Notes – The 2014 Rothbard Graduate Seminar

In 2014 I attended the Rothbard Graduate Seminar at the Ludwig von Mises Institute in Auburn, AL as an observer. The following are notes I typed while listening to lectures and discussions between faculty and graduate students. They have been edited for clarity, organization and in some cases privacy.

Lecture 1, Praxeology, David Gordon

• Praxeology is the science of human action, uses deductive methodology, begins with axiom of man acting, deduced with supplementary postulates (Rothbard uses action axiom, Mises never refers to “Man acts”, he refers to the concept of action)
• Supplementary postulates: leisure is desired over work, there are a variety of economic resources
• Economics is the best-developed branch of praxeology: Crusoe economics (isolated human action), catallactics (economics of exchange) including barter and money
• The study of violent intervention in the market, socialism and interventionism, are also part of praxeological analysis, as well as “games”, but these have not been well-developed (no systematic treatises?)
• Examples of praxeological reasoning— every action uses means to achieve an end; every action is a choice between alternatives; the actor always chooses his highest valued alternative
• Methodological individualism— only individuals act, not groups or societies or nations or classes, however this doesn’t imply that nations and classes don’t exist
• “On Austrian Methodology” by Robert Nozick, an interesting article
• Methodological Individualism has been used to deflate various ideologies such as nationalism, statism, etc.
• Why should we do economics this way (praxeology)?
  • Popular objection: principles of praxeology are supposed to be synthetic (truth about the world) and a priori (knowable by simply thinking about them), but you can’t learn about the world just by thinking about it, the meaning of concepts is conventional, people just decide to use words a certain way, you can’t make something true about the world just by defining words, other a priori truths are logical and tautological that say nothing new about the world
  • Rothbard’s answer: concepts come from experience, action isn’t an arbitrary construction but rather an abstraction from experience, if we get the concept from experience we know action exists, then anything we deduce from that applies to the world, deduction transmits truth from premises to the conclusion, if the premises are true the conclusion is true
  • Tautology objection: rests on an equivocation
  • Rothbard’s objections to the mainstream: they construct mathematical models and then test predictions derived from the models; math substitutes functional relations for causation, also introduces the false assumption of continuity but human action occurs in discrete steps, he objects to the testing because there is no way to perform controlled experiments as all phenomena are occurring simultaneously, and there are no quantitative laws of human action, human action is the product of choice

Questions:

1. In property rights theory, how can joint ownership (or government ownership) of a resource be explained if “only individuals act”?
2. How do we know the experience of action is true? Don’t we need a prior theory to interpret the empirical experience of action as action?
3. Can Austrian economics be translated into math? If not, does this suggest it is not rigorous or coherent?
4. Why is the Austrian ERE a useful abstract tool for studying elements of reality in isolation, but the “equilibrium” economy of mainstream thought is not?

Discussion session:

Rothbard’s book (Economic Controversies) had great depth, not just covering epistemology and economic theory but historical commentary, etc., this book is also digestible, repetitive so you get the same concept dissected from different angles, straight to the point, challenges the mainstream orthodoxy, accessible to the layperson, Rothbard starts with realistic premises and deduces from there which makes this approach even more empirical (econometric models falsify the real world), his criticisms are very thorough and you want to smile after you read them which is unique in reading academic papers. Rothbard isn’t ashamed to say there is meaning and truth.

Methodological individualism applies only to the concept of action, it does not exclude the idea of something like a “cosmic consciousness”, there is a difference between ontological and methodological claims; praxeology is not a metaphysical system, it simply takes the world as we find it

Mathematical annotation is more precise than verbal logic, but one problem is how do you convert initial premises into mathematical annotation (and back when a conclusion is reached)?

“Academic choice”, public choice analysis applied to the incentive structure of academia and how this influences their search for truth

Lecture 2, Methodological Debates, Jeff Herbner

• Every academic discipline is defined by its method and scope (boundaries).
• Rothbard— Each subject matter has a proper method; neoclassical approach— there is only one scientific method.
• Praxeology’s divisions:
  • Theory of Isolated Person (autistic exchange)
  • Theory of Voluntary Exchange
    •  barter
    • medium of exchange (catallactics)
      • unhampered market
      • violent intervention
      • violent abolition of market
  • Theory of Games
  • Theory of War
  • Unknown
• Neoclassical divisions:
  • Rational choice model
    • Market participants
    • Political participants
    • Social participants
  • Behavioral economics
• Categories of the social sciences
  • Economics— voluntary associations w/ economic calculation (UME, HME)
  • Sociology— voluntary associations w/o economic calculation (family, church)
  • History— contingent, concrete conditions of action blended w/ theory
  • Ethics— personal action, interpersonal action, voluntary and involuntary
  • Politics— involuntary associations (gangs, states)
• Praxeology— logic of action, economizing, underneath all 5
• Praxeology and Ethics— public policy (economic science is value free, but economic policy is value laden and requires assumptions or principles about ethics and what is desirable to make conclusions), critique of ethics, political philosophy, welfare economics
• Misesian Economics— a.) economic theory b.) economic history (understanding economic action in the past) c.) applied economics (predicting economic effect in the future based on proposed economic cause, i.e., policy)
• Neoclassical Economics— economic model and empirical testing

Questions:

1. Is the division in economics between calculating and non-calculating, or financial calculation and non-financial calculation? How are non-calculating actors choosing if not by some form of calculus?
2. Who has best developed Games and War theories of praxeology?
3. Why aren’t Austrians trying to develop comprehensive treatises in these fields
4. What is the application of game theory?
5. How do you know when a circumstance is new and requires an extension of the existing theory, or when it is “unoriginal” and can be explained by the previous body of theory? How do we know when existing theory can’t explain a new phenomenon or historical incident? How is this explanation different from the pragmatist argument about a lack of common principles?
6. Who, if anyone, is worth reading right now outside of the Austrian tradition, and why?
7. How can “proportionality” be administered in a judicial punishment setting without treading into utilitarianism or other non-subjectivist value systems?

