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Booms, Busts, and Food Prices

  Booms, Busts, and Food Prices

by Gary North

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Maybe you have heard about rising food prices. It is happening all over the world. We hear of Third World rural populations that are trapped by rising food prices.

Why are food prices rising? Simple: because urban people in formerly Third World nations are getting richer. India and China are the obvious examples. As these economies are freed from the regulations that once burdened them, the growing urban middle class bids up the price of food. People with money in their pockets like to eat more and better food. In the bidding war between rural people with little capital and therefore low incomes vs. urban residents with more capital and higher incomes, rural people lose.

The price of food is rising not just in U.S. dollar terms, but in terms of all currencies. This is not a U.S. phenomenon only. This is international.

When we compare the rise in the price of oil since 1999, the rise in the prices of commodities in general (including gold and silver), and the price of food, food remains a bargain. Two charts are here.

COLLAPSE IN 2008

The recession in 2008 drove down the oil price from $147 to $33 in the final five months. This was a collapse. The price of food fell, too, though not to this extent. Silver and gold fell – silver far more sharply than gold. This indicates the degree to which commodities are tied to the worldwide business cycle. Commodity prices fell because the international economy fell.

Commodities are not the initiating force in price inflation; monetary policy is. The prices of raw materials rose in the first decade of the 21st century because central bank policies around the world were expansionary. When the recession hit in 2008, the prices of commodities fell, but not until several months into the recession. (Gold and silver fell in March, before the others fell.)

There is an ancient error, stretching back to Adam Smith, which says that retail prices rise because of cost-plus inflation. Prices for raw materials rise, forcing up retail prices. This was refuted by Carl Menger, the original Austrian School economist, in 1871. He showed that production costs rise in response to bids by entrepreneurs, who in turn expect rising demand for the output of their enterprises. The prices of economic inputs rise in response to expectations.

When, in the second half of 2008, entrepreneurs and speculators finally recognized the extent of the recession, they stopped bidding for as many raw materials. So, the prices of these production goods fell.

It is true that monetary policy affects the business cycle. It is true that QE2 is inflationary. But let us not mistake cause and effect. The increase in commodity prices all over the world ever since early 2009 is the result of simultaneous central bank policies. The Federal Reserve System and other large central banks began inflating in late 2008 to reverse the banking panic by large depositors, not small depositors, who were covered by FDIC rules.

The policies of late 2008 have not produced mass inflation, because commercial bankers have increased their banks' excess reserves at the FED and other central banks. They are not lending all of the money that they are legally entitled to lend.

QE2 has nothing to do with much of anything. Yet.

QE2 AND PRICES

First, QE2 did not get rolling until early in 2011. For most of 2010, the Federal Reserve System was deflating. This is seen in the chart of the adjusted monetary base.

Second, commodity prices rose in 2009 and 2010.

Third, the cause of this increase was the prior monetary policies of central banks, late 2008 to early 2010.

Fourth, the increase in the adjusted monetary base in 2011 indicates that the "exit strategy" of 2010 has ended. Bernanke keeps talking about being ready to adopt an exit strategy when the time is ripe. This is a smoke screen. The FED actually began to adopt a policy that can best be described as an exit strategy in March 2010. It has made a fast exit from the exit strategy in 2011.

That commodity prices could continue to rise in expectation of a QE2-generated recovery later this year is quite possible. It depends on what entrepreneurs expect commercial bankers to do. Will bankers lend? If so, the M1 supply will rise, and so will the M1 multiplier. That will force up prices. But QE2 may fail to persuade commercial bankers to lend. Then the FED will be pushing on a string.

My point is this: you should pay no attention to anyone who tells you that the rise in food prices has been the result of recent Federal Reserve policies. Commodity prices rose in 2010 despite a policy of monetary deflation by the FED. This is rarely discussed by financial commentators.

I think the upward move of commodities will continue until China goes into recession. China's central bank is raising interest rates. As far as we are told, monetary policy remains expansionist. But rising rates for commercial banks will have the effect of making commercial loans unprofitable for some entrepreneurs. They will cease hiring workers. They will cease buying commodities. This is what the Austrian theory of the business cycle teaches. In order to avoid price inflation, the central bank changes course and lets interest rates rise. This ends the boom.

