The article explains in simple terms why the West and China are locked in the vicious circle of turbo-charged export from China and deindustrialization and the coming bankruptcy of Western economies.
It explains in simple terms KEYNESIANISM and MERCANTILISM and what role these idiotic economic schools play in the epic drama of today.
It also explains why Austrian School of free market has no chance so long the bureaucracies in both East and West have hijacked democracy: both political and economic.
(OK, this one is a bit long but worth the 5 minutes of yours.)
(OK, this one is a bit long but worth the 5 minutes of yours.)
Daily Reckoning Issue 1025
by Bill Bonner December 24, 2010
The folly of Nations - Why Free Market has no chance
"Thou shalt not steal, except by majority vote."
-- The Gospel According to Keynes, Chapter 1,
|Keynes - economic moron and socialist|
Keynesianism is an economic
philosophy based on the idea that
the free market required intervention
from the civil government in order
to maintain justice and efficiency.
The free market is both inefficient
and unfair to the common man,
So does mercantilism.
Keynesianism is almost universally believed today.
Therefore, mercantilism is almost universally believed.
This connection is not intuitive, but it is nonetheless
true. What the economics textbooks do not say, because
they are written mostly by Keynesians, is that Keynesianism
is mercantilism with equations.
The textbooks are officially anti-mercantilistic.
There is a reason for this. Mercantilism is officially
wrong, because it is undeniably old. Textbooks promote
that which is new: "The latest is the greatest."
Mercantilism was believed from 1650 to 1750. It is
Yet it is in fact the dominant economic philosophy
today. But it operates under cover. The cover is called
"managed trade." It is sometimes called "fair trade." The
high priests of mercantilism baptize the new convert in the
name of free trade, but then they catechize him in terms of
modified mercantilism. Modern mercantilism is "free trade
with modifications for justice's sake." "Justice" is
defined operationally as "protecting a politically favored
Keep your eye on the modifications. Here is where the
sleight-of-hand operates. Here is where slick-talking
fellows from the best economics departments separate the
rubes from their money.
BAIT AND SWITCH
There is a gigantic bait-and-switch operation going on
in economics textbooks and history textbooks. The
textbooks sell beginning students on mercantilism, but in
the name of anti-mercantilism.
All collegiate textbooks promote mercantilism in
monetary affairs. They all promote the cause of central
banking. They all refuse to apply the logic of the chapter
on cartels to central banking. Cartels are recognized as
mercantilism for trade. But central banks are not
presented as cartels, despite the fact that they are, both
in theory and practice.
Whenever that which should be obvious both logically
and historically is never mentioned by a promoter, keep you
hand upon your wallet and your back against the wall.
The few textbooks written by Chicago School economists
all rest on Milton Friedman's statement of faith back in
1965: "We are all Keynesians now." As he later explained,
he meant only methodologically. But that is the whole
point, as any good Austrian School economist will tell you
. . if you can find one.
Textbooks are fat, boring books written in a way to
get through a committee. The committee is hired by the
publishing firm to act on behalf of other committees: the
departmental committees that assign textbooks to freshmen.
A book that does not promote the reigning methodology does
not get through the publisher's committee.
"We are all Keynesians now" means "the publishers'
screening committees are all Keynesian now."
Original mercantilism was a widely believed and
invariably incorrect theory of trade that insisted that a
nation grows rich by exporting more than it imports. David
Hume, the Scottish philosopher, refuted this logic over 250
years ago. His fellow Scot, Adam Smith, refuted it in
detail in 1776.
A nation gets rich only if its residents get rich.
Residents get rich by increasing their productivity. They
stay rich by being allowed by the government to do whatever
they want with their wealth, whether counted in gold, bank
accounts, or goods. Liberty is the #1 basis of increasing
people's ability to become more efficient and therefore
more productive. That was Smith's argument in 1776. This
is denied by Keynesianism.