Lecture 3, Austrian Microeconomics, Peter Klein

• Price theory, production theory, the theory of the firm, some parts of capital theory, etc., constitute “Austrian micro”
• It is not mainstream micro minus calculus and some graphs plus “spontaneous order” and “radical subjectivism”, etc.; this is a misconception of the contribution of Austrian econ
• Mengerian economics— focused on mundane topics, not esoterica; shares subjective utility and marginal analysis of Walras and Jevons; not simply verbal version of neoclassicism, emphasized cause and effect real market behaviors and thus “causal-realist”
• Fundamentals of Austrian micro— economics as the analysis of action (praxeology); teleology, means and ends; economic goods which are concrete (real prices of real goods, not abstract prices of conceptual entities) and are limited and desirable, split into consumer and producer goods (direct and indirect serving of human needs); time, implied by action, itself a scare means and the notion of time preference; production is rearrangement, not creation ex nihilo, takes time and uses stages
• General insights on valuation include emphasis on discrete, marginal units, not abstract categories, as well as attention to demonstrated preference
• Menger’s utility theory— the value of particular means, marginal utility being the value of the highest-ranked end that cannot be achieved if a unit is lost, law of diminishing marginal utility (not a psychological concept, a logical concept focused on individual use of each unit not the benefit)
• Contrasts with neoclassical utility theory— consumers in NCM are choosing among heterogeneous bundles, choosing between total utility of each bundle; marginal rate of substitution is rate at which consumer substitutes unit of good X for unit of good Y (slope of indifference curve) vs. causal-realist where substitution occurs at the margin and demonstrates that the marginal utility of X is greater than the marginal utility of Y w/ no separate income or substitution effects; indifference can not be demonstrated in action and is therefore not a scientific concept (focus is on explaining actions, not states of being)
• Price determination— analysis of the marginal pairs (see Greaves, paper by Egger) states that prices are set by pairs of buyers and sellers; characteristics of the equilibrium price, determined exclusively by individuals’ subjective valuations, subjective valuations of buyers and sellers matter, not set unilaterally by sellers, the real prices actually paid in market transactions
• Prices and knowledge— buyer and seller valuations can include speculative demands (they don’t need to know in advance what equilibrium price will be), prices as signals (Hayek)
• Factor pricing— Austrian theory of imputation, rental prices imputed backwards to the ???
• Applications and extensions— no distinction between production and “distribution” (Piketty), wealth is “distributed” in the act of production, it is not produced and then arbitrarily distributed by capitalists, government, etc.; rent = unit price of services of any good (Fetter); production functions, but no cost curves; firm as an organization, not a productive unit

Discussion section:

Kirzner and Schumpeter restrict entrepreneur to nothing but alertness, the Misesian approach is more expansive and includes everyone in some capacity acting as an entrepreneur

Mises in Human Action talks about the entrepreneur as a leader, who is far-seeing, comes from Weiser, who also mentored Schumpeter; Mises was uncharacteristically fuzzy and unclear on his writings on the entrepreneur, occasionally he refers to the “promoter” (ideal type) involving leadership, having a quicker eye than the crowd, etc., but typically he refers to the function of entrepreneurship

Kirzner is talking about alertness to opportunities for profit, but entrepreneurs create goods, capital, companies, etc., not “opportunities for profit”, opportunity implies objective configurations of resources that allow for a decision or action or take place, but is this analogous in the business world? Or is “opportunity” a metaphor? Do we need the construct of “opportunity” to explain what entrepreneurs do?

Salerno, “The Entrepreneur, Real and Imagined” [PDF]

Kirzner’s equilibrium is the condition under which no unfound profit opportunities exist

Mises vs. Knight on judgement— Mises never refers to Knight in this context, judgement is more of a black box for Mises than for Knight

Klein, “The Capitalist and The Entrepreneur” [PDF]

Questions:

1. If Austrian econ is not distinct, why do mainstream thinkers argue so violently with Austrians?
2. Did the anglo-American Austrians, etc., self-consciously identify with the “Austrian school” or did we lump them in post hoc? If so, what did they refer to themselves as?
3. When challenging Keynesianians and other mainstream opponents, Austrian critics often accuse them of “not understanding economic calculation”. Is this criticism accurate? Why or why not?
4. Would it be better to distinguish between “offers” and “prices”, where “offers” are ratios of exchange advertised but not consummated, hypothetical, whereas “prices” represent historical data of consummated exchanges between buyers and sellers?
5. Is Kirzner’s “capital-less entrepreneur” really a description of professional managers, and if it is, is it a legitimate analysis or does it still lack connection to reality?
6. Is “public choice” an analysis of entrepreneurship in socialism, or in privatization within socialism?

Lecture 4, Taxation and Public Finance, Mark Thornton

• Rothbard’s approach: nature of taxation; technical corrections to mainstream analysis; theories of “just” taxation; neutrality of taxation; approaches to tax reform
• Interventionism: autistic (ruler tells the ruled what to do); binary (e.g., taxation, transfer of property from owner to intervener); triangular (ruler tells two ruled how they can interact with each other, e.g., prohibitions and regulations)
• Impoverishment caused by taxation is in proportion to the amount of taxation, not the form the taxes take
• Taxes can not be passed on to consumers because of competitive pricing of supply and demand
• Taxation distorts market outcomes in two ways: the withdrawing of resources from the economy, and the redistribution of those resources across the economy
• “Benefit principle”— pay taxes in accord with the benefits you receive
• “Ability to pay principle”— pay taxes in accord with your relative wealth
• There are no scientifically valid principles of taxation, there is no conceptually possible neutral tax

Discussion section:

How to explain countries where majority of taxes are paid by a minority of people, as Calhoun’s analysis suggests the majority bear the costs for a small minority to benefit from? The answer could be additional implicit subsidies such as protections from the State in terms of liability or regulation that they see taxation as payment for

Can the State make investments? Rothbard is writing against the idea of “social investment” such as infrastructure spending, and he is writing in terms of capital structure— they’re not integrated into economic calculation, they’re not part of the capital structure; counter-example, State-owned oil production

Questions:

1. Why doesn’t taxation create business cycles due to mass misallocation of resources
2. When taxes are “shifted backward” to suppliers through lowered net revenue, aren’t consumers STILL paying the tax due to lower supply and lower quality of remaining supply versus free market outcome?
3. Why can employers shift taxes to employees if businesses can’t shift taxes to consumers?
4. In the marketplace, how is price discrimination explained in reference to the benefit principle?
5. Does the lack of scientificness of taxation principles imply the irrationality and injustice of government in general?
6. “Over” and “under” exploitation of a government owned resource… relative to what? How do we know how much the free market would exploit it?