At the margin, Western consumers are not the source of the rise in food prices. The West is rich. It allocates relatively little of its monthly expenditures to food. When Western incomes increase, the bulk of the money does not go to increased consumption of rice, wheat, and corn. This is not the case in the Third World. When people move from the country to work in urban settings, they increase their purchases of food. Their mark of wealth is their ability to buy more food. They bid against each other. They bid against rural residents.

The rising price of oil and food indicates a growing economy worldwide, just as falling prices in the second half of 2008 indicated a contracting economy.

Oil is extremely volatile because of the inability of buyers to store large quantities in reserve. This is not true of foodstuffs. The food is kept in grain elevators. The price of food is less volatile than energy prices, because entrepreneurs who hold grain in reserve can sell into this increased demand. This increases the supply of food available to retail food producers.

DOLLARS AND FOREIGN CURRENCIES

One of the marks of an ill-informed analyst is the absence of any discussion of foreign central bank policies in relation to Federal Reserve policies. Let me explain.

Food in foreign countries is priced in the domestic currency units of those countries. What the Federal Reserve does is not directly relevant to the economies of those countries.

When the FED increases the monetary base by purchasing Treasury debt, this reduces the interest rate of short-term bills, but it can – and did – increase the mid-term rates. This was not what Federal Reserve economists would have imagined. You can see what happened in February.

Higher rates of limited magnitude have little effect on foreign central banks. They buy U.S. Treasury debt for other considerations than a few hundredths of a percentage point in interest. They buy for reasons of mercantilism: subsidizing their export sectors.

The average resident in a foreign nation bids for food, as for all other scarce resources. But he bids in terms of his nation's currency unit. This has nothing directly to do with the Federal Reserve and QE2. The bidding process raises the price of food. Americans must bid more dollars to buy food. But this demand is in terms of consumers' output, not dollars. Japanese residents bid with yen. Americans bid with U.S. dollars. Chinese residents bid with yuan. But to buy yen, dollars, or yuan, residents must sell their output. They are buying food with their output. This is the fundamental fact of all pricing.

The FED inflates the monetary base. This may or may not lead to increased M1 and a higher M1 money multiplier. At some point, Americans will get their hands on some of this new money. They will bid for goods and services. But they will not bid very much extra for increased food. If Richard Simmons had his way, Americans would bid more for a new Richard Simmons DVD on how to lose weight by this or that technique. They would bid more for fresh fruits and veggies and less for snack foods that most people enjoy eating. Snack foods are more about packaging and taste than about the cost of grains to produce them.

So, what matters most for the price of food in a foreign country is the domestic monetary policy and economic output in that country.

If the central bank of some Asian country tries to keep its currency from rising in relation to the U.S. dollar by inflating the domestic currency, this will affect the price of food there. The increased monetary expansion will fuel the boom phase of the boom-bust cycle. This will goose the economy by lowering nominal interest rates. But this effect would not take place if the central bank did not tamper with the money supply or the interest rate on short-term government bonds.

To blame Bernanke and the FED for the rising cost of food is based on a misunderstanding of the currency markets. It blames a cause which is not in fact the primary cause. The primary cause is rising output – increased bids – in Third World countries that are experiencing economic growth. To the extent that this rising output is based on long-term innovation and capital investment, this is positive. To the extent that it is based on fractional reserve banking and central bank purchases of debt, it is not positive. Rather, it is creating a boom that will turn into a bust, just as it did in the second half of 2008.

DESPERATE CENTRAL BANKERS

Central banks inflate to keep government debt markets solvent. That is their official task. It has been ever since the Bank of England was created in 1694.

Central banks inflate also to keep large commercial banks solvent in a financial panic. That has been their unofficial task for at least a century.