Modern academic mercantilism in the West has reversed
the emphasis on exports. It holds that a nation grows rich
by importing more than it exports. The difference between
the value of exports and the value of imports is made up by
debt. The system might be called "spend and grow rich,"
which means "borrow and grow rich." This is Western
It is balanced by Asian mercantilism, which is the
older mercantilism: export and grow rich. There is this
difference. In 1750, the mercantilists argued that gold
should flow into the domestic economy to pay for the
exports. Asian mercantilism teaches that IOUs from
governments are to flow in, not gold.
The older mercantilism made a lot more sense.
|Hamilton - a staunch mercantilist|
Western academic Keynesian mercantilism and Asian
mercantilism are Siamese twins. Each supports the other.
The Asians' central banks lend newly created fiat money to
buy Western currencies, which is then lent to Western
governments. This holds down the value of Asian
currencies. Westerners can therefore buy more Asian goods.
Western governments run up huge debts to Asian central
banks, so that domestic interest rates can be kept low,
lots of economic growth will result, and politicians will
The mercantilism of the American voter is the older
mercantilism. Workers want protection from foreign
imports. They want an export-based economy, with sales
taxes imposed on imports. They get little support from
academic Keynesian mercantilists, who want more imports
funded by debt issued by Asian governments and central
Politicians and bureaucrats on both sides of the
border do not accept free market economics, for the
implication of free market economics is that the government
should have less power over the economy, including the
money supply. It is not in their self-interest to see the
government's control over people's lives reduced. Their
gain as citizens would be minimal: the per capita increase
in liberty and wealth. Their per capita losses as sellers
of influence and as extenders of personal power would far
outweigh their per capita gains as citizens.
But what of Western voters? Don't they understand
that tariffs are sales taxes, and increased taxes are bad
for them? No, they do not. They see tariffs as a way to
tell all those foreigners to get lost. They think of their
wealth as citizens of a protected country -- protected by
sales taxes -- as increasing when they have less after-tax
money to spend on what they want to buy.
Are they crazy? No; they are traditional
mercantilists. They are immune to economic logic. They
cannot think through the logic of their position. They
think that less is more: less after-tax income for them as
private citizens means more wealth for them as members of
But what of Asian voters? Don't they see that
policies subsidizing exports reduce their ownership of
goods? Don't they see that they are made poorer? No, they
don't. They think of themselves as workers. They see
exports to the West as benefits. They do not consider
sales to each other as equally the basis of jobs
domestically. They focus on what is seen -- income from
exports -- and ignore what is not seen: lost demand
Keynes went mercantilist in the early 1930s, and he
carried the younger economists with him. By then, he
promoted the idea of state economic planning, for he was a
Treasury official. He trusted the judgment of other
Treasury officials, just so long as they followed his
We find that most economists are Keynesians, because
most economists think that the government -- when advised
by them -- is wiser than the mass of producers, who then
act as consumers. The masses act in their own self-
interest, and most economists think that Ph.D.-holding
economists have far better judgment as advisors to
bureaucrats than citizens do. The economists are trained
to think macroeconomically, whereas the masses think
WHAT'S IN IT FOR ME?
They all think microeconomically. They ask: "What's
in it for me?" Economists look at all that tax-funded
money they can tap into as advisors, and they conclude: "I
must support big government." The voters look at their
vulnerability to foreign producers, and they think: "I must
support big government."
This is why mercantilism persists. Economists believe
that people act in their own self-interest, and most people
believe that they can use state coercion to feather their
nests more than other people can use state coercion to pick
can use political power to get into your wallet deeper than
you can use political power to get into mine." It appeals
to men's egos. Men think of themselves as very clever
politically. They do not think of themselves as equally
clever in the competitive free market. They see, day after
day, that other men can compete against them as producers.
They see the results of political competition only vaguely.
They cannot trace the effects of political interference
with the economy. Even when they see that politics is
stropping them of the liberty and their wealth, they
reassure themselves: "Our side can do better at the next
All sides find that they are losing their liberty, but
all sides have confidence that the next election will bring
them the victory they need to make the government act in
the interest of their political party.