Lecture 5, Monetary Theory, Joe Salerno 

• Money as a medium of exchange— trade requires barter in the absence of money, creating high search costs due to the double coincidence of wants
• Money as unit of account— used to express prices and record debts, simplifies relative price comparisons
• The value of money— measured as the inverse of the price level measured against an arbitrary basket of goods (i.e., 1/P), what does one unit of money buy?
• The (neo-)classical dichotomy— the theoretical separation of nominal and real variables; Hume and classical economists suggested monetary developments affect nominal variables but not real variables; if money supply doubles, for example, all nominal variables, such as prices, will double; in the short run, supply and demand determine the value of money, in the long run cost of production determines the value of money
• The neutrality of money— proposition that changes in the money supply do not affect real variables
• Purchasing Power Parity (PPP)— relies on the “law of one price” which establishes that arbitrage opportunities eliminate differences in value of common goods in different markets; exchange rates are supposed to be ratios of price levels between two economies

Discussion section:

“What Has Government Done To Our Money?” is Rothbard’s explanation of how an economy “progresses” from commodity to fiat money, because Mises said that a true fiat money is a historical question given that every episode in the past has been a form of “credit money” based on expectations about an eventual return to a commodity money that predated it

Questions:

1. For a relative price to be a useful data, wouldn’t it have to be collected from a real exchange (i.e., barter exchange)?
2. Do mainstream models explaining fiat money violate Occam’s Razor?
3. If velocity of money is increasing, isn’t the “velocity of hoarding” increasing at the same rate because all money balances must be held by somebody at some time?
4. If IEOR policy is causing banks to “hoard” bank balances and this is non-expansive, is this money “neutral” to the economy or what effect is it having? What role does it serve? (Compare to Jingjing’s question on corrupt Chinese official cash balances)

Lecture 6, Professional Strategies, Career Advice and Current Research Topics, Peter Klein

[I did not take any notes during this discussion.]

Discussion section:

[I did not take any notes during this discussion.]

Questions:

1. What about pursuing a career as a “private lecturer” by establishing yourself as an authority on Austrian economics with a crisp website?
2. How can Austrian economist career hopefuls improve their career by thinking in terms of their “personal brand”?

Lecture 7, Monetary Policy, Jeff Herbener

• Monetarists— micro efficiency, but macro instability caused by monetary regime; optimal monetary regime would create stability in the price level; requires an elastic money supply to offset forces causing price inflation or deflation to keep price level roughly stable; avoid trade imbalances w/ flexible exchange rates
• Monetary Disequilibrium Theory (MDT)— micro efficiency, macro inefficiency; means of payment must accommodate changes in money demand; avoid price deflation from excess demand for money; separate unit of account from general medium of exchange, supplant general medium of exchange with means of payment; competitive issue of means of payment adjust to accommodate changes in money demand;
• Banking school FB— micro efficiency, macro inefficiency; money stock and credit supply must accommodate the needs of trade; avoid price deflation from excess demand for money; competitive issue of fiduciary media adjust to accommodate changes in money demand
• Currency school FB— micro efficiency, macro efficiency; production of money and money substitutes should be integrated into the social economizing process of economic calculation by entrepreneurs
• “Free banking” in Scotland— Rothbard suggests using Vera Smith’s schema of 4 groups (free vs. central banking Banking School, free vs. central banking Currency School) rather than Larry White’s 3 groups; there was no Banking School free banking in Scotland, and the system didn’t work well, numerous bailouts, pyramiding credit on top of Bank of England notes;
• Free Market Monetary reform— separate money from the State; abolish fFed, dollar redeemable in gold, legal enforcement of 100 percent reserve on money substitutes;
• Ancillary roles for the State— Hayek (Sennholz), abolish all legal disabilities on private enterprise production of money and money substitutes; Yeagar (Timberlake), state defines the unit of account in terms of market-basket of goods, the general medium of exchange is eliminated, private enterprise provides means of payment
• Central role for the State— Fisher, state defines a market-basket of goods for the unit of base money, currency is redemption claim for base money, supply of currency managed to keep price level stable; Friedman, Fed conducts non-discretionary monetary policy to keep the price level stable

Discussion section:

[I did not take any notes during this discussion.]

Questions:

1. What “problem” did the MDT respond to? Similarly, did the Monetarist framework develop in response to existing statist monetary regimes or was it to address perceived problems with a theoretical free market monetary regime?
2. Does the existence of taxation in general complicate or prevent the possibility of private production of the money supply?
3. Is “balance of payments” thinking by mainstream economists an anachronistic way of thinking in a non-commodity standard money world?
4. Why do socialist countries have money? How does money function in these economies?
5. How can the crash and then explosion in the price of gold since ~2000 be explained in Austrian monetary theory?

Lecture 8, Mark Thornton, Comparative Economic Systems

• Hoppe’s A Theory of Socialism and Capitalism (1988)— systematic, offers a theory of comparative economic systems, based on the concept of private party
• Capitalism— based on property rights; property is the result of scarcity; provides non-violent mechanism for resource allocation; Garden of Eden, property right to your body; original appropriation; contractual exchanges; wealth; absence of systematic aggression; no unemployment (idle resources) problems
• Russian-style socialism— socialism par excellence; State owns the means of production; equality vs. anarchy of production; aggression and democracy; less investment, appropriation (black market); calculate the structure of production = waste; Mises (1920) complete vs. relative; East vs. West Germany
• Social democratic socialism— “reform”, taking steps at the ballot box; “commanding heights” (the sectors deemed essential by socialist planners for control such as education, utilities, transportation networks, etc.); owners remain caretakers with partial ownership; property owners taxes for redistribution; dominant form in Europe; Sweden
• SDS vs. Russian-Style and Capitalism— solves the calculation problem; compared to Russian, less impoverishment, less over utilization of resources, more leisure, more incentive to work, save and invest; but it’s still poor compared to capitalism; both reduce production of talent and skills, increase the production of aggressive and political skills, both increase barter and black market activities
• Conservative-style socialism— supports status quo, old order; private property, commanding heights; sin taxes, not income taxes; price controls, unions, prohibitions, not redistribution; regulations and cartels; Nazi Germany, Fascist Italy, Imperial Japan (Prussian social monarchy?)
• Similarities between conservative and social-democratic socialism— both have private property and commanding heights; both infringe on private property; both have negative effects on labor, savings, investment, innovation; SDS stresses egalitarianism, CS stresses nationalism; both underperform capitalism
• Socialism of social engineering— American pragmatism, technocracy; positivism and empiricism; reality must be verifiable or falsifiable by experience, “socialism might work”; however, empiricists must implicitly assume the existence of non-empirical as knowledge of reality, i.e., logic, math, geometry
• Empiricism— must assume some sort of existence of cause and effect; must presume the constancy principle in order to proceed in its investigation, but the constancy principle (there are relationships to be found empirically) is not established, confirmed or falsified empirically, it is a given a priori; life proceeds on the basis of cause and effect; social engineering via empiricism is a giant contradiction