They began doing this as a depression hedge in the early 1930s. John Maynard Keynes announced his last career flip-flop in 1936, with the publication of The General Theory of Employment, Interest, and Money. Here, he set forth his recommended cure for the Great Depression: government spending. This could be done through taxes, borrowing, and monetary inflation. He preferred the second, but he was not limited to it, nor have his disciples been limited. Keynes baptized policies that Western governments had already adopted. He invented a new terminology to cover his tracks. He was merely promoting the crackpot monetary theories of Major Douglas and Silvio Gesell, as he admitted (pp. 353-58).

Bringing Keynesian policies up to date, the unprecedented increases in the monetary base of the Federal Reserve, the Bank of England, and the European Central Bank, beginning in late 2008, were the cause of the reversal of the collapse of the financial markets. This reversed the recession. This led to a recovery of commodity prices after 2008. These effects had impact on the eating habits of Chinese and Indian consumers. China and India are part of the international economy. But the effect on food prices was indirect. They rose because demand for Asian exports recovered. The people involved in the export trade were able to bid up the price of food.

There is talk about food being a bubble sector. Given what happened in the second half of 2008, this is a legitimate conclusion: the bubble popped. If the central banks continue to inflate, and the West's economy avoids another major recession, then food prices will continue to increase. Poor people are becoming less poor, and as they become richer, they will eat more. They will also move from bicycles to motor bikes. Motor bikes consume gasoline.

Commodities rise in price when there is increased demand for them as factors of production. There will be increases in technology in these sectors, but the rate of speed at which Indians and the Chinese are getting richer is greater than increases in production of raw materials. This is a bubble in the sense of central bank policies promoting a boom economy through inflated currencies. But the general upward move of commodity prices, as distinguished from consumer goods prices, will likely continue over the next two decades.

There will be a bust at some point, perhaps in the next few years, and maybe before. Central bankers in China and India will separately decide to put on the monetary brakes in order to avoid mass price inflation. There will be recessions in both nations. This will once again force down the price of food. But this will be a buying opportunity. The long-run trend is up, because the long-run trend of Asian productivity is up.

Bernanke is responsible for persuading all of the FOMC members except Hoenig to vote for the expansion of the monetary base. To the extent that this delays the day of reckoning, when capital is finally priced apart from monetary inflation, the FED is responsible for the bubble in food prices. But this increase has been going on for a decade. This is not recent. It has nothing to do with QE2. Yet.

CONCLUSION

The rise in food prices is a mark of deliverance out of poverty for hundreds of millions of Asians. The fact that they are saddled with imitations of the Bank of England, just as residents of the West are, is unfortunate. It will be even more unfortunate when the era of central banking and the welfare state reaches its apogee and collapses.

The universal bankruptcy of the national welfare states will provide a great opportunity for free market economists to say, "We told you so," and perhaps gain their followers a market for the reconstruction of the political order from the bottom up.

There will be a price to pay. The rising price of food in the boom phase of the great transformation is likely. When poor people get richer, they spend money more on food, but less time producing it. The bubble in food prices is indeed a bubble, because Asian central banks are inflating. But in the long run, food prices and oil prices will rise because newly middle-class people prefer to buy food and fuel with their increased output.

The supreme mark of a more productive economy is the increase in the price of land, meaning the raw materials that land produces. Capitalism is reducing poverty today on a scale never before seen. So, food and fuel prices will rise until new technologies are implemented that allow raw materials suppliers to keep pace with the move from the Asian countryside to the cities. Such innovations will not keep pace for the next 20 years.

Be thankful that you are not some middle-aged peasant trapped in the pre-capitalist economy of some Asian village. For him, this vast increase of urban wealth will be no picnic.

February 26, 2011

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North

 
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Why is price inflation raging in China, but not in the US?

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Why is price inflation raging in China, but not in the US?  Both countries and their central banks showered banks with stimulus money.  The short answer to that question is because the Chinese state-owned banks kept lending to businesses and individuals while US commercial bankers have tightened lending.