Those few groups that benefit from ever-greater
government spending staff the political parties. They
cannot lose, because they always promise the same thing:
"More booty next time. More free lunches next time. More
fame, honor, and glory next time. Trust us." The voters
do just that.
Mercantilism is an easy sell. It sells to people who
believe that badges and guns are the basis of wealth, if
the good guys can somehow get their hands on badges and
The trouble is, bad guys always seem to have the
larger guns. But the faithful do not conclude that it
would be better to issue fewer badges and fewer guns. They
call for more laws, more taxes, and more badges and guns.
Next time, next time, next time: the good guys will win.
The rich and influential people who sell to the
government smile and nod in agreement. "We will help you
toss out the bad guys next time." The voters on all sides
The economic philosophy of this religion of "Next Time
for Sure" is mercantilism. This religion is widely
believed. It appeals to the larceny in men's hearts, of
which there is a never-ending supply at zero official
price. It has a statement of economic faith: "Thou shalt
not steal, except by majority vote."
The headline on Google News announced that China has
promised to provide support for Portugal and other hard-
pressed PIIGS. The story was run by numerous sites.
The stories were all brief. They were based on a
statement by a lone female bureaucrat. It turns out that
she is employed by the foreign ministry. But this ministry
has no authority over the People's Bank of China, which is
sitting on $2.6 trillion in foreign currency reserves,
meaning IOUs from other governments.
The woman did not say how the central bank would get
the money to buy PIIGS bonds. Obviously, it would print
the money, buy the currency and buy the bonds.
Why would the central bank do this? She did not say.
She did not have to say: to support the euro. The euro is
being threatened by the ever-rising bills facing the
European Central Bank and the European Union itself. The
International Monetary Fund is also involved: loans to
Why would China's central bank support the euro
indirectly in this way? To keep the euro-yuan ratio high.
Why would the bank want this? To subsidize exports from
China to Europe. If the euro stays high, then Europeans
will buy more goods from China.
The policy of subsidizing European exports is good
news and bad news for bureaucrats in Washington. It is
good news for Timothy Geithner, who is constantly
haranguing the Chinese government for holding up the
dollar-yuan ratio as a way to subsidize American imports
from China. If the Bank of China uses newly counterfeited
yuan to buy euros, so that it can buy PIIGS government
bonds, it cannot use that counterfeit money to buy U.S.
bonds, thereby holding up the dollar, so that Americans can
buy more goods from China. The dollar will tend to fall in
relation to the yuan. Geithner will be seen as a tough
negotiator rather than a feckless whiner whom the Chinese
can safely ignore, just as they have for two years.
On the other hand, the announcement is bad news for
Timothy Geithner, who is facing a $1.6 trillion deficit in
fiscal 2011, and who needs China's purchase of Treasury
debt to hold down interest rates.
THE DILEMMA FOR CHINA AND GEITHNER
The Chinese decision-makers face a dilemma: they must
buy the IOUs of Western governments that will inevitably
default. The PIIGS will go bust. This includes the U.S.
government, whose debts dwarf those of the PIIGS. When the
default comes, the People's Bank of China will be sitting
on top of a mountain of bad debt -- the worst kind of bad
debt: the kind that is openly in default, not merely
incapable of repaying, as is the case of Treasury debt
The American decision-makers also face a dilemma: the
dependence of the U.S. government on Chinese decision-
makers. The U.S. Treasury needs China's central bank to
buy Treasury debt. If that bank ever refuses, the U.S.
central bank will have to buy the debt in order to keep
interest rates from rising on Treasury debt. But the
continuing purchase of Treasury debt by the Chinese central
bank means that the United States will continue to import
more from China than it exports to China. This is bad news
for mercantilists. It's the dreaded negative balance of
This is great for American consumers, of course. The
goods that the Chinese citizens cannot buy, because we buy
them, benefit American consumers. When you walk into Best
Buy or Wal-Mart, and you see a wall of wide-screen TVs, you
know this: they were not made in the USA. They were made
in China, labeled by a Koran or Japanese company, and
exported to the USA.