Discussion section:

Crony capitalism is the modern day equivalent of mercantilism

Old wine in new bottles, people can intellectually reject an idea like mercantilism as an historical phenomenon but if it is repackaged in a new brand they might adopt it as sensible

Are many of the distinctions of totalitarian regimes explained by the path to power? IE, Hitler came to power through the ballot box, Mao led a peasant rebellion, Lenin was elected by the army

Democracy is one of the most stable forms of the State; democracy involves participation of the population, and has a process for slowly implementing policies vs. unitary or limited participation and the ability to make drastic, sudden changes via emperor or dictatorship; democracy tends to hand out favors to large groups of people so it is hard to create an opposition coalition to overturn it

Mises’s three pre-conditions of the division of labor and economic specialization: private property in the means of production, free exchange (for price formation) and ???

Questions:

1. There seem to be an endless variety of “socialisms” reflecting the unique cultural and historical factors of each society that has suffered them; what are some UNIVERSAL elements of socialism that must be or always are present to be declared a socialist system?
2. Does technological innovation and economic “evolution” allow for political change or does it work in the opposite order?

Lecture 9, Property Rights and the Public Sector, David Gordon

• Ethics and economists— one of Rothbard’s most original contributions is his criticism of the way mainstream economists deal with normative issues; economists want economics to be value free, economics is a science, normative judgments are mere subjective preferences; Rothbard agrees that economics is value free, but he doesn’t think that ethical judgments are mere subjective preferences; mainstream economists are caught in a dilemma, they want to make normative judgments that do more than express their preferences, how can they do so?
• Concealed value judgments— some economists think that they can escape the dilemma by endorsing a value-free statement that still leads to normative recommendations; if everybody prefers something, then it should be done (strong Pareto criterion), if at least one person favors something and it makes no one worse off, it should be done (weak Pareto criterion), these principles still involve value judgments; what if everyone has wrong views about what is desirable, or the starting point involves violating someone’s rights?
• Unanimity principle— Rothbard thinks that the unanimity principle has had bad results in practice; because unanimous agreement can’t in practice be reached, Buchanan and Tullock settle for less than full unanimity
• Rothbard on the State— it is a fundamental mistake to view the state as a voluntary organization; it is a parasitic, predatory gang that seizes resources from the productive; Rothbard follows Oppenheimer and Nock
• Public sector— if the State is predatory, then the productivity of the public sector is problematic; the State takes resources by force, thus, its activities cannot be considered productive; government expenditures should be subtracted from, not added to, production statistics; Rothbard’s definition of productivity is intertwined with an understanding of demonstrated consumer preference on the market
• Statistics— Rothbard is suspicious of statistics collection; they are not value neutral but are essential to government control
• Utilitarianism and property rights— many economists take some version of utilitarianism for granted; it’s argued that recognition of property rights makes nearly everybody better off; this isn’t a value-free claim, but it’s defended as non-controversial; Rothbard objects that this position doesn’t consider the justice of property rights, any stable system of property rights is accepted;
• Escape from the dilemma— Rothbard believes the dilemma of the economists can be escaped by developing an objective ethics based on natural law; self-ownership, Rothbard defends the concept by rejecting alternatives, slavery and a system where everyone owns part of everyone else; if you own yourself, then by mixing your labor with unowned resources you own them as well; once you own something you can exchange it and give it to anyone you want, including the right of bequest;
• Externalities

Discussion section:

[I did not take any notes during this section.]

Questions:

1. Can any philosophical principle be established simply by rejecting alternatives? (Last man standing philosophy?)
2. What criteria are sufficient for “mixing labor” and taking ownership? If mixing labor with factors of production, why doesn’t this mean workers own them? What makes “mixing labor” effective in one circumstance and not effective in another?
3. Walter Block claims that it’s okay for libertarians to take from the State, but no one else. Is there any logic to this?
4. Maybe there is a Coaseian solution for the dismantling of the State— it doesn’t really matter HOW it is privatized, it just matters that it IS privatized?
5. When your money is taxed, it is stolen, and your money is fungible and spent, so what legitimate claim do you have to fungible, disposed assets that can not be traced?
6. What about when government functionaries in “marketable” positions are part of unions or agitate for State privilege?

Lecture 10, Current Debates and Critiques, Joe Salerno

[I did not take any notes during this section.]

Discussion section:

Is the term “Austrian” valuable as a marketing concept? “Capital Based Macro”, “Causal Realism”

You don’t want to be the kid at camp who picked their own nickname, names come from the outside

Is there rhetorical value in labeling opponents in sensational ways (“Friedman is a socialist”) or does that hurt your cause more than it communicates information?

Questions:

1. What might have happened to the Austrian school’s influence if WW2 had never occurred?
2. What critical lessons have we learned (as a “movement”) from the Salerno/Hulsmann theory of the decline and rebirth of Austrian economics?
3. Why aren’t there more applied economic works in the Austrian tradition? What would be some priority applications?
4. What is “Austrian economics in a nutshell” or the Austrian elevator pitch? Why Austrian?

Review – The Panic Of 1819

The Panic of 1819: Reactions and Policies

by Murray Rothbard, published 1962, 2007

Please note, this book is also available as a free PDF on the Mises.org website, which is how I read it [PDF]

Introduction

Rothbard’s “The Panic of 1819” is a lot of things, but the thing it is most is yet another reminder of the old dictum “Plus ca change, plus c’est la meme chose”. Contained in this approximately 250-page reporting of the causes, consequences and social responses to the Panic of 1819 are the same behaviors and political programs that could be found in today’s headlines about corrupt Chinese banking practices, Chicago-school monetarism and Keynesian pump priming, including early recognition that attempts to kickstart “idle resources” logically implies a totalitarian command economy where the government manages all resources (and all people) at all times.