The fractional-reserve lending process creates money.  Money creation adds to the money supply that comprises people’s checking accounts (M1).  People spend the money in their checking accounts to purchase goods.  More money chasing the same amount of goods leads to higher prices (all other things being equal).  To better understand how this process functions to create money click here: http://en.wikipedia.org/wiki/Fractional_reserve_banking .  Also, Murray Rothbard’s “The Mystery of Banking” is a bit longer, but it is so elegant an explanation of this process that affects us all.  http://mises.org/resources/614/Mystery-of-Banking-The

The US commercial bankers are not lending the over one trillion dollars in excess reserves that they received from the Federal Reserve.  Lending is the process in which the reserves are transformed into M1 money supply.  Individuals in the US are going to experience massive price inflation once the bankers expand lending.  These price increases will make the 1970’s seem like a sunny afternoon.

The Chinese government bankers do not face negative career sanctions if they drive their banks and country into the ground.  Only the biggest US banks are protected by the Federal Reserve.  All other bankers are tightening for their lives.  The biggest banks are not lending to shore up their pathetic balance sheets.

They Chinese government bankers are lending like crazy despite the obvious price increases in goods and real estate in China.  Their price increases are going to lead to strife in China.  There are millions of unmarried, unemployed Chinese males due to the government’s one child policy that are facing increased prices and poor employment prospects.  That spells revolution in most historical cases.

What is happening in China will happen to us.

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Chinese shoppers struggle with spiraling prices

Chinese shoppers struggle with spiraling prices as government tries to cool inflation

A woman selects vegetables on a store inside a market in Beijing, China Tuesday, Feb. 15, 2011. A jump in food prices pushed China's inflation higher in January, adding to pressure on Beijing to control surging living costs. (AP Photo/Andy Wong)

, On Tuesday February 15, 2011, 5:33 am EST

BEIJING (AP) -- Spiraling prices have made the grocery store a scary place for Chu Yun, a 27-year-old office clerk.

"Prices for everything are going up and it seems it will never stop," Chu said as she hunted bargains in a supermarket. "I have no confidence prices can be brought under control this year. I think they will keep going up."

China's public is struggling with a monthslong surge in food prices that has defied government efforts to combat inflation with interest rate hikes, price controls and a campaign to boost vegetable and grain output.

On Tuesday, the government reported inflation accelerated in January, rising to 4.9 percent from December's 4.6 percent. That was driven by a 10.3 percent jump in food costs amid tight supplies and strong demand.

Economists expect more sharp price rises in coming months because China faces a problem it cannot quickly fix: Demand is outstripping food supplies, while high global commodity prices mean it can't fill the gap cheaply with imports.

"Inflation is unlikely to come down substantially in the first half of the year," said Mark Williams of Capital Economics. Analysts expect more rate hikes, but Williams said that on their own, "they aren't going to bring more crops to the market."

Inflation is dangerous for China's leaders because it erodes economic gains that underpin the Communist Party's claim to power. And it hits the poor majority hardest in a society where millions of families spend up to half their incomes on food.

That is politically awkward as Beijing tries to enforce stability ahead of a once-a-generation handover of power next year to younger Communist Party leaders.

"The political backdrop of the transition is paramount in the policymakers' minds," said Dariusz Kowalczyk, senior economist at Credit Agricole CIB. "They realize the poorer people who still are the majority of China's population are hurt by inflation to a larger degree than they benefit from growth."

Beijing has tried to mollify the public by paying food subsidies to poor families, holding down prices in university cafeterias and ordering local leaders to see that vegetable markets have adequate supplies. It has tried to diffuse public frustration by claiming hoarding and price-fixing by speculators is partly to blame.

But analysts say Beijing also failed to act quickly enough to head off inflation after it deflected the 2008 crisis by flooding the economy with stimulus money and bank lending. The economic rebound gave consumers more money to spend and banks are pumping out loans despite orders to curb credit.

Beijing has raised interest rates three times since October, but economists say more rate hikes are needed and it will be months before the effect is seen.

"It seems Chinese policymakers are behind the curve in fighting inflation," Kowalczyk said. "They have been too cautious."

The headline inflation numbers hide even sharper increases in key items.

In January, the price of fresh fruit soared by more than a third from year earlier, while eggs rose by a fifth, the National Bureau of Statistics reported.

At the Xinya Shopping Center, a supermarket on Beijing's east side, the price of sugar is up 80 percent over a year earlier, while high-quality rice costs 65 percent more, according to manager Wang Yongyi.

