Open Letter to Congresswoman Shelley Berkley

Below is my open letter to Congresswoman Shelley Berkley (D-NV)

Dear Congresswoman Shelley Berkley:

This open letter is my appeal for you to reconsider prevailing economic orthodoxy. I write this letter out of deep concern for the future of this country. In this letter, my intention is to be as thorough as possible, since orthodoxies are treated as self-evident absolutes which must be overthrown through careful argumentative rigor. Platitudes would be insufficient. For repeating myself at times, I apologize.

The loan market is collapsing, people are losing their jobs and homes, and the "solutions" involve more central planning: viz., government spending disguised as "tax rebates," or the Federal Reserve lowering the Federal Funds Rate and/or the Discount Rate. It is my contention that these solutions are tantamount to pouring gasoline onto a fire.

Too often, the focus is on the symptoms, which then get transmuted into causes. Foreclosures and job losses do not determine economic conditions. Economic conditions determine foreclosures and job losses. Trying to stop these symptoms through central planning is akin to mopping up wetness to stop the rain. By focusing on the symptoms, this mitigates discussion of the underlying problems.

It is now generally accepted that inflation is a rise in prices, as measured by the Consumer Price Index. This definition of inflation is the first error, which begets more error. Defining inflation as a rise in prices contorts Irving Fisher's own quantity theory of money. The rise in prices is the usual result of inflation, which is an expansion of the money supply. In fact, it is hard to have a general rise in prices without an expansion of the money supply. By inverting this order, government will resort to price controls, or inflating even more--as though there is a dollar shortage--to compensate for higher prices. In other words, fighting the effects of its own policies.

Prevailing economic orthodoxy even teaches the fallacy called "cost-push" inflation, which blames rising prices on rising prices. If a rising price creates a domino effect, then why doesn't a falling price do the same thing? Where is the "cost-push" deflation at? Or, an even better question: if prices are determined by other prices, how is it that prices change at all? Wouldn't those other prices be determined by yet other prices?

The fallacy of "cost-push" inflation contains within itself a germ of truth: i.e., rising prices will beget a higher cost of living. The reason isn't because the price of one thing caused other prices to rise. It is because the rising price is embedded within other goods and services. To illustrate this, look at the price of gold which has more than tripled since 2001. This might mean a higher-priced computer--not because the price of gold caused the computer price to rise higher-than-it-otherwise-would-have-been--because there are gold parts within the computer. A transportation service might have to raise its prices due to higher gasoline prices, because the price of gasoline is embedded within the price of the service.

I am not sure how the Consumer Price Index came to be regarded as the holy grail in measuring inflation, and I would like to discuss a few of the plurality of reasons why it shouldn't be regarded as such.

Prices change not only due to inflation or deflation, but also due to things other than inflation or deflation (i.e., a contraction of the money supply, which we haven't had). For example, prices change due to supply and demand. The price of air isn't going up. Is this because there has been no inflation? No. It is because air is super-abundant. Thus, even with inflation--i.e., an expansion of the money supply--prices could fall, if supply exceeds demand. To really see the full effects of inflation, the uncalculable price that would need to be determined is the price that would have otherwise been--with all other variables remaning static--had there not been an expansion of the money supply. Measuring changes of prices does not give us that information.

Because prices change due to things other than inflation, and prices do not change proportionately, the CPI's methodology of averaging prices of completely different goods in a "basket-of-goods," in order to arrive at a "rate" of inflation, is an absurdity. This makes about as much sense as would averaging temperatures between Alaska and Las Vegas when reporting the weather. Such a temperature would have no relevance whatsoever to Las Vegans and Alaskans.

Suppose you walk into a car dealership and pay $15,000 for a car, but the dealer mugs you for another $15,000, how much did you really pay?

Many industries and corporations are beneficiaries of government subsidies in one way or another. Wal-Mart has received subsidies through Tax Increment Financing schemes at the local level. Agricultural subsidies are in the billions. How much does the military-industrial complex get in order to "protect" oil? The subsidies that the pharmaceutical-industrial complex receives are in the billions. What this means is that those cheap goods at Wal-Mart aren't as cheap as we think they are. We pay more for our gas than what we pay at the pump. Medications are even more expensive than we can calculate. What we are paying for milk isn't the full price.