It’s all here, and more. There is nothing new under the sun.

How the business cycle gets started

Early on page 16 the reader is entreated to an excerpt from private correspondence between Pennsylvania politician Condy Raguet and European economist Richard Cantillon in which Raguet tries to clear Cantillon’s confusion as to how fractional reserve banking manages to operate to the point of a catastrophic bubble instead of wobbling and crashing under its own confusing weight:

You state in your letter that you find it difficult to comprehend, why person who had a right to demand coin from the Banks in payment of their notes, so long forebore to exercise it. This no doubt appears paradoxical to one who resides in a country where an act of parliament was necessary to protect a bank, but the difficulty is easily solved. The whole of our population are either stockholders of banks or in debt to them. It is not the interest of the first to press the banks and the rest are afraid. This is the whole secret. An independent man, who was neither a stockholder or debtor, who would have ventured to compel the banks to do justice, would have been persecuted as an enemy of society.

Today’s full reserve Austrian economists, caught between clueless and complacent bank executives, a massively indebted “ownership society” public, Keynesian and monetarist adherents and “free banking” friends who are anything but, simply has no place to turn for safety. He defaults to “enemy of society” status in the ensuing confusion though he seeks only to point out the folly of these fractional reserve systems which inevitably injure all in tying their fates by one string.

The Panic of 1819 followed the War of 1812. During the war, imports and exports came to a halt due to the sea being a battleground and many products which would’ve been imported were kept in their home (overseas) markets to furnish the war effort. As a result, the young States United of America saw the development and growth of domestic manufactures and exportable industries. However, when the war ended and international trade resumed, many domestic manufacturers found they weren’t actually competitive facing world markets (this makes sense because if they had been they probably would’ve developed before the war, not during it in a period of “isolationism”). This created a nascent strain of “protectionist” thinking and monied interests who saw a benefit to adding tariffs on imported products.

The end of the war and the resumption of trade saw a banking boom (fractional reserve) which finally ended in 1819 with the panic. From about 1819-1823 the country was in and out of what could be termed depressed economic conditions. In many ways the early country’s experience mirrored the present day experience from 2008-2009 onward, especially the contentious economic and political debates about how to respond.

Something I found fascinating was what happened to various “macro” economic metrics during the Panic (what we’d call a crash):

The credit contraction also caused public land sales to drop sharply, falling from $13.6 million in 1818 to $1.7 million in 1820, and to $1.3 million in 1821. Added to a quickened general desire for a cash position, it also led to high interest rates and common complaint about the scarcity of loanable funds.

That last bit is especially fascinating to me. I don’t know what the state of federal funded debt was in this time period as Rothbard doesn’t really go into the concept or existence of a “risk free rate” but it is interesting to see “deflation” leading to HIGHER rather than LOWER interest rates. In today’s topsy turvy world, low rates are supposed to be the result of the flight to safety during a depression while high rates are supposed to herald an economic recovery. However, it seems it was just the opposite in 1819.

I found myself charmed by the ability of so many in 1819 to see what was the cause of the bubble and the collapse, even politicians. For example, in an address supporting a “relief bill”, Illinois Senator Ninian Edwards observed:

The debtors, like the rest of the country, had been infatuated by the short-lived, “artificial and fictitious prosperity.” They thought that the prosperity would be permanent. Lured by the cheap money of the banks, people were tempted to engage in a “multitude of the wildest projects and most visionary speculations,” as in the case of the Mississippi and South Sea bubbles of previous centuries.

I enjoyed learning that even medical analogies to describe the cause and effect of monetary expansion and collapse were popular in 1819. One government committee, the Hopkinson Committee, arguing against “debt relief” legislation, noted:

palliatives which may suspend the pain for a season, but do not remove the disease, are not restoratives of health; it is worse than useless to lessen the present pressure by means which will finally plunge us deeper into distress.

I thought that pain pill and hangover analogies were something recent and peculiar to adherents of the Austrian school but critics knew of these rhetorical flourishes even two hundred years ago, at least!

On the topic of “flight to safety”, I did make note of one paragraph which seemed to suggest that while interest rates on bank debt and other commercial lending may have risen, interest rates fell dramatically on tax-backed (ie, “guaranteed”) government issues, for example:

“A Pennsylvanian” pointed to United States and City of Philadelphia 6 percent bonds being currently at 3 percent about par– indicating a great deal of idle capital waiting for return of public confidence before being applied to the relief of commerce and manufacturing. Thus, in the process of criticizing debtors’ relief legislation, the “Pennsylvanian” was led beyond a general reference to the importance “confidence” to an unusually extensive analysis of the problems of investment, idle capital, and the rate of interest.

This theme of “idle capital” was remarked on more than once in the text and by various parties with differing viewpoints. This is a particular fetish of Keynesians and monetarists who cite the existence of “idle capital” as an excuse for government to raise public spending to “put it to work.” It is fascinating to see these early Americans predicted Keynesianism by almost 150 years!

Another thing I found remarkable was the prevalence of either state-owned banks (federal, with the Bank of the United States, or individual states) or strong political pushes to establish these banks in response to the ensuing depression and the stress this created on the banking system. In other words, nationalization of the banking industry as a political prop to collapsing FRB institutions is nothing new:

The Alabama experience highlights the two basic measures for monetary expansion advocated or effected in the states: (1) measures to bolster the acceptance of private bank notes, where the banks had suspended specie payment and where the notes were tending to depreciate; and (2) creation of state-owned banks to issue inconvertible paper notes on a large scale. Of course, the very fact of permitting non-specie paying banks to continue in operation, was a tremendous aid to the banks.

People refer to the United States economy and monetary system at various points in time being “free market”, and while it’s true that tax rates and business regulations were generally less cumbersome near the nation’s founding than today, it is also true that there has been a virulent strain(s) of interventionist thinking and policy-making from very early on. It wasn’t until 1971 with Richard Nixon’s closing of the gold window that the US currency finally went fully inconvertible, and yet already in 1820 (if not earlier), people were calling for inconvertible paper currencies issued by state-owned banks. Some free market!