"Since the second half of last year, we have been busily changing the price tags to mark the prices up," Wang said. "It seems that the more control we had from the government, the higher prices rise."

Inflation could also spill over into higher Chinese export prices. That might raise costs for Western consumers but also could help countries such as Vietnam and India compete with China as suppliers of clothing, furniture and other low-cost goods.

Global Sources, a company that connects Chinese suppliers with foreign customers, said this week that a survey of 232 Chinese companies found 74 percent of them raised prices last year -- some by up to 20 percent -- due to higher costs for materials and components.

"China is steadily moving away from being the world's low-cost source of various products," the company said in a report released this week.

A separate Global Sources survey of 385 foreign buyers last month found 31 percent were increasing purchases from Vietnam due to higher Chinese prices.

Higher inflation also might prompt Beijing to slow the rise of its currency, the yuan, against the U.S. dollar to help its exporters compete. That might add to strains with Washington and other governments that complain the yuan is kept undervalued, giving China's exporters an unfair advantage and adding to its huge trade surplus.

Adding to pressure on food supplies, China's northeast faces a crippling drought that threatens its winter wheat crop. Global wheat prices are high, limiting Beijing's ability to fill the gap by boosting imports at a reasonable price.

The government has launched a $1 billion campaign to save the harvest with emergency irrigation and cloud-seeding to make rain.

"I hope the government can rein in the food price rises this year, or else people's lives will be greatly hurt," said Wang, the supermarket manager. "No matter how high prices go, people need to eat anyway, right?"

AP researcher Yu Bing contributed.

China National Bureau of Statistics (in Chinese): http://www.stats.gov.cn

China's Economic "Hard Landing" Will Cause a Commodity Crash, Says Gary Shilling

by Peter Gorenstein

China, now the second largest economy in the world, is headed for (relatively) hard times, says economist Gary Shilling, president of A. Gary Shilling & Co. He expects the economy will experience a "hard landing within this calendar year or perhaps the first half of the next calendar year," he tells Aaron Task in this accompanying clip.

China's Hard Landing Is Another Country's Boom

Shilling says a hard landing will result in 6% growth, not the double-digit growth they've been used to over the past decade. The irony, of course, is that kind of growth in the U.S. and other developed countries would be considered an economic renaissance. But not in China.

It's the Inflation, Stupid

China is currently trying to battle inflation that rose 5 percent in January and included a 10 percent gain in food prices, putting new stresses on domestic consumers. Shilling says rising prices are an ill effect of China's $585 billion stimulus package implemented in 2009, in the wake of the global financial crisis. 

The stimulus package, which amounted to 12% of the Chinese economy -- twice as large a percentage as the U.S.'s stimulus -- has manifested itself in a commodity and speculative real estate bubble that Shilling thinks is set to pop.

So far, Beijing has unsuccessfully tried to cool the economy by raising interest rates three times since October.  It won't have the desired effect, Shilling argues.  "I think that they are probably going to overdue it."

Commodity Crash Coming

That hard landing is bad news for commodity prices.  He's betting against the entire commodity complex, saying once the industrial metals such as copper fall, it will cause a domino effect in agricultural products such as cotton, wheat and soy beans.

That commodity crash will also manifest itself in weaker "commodity" currencies such as the Australian dollar, the New Zealand dollar and, to a lesser degree, the Canadian dollar.

Link to original article: http://finance.yahoo.com/tech-ticker/chinas-economic-hard-landing-will-cause-a-commodity-crash-says-gary-shilling-yftt_535929.html

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How the Fed Fuels Unemployment.

Read this excellent, short article on how the Federal Reserve policies fuel unemployment past and present.  A basic understanding of Austrian economics can save you thousands of dollars by preventing you from being hoodwinked by the Fed and its shills in the financial press organizations (CNBC, Wall Street Journal, etc).

