tried to sell the public on the bailout by suggesting that the toxic assets (or bank shares) acquired by the government might one day be resold at a profit for the taxpayers. But if the assets do sell for more than the government paid, will taxes be cut to reflect the profit? Fat chance. Politicians tend to spend every penny they can get their hands on—and then some. It is they who would profit, not the taxpayers. They ain’t us.

Another reason to oppose government conditions on bailout money is that they are likely to make things worse. I seriously doubt whether anyone at the Fed or Treasury is qualified to design compensation packages that would encourage just the right amount of risk, not too much or too little.

A third reason to reject this government intervention is that it will serve as a justification for further intervention. Pay czar Kenneth Feinberg already says he hopes the pay scheme will become a model for the rest of Wall Street.

My final reason for saying no to the pay czar and bank regulators is that I want to make sure that such bailouts never happen again. Maybe the people will be less likely to acquiesce the next time if they see the current corporate rescue for the plunder it is.

We can’t change the past. The bailouts happened. Now we have to deal with the consequences. We should concentrate on stripping government of the power to bail out companies in the future. We should also begin to fully separate State and banking. A good start would be to abolish government deposit insurance, which only lulls depositors into a false sense of security and creates the very systemic risk the regulators say they want to avoid.

* * *

“Green jobs” are the magic words promising to bestow prosperity and environmental bliss through costless government manipulation. Do you need more reason to be skeptical? Andrew Morriss performs the debunking. Richard Fulmer adds an insight on the shortcomings of alternative energy sources.

In the mixed economy, is freedom’s glass half full or half empty? George Leef shows that this is more than a philosophical question.

Walmart inspires hisses and hosannas. Which are more deserved? Art Carden sorts it all out.

These days it’s especially popular to scapegoat anyone engaged in complex financial transactions not readily understood by laymen. Example: short sellers. They’re accused of manipulating the stock market for personal profit, so the government has its eye on them. Warren Gibson comes to the defense of this valuable yet unappreciated group.

The government’s money managers are willing to risk inflation to avoid deflation. Good idea? Steven Horwitz distinguishes good deflation from bad.

One of the great pieces of American folklore is that businessmen don’t like regulation. Bruce Yandle sets the record straight.

Here’s what our columnists have come up with this time around. Lawrence Reed declares himself a Locofoco. Donald Boudreaux won’t let Chinese currency manipulation keep him up at night. Stephen Davies demonstrates the power of historical myth. John Stossel looks at the tax system and doesn’t like what he sees. David Henderson says don’t fear the trade deficit. And Theodore Levy, encountering the claim that markets for medical care cannot work, remonstrates, “It Just Ain’t So!”

Volumes about the alleged failure of the market, a crusty old individualist, the law, and American public policy undergo scrutiny by our reviewers.

Each of the ten essays is an estimable work, but some are likely to be of particular interest to Freeman readers. I’ll focus on four.

At the top of that list, I would place Peter Leeson’s essay, “Do Markets Need Government?” Most free-market advocates assume that “the rules of the game” must come from and be enforced by the government. Leeson, however, argues that market participants may do a better job than the State, writing, “The long-standing existence of vibrant markets under conditions of real or quasi-statelessness suggests that private ‘rules of the game’ must be possible without  government.” In commercial transactions, he points out, the participants have a lot at stake in the performance of contractual obligations.

That led them to develop commercial law completely independent of government, as well as tribunals to adjudicate disputes. Those tribunals did not have enforcement powers, but the need to maintain a good business reputation minimized flouting of their decisions. Violators were apt to face ruinous ostracism. Adam Smith’s “invisible hand” worked remarkably well.

Leeson goes on to show that the spontaneous order of the market also devised mechanisms to deal with criminal conduct. After reading his essay, it’s evident that the Hobbesian notion that society would be chaotic violence without a powerful state is untenable.

Another particularly valuable contribution is the late Norman Barry’s essay, “Economic Rights,” in which he laments that “for most of the time, in all countries, economic rights have been at the mercy of legislatures . . .with little or no protection from the courts or written constitutions.” He attributes this unfortunate state of affairs to the abandonment of the Enlightenment concept of the unity of liberty. In this concept, economic liberty is integral to an overall concept of liberty; most modern thinkers, by contrast, conclude that some aspects of liberty are important and others are not. They say they can tell wheat from chaff, with property rights and economic liberty being chaff. “There is scarcely any recognition of the connection between economic rights and other, more fashionable notions,” Barry writes.