We are paying what I call subsidized prices--something that the Consumer Price Index can't capture. The CPI only captures prices of particular transactions at the retail level. In short, the government, through the Bureau of Labor Statistics, is trying to measure inflation by measuring prices in a price structure that isn't intact.

To really understand what I am saying, look at sectors of the economy in which the government runs exclusive monopoly franchises: e.g., roads. I can get into my car and drive out on the roads without having to pay anything. In a narrow sense, it seems free to drive on government roads. But it isn't really free. The government subsidizes roads through taxation. This is the cost of government, which the CPI doesn't capture. Thus the government could literally print money (i.e., inflation) like crazy to subsidize everything--displacing consumer spending--and inflation could actually fall pursuant to the CPI's method. Real inflation could very well obfuscate price inflation, as calculated by the CPI. Just wait until we get universal healthcare, and then inflation will "drop" like a rock, pursuant to the CPI's method.

In fact, the Bureau of Labor Statistics' own web site says: "Since medical care only includes consumers' out-of-pocket expenditures (and excludes employer provided health care), its share in the CPI is smaller than its share of gross domestic product (GDP) and other national accounts measures." Which brings me to my next point.

Not only has the cost of government been conveniently excised from inflation statistics, it has been placed--erroneously--into the Gross Domestic Product.

Wealth is that which satisfies demands. Inasmuch as businesses satisfy consumer demands, they are being productive. Within the construct of the pure free market, productivity can be measured by income, since income is earned by satisfying consumer demands. The government, on the other hand, does not sustain itself by satisfying consumer demands--i.e., earning its income. The government uses the threat of violence, or actual violence, to obtain its revenue--i.e., compulsory taxation. Thus the government can't get away with saying that the more it taxes the more productive it is becoming.

The technocrats and hierophants had to come up with a different excuse for government: Government spending is productive! So, government spending has been placed into the GDP.

If you look at the textbook definitions of economic growth, objectively, it is defined as a rise in the GDP. A rising GDP means we are having "economic growth," because the GDP measures "economic growth," and "economic growth" is defined as a rising GDP. Before you can measure economic growth, you should be able to define it. Defining economic growth as a rise in the very indicator that supposedly measures economic growth is obviously flawed.

The simplest definition of economic growth is a lessening of the unsatisfaction of wants or demands. We are diverse, and our wants, or demands, are subjective. Politicians and econometricians are not psychics. There is no way to quantitatively measure economic growth. Besides, when our economy improves, we won't be needing a statistician to inform us.

Prevailing economic orthodoxy tells us that there are two kinds of GDP growth: Nominal and real. This is where thinking on the subject becomes cloudy. Real GDP growth is defined as nominal GDP growth discounted for inflation, which is determined by the unreliable CPI.

Let's start with a simple thought: Economic growth need not be discounted for inflation. Either we are having economic growth, or we aren't. If the GDP must be discounted for an inflation component, then this means that some GDP growth is good, but other GDP growth is bad. But if the GDP is measuring the same thing(s) constantly, this makes little sense. Either the GDP measures economic growth and any rise in the GDP is good, or the GDP measures inflation and any rise in the GDP is bad.

Government spending is in the exact wrong index. My contention for several years has been that the GDP tells us more about inflation than it does about economic growth. The GDP is a far better measurement of inflation than is the CPI.

Inflation is the cause of our economic woes, and it is much worse than the government would like people to believe. The economics profession has been taken over by good mathematicians, but terrible economists. The most sinister thing about this is that while the government deceives people about inflation, it then punishes businesspeople and entrepreneurs for overestimating profits--i.e., overvaluing the dollar. In fact, the process of inflation, which is a government policy of debauching the currency, could not work were people not deceived. If everybody properly accounted for inflation, this would nullify the positive effects of inflation for the narrow group of beneficiaries.