The whole episode seems to beg a question that, sadly, Rothbard did not explicitly address or explore, namely, Why did banks need to be chartered by the government in the first place? Although there were calls during the response to the economic crisis for various forms of occupational licensing and business regulation (aimed at stemming the flood of superior imports damaging local industries), the reality is that any other business but banking, such as butchering, baking, sawmilling, leather tanning, import/export, etc., did not require special permission granted by a session of the local legislature, state or federal. Why was banking different, requiring an act of congress to get the enterprise going?

Besides the fact that many such banks seemed to be public-private partnerships which included state “capital” injected into them, the only answer I have managed to come up with so far that makes any sense is that the banks were all set up on a fractional reserve basis, and a blessing by the government served to either 1.) grant legitimacy to an illegitimate institution or 2.) create the pretense and wishful thinking of providing some kind of “legal oversight” to what everyone at the outset understood to be an essentially criminal organization operating with a special legal privilege or 3.) both.

Because every bank had to be chartered, when the FRB system inevitably hit a bump in the road as it did in 1819 and many banks wished to suspend redeemability of their bank notes to stem outflows of specie, their status as creatures of the public legal mechanism meant they could run to the legislature for permission to violate their own contracts– and they almost always got the permission granted. Now, for example, if angry pitchfork-wielding townsfolk show up to break into the vault, take their gold and lynch the bankers, the Sheriff might step in with his posse to make sure everyone remembered their role.

Keynesians and monetarists and Chinese bankers

Continuing the theme of “everything new is old”, I was struck by commentary from a Pennsylvanian congressman named Henry Jarrett suggesting that government relief money might serve to prime the pump of the economy:

An inconsiderable sum of money, for which the most ample security could be given, being loaned to a single individual in a neighborhood, by passing in quick succession, would pay perhaps a hundred debts.

Kind of sounds like George W. Bush urging Americans to go shopping after 9/11, in order to get confidence in the economy back. It’s a crass Keynesian tactic inspired by a confused understanding of the relationship between production, consumption and the role of money in the economy.

It was also interesting to see how many people back then could sense there was a problem with the way the banking system operated, but were confused into thinking banking in and of itself was illegitimate, rather than simply the practice of issuing a greater supply of banknotes than the amount of specie held in reserve. Consider a campaign circular for a candidate for Congress from mid-Tennessee, who said:

banking in all its forms, in every disguise is a rank fraud upon the laboring and industrious part of society; it is in truth a scheme, whereby in a silent and secret manner, to make idleness productive and filch from industry, the hard produce of its earnings

If you substitute “banking in all its forms” with “fractional reserve banking”, you’ve got a pretty accurate description of the nature of the problem.

It’s also worth quoting at length the argument of “An Anti-Bullionist”, who thought that the economic crisis of 1819 was caused by specie money specifically, rather than abuse of specie money via fractional reserves. In its place he sought to create a fully inconvertible paper currency issued by the government which would of course be “well regulated” and serve to protect the economy from the inevitable deflationary death spiral of the specie system he believed he was witnessing. Shades of later monetarist thinking abound:

His goal was stability in the value of money; he pointed out that specie currency was subject to fluctuation, just as was paper. Moreover, fluctuations in the value of specie could not be regulated; they were dependent on export, real wages, product of mines, and world demand. An inconvertible paper, however, could be efficiently regulated by the government to maintain its uniformity. “Anti-Bullionist” proceeded to argue that the value of money should be constant and provide a stable standard for contracts. It is questionable, however, how much he wished to avoid excessive issue, since he also specifically called a depreciating currency a stimulus to industry, while identifying an appreciating currency with scarcity of money and stagnation of industry. One of the particularly desired effects of an increased money supply was to lower the rate of interest, estimated by the writer as currently 10 percent. A lowering would greatly increase wealth and prosperity. If his plan were not adopted, the writer could only see a future of ever-greater contractions by the banking system and ever-deeper distress.

Even chartalists will be happy to see that early proponents of the “American System” of nationalist public-private industry were representing their views in the debates of the early 1820s, for example:

Law pointed to the great amount of internal improvements that could be effected with the new money. He decried the slow process of accumulating money for investment out of profits. After all, the benefit was derived simply from the money, so what difference would the origin of the money make? And it would be easy for the government to provide the money, because the government “gives internal exchangeable value to anything it prefers.”

Why even have a private industry? Or money, for that matter?

Luckily, advocates of laissez-faire existed in this time period, too, and they were not silent. Commenting on one proposal to deal with “idle capital” by Matthew Carey, the “Friends of Natural Rights” wrote:

The people of the United States being in a very unenlightened condition, very indolent and much disposed to waste their labor and their capital… the welfare of the community requires that all goods, wares, merchandise and estates… should be granted to the government in fee simple, forever… and should be placed under the management of the Board of Trustees, to be styled the Patrons of Industry. The said Board should thereupon guarantee to the people of the United States that thenceforth neither the capital nor labor of this nation should remain for a moment idle.

[…]

It is a vulgar notion that the property which a citizen possesses, actually belongs to him; for he is a mere tenant, laborer or agent of the government, to whom all the property in the nation legitimately belongs. The government may therefore manage this property according to its own fancy, and shift capitalists and laborers from one employment to another.

Finally, I don’t seem to have made a good note of the specific passage that caught my attention in this regard but I chuckled when reading the description of the operations of the average bank before collapse. These bankers would set up a new bank and pay only a fraction of capital with specie, the rest would be constituted by additional promissory notes from other banking institutions (which were themselves fractional). The bankers would pay themselves dividends, in specie, while the bank operated, and issue themselves and their friends enormous loans with which they’d purchase real goods and services, all while the real specie capital of their bank depleted. When crisis hit and they could not redeem their depositors’ money, they’d get legal permission to suspend redemption, ask for infusions of new capital from state authorities and/or set up a brand new bank whose purpose was to steady the previous institution. Ultimately, the bank would collapse and this too would work in their interest because they’d already hauled off the specie via dividends to themselves, and many of them were debtors of the bank who now had loans due in a worthless currency that was easy to obtain.

It reminded me a lot of the present Chinese state capitalist model.

Conclusion

“The Panic of 1819” is not light reading and for some readers it may not even be interesting reading. It depends a lot on how fascinating you find in depth examinations of “minor” historical economic events.

But that doesn’t mean it isn’t surprising, well-written (for all the facts and data, Rothbard still manages to weave together a narrative that helps the reader appreciate the nuances of the various factions and viewpoints of the time) and at times, depressingly relevant. People who care about economic and financial history and unique, formative episodes in the early history of this country, will find a lot of insights and curiosities in this work. I strongly recommend it.