He concludes that nations would reap huge productivity gains if they would steer away from “welfare rights” and regulatory intervention, and instead allowed people to produce and trade as they choose.

Julian Morris also merits special mention for his essay, “Private Versus Public Regulation of the Environment.” He takes issue with the presumption that the State alone is capable of solving environmental problems: “The reader may be surprised to learn that many environmental problems have in fact been caused by governments, sometimes in spite of attempts by private industry or businesses to stop them.”

I’ll mention one more essay, Cento Veljanovski’s “The Common Law and Wealth.” In it Veljanovski looks at this intriguing question: What kind of legal system is apt to contribute more toward a nation’s ability to produce wealth—common law or civil law? He notes that Gordon Tullock, among others, has observed that common law tends to be “untidy,” with duplicative costs, inefficient methods of ascertaining facts, and great latitude for wealth-destroying judicial activism. Other scholars, however, such as Richard Posner, maintain that since common law is premised on the legality of the status quo, it places a restraint on the use of law to redistribute wealth. This is an interesting debate with no resolution in sight.

Scholars who are interested in the field of law and economics will want to have this book on their shelves, and professors teaching a variety of law, economics, and political science courses will find in it a good many supplemental readings to get sharp students thinking about questions that mainline textbooks almost always overlook.

But, alas, in the end Krugman resorts to the arguments of the great economic cranks of history, from Silvio Gesell to John Maynard Keynes. He’s like the mechanic who expertly describes a problem with your fuel pump—then insists your car needs more gas. If the tank is full, he tells you to attach an auxiliary tank.

In other words, Krugman is still the one-trick pony featured in the Times. Whatever the problem, his solution is always the same: inflation. It shows up in the example he uses throughout the book, a 1970s babysitting co-op on Capitol Hill.

The baby-sitting “economy” is a co-op in which the couples agree to babysit one another’s children for coupons (babysitting credits) instead of dollars. But Krugman says this scheme ran into problems during the winter. The couples hoarded their coupons (that is, they refused to hire babysitters) while trying to get more coupons (sell babysitting services) so they would be able to go out more often in the summer.

Unfortunately, with everyone pursuing the same strategy at once—trying to sell without buying—Krugman writes, the co-op went “into a recession.” But never fear: This babysitting “liquidity trap” ended when the directors of the co-op printed and distributed more coupons and everyone lived happily ever after.

The problem with drawing general lessons from this situation should be obvious. A babysitting co-op in which a few people with similar preferences produce one good cannot be a model for a complex economy. But since Krugman—like other Keynesians—believes an economy is a crude, simple mechanism controlled by “aggregate demand,” this is the best he can do.

Writing about this “fix” for the co-op, Krugman says, “Recessions, in other words, can be fought simply by printing money—and can sometimes (usually) be cured with surprising ease.”

Even though I have read many of Krugman’s columns and was not surprised by this answer, it is nonetheless shocking to read that a Nobel laureate actually believes that we can “cure” almost any economic downturn by cranking up the printing presses.

That’s bad enough, but Krugman also likes to rewrite economic history.

He says our present economic and financial troubles are due to free markets and financial deregulation. He argues that the cartelized financial system created during the New Deal should have remained unchanged, even though it was actually in crisis back in 1980. The alleged “deregulation,” however, did not create free markets but expanded moral hazard by increasing deposit insurance and empowering the Fed to “backstop” financial market losses, which invited reckless behavior on Wall Street. All this federal interference with both free markets and an authentic profit-and-loss system resulted, predictably if sadly, in the current financial meltdown.

From blaming the Great Depression in part on the gold standard to caricaturing free markets, Krugman places himself squarely in the socialist-interventionist camp. He writes: “Some people say that our economic problems are structural, with no quick cure available; but I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men.” Unfortunately Krugman counts freedom among them.

Never mind the federal government’s own indispensable role as an enabler in the crisis, from its reckless monetary policy to its jawboning banks into making dubious mortgage loans. Never mind the long-term danger of its assumption of colossal new obligations and the moral hazard in the message its intervention sends. My response to my friend was of a more narrow focus. “Thank God we have the private sector to bail out the federal government not just last week, but every week!” I exclaimed.

Think about it. Taxes on the private sector pay a majority of the federal government’s bills. For most of the rest, the government borrows by selling its debt obligations, mostly to private-sector entities–including banks, insurance companies, and individuals.