Inflation is an expansion of the money supply, which the government and its central bank--i.e., the Federal Reserve--are responsible for. The process of debauching the currency is fragmented between the government and its central bank. This has probably been by design, so as to obfuscate what is happening. The central bank inflates the money supply when it monetizes government debt, which is backed by nothing other than the government's power to tax. Of course, the central bank has a few other tools in its arsenal to devalue the dollar, such as lowering the reserve requirement. But the primary method is to buy government bonds. This provides the politicians on the Hill with a convenient way to finance spending. Monetary policy is an instrument of fiscal policy. Monetary and fiscal policy have been fragmented into separate compartments, causing people to overlook this nexus.

The subject of interest can be confusing, since the word interest is used in different contexts. When the Federal Reserve cuts interest rates, it is referring to either the Discount Rate or the Federal Funds Rate. The Discount Rate is the rate the Fed charges commercial banks to borrow from itself, in which case new reserves are being injected into the banking system. The Federal Funds Rate is the rate that commercial banks charge other banks to borrow "excess reserves"--i.e., "reserves" in excess of the reserve requirement.

The nominal interest rate that people pay on their loans is the prime rate. This is higher than the Discount Rate and the Federal Funds Rate. Long term rates can even run inversely with short term rates, since the market can account for inflation by adding an inflation agio onto rates.

The real rate of interest is the nominal rate of interest discounted for inflation. Suppose inflation is at ten-percent, but the nominal rate is five-percent, then the real rate of interest is below zero.

But what is interest? Interest is the discount rate of future goods against present goods.

Congresswoman Berkley, suppose you ask me to get you a sandwich to eat. I tell you I will get it in a few minutes. You tell me that would be okay. Suppose I redact it to an hour or so. You tell me that would be okay. Then I change it to four hours. You hesitate a little bit, but then agree that would be alright. I then change it to tomorrow. Or next year. Or ten years from now. What would you say?

Present goods are more valuable than future goods, since present goods are in greater demand than future goods. Thus it is imperative to discount future goods with interest. Time preferences determine the natural rate of interest.

The government and its central bank do everything to interfere with the market setting the natural rate of interest. Inflation turns time preferences upside-down, by making future goods comparatively more expensive than present goods. This diminishes the incentive to save, speeding up consumption. Inflation artificially suppresses both nominal rates and the real rate of interest.

When the government sends a bond over to the Federal Open Market Committee [FOMC] to finance its spending orgy, the FOMC writes out a check, depositing all newly created funds out-of-thin-air into the loan market. By injecting these new funds into the loan market, the supply of loanable funds is increased. In and of itself, this increase in the supply of loanable funds has a suppressive effect on nominal interest rates, as would increasing the supply of anything else tend to reduce its price. While it is true that the market can account for inflation by tacking an inflation premium onto nominal rates, the act of increasing loanable funds, by itself, tends to lower nominal rates. The movement of nominal rates depends upon which force is more dominant.

Inflation lowers the real rate of interest (i.e., nominal rate discounted for inflation), by allowing borrowers to pay back lenders with a devalued dollar.

Congresswoman Berkley, artificially low interest rates pose a serious problem. It isn't that I am opposed to low nominal rates per se. I am not opposed to low nominal rates any more than I am opposed to low prices. In fact, artificially low interest rates are nurturing high prices. My point is that artificially suppressed interest rates are just as destructive as are government price controls to artificially suppress prices.

The discussion of subprime lending misses the real problem entirely. The problem isn't subprime borrowers, or even bad lenders. The problem is the monetary system--i.e., inflation. In April of 2003, I wrote the following words in a commentary that can be found online:

"The loan market cannot keep underbidding the natural rate of interest and sustain itself for long."

In a free market, savings would be much more abundant, giving rise to a lower natural rate of interest. Only can the government use up savings, penalize savers, and suppress interest rates all in one motion. It does this through inflation. When nominal interest rates are outstripped by inflation, that is a negative rate of return. In my estimation, the real rate of interest has been below zero for a long time. That is the problem with the loan market. If businesses consistently sold inventory below cost, how long are they going to survive without government coming to the rescue over and over and over again? The loan market enjoys privileges that other sectors of the economy do not, thanks to the central bank.