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How the Fed Fuels Unemployment

by Thomas J. DiLorenzo
by Thomas J. DiLorenzo
Recently by Thomas DiLorenzo: Another Court Historian’s False Tariff History

Testimony of Dr. Thomas DiLorenzo
Professor of Economics, Loyola University Maryland
Committee on Financial Services, Subcommittee on Domestic Monetary Policy and Technology
Wednesday, February 9, 2011
2128 Rayburn House Office Building

Mr. Chairman and members of the committee, I thank you for the opportunity to address the issue of today’s hearing: "Can Monetary Policy Really Create Jobs?" Since I am an academic economist, you will not be surprised to learn that I believe that the correct answer to this question is: "yes and no." Monetary policy under the direction of the Federal Reserve has a history of creating and destroying jobs. The reason for this is that the Fed, like all other central banks, has always been a generator of boom-and-bust cycles in the economy. Why this is so is explained in three classic treatises in economics: Theory of Money and Credit by Ludwig von Mises, and two treatises by Nobel laureate economist F.A. Hayek: Monetary Theory and the Trade Cycle and Prices and Production. Hayek was awarded the Nobel Prize in Economic Science in 1974 for this work. I will summarize the essence of this theory of the business cycle as plainly as I can.

When the Fed expands the money supply excessively it not only is prone to creating price inflation, but it also sows the seeds of recession or depression by artificially lowering interest rates, which can ignite a false or unsustainable "boom" period. Lower interest rates induce people to consume more and save less. But increased savings and the subsequent business investment that it finances is what fuels economic growth and job creation.

Lowered interest rates and wider availability of credit caused by the Fed’s expansionary monetary policy causes businesses to invest more in (mostly long-term) capital projects (primarily real estate in the latest boom-and-bust cycle), and there is an accompanying expansion of employment in those industries. But since the lower interest rates are caused by the Fed’s expansion of the money supply and not an increase in savings by the public (i.e., by the free market), businesses that have invested in long-term capital projects eventually discover that there is not enough consumer demand to justify their investments. (The reduced savings in the past means consumer demand is weaker in the future). This is when the "bust" occurs.

The economic damage done by the boom-and-bust policies of the Fed occur in the boom period when resources are misallocated in the ways described here. The "bust" period is actually a necessary cure for the economic miscalculations that have occurred, as businesses liquidate their unsound investments and begin to make decisions on realistic, market-based interest rates. Prices and wages must return to reality as well.

Government policies that bail out businesses that have made these bad investment decisions will only delay or prohibit economic recovery while encouraging more of such behavior in the future (the "moral hazard problem"). This is how short recessions can be turned into seemingly endless ones. Worse yet is for the Fed to create even more monetary inflation, rather than allowing the necessary economic adjustments to take place, which will eventually set off another boom-and-bust cycle.

As applied to today’s economic situation, it is obvious that the artificially low interest rates caused by the policies of the Greenspan Fed created an unsustainable boom in the housing market. Thousands of new jobs were in fact created – and then destroyed – giving an updated meaning to Joseph Schumpeter’s phrase "creative destruction." Many Americans who obtained jobs and pursued careers in housing construction and related industries realized that those jobs and careers were not sustainable after all; they were fooled by the Fed’s low interest rate policies. Thus, the Fed was not only responsible for causing the massive unemployment that we endure today, but also a great amount of what economists call "mismatch" unemployment. The skills that people in these industries developed were no longer in demand; they lost their jobs; and now they must retool and re-educate themselves.

The Fed has been generating boom-and-bust cycles from its inception in January of 1914. Total bank deposits more than doubled from 1914 to 1920 (partly because the Fed financed part of the American involvement in World War I) and created a false boom that turned to a bust with the Depression of 1920. GDP fell by 24% from 1920–1921, and the number of unemployed more than doubled, from 2.1 million to 4.9 million (See Richard Vedder and Lowell Galloway, Out of Work: Unemployment and Government in Twentieth-Century America). This was a more severe economic decline than was the first year of the Great Depression.

In America’s Great Depression economist Murray N. Rothbard demonstrated that, once again, it was the excessively expansionary monetary policy of the Fed – and of other central banks – that caused yet another boom-and-bust cycle that spawned the Great Depression. It was not the Fed’s subsequent restrictive monetary policy of 1929–1932 that was the problem, as Milton Friedman and others have argued, but its previous expansion. The Fed was therefore guilty of contributing greatly to the massive unemployment of the Great Depression.