The federal government is the world’s biggest taxer and the world’s biggest debtor. If those of us in the private sector didn’t pay our taxes or didn’t buy Washington’s paper, the feds would have gone belly-up decades ago. We’ve rescued Washington to the tune of tens of trillions of dollars over the years. A big difference between Washington’s bailing out the private sector and the private sector’s bailing out Washington is that the private sector has to work, invest, employ people, and produce goods to come up with the cash. It can’t create it out of thin air like Ben Bernanke can.

Our friends in Washington have blessed us with future burdens almost too astronomical to comprehend.  In the name of taking care of us in our old age, we are saddled with no less than $6 trillion in Social Security payouts over the next 75 years–for which there are no presently earmarked funding streams. According to Brian Riedl of the Heritage Foundation, the unfunded obligations for the new federal prescription drug program, enacted under President Bush, total another $8 trillion.

On and on it goes. The private sector has an awful lot of bailing out to do in the coming decades. I shudder to think how deeply we taxpayers will have to dig in the not-too-distant future to pay the bills of our benevolent, compassionate, and forward-thinking government.

Since Barack Obama took office in January 2009, the federal government has spent a full billion dollars every single hour. Before his term is half over, federal spending will have doubled in just a decade. The deficit in one year’s budget is now as large as the entire budget in George W. Bush’s first year as president, 2001–and I thought not very long ago that the spending spree he and the Republicans gave us would be tough to beat! The flood of red ink is now adding to the national debt to the tune of about $4 billion every day. At well over $11 trillion, that debt amounts to $37,000 for every living American.

Too Big to Succeed?

We’re told by the wise planners in Washington that certain private firms are “too big to fail.” So we’re handing big chunks of them over to the government.

The question we all should be asking ourselves is this: Are we trusting our economy and our lives to a government that is too big to succeed?

Once upon a time in America, most citizens expected government to keep the peace and otherwise leave them alone. We built a vibrant, self-reliant, entrepreneurial culture with strong families and solid values. We respected property and largely kept the spirit of the Eighth and Tenth Commandments against coveting and stealing. We understood that government didn’t have anything to give anybody except what it first took from somebody and that a government big enough to give us everything we want would be big enough to take away everything we’ve got. We practiced fiscal discipline in our personal lives and expected nothing less from the people in the government we elected, or we threw them out.

But somewhere along the way we lost our moral compass. And just like the Roman Republic that rose on integrity and collapsed in turpitude, we thought the “bread and circuses” the government could provide us would buy us comfort and security.

We gave the government the responsibility to educate our children, though government can never be counted on to teach well the main ingredients of a free society–liberty and character–or just about anything else, for that matter. We asked the government to give us health care, welfare, pensions, college education, and farm subsidies, and now our politicians are bankrupting the country to pay the bills. This welfare state of ours has become one big circle of 305 million people, each with his hand in the next fellow’s pocket.

This is a government whose reach even before the financial crisis scarcely left an aspect of American life untouched, from the cradle to the grave and the volume of our toilet-bowl water in between. As a portion of our personal income, its tax and regulatory burden consumes at least five times what it did just a century ago. But to the majority on the Potomac, government is nowhere yet big enough. This is madness writ large.

Stick to the Knitting

Remember In Search of Excellence, the 1982 best-selling management book by Tom Peters and Robert Waterman? One of its salient points is that an organization gets off track when it no longer “sticks to the knitting.” When it allows its mission to blur and stretch far beyond its founding design, when it becomes distracted by endless and dubious new responsibilities, its core competency evaporates. It will fail to do what it is supposed to do, because it’s doing too much of what it’s not supposed to do.

It may come as a surprise to those who see aspirin made in Washington as the cure for every ailment, but the federal government is not God. It can’t even be a good Santa Claus. It’s no Mother Teresa either, because on those occasions when it does some good it usually costs an arm and a leg and sends a big part of the bill to generations yet unborn. The fact is, the bigger government gets, the more it starts to look like Moe, Larry, and Curly.

Accentuating the madness of the present day, the cover of Newsweek declared last March, “We are all socialists now.” Pardon me, but I’m not about to sign on to a proven flop.

These are the times that try men’s souls. The summer soldier and the sunshine patriot will, in this crisis, shrink from the service of their country; but he that stands by it now, deserves the love and thanks of man and woman. Tyranny, like hell, is not easily conquered; yet we have this consolation with us, that the harder the conflict, the more glorious the triumph. What we obtain too cheap, we esteem too lightly: it is dearness only that gives everything its value. Heaven knows how to put a proper price upon its goods; and it would be strange indeed if so celestial an article as freedom should not be highly rated. –Thomas Paine

So began the first of 16 pamphlets under the title “The American Crisis,” by patriot Thomas Paine. These very words were read aloud to General George Washington’s forlorn and bedraggled men on Christmas 1776, the night before the Battle of Trenton.