Who Is YCombinator Trying To Fool With Their New Cities Research Project?

Two friends independently linked me to YCombinator’s “New Cities” blog post and it interested me enough that I thought to write about it in brief. The idea of a new city started “from scratch” excites me as an advocate of the private property society. I have a hard time imagining how my preferred values and ideas for peaceful, voluntary social arrangements will come to be implemented incrementally within the existing coercive institutions we call “city governments”. Starting with a bare plot of land, wholly-owned by one or more sympathetic parties and going from there seems like the only viable option for realizing this ideal and building a working model.

I was excited, then, to see that some well-known and resourceful people in the Silicon Valley VC community seem to be on to the same idea. But then I started reading their short post and I ended up with a lot of questions, the primary one being “What are they really trying to accomplish with this?”

I’m having trouble trusting their motives as sincere because of this: if they’re trying to build new cities, and they think they need to conduct “research” to figure out things like…

• How can we make and keep housing affordable? This is critical to us; the cost of housing affects everything else in a city.
• How can we lay out the public and private spaces (and roads) to make a great place to live? Can we figure out better zoning laws?
• What is the right role for vehicles in a city?  Should we have human-driven cars at all?
• How can we have affordable high-speed transit to and from other cities?
• How can we make rules and regulations that are comprehensive while also being easily understandable? Can we fit all rules for the city in 100 pages of text?
• What effects will the new city have on the surrounding community?

…they could prop open a free copy of Rothbard’s Man, Economy and State, Scholar’s Edition (with Power and Market) and start reading the basic economic theory underlying these questions, with special emphasis on the sections about “The Economics of Violent Intervention in the Market” which specifically deal with the problems they mention which relate to artificial scarcity of housing, zoning laws, street use permitting, mass transit policies and legislative efficiency. All the brainwork has been done for them, there is no need to reinvent the wheel and “discover” these effects independently if only they will consider what Rothbard has to say on the matter.

In fact, anyone who has read such material would immediately look at the “high-level questions” the YC Research project hopes to think through and notice the flawed premises evident in asking them. For example, asking “What should a city optimize for?” implies a city has some kind of monolithic identity and singular purpose, rather than being an unplanned, spontaneous outcome of the individual plans and values of the multitude of people who compose it. In asking the wrong questions, this project is doomed to arrive at arbitrary answers that are worse than wrong– they will be unknowledge which will set people back in believing it to be true and acting on it.

I don’t expect anyone at YCombinator or the research project to take a concern like this seriously, because I don’t believe their stated motivation is authentic. If it was, I would expect them to study the conclusions of 350+ years of economic pondering on these very unoriginal curiosities before proceeding with their experiment, which will never happen.

So my question remains. What are they really trying to accomplish with this? (And their Basic Income research project, which almost seems like expertly engineered trolling for the same reason I question the motivation of this New Cities project.)

 

Is Education Fundamentally A Technology Problem?

What happens when the computer engineering bubble hits the Silicon Valley finance bubble in a collision directly overhead of the philosophy of education?

AltSchool.

In “Learn Different“, the New Yorker surveys a for-profit, tech-inspired elementary education startup. Some key takeaways of the company’s approach to education, according to the reportage:

• No professional school admin; school is run by teachers
• “Micro-school” with small total enrollment
• Mixed classrooms; pre-K through 3rd grade in combined learning environment
• “Franchise” model; locations in major cities throughout the US
• “Highly tailored” education that uses technology to track student progress
• “Playlist” driven lesson plan; students work through pre-assigned steps on tasks of interest
• Surveillance; students are recorded with video and audio for later playback and analysis by teachers
• Big data; used to analyze student progress and adapt lesson plan to strengths and weaknesses
• Private tuition, approx. $30,000/yr

According to the editor’s tag on the article, AltSchool is an example of “Silicon Valley disrupts education.” In the disruption literature there is the idea of disruptive and sustaining technologies– disruptive technologies create a paradigm-shift in the strategic world upon which the industry in question competes, while sustaining technologies simply allow for more efficient continuation of the existing competitive dynamic. Better horse breeding practices are an example of sustaining technology in the era of the horse and buggy, while the internal combustion automobile is an example of a disruptive technology in personal transportation.

If AltSchool is disruptive technology, then the questions are:

1. What is the primary strategic principle for mainstream education?
2. How does AltSchool represent a paradigm-shift?

It’s perhaps difficult to say exactly what the principle of mainstream education is. There are many interest groups who vie for influence over the system so it is by no means a monolithic group. That being said, there is perhaps a cohesiveness of interests: provide jobs and economic resources for “educators” and administrators (including the politicians who are the ultimate stewards of the system) while creating a student body that will be cooperative with the political system around it and willfully integrate into the various economic relationships that sustain it. “Question everything” this is not.

The AltSchool gives meek lip service to the idea of an individual-oriented learning experience, but upon further investigation it seems that this is not about making the student the master of his education, but making the education a more subtle component of the student’s social indoctrination.

Ventilla [the founder of the company] also wanted students to focus on developing skills that would be useful in the workplace of the future, rather than forcing them to acquire knowledge deemed important by historical precedent. “Kids should be spending less time practicing calculating by hand today than fifty years ago, because today everyone walks around with a calculator,” Ventilla told me. “That doesn’t mean you shouldn’t be able to do math—I shouldn’t have to whip out my phone to figure out if someone gave me the correct change. But you should shift the emphasis to what is relatively easier, or what is relatively more important.”

While there isn’t necessarily anything blame-worthy in being mindful of conditions in the workplace which students might one day be interacting with, it also isn’t exactly revolutionary to incorporate job-worthiness into one’s educational philosophy. The “workplace of the future” is an extrapolation of the “workplace of the present” into future periods.

In San Jose, students’ scores on annual state tests were made available only after the end of the school year. At AltSchool, Seyfert could keep tabs on her students’ daily, if not hourly, progress. Every task card on a student’s playlist is tagged to denote not just academic skills, like math and literacy, but also social and emotional skills.

What is the value of all of these statistics? If you are teaching to a standard (ie, you have an end goal in mind of what your student should “look like” when their education is “complete”), then being able to measure progress toward that standard would be instrumental. The application of technology to this problem of measurement might introduce some efficiencies or even  capabilities that are impossible without it. But then, this wouldn’t be a disruptive innovation but rather a sustaining innovation.