China's central bank can create fiat money, and it does.
It can buy foreign currencies with this newly created
money, and it does. It can buy IOUs from foreign
governments, and it does.
Why does it do this? Because its staffers are
Keynesians. They were trained in the best foreign
universities. The professors of economics in China's best
universities are also Keynesians.
Keynesian economics rests on two premises: (1)
economic growth comes from deficit spending by the central
government; (2) central banks can create sufficient money
to buy government IOUs at low, economically stimulative
interest rates. To this is added traditional mercantilism:
national wealth is attained by exporting more goods than
Bureaucrats and politicians on both sides of a border
cannot achieve this goal. Both nations, meaning producers
on both sides of an invisible line, cannot export more
goods and services than it imports from the other side.
One side or the other will export more goofs. To do this,
it must buy more investment assets on the other side.
If China's exporters are to export more than the
Chinese people import, then someone must lend foreigners
the money to buy those "excess" goods. The payments always
balance, unless one side is giving away goods. If China
exports $500 billion more in goods than it imports, someone
in China must lend $500 billion to the foreigners who
import all those goods. China's central bank is the
lender. It creates the computerized money to make those
If China's decision-makers were all committed to
Austrian School economics, they would tell the central
bankers to cease buying or selling assets. The best
central bank policy is to close up shop, meaning shut down.
The second-best policy is to do nothing. But central
bankers ask: "What's in it for us?" They conclude that it
would be unwise, career-wise, to shut down or do nothing.
They sell the decision-makers on the need for more loans to
the West, thereby funding more exports to the West. They
Austrian economics is a hard sell.
This is not to say that it is an impossible sell. It
is selling to Chinese citizens who read Austrian School
sources on the Web. The main ones are www.Mises.org and
www.LewRockwell.com. But the market for this outlook is
limited in governmental circles.
The market for liberty is decentralized and therefore
politically diffused. The market for power is centralized
and therefore politically concentrated. The individual
payoff from political power is greater than the individual
losses from any increase in political power, but only for
those who survive the screening process. Those who survive
are the decision-makers. They decide to pursue more power.
The coin of the realm of the politically screened is power.
The coin of the realm for their victims is liberty. But
their victims do not see this clearly. They trust the
screened and the system of political screening. It takes a
leap of faith to abandon this trust.
In an economic collapse, the politically screened must
blame something else than the existing system of
government. The victims may at last blame the screening
system. But this has not happened in the West for a
century. The more that governments fail to deliver the
goods, the more that voters call for more government
intervention. That is the Austrian School's dilemma, best
expressed six decades ago in his essay, "The Middle of the
Road Policy Leads to Socialism."
For as long as China's decision-makers hold to
Keynesianism, they will be trapped by mercantilism. They
will buy the IOUs of implicitly bankrupt PIIGS, which
includes the biggest pig of all, the United States
government. Eventually, the implicitly bankrupt issuers of
IOUs will default, one way or another.
Until then, we can buy all those wonderful goods from
China, produced from resources, both human and mineral,
inside the invisible border of China. The Chinese people,
still poor by Western standards, will continue to subsidize
Western consumers. Their central bank will buy our
government's IOUs, thereby leaving us free to buy wide
Every time I turn on my TV, I ought to thank the
central bankers of the People's Bank of China.
Let us hope that Geithner the hawker of IOUs will
succeed, whereas Geithner the nagging critic of managed
yuan fails to make any headway. As long as the U.S.
government is going bankrupt, which it clearly is, I might
as well be able to buy those Chinese imports cheap.
I am hoping that 3D TVs without polarized glasses will
get here before Uncle Sam goes bust. That is what's in it
Since we are stuck on the Titanic, we might as well
enjoy all the entertainment.