Consider the backdrop: For the six months since the Declaration of Independence, Americans had been in almost constant retreat. To a disinterested observer, the American cause must have seemed hopelessly quixotic. To many patriots as well, it appeared all but lost. But Paine’s stirring words helped give the troops the morale boost they needed. The next day they accomplished the impossible, capturing nearly the entire force arrayed against them. Desertions plummeted and reenlistments soared.

Lovers of liberty need a little Paine today in the face of all the pain around us. It seems at times that the world has gone mad. Companies that lose billions are being bailed out by a government that loses trillions. The same federal Leviathan that outlaws competition in first-class mail delivery but still can’t deliver letters at a profit now supposedly knows how to run auto companies, banks, and insurance firms. Debt, deficits, bureaucracy, regulation, government spending—the depressing stuff already in frightful superabundance pre-financial crisis—now threaten our diminishing liberties more than ever before. The cover of the March 15 issue of Newsweek proclaimed, “We Are All Socialists Now.”

No Sunshine Soldiers

Maybe we have good reason to feel like those dispirited troops on Christmas Day in 1776, but we should learn from what they did just a day later. We can either be summer soldiers and sunshine patriots, or we can let the very principles we profess be our rallying cry for the battles ahead.

Eternal optimist though I am, I admit that pessimism really tugs at me when I read the morning papers. At every speech I give these days, there’s a sizable portion of the crowd that seems ready to crawl under a rock and let the world go to a statist hell in a hand basket.

But then I ask myself, what good purpose could a defeatist attitude possibly promote? Will it make me work harder for the causes I know are right? Is there anything about liberty that an election or events in Congress disproves? If I exude a pessimistic demeanor, will it help attract newcomers to the ideas I believe in? Is this the first time in history that believers in liberty have lost some battles? If we simply throw in the towel, will that enhance the prospects for future victories? Is our cause so menial as to justify deserting it because of some bad news or some new challenges? Do we turn back just because the hill we have to climb got a little steeper?

Readers of this magazine should know the answers to those questions.

This is not the time to abandon time-honored principles. I can’t speak for you but someday I want to go to my reward and be able to look back and say, “I never gave up. I never became part of the problem I tried to solve. I never gave the other side the luxury of winning anything without a rigorous, intellectual contest. I never missed an opportunity to do my best for what I believed in, and it never mattered what the odds or the obstacles were.”

A Tradition of Courage

Remember that we stand on the shoulders of many people who came before us and who persevered through far darker times. The American patriots who shed their blood and suffered through unspeakable hardships as they took on the world’s most powerful nation in 1776 are certainly among them. But I am also thinking of the brave men and women behind the Iron Curtain who resisted the greatest tyranny of the modern age, and won. I think of those like Hayek and Mises who kept the flame of liberty flickering in the 1930s and ’40s. I think of the heroes like Wilberforce and Clarkson who fought to end slavery and literally changed the conscience and character of a nation in the face of the most daunting of disadvantages. And I think of the Scots who, 456 years before the Declaration of Independence, put their lives on the line to repel English invaders with these thrilling words: “It is not for honor or glory or wealth that we fight, but for freedom alone, which no good man gives up except with his life.”

As I think about what some of those great men and women faced, the obstacles before us today seem rather puny. We just need to gird our loins. We have to get a lot smarter and better at reaching more fellow citizens with a compelling alternative to the dead hand of the corrupt and incompetent State. We need to put confident smiles on our faces and sally forth.

Time to Rally

We should not squander a second feeling bad for ourselves. This is a moment when our true character, the stuff we’re really made of, will show itself. If we retreat, that would tell me we were never really worthy of the battle in the first place. But if we resolve to let these tough times build character and rally our dispirited friends to new levels of dedication, we will look back on this occasion someday with pride at how we handled it. Have you called a friend yet today to explain to him or her why liberty should be a top priority?

Nobody ever promised that liberty would be easy to attain or easy to keep. The world has always been full of greedy thieves and thugs, narcissistic power seekers, snake-oil charlatans, unprincipled ne’er-do-wells, and arrogant busybodies. Sometimes they’re nattily dressed in custom-tailored, pin-stripe suits and give good speeches; sometimes they’re bedecked in jewel-studded robes and give lousy speeches; on yet other occasions they wear well-worn street clothes and don’t bother with a speech at all as they hold you up. It doesn’t matter how they’re dressed or what they say. No true friend of liberty should just roll over and play dead for any of them.