That there is no free market in the U.S. banking system should become self-evident with things as simple as the Federal Funds Rate. You know what the Federal Funds Rate is? It is the rate of bank-to-bank lending. In other words: the revenue-sharing rate, as I call it. What other industry engages in revenue sharing on a massive scale? And if they can't get funds from eachother, then they go to the Fed. By God, why should the loan market engage in responsible practices when they enjoy such privileges?

So long as interest rates are artificially suppressed, it doesn't matter how good the borrowers are. Lenders shouldn't be scapegoated for the problem any more than Social Security recipients should be scapegoated for the welfare state that politicians have created. If your competitors are taking cheap money, and you must do the same thing in order to remain competitive, are you going to refuse? That the central bank repeatedly injects funds into the loan market is not the loan market's fault.

Inflation is what causes recessions. As dollars are devalued, profits are overestimated. This causes malinvestment. Suppose the nominal rate return is five-percent, but inflation is ten-percent. That is a negative rate of return. Because of this overestimation of profits, there is also a higher tax burden in real terms. Sellers exchange goods and services for these devalued dollars, earning what looks like a positive rate of return. When the seller has to replace capital or restock inventory, it is then discovered that the real rate of return was less, since prices have risen. In nominal terms, it looked profitable, at first. This encourages even more malinvestment in those sectors. It is later discovered that the real rate of return was lower--maybe even a negative rate of return in real terms. This forces a contraction.

The recession is the revelation of malinvestment, which was induced by inflation. That which is unproductive would be unprofitable within the construct of the unhampered free market. The biggest beneficiary of inflation is the inflator itself: Government. Just look at how huge the government is, and it is not only unproductive, it is counter-productive. This should lay to rest any doubt about how inflation nurtures malinvestment.

The catharsis for malinvestment is liquidation, which is the only true correction. Especially as firms and businesses are trying to combat the effects of inflation by cutting costs, the worst thing the government can do is to inflate even more to delay the correction. Unfortunately, the mainstream economics profession is lax in this understanding. It is normal that certain prices should drop due to malinvestment. This is where mainstream economists turn logic upside down. Instead of realizing that the inflation before the recession was the cause, these econometricians examine piles of data. The data itself becomes synonymous with the recession, as though nothing in the past helped cause the recession. The recession caused itself. From this thought pattern, it then follows that to adjust those "markers" of the recession is to provide the cure. If certain industries are collapsing and prices are falling, the government is supposed to inflate even faster, argue the econometricians.

Inflation to "cure" the recession is even more destructive than the inflation at the beginning of the artificial boom. Since supply helps determine prices, increasing supply can obfuscate inflation. Conversely, decreasing supply will compound the effects of inflation. Inflation coupled with capital decumulation creates a synergistic effect on prices. Thus it takes lower levels of inflation to cause rising prices. This is why it was easy for me to make the on-radio prediction at the end of the year 2001 that the price of gold would rise, and that people should get some, while others laughed at me, warning about the "danger" of "deflation."

Congresswoman Berkley, do you believe people are losing their homes because homes are too inexpensive? The market is trying to correct itself and recover from inflation, while simultaneously being attacked by the government and its central bank with more inflation to combat the correction.

I would like to remind you, as I have stated earlier in this letter, certain prices falling doesn't mean that there isn't, or hasn't been, inflation. Prices do not rise proportionately. Furthermore, in a paradigm of falling prices, if wages fall, but prices are kept artificially "stable," then the real cost of living is going up. If prices fall, but wages are kept artificially "stable," then there will be unemployment. The government should not be trying to prop anything up. We need to let the unhampered free market run its course.

