Review of: Making Economic Sense, Murray Rothbard (Chapter 2)

[Originally published in the Front Range Voluntaryist, review by Amelia Morris]

According to Rothbard, there are ten major economic myths and they are as follows:

The first are two myths that contradict each other but neither are true: Deficits are the cause of inflation and deficits have nothing to do with inflation. Deficits mean that the federal government spends more money than they receive in taxes. There are two ways to finance this spending. They can (1) sell Treasury bonds to the public. By doing this, no new money is created because people just take from their bank accounts and that money is spent by the government. They can also (2) be financed by selling bonds to the banking system. In this case new money is being created in the sense that the banks create new bank deposits and use those to pay for the bonds. The new bank deposits are spent by the government, thereby entering into the economy, raising prices. Rising prices are the effect of inflation, which is defined as an expansion in the money supply.

As Rothbard explains,

“Thus, deficits are inflationary to
the extent that they are financed by
the banking system; they are not
inflationary to the extent they are
underwritten by the public.”

Changes in price are determined by the supply of, and demand for, money. If the supply [of money] rises but demand does not, prices will rise; and if demand for money rises while the supply stays the same, prices will fall. In the early eighties, policymakers believed they had proof that deficits and inflation had nothing to do with each other because deficits were accelerating, and inflation was abating. The government was creating a lot of new money, much of it being used to finance the growing deficit. However, the severe depression during this time increased the demand for money due to severe business losses. This short increase in demand fell as recovery picked up, along with spending, accelerating price inflation in the process.

The second myth is that deficits do not have a crowding out effect on private investment. The U.S. has a low rate of saving and investment. Policymakers tried to stomp out the worry that deficits would divert savings into unproductive government spending, crowding out productive investment and lowering living standards. Logically, if savings go into government bonds, there will be less savings available for productive investment, and interest will be higher than they would be without the deficits. If deficits are financed by the public, it makes sense that the money would go right back into wasteful government projects. If the deficits are financed by the bank, the crowding-out takes place by new money competing with already existing money. Realistically, deficits probably have the largest effect on crowding out, as they tap into the public’s savings, which, as well as consumption, is already depleted by taxation.

The third myth is that tax increases are a cure for deficits. Raising taxes, i.e. simply giving more money to the government, is the most detrimental because at least with inflation, though it is still technically a form of taxation, the public still benefits from the exchange. The only sensible “cure” for deficits is to cut the federal budget wherever possible.

In Rothbard’s classic tone,

“Curing deficits by raising taxes is
the equivalent to curing someone’s
bronchitis by shooting him.”

The fourth myth is that every time the Fed tightens the money supply, interest rates rise (or fall); every time the Fed expands the money supply, interest rates rise (or fall). A rising money supply is interpreted as lowering and raising interest rates as well as being inflationary on prices. The same goes for when the Fed tightens the growth of money. Because the Fed expands the money supply by creating credit, forecasting it can never be a sure thing.

Myth number five is that economists, using charts or high-speed computer models, can accurately forecast the future. This might be possible if economic trends never changed, but forecasters have yet to be able to catch when trends change. Because the economy depends on individuals, and individuals cannot be predicted, this will never be possible so long as humans are involved.

The sixth myth is that there is a trade off between unemployment and inflation. Inflation may temporarily reduce unemployment, but in the long run, wage rates will catch up with inflation, bringing recession and unemployment. Despite what Keynesian economists say to try to convince the public otherwise, this has been proven in the past. The episode in the 1970s was essentially an empirical refutation of the Keynesian doctrine which supposed that neither could occur at the same time.

The seventh myth is that deflation—defined here as falling prices—is unthinkable, and would cause a catastrophic depression. This can be simply disproved by the fact that when selling prices fall, costs fall as well. “Usually, wage rates remained constant while the cost of living fell, so that “real” wages, or everyone’s standard of living, rose steadily.” All that matters for profitability is a spread between costs and revenue. The fear of deflation is usually just a justification for a policy of inflationism.

The eighth myth is that the best tax is a “flat” income tax, proportionate to income across the board, with no exemptions or deductions. What this suggests is that the government essentially owns 100% of someone’s income and just allows them to keep a portion of that income. This is a wrong way of approaching things. And while, really, the best tax is no tax, if taxes were levied like market prices, they would be equal to everyone.

The ninth myth is that an income tax cut helps everyone; not only the taxpayer but also the government will benefit, since tax revenues will rise when the rate is cut. This is merely an attempt to maximize government revenue. There is no telling how long it would take for an income tax cut to help the taxpayers. It’s like throwing a bone to a dog when the public should be focused on lowering tax rates much farther below what the government deems appropriate.

The final myth is that imports from countries where labor is cheap cause unemployment in the United States. This was probably the easiest myth for Rothbard to disprove. The U.S. is in no danger of unemployment due to cheap labor from other countries because we are aided by much more capital here, bringing prosperity. In countries where wage rates are low, it makes sense that productivity is also low.