Wipe that frown off your face and get to work. Liberty’s future depends on you.

During 1933, Roosevelt’s first year in office, GDP increased about 17 percent. What would have accounted for that?

Not FDR’s 1933 decision to seize privately owned gold and devalue the dollar from $20 per ounce of gold to $35. This increased the value of gold held by the U.S. Treasury and entitled it to print an additional $3 billion of greenbacks. The Thomas Amendment to the Agricultural Adjustment Act (AAA) authorized the Treasury to print $3 billion more. Nonetheless, the total amount of currency held by the public didn’t increase until 1934. The Fed wasn’t very active during this period.

The most sweeping pieces of legislation passed in 1933—the climax of the Hundred Days—were the National Industrial Recovery Act (NIRA) and the Agricultural Adjustment Act, but both promoted contraction, not expansion. The NIRA authorized FDR to establish cartels fixing wages, prices, and output. The AAA aimed to reduce agricultural acreage.

Recovery Preceded Policy

It’s not clear how any of FDR’s 1933 policies could have accounted for a 17 percent increase in GDP, even if they promoted expansion, because they wouldn’t have had time to ripple through the economy. It seems more likely that FDR had the good fortune to come into office near the bottom of the Depression, and enough adjustments in wages, prices, and other factors had occurred that the economy was ready to recover. The economy had recovered from previous panics, crashes, and depressions without a big-government program. Undoubtedly FDR’s sunny personality and formidable communications skills helped give people confidence they could achieve a turnaround.

From 1933 to 1937 GDP increased about 60 percent. This was the biggest GDP expansion of the New Deal—and it occurred without federal spending and deficits that would qualify as Keynesian stimulus. Krugman wrote, “[T]he New Deal didn’t pursue Keynesian policies. . . . [F]iscal policy was only modestly expansionary.” Other economists, such as Price V. Fishback, agree that New Deal budget deficits probably didn’t contribute to recovery—Fishback calls FDR’s deficits “tiny.”

Since the NIRA and AAA promoted contraction, the Supreme Court gave the economy a boost in 1935 by striking them down. Ironically, FDR viewed the anti-New Deal justices as the “Four Horsemen of Reaction.”

Raising Labor Costs

It has often been said that the depression-within-a-depression of 1938 happened because FDR foolishly cut federal budget deficits, but that couldn’t have been the case since the dramatic 1933–1937 expansion occurred without meaningful deficit stimulus. Other factors help explain that depression, starting with the newly centralized Federal Reserve Board’s decision in July 1936 to increase minimum required bank reserves 50 percent and its decision in January 1937 to increase bank reserves another 33.3 percent. Suddenly, less money was available for lending, and interest rates went up—a double whammy for employers. The Social Security excise tax on payroll began to be collected in 1937, making it more expensive for employers to hire people. The undistributed profits tax became a big issue in 1937. The Supreme Court upheld the Wagner Act in 1937, setting off the rapid unionization of mass-production industries, which led to an 11 percent increase in wage costs during that depression year—and a resulting surge in unemployment.

The problem with the New Deal wasn’t expansion. The problem was the persistence of high unemployment despite expansion. Many economists point to New Deal laws such as the NIRA, the Wagner Act, and the Social Security payroll tax (there weren’t yet any Social Security benefits), which made it more expensive for employers to hire people. Whenever anything becomes more expensive, there’s likely to be less demand for it.

Uncertain Tax Environment

In addition, the succession of New Deal tax increases—1933, 1934, 1935, and 1936—reduced private funds available for hiring. And the constant tax changes made it hard for investors to estimate their potential risks and returns, so they remained on the sidelines. Investors, like everybody else, need predictable rules. No wonder investment was at historic lows during the 1930s. Without investment it was very difficult to create new jobs.

When FDR came into office he had Congress and the nation at his feet. He was hailed as a conquering hero. With his rhetorical acumen and political genius, he might have begun by forming coalitions to undo his predecessor Herbert Hoover’s biggest disasters: the 1930 Smoot-Hawley Tariff that throttled trade and the 1932 revenue act that doubled many taxes. Ending rather than embracing Hoover’s disasters would have been change that people could believe in! If, furthermore, FDR had avoided his own misguided policies, the expansion probably would have been more robust, and without the blunders of 1937, it might have lasted longer—and most important, it would have enabled the private sector to create millions more jobs.