These "stimulus" packages will not work. To say so is to imply that the problem has been a lack of government spending. Lowering interest rates will not stimulate the economy. To say so is to imply that the problem has been high interest rates. It has been the exact opposite. Unfortunately, we are now in a situation where interest rates must be allowed to rise in order for the economy to repair itself. By that, I don't even mean that the Fed should raise nominal rates. Inflation lowers the real rate of interest. Conversely, deflation will raise the real rate of interest. Dollar revaluation is the only answer, and it will require cuts in federal spending.

If orthodox economics is so hot, why are we in the mess that we are in with more credentialed economists than a century ago? Why is it that orthodox economists can t tell us exactly what causes a recession, nor can they tell us that we are in a recession until months after we have been in one? There is a tendency to process information in a vacuum.

Conventional wisdom tells us that President Jimmy Carter was a failure because interest rates were high while he was the President. Reagan was good because interest rates fell and there was an economic recovery during his tenure. This is wrong. The guns-and-butter policies of the Vietnam War precipitated the high interest rates during the latter part of the seventies and early eighties. The high interest rates of the seventies and early eighties precipitated the economic recovery under Reagan.

Social Security benefits are being surpassed by inflation. Congresswoman, do you understand the significance of this? Objectively, Social Security is being abolished....slowly. One little problem: it isn't being abolished by cuts in government spending, but by excessive government spending. The welfare state is collapsing under its own weight.

This means that the Social Security problem can't be fixed without addressing more abstract issues, such as sound money vs. fiat money and the inflationary spending orgy. To finance this spending orgy, the politicians print money--i.e., inflation--by using their central bank to monetize debt. It is this spending that begets inflation, begetting higher prices. The Social Security problem can't be fixed by simply increasing benefits.

Increasing government spending will only increase inflation. Chasing inflation with inflationary spending is a calculus for run-away government spending and an eventual train wreck. To say that the government should, or can, increase spending, but only at the rate of inflation, is akin to saying that it should rain, but only at the rate that it is flooding. Increasing Social Security benefits isn't even a band-aid solution. The Social Security problem can't be fixed without bringing aggregate government spending into check. The only way to do that is to make dramatic cuts in government spending somewhere.

Other problems that are hotly debated, such as the trade "deficit," are but symptoms of the monetary system. A trade "deficit" isn't bad per se. A trade "deficit" between two countries is no worse than a trade "deficit" between two towns. Not only that, as the economy tanks, expect imports to decline and the trade "deficit" to fall. The bad part is if the trade "deficit" is due to something other than comparative advantage, such as....inflation.

"Again, suppose, that all the money of GREAT BRITAIN were multiplied fivefold in a night, must not the contrary effect follow? Must not all labour and commodities rise to such an exorbitant height, that no neighbouring nations could afford to buy from us; while their commodities, on the other hand, became comparatively so cheap, that, in spite of all the laws which could be formed, they would be run in upon us, and our money flow out; till we fall to a level with foreigners, and lose that great superiority of riches, which had laid us under such disadvantages?" --David Hume, Essays, Moral, Political, and Literary, 1752

What mainstream economists teach runs contrary to what David Hume taught us in 1752. Prevailing economic orthodoxy inverts the trade cycle. We are told that inflation mitigates the trade "deficit." By inflating the money supply, dollars will become less attractive to foreigners. Thus, runs the argument, foreigners will follow by curtailing exports to the U.S. Somehow, domestic productivity will magically be increased, stimulating exports.

The genesis of this error is begotten by the underlying macroeconomic assumptions. Rather than using microeconomic principles to understand macroeconomic phenomenon, mainstream economics fragments microeconomics and macroeconomics into separate compartments. Macroeconomics then becomes myopic, by lopping individuals out of its paradigm. Myopic macroeconomics doesn't see individuals, only aggregates.

Translated, the macroeconomic analysis is this: the country has dollars. If the country, or nation--or whatever aggregate you wish to use--decides to print more dollars, obviously the country, or nation, isn't going to refuse to use its own dollars. However, the country, or nation, of, say, France, being a different country, won't like very much the devalued American currency.