In summary, the Fed’s monetary policies tend to create temporary and unsustainable increases in employment while being the very engine of recession and depression that creates a much greater degree of job destruction and unemployment.

February 10, 2011

Thomas J. DiLorenzo [send him mail] is professor of economics at Loyola College in Maryland and the author of The Real Lincoln; Lincoln Unmasked: What You’re Not Supposed To Know about Dishonest Abe and How Capitalism Saved America. His latest book is Hamilton’s Curse: How Jefferson’s Archenemy Betrayed the American Revolution – And What It Means for America Today.

Copyright © 2011 by LewRockwell.com. Permission to reprint in whole or in part is gladly granted, provided full credit is given.

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Here is the link to the original article: http://www.lewrockwell.com/dilorenzo/dilorenzo200.html

Politicians exploit economic ignorance

Politicians Exploit Economic Ignorance

by Walter E. Williams

Recently by Walter E. Williams: Liberals Confuse Me

 
  

One of President Obama's campaign promises was not to raise taxes on middle-class Americans. So here's my question: If there's a corporate tax increase either in the form of "cap and trade" or income tax, does it turn out to be a middle-class tax increase? Most people would say no but let's look at it.

There's a whole subject area in economics known as tax incidence – namely, who bears the burden of a tax? The first thing that should be recognized is that the burden of a tax is not necessarily borne by the party upon whom it is levied. That is, for example, if a sales tax is levied on gasoline retailers, they don't bear the full burden of the tax. Part of it is shifted to customers in the form of higher gasoline prices.

Suppose your local politician tells you, as a homeowner, "I'm not going to raise taxes on you! I'm going to raise taxes on your land." You'd probably tell him that he's an idiot because land does not pay taxes; only people pay taxes. That means a tax on your land is a tax on you. You say, "Williams, that's pretty elementary, isn't it?" Not quite.

What about the politician who tells us that he's not going to raise taxes on the middle class; instead, he's going to raise corporate income taxes as means to get rich corporations to pay their rightful share of government? If a tax is levied on a corporation, and if it is to survive, it will have one of three responses, or some combination thereof. One response is to raise the price of its product, so who bears the burden? Another response is to lower dividends; again, who bears the burden? Yet another response is to lay off workers. In each case, it is people, not some legal fiction called a corporation, who bear the burden of the tax.

Because corporations have these responses to the imposition of a tax, they are merely government tax collectors. They collect money from people and send it to Washington. Therefore, you should tell that politician, who promises to tax corporations instead of you, that he's an idiot because corporations, like land, do not pay taxes. Only people pay taxes.

Here's another tax question, even though it doesn't sound like it. Which workers receive higher pay: those on a road construction project moving dirt with shovels and wheelbarrows or those moving dirt atop a giant earthmover? If you said the worker atop the earthmover, go to the head of the class. But why? It's not because he's unionized or that construction contractors have a fondness for earthmover operators. It's because the worker atop the earthmover is working with more capital, thereby making him more productive. Higher productivity means higher wages.

It's not rocket science to conclude that whatever lowers the cost of capital formation, such as lowering the cost of investing in earthmovers, enables contractors to purchase more of them. Workers will have more capital to work with and as a result enjoy higher wages. Policies that raise the cost of capital formation such as capital gains taxes, low depreciation allowances and corporate taxes, thereby reduce capital formation, and serve neither the interests of workers, investors nor consumers. It does serve the interests of politicians who get more resources to be able to buy votes.

You might wonder how congressmen can get away with taxes and other measures that reduce our prosperity potential. Part of the answer is ignorance and the anti-business climate promoted in academia and the news media. The more important reason is that prosperity foregone is invisible. In other words, we can never tell how much richer we would have been without today's level of congressional interference in our lives and therefore don't fight it as much as we should.

October 5, 2010

Walter E. Williams is the John M. Olin distinguished professor of economics at George Mason University, and a nationally syndicated columnist. To find out more about Walter E. Williams and read features by other Creators Syndicate columnists and cartoonists, visit the Creators Syndicate web page.


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