An opposing position traces our current problems not to interventionism but instead to deregulation in the financial industry. Economists who argue this way, notably former Federal Reserve chairman Alan Greenspan, may merely be presenting the corollary to the “blame-the-free-market” position. But there is a certain sense in which the banking deregulation of 1980 and 1999 may in fact be to blame. How can one maintain that the free market is not to blame but at the same time see the problem stemming from deregulation?

This paradox exists because of an ambiguity in the way some economists have interpreted the “dynamics of interventionism”—the core concept in the political economic scholarship of Ludwig von Mises, F. A. Hayek, and Israel M. Kirzner. That ambiguity, I believe, arises from a natural tendency to overemphasize the “expansionary phase” of the interventionist process, in which the size and scope of the state are growing, and to neglect the dynamics of the “contractionary phase” when the state is “disintervening.”

First, what exactly are the dynamics of interventionism in the expansionary phase? (For an extended treatment see Ludwig von Mises’s Interventionism: An Economic Analysis [FEE] and my Dynamics of the Mixed Economy [Routledge].)

The core ideas are that 1) government interventions into the market process tend systematically to generate unintended consequences; 2) many of these unintended consequences frustrate the announced goals of those who support the interventions; 3) the response to these frustrated intentions tends strongly in the direction of further intervention; 4) the economic system performs less effectively in coordinating the plans of buyers and sellers as it becomes burdened with the cumulative effects of an increasingly chaotic mix of interventions; and 5) the process comes to an end when these cumulative effects result in a major system-wide crisis and public choosers decide to reject interventionism in favor either of comprehensive planning or radically freer markets.

The stages outlined above can apply at the level of the macroeconomy, such as the U.S. or global economy, or at the industry or sectoral level. 

Examples of the move from piecemeal to comprehensive intervention are found in the 1930s after the collapse of social democratic policies in Weimar Germany and in the United States after the failed interventions of the Hoover administration. Both events heralded even more radical (and tragic) interventions.

What we witnessed in 2008 in the housing and financial markets exemplifies in many ways the interventionist process, although it’s really just the latest stage (though not the last) of a long string of interventions begun decades ago.

Interventionist Origins of the Crisis

It’s easy to show that there has been no “free market” in housing or finance in the United States in recent memory and that the idea that “the free market” caused the housing bubble is untenable. (The main sources for this section are Murray Rothbard’s book America’s Great Depression, Stan Liebowitz’s “Anatomy of a Train Wreck”, and Roger Congleton’s “Notes on the Financial Crisis and Bail Out”.)

Perhaps the place to begin is 1913, when the U.S. Congress created the Federal Reserve system to serve as the country’s central bank and lender of last resort. In the 1920s the Fed discovered how to manipulate the interest rate—what we call today the federal funds rate—by buying and selling Treasury bonds from and to its member banks. It used this technique to create the artificial boom of the “Roaring Twenties.” The result was the Crash of 1929 followed by the Great Depression of the 1930s. It was in the midst of the Great Depression, in 1938, that Congress created Fannie Mae, the Federal National Mortgage Administration, whose mission was to promote private home ownership, with government support, by insuring and buying mortgages originated by local banks. As a result of this artificial boost, home ownership in the United States increased from 43 percent of all residences in 1949 to 62 percent in 1960.

In 1970 Congress then created Freddie Mac, the Federal Home Loan Mortgage Corporation, which together with a revamped Fannie Mae were mandated to insure or to buy and repackage (securitize) mortgages as part of a deliberate government policy to boost homeownership further and promote the American construction industry. By 2008 Fannie and Freddie had issued more than 60 percent of these mortgage-backed securities (MBSs), of which they themselves held $1 trillion, and insured about half of all MBSs.

Congress and various presidential administrations pressured Fannie and Freddie to take on a larger portion of MBSs while encouraging banks to loosen their traditional lending standards, to promote homeownership among lower-income minority residents, many of whom could not meet traditional lending criteria. Congress then passed the Community Reinvestment Act (CRA) in 1977, as well as other supporting legislation, to monitor its implementation. The CRA was strengthened in 1999. The unintended consequence of this policy and the pressure brought to bear on both lending institutions and Fannie and Freddie was to significantly undermine lending standards across all segments of the industry, not just for the poor and higher-risk borrowers. From these circumstances blossomed the so-called “subprime lending market,” which Congress and U.S. presidents encouraged Fannie and Freddie to make an increasing part of their own portfolios.