I guess we aren't supposed to ask why both inflation and the trade "deficit" have been rising in juxtaposition with one another. Sound economics gives us that answer.

The economy is made up of individuals making choices in exchanges. When the government devalues the currency, this doesn't only make dollars less attractive to individuals abroad, but also to individuals right here at home. This is reflected with higher prices. It isn't about aggregates printing more money for use by aggregates.

Since the government dumps dollars on us here at home first, it is right here where the effects of inflation are first felt. The domestic cost of production goes up. Thus, to reduce costs, capital flight takes place. Inflation actually increases the dependance upon cheaper foreign markets to supply goods. As David Hume saliently articulated in 1752, inflation makes not only the currency less attractive abroad, but also the higher-priced goods. It also makes the higher-priced goods less attractive right here at home. Using inflation to remedy the trade "deficit" is akin to breaking a leg to make yourself more competitive.

The inflation-induced imbalance of trade also explains another phenomenon: American workers being displaced by foreigners. As a disabled veteran, I have noticed more often that people working in professional class jobs at the Department of Veterans Affairs are speaking very broken English. The doctors are coming from Asia and elsewhere. The nurses are coming in from the Philippines.

There is nothing wrong with immigration per se, nor is there anything wrong with foreigners working in professional class jobs per se. But why is this happening? Several years ago the argument used in favor of immigration was that the immigrants are taking jobs that Americans don't want. Now we are seeing immigrants working in professional class jobs. Is this because Americans don't want professional class jobs? Hardly.

Not only has inflation driven up the cost of production, forcing us to depend upon cheaper foreign markets to supply goods, but inflation has done the same thing to the labor market. I am not talking about "outsourcing." I am talking about foreigners coming to work here in the U.S. The cost of obtaining the credentials, in order to satisfy government requirements to work in the professional class jobs, has become unaffordable to the average American. It is now prohibitively expensive to meet the qualifications necessary to work in these occupations, pursuant to government regulations.

By contrast, it is a lot easier to purchase those accredited credentials in foreign markets that haven't had the inflation that we have had. Thus, we are now dependant upon cheaper foreign markets to supply us with professional labor domestically. We can't afford to work in the professional class jobs in our own country. Not only are we having to import our goods, we are also having to import labor.

Congresswoman Berkley, I notice that on your Congressional website you claim accolades for relief in the Alternative Minimum Tax. I ask you, Congresswoman Berkley, what good does it do to cut one particular tax, while simultaneously raising the overall tax burden? It was this kind of thinking that caused people to forget about the AMT to begin with. I might add that it was the school of economics that I belong to--i.e., the Austrian School of Economics--which predicted the soon-to-be encumbering AMT. See: www.mises.org/article.aspx?Id=721 I was talking about the AMT back in 2001.

But there is yet another tax, Congresswoman Berkley. Republicans claim accolades for having "cut" taxes. I submit to you that there hasn't been a real tax cut. Oh yes, particular taxes have been cut. But, objectively, there has been a gigantic net tax increase.

When President Bush first became President, federal spending was below $2 trillion per year. Today, the federal government alone spends around $3 trillion per year, not even counting off-budget outlays. To help finance this, the government creates new money out-of-thin-air--i.e., inflation. There is no objective difference between the government taking the money you have in your pocket and duplicating the money you have in your pocket, consequently devaluing the money you have. This is a stealth tax, called the inflation tax, which we feel with higher prices and a higher cost-of-living.

So long as the bipartisan spending orgy is left intact, we will not have had a real cut in the tax burden. If all the politicians do is cut apparent, or transparent, taxes, while leaving the spending orgy intact, then this increases the stealth tax of inflation. Government spending must be paid for one way or another. Cuts of particular taxes should not be conflated with a cut in the overall tax burden. What good does it do if the government leaves you with a little more money that has been devalued by a lot? Congresswoman Berkley, if you wish to do something about the problems we face, then I suggest you do something to help curtail the metastasizing government, the out-of-control police state, the bipartisan spending orgy, and the geopolitical policy of imperialism.

Cordially,

Mark Anderson