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Suggestions for Greenspan’s Summer Reading

Suggestions for Greenspan’s Summer Reading
By J. Bradley Jansen
August 22, 2001

Maybe Alan Greenspan should read Karl Marx. Now that I have your attention, I should explain what I mean. In the middle part of Marx’s second book of Capital, the explanation of the boom and bust cycle could be read as a contemporary criticism. The idea of “fictitious capital,” that is, capital financed through the monetary system without real savings, is an important one.

The more fictitious capital distorts the price mechanism of money, the less useful such information becomes. Since rational businessmen and consumers make decisions based on the information available to them, such artificial monetary distortions to the price signals lead them to make decisions different than they would have made in the natural economy. The resulting malinvestment manifests itself in the boom and bust cycle such as we have today. Marx and Engels even got part of history right in The Communist Manifesto. “The
bourgeoisie has played a most revolutionary role in history. The bourgeoisie has been the first to show what man’s activity can bring about. It has accomplished wonders far surpassing Egyptian pyramids, Roman aqueducts, and Gothic cathedrals; it has conducted expeditions that put in the shade all former migrations of nations and crusades . . . The bourgeoisie has given a cosmopolitan character to production and consumption in every country. The bourgeoisie, by the rapid improvement of all instruments of production, by the immensely facilitated means of communication, draws all nations, even the most barbarian, into civilization.”

Marx’s description of the end of the business cycle may even provide a glimpse of where our economy is headed: a scarcity of circulating capital and a consequent rise in interest rates make it impossible either to complete the large projects for investment in fixed capital or profitably to use the additional plant.

It is central banks that are responsible for the “fictitious capital” which has no place in a free market economy. It was the Federal Reserve’s 1920s credit boom that lead to the bust of the Great Depression. In one of history’s ironic twists, the devastating effects of the deviation from free market policies substantially increased support for socialism.

Some people looked at the failure of central planning through central banking and announced capitalism’s failure. When tens of millions were unemployed, throughout the western world, many thought Marx’s prophecy of capitalism’s demise was accurate, and that collective, state controlled means of production, as in the Soviet Union, was the best way to achieve a stable and productive economy.

Fortunately, a few people understood that the distortions of the price signals that Marx had explained prohibited the successful planning of the economy-an idea that still attracts many followers. Such economic planning could only work if the central planner were omniscient and could plan more than just our economic life.

The great economist and social thinker F.A. Hayek understood Marx’s both positive and negative contributions. Hayek’s Prices and Production explains well the structure of production problems of the business cycle theory that Marx addressed.
However, Hayek wrote in The Fatal Conceit, “Karl Marx was thus right to claim that ‘capitalism’ created the proletariat: it gave and gives them life.” According to Hayek, “only capitalism makes democracy possible.”

The Road to Serfdom, the book that made Hayek famous, is still the best safeguard against economic disaster and social dictatorship and explains what Marx got wrong. Central bankers, other central planners and their misguided supporters, still seem to be trapped in the same fallacies that Hayek unmasked a half-century ago.

Low, nonexistent or negative savings make investment in the real economy more difficult. Interest rates in a natural economy should reflect the ratio of savers’ willingness to lend versus others’ willingness to borrow. “Fictitious capital” rose during the Asian monetary crises, the Long-Term Capital Management bailout and the run-up to Y2K. The fear now is not just that we will have the correcting bust to the artificial credit induced boom, but that the bust will give credence to anti-capitalists.

The central banking artificial boom contributed to the debt-based behavior we are witnessing today. Mortgage debt is high, and the credit card loss rate is the highest in four years. Such distortions from the natural economy have resulted in wasted resources: losses over the past year for companies on the high-tech heavy Nasdaq have erased all of the profits since 1995.

With such troubles on the horizon, a new anti-capitalist manifesto, Empire, has emerged. Written by Duke literature professor Michael Hardt and Antonio Negri (currently in a Roman jail), their book proposes a “new system” that would “eliminate inequalities between rich and poor and between powerful and powerless.”

Hopefully, their contribution will be as lasting as that of Herman Finer’s 1945 The Road to Reaction. As Hayek explained, a claim for equality of material position can be met only by a government with totalitarian powers.”

Thirty years ago this week, Nixon closed the gold window and greatly enabled the central bank to create unlimited “fictitious capital.” The stagflation we experienced then and the boom and bust we have now are the results. Such policies erode our economic freedom. As Hayek argued clearly, “We have progressively abandoned that freedom in economic affairs without which personal and political freedom have never existed in the past.”

I hope Greenspan has at least read Hayek.