Meanwhile, the Fed drove the federal funds rate down from 6 percent in January 2001 to 1 percent in January 2004. Since mortgage rates generally track that rate (although they are substantially higher owing to higher default risk and other factors), these also fell during this same time period, fueling further borrowing and, most important, reckless speculation.

What Are “Disinterventionist Dynamics”?

The core ideas of the “contractionary phase” of interventionist dynamics are in many ways simply the reverse of the dynamics of the expansionary phase, but with some key differences:

1) In a systemic crisis it becomes obvious that the current system is untenable, so that public choosers have to decide whether to jettison interventionism for more comprehensive planning or for significantly freer markets; 2) the latter entails large-scale rather than piecemeal disintervention because minor changes would do little to untangle interventionist gridlock; 3) if, however, disintervention leaves important areas of the system under effective state control, entrepreneurial energies will tend to shift into relatively less-regulated areas, causing bottlenecks in those areas; 4) these bottlenecks create negative unintended consequences (shortages, sharply rising prices, or perverse investments) that frustrate the intentions of the supporters of disintervention; 5) the response by public choosers to these consequences will depend a great deal on their ideological commitment to disintervention, and because the ideology of interventionism is typically still fresh in public choosers’ minds, recidivism—a return to state expansion—will usually occur. 

Recall the experience with banking and finance in the 1970s. Among other interventions at that time, Regulation Q forbade banks to pay interest on checking accounts or branch out beyond the state in which they were chartered. Entrepreneurial pressure finally made matters untenable. For example, many banks resorted to offering their depositors toasters and other products in lieu of interest payments. By 1980 these market pressures compelled Congress to dramatically deregulate the banking industry, at the time one of the most regulated industries in the U.S. economy.

But it matters a great deal how and the extent to which disintervention occurs. The Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 permitted branch banking, mergers among banks, payment of interest on demand deposits (removing Regulation Q), and checkable deposits at credit unions and savings and loans (S&L). An unintended consequence of this partial deregulation, however, was the placement of the S&Ls in the untenable position of having to pay rising short-term interest rates on their deposits—inflation was raging—while being burdened with fixed-interest payments on long-term mortgage loans. This was “remedied” by letting the S&Ls make other kinds of investments. However, federal deposit insurance remained in place and even strengthened, buffering depositors from the S&Ls’ reckless speculation. Hence the so-called S&L crisis of 1980s. Thus, bottlenecks occur with partial deregulation, which can generate negative unintended consequences that will encourage recidivism.

As noted, entrepreneurship flows to areas with less control and regulation. Critics of deregulation complain that trading in new financial derivatives, such as credit default swaps, occurred in an unregulated part of the market. Exactly. And if the current mood results in more intervention into the financial industry, “quicksilver capital” will find its way into other as yet unregulated areas. The inevitable consequence of this process of piecemeal re-intervention is the socialization of the entire financial industry, to a state perhaps even worse than prevailed before the partial deregulation of 1980.

That partial deregulation and the repeal in 1999 of the Glass-Steagall Act, which banned the same institution from engaging in both commercial and investment banking, went a long way to resolve the mounting contradictions within banking and finance that decades of regulation had produced. Unfortunately, these deregulatory steps left in place the government-sponsored enterprises Fannie Mae and Freddy Mac (as well as the Government National Mortgage Association or Ginnie Mae), and most important, the Federal Reserve itself, with its power to arbitrarily influence the structure of interest rates in the United States and indeed globally. These resulted in the pressures and policies discussed earlier.

People as different as Paul Krugman and Alan Greenspan blame deregulation for the mess Wall Street got itself into. Supporters of the free market respond, correctly, that the primary culprits are the incentives and pressures government created in the housing and finance industries that precipitated the housing bubble. But in the context of the theory of intervention outlined here, the grain of truth in what the market critics say is that partial deregulation, not deregulation per se, is to blame. The problem was not too much but too little deregulation.

We face a serious economic crisis, one that may have determined the 2008 presidential election and strengthened one-party government in Washington, D.C. As such, it looks to be a turning point in the interventionist process. Unfortunately, it appears that for the time being the direction of politico-economic change, supported by popular sentiment, is toward more government and more inflation. But this is no time to give up hope. The past 30 years demonstrate that, as FEE’s founder Leonard Read taught us, ideas matter. It’s in times like these that our own commitment to learn and spread economic literacy is more important than ever.

As the government’s war outlays rose steeply and the incomes of a growing legion of war-industry workers rose along with them, consumer demand for goods and services increased rapidly. If prices had been unregulated, this increasing demand would have pushed prices ever higher, especially given that the resources available for augmenting the supply of civilian goods were being depleted by the government’s buildup of the armed forces and the war industries. But because price controls eventually kept the legal prices of civilian goods and services from rising substantially, civilian markets became subject to excess demand and the available goods had to be rationed by nonprice means, such as first-come-first-served transactions and discrimination according to race, sex, and friendship.

Supplies of some goods—including rubber products, sugar, and coffee—had been diminished by Japanese capture of supply sources (Malayan rubber plantations) or by naval warfare or scarcity of shipping services (German U-boats sank many U.S. merchant ships early in 1942). Government claims on rubber and tin cut further into supply, creating extreme excess demand for these goods. Shortages arose for automobile, truck, and tractor tires as well as for sugar and coffee—goods obtained largely from Latin American sources. Canned foods grew much scarcer because imports of Bolivian tin, used to coat the inside of cans, had been diminished by the increased shortage of shipping services. Therefore, many consumers could not obtain certain goods they normally consumed, and workers and housewives grew restive.

To curb the growing dissatisfaction, the OPA subjected scores of basic goods and services (which accounted for about one-seventh of all consumption spending) to rationing, creating a two-price system. To purchase a rationed good legally, the buyer had to surrender to the seller not only the (controlled) money price but also a stipulated amount of ration coupons or stamps (“points”). The system quickly became complex, and it remained subject to periodic changes and to a variety of exemptions for certain classes of buyers and goods. The table on the next page shows the program’s coverage and duration.

Rationing greatly increased the transaction costs of shopping for ordinary goods. Historian Richard R. Lingeman writes in Don’t You Know There’s a War On? (1970):

For the housewife, the rationing system meant the mastery of a constantly changing system of point values in the papers; while shopping, she kept one eye peeled on the monetary price and the other on the little red numerals posted on the shelf below products indicating their point price. She practiced double budgeting: money and points. She had to keep track of which stamps were valid during a certain time period, which were outdated, and what they might buy.

Mastering the prevailing stamp regime was only half the battle. Lingeman writes, “Housewives trekked from one market to another seeking meat for tonight’s supper; some days they were lucky to get frankfurters.” All sorts of expedients cropped up in response to these shortages. Lingeman continues, “So in demand were [frankfurters] that OPA told meat-packers to stretch them with various fillers such as soybeans, potatoes or cracker meal.” Coffee also suffered the addition of various fillers. Even gasoline was adulterated, with a substance known as Lubrigas. Even so, gasoline—along with sugar, butter, beef, pork, and bacon—at times disappeared from local markets. Lingeman concludes that “compared to the average level of peacetime living that most [Americans] were used to, they underwent hardships.” So much for “wartime prosperity.”

Making Crime Pay

Price controls and rationing created opportunities, however, for people willing to break the law. Active black markets developed all over the country. Substantial proportions of all transactions in some goods—especially beef and gasoline—occurred illegally. Housewives routinely bent the rules by trading, giving away, or selling ration stamps, which the law forbade. Mobsters entered the scene en masse, stealing ration coupons from OPA offices and reselling them, counterfeiting ration coupons and selling them, and hijacking trucks and selling their cargos without collecting ration stamps. Cattle rustling made a comeback.

Between February 11, 1941, and May 31, 1947, the OPA instituted 259,966 sanctions of various sorts. “One in fifteen businesses—wholesale, retail, service and so on—was charged with illicit transactions,” and “one in five of all establishments in the country received some kind of warning short of criminal prosecution,” according to Lingeman. Of course, many violations escaped notice, even though the OPA enforcement corps included at various times 2,000-5,000 investigators, working under 500-1,000 attorneys, and many thousands of part-time volunteers. As economic historian Hugh Rockoff notes, “[B]lack-market activities do not leave good statistical records and any estimate must be viewed as having a wide margin of potential error.” Yet he also remarks that “the appearance of deterioration and related evasive schemes in relatively homogeneous commodities,” such as fuel oil, coal, and gasoline, “testifies to the ubiquity of evasion.”

After an extensive study of wartime price controls during World War II, Rockoff concludes in his book Drastic Measures (1984): “The modern state has the power to control prices even in the face of a vast expansion of aggregate demand relative to output, but it can do so only through a drastic regimentation of economic life.” Rationing was an important part of that regimentation.