If your methodology is centered around the development of the individuality of the student himself, then the best such statistics can provide is a description of strengths and weaknesses. There would be nothing actionable as there would be no specific goal. Suzie is good at math. Jerry is good at reading. But what of it? And even then, these descriptions would only be valuable to compare Suzie and Jerry to others, but what value are such comparisons to the individual being compared? He cares not for it.

Like other AltSchool teachers, Seyfert was drawn to the startup because of its ambition to make systemic change. Two or three times a week, she told me, she gives colleagues feedback about the school’s digital tools. The Learner Profile, Stream app, and other tools are only about a year old, and AltSchool’s personalization still requires considerable human intervention. Software is updated every day. Carolyn Wilson, AltSchool’s director of education, told me, “We encourage staff members to express their pain points, step up with their ideas, take a risk, fail forward, and fail fast, because we know we are going to iterate quickly. Other schools tend to move in geologic time.” (Ventilla may question the utility of foreign-language acquisition, but fluency in the jargon of Silicon Valley—English 2.0—is required at AltSchool.)

The obsession of the school seems to be in building excellent quantitative measurement tools. These pieces of software can be updated and tested rapidly. But the educational principles themselves produce effects which are long in both maturation and duration. We can’t be sure of their results until many years have passed, if even then, and they’re most easily tested through logical inquiry, not mathematical interpretation. As human nature and cognitive capability are not improving any faster than iteratively through “geologic time”, it’s unclear what value these rapid upgrades to the software provide to the improvement of the philosophic principles of education that have supposedly been disrupted by AltSchool.

There was some humorous contrary evidence:

The previous day, Otto said, a guest teacher had come in to lead several students in a 3-D-modelling project, using a Web site called Tinkercad. “We built little models online—some people built phone cases, or little towers, or yo-yos,” Otto said. “I built a toilet, because I thought it would be fun. It has lots of different components—you have the base, you have the seat, you have the back.” He clicked to the site and pulled up his model. “I was looking around at pictures of toilets online,” he said. “I think I want to make it a bit more shaped for your back. I also want really sanitary toilets. And I want to make it really comfy. I’m quite bony, and I’m small, and if they don’t have a cushion they hurt.” Eventually, Otto said, he planned to 3-D print his prototype: a model toilet, fashioned to his personal specifications and preferences.

I really enjoyed this comment and I am glad the journalist captured it. First, it suggests that maybe the AltSchool is creating some spaces for the individual student to explore their interests, deeply. Second, Otto comes from a financially successful family whose parents are accomplished corporate types. It seems that, given the freedom to pursue his own interests, he can think of nothing better than building a comfortable toilet. That must give mainstream educators (and maybe even his ambitious parents) the chills!

If you can pull your own preferences out of your head for a moment and just look at this boy’s effort from his own perspective, though, isn’t it glorious?

The point of the hackathon was to sketch out in code potential solutions to “robot tasks”—routine aspects of a teacher’s job that don’t require teaching skills. Kimberly Johnson, the head of product success and training, addressed the team. “Basically, what we have told teachers is we have hired you for your creative teacher brains, and anytime you are doing something that doesn’t require your creative teacher brain that a computer could be doing as well as or better than you, then a computer should do it,” Johnson said.

Since the previous hackathon, three months earlier, teachers at AltSchool had filed more than a hundred digital “tickets” to Johnson, indicating how AltSchool software might be improved. Some teachers had asked for a more streamlined way to input data. Johnson acknowledged, “It is a lot of work to go into each card and click the learning objective and click the score and click ‘save.’ It’s just four or five clicks, but it adds up.” The teachers also wanted to enter assessment scores to groups of kids at once. “If you say, I want to give all of these kids threes, and all of these kids fours, there must be an easy way to do that,” Johnson said. “I don’t know what it would look like, but you could probably hack something together.”

Again, the emphasis on data technology over teaching philosophy. Now, it sounds like the school is trying to free up the teachers to focus on teaching by improving their technology interface. But the question begged is, “What makes the technology interface so central to their teaching philosophy?” This comes back to the question of disruptive versus sustaining technology. How is the student served by all the assessments? Life is its own assessment.

But AltSchool’s philosophy of education is also essentially utilitarian, even as it celebrates the individuality, autonomy, and creativity of its students. It holds that children should be prepared for the workplace of the future—and that the workplace of the future will demand individuality, creativity, collaboration, and critical thinking.

We turn now to that great social philosopher, Ludwig von Mises, who said of genius and the creation thereof in his “Human Action“:

The genius does not deliver to order. Men cannot improve the natural and social conditions which bring about the creator and his creation. It is impossible to rear geniuses by eugenics, to train them by schooling, or to organize their activities. But, of course, one can organize society in such a way that no room is left for pioneers and their path-breaking.

Now here are two very different philosophies. At AltSchool, “individuality” and creativity are being taught as part of the lesson plan and the methodology of the school in service of the demands of a future workplace so envisioned. For Mises, the creative individual is something natural, inexplicable and uncontrollable and he is in service to himself first and foremost.

I think it is Mises’s ideas that are disruptive here.

AltSchool’s perspective does not necessarily require abandoning texts that have long been considered central to a humanist education, but it does mean approaching them anew. One middle-school class undertook a lengthy study of the Iliad by focussing on the theme of “rage” and designing a spreadsheet that logged instances of it. They then used data-visualization techniques to show their findings, and wrote persuasive essays based on their results. Afterward, their teacher, James Earle, wrote, “Analyzing a piece of literature this way turns the work into a piece of robust data that can be understood quantitatively, in addition to allowing a qualitative reading.”

But what is the value of this new understanding? What does it add that is new and different? Yes you can do this, but what thinking informs the should?

Mediratta [vice-president of product] envisaged a time when AltSchool technology would get “into the sci-fi realm.” What insights might be drawn from aggregated data culled from video and audio? He spoke of the video moments that teachers were bookmarking. “The next useful thing would be for us to analyze all the things that are bookmarked, and to draw inferences,” Mediratta said. “Like, bookmarks seem to happen when the classroom is noisy. So let’s generate a few other interesting moments that the teacher might want to look at—say, a moment when the classroom was full of kids but was dead quiet. What was happening there? Is this good? Is this bad? Or you could look at a moment when it was absolutely chaotic—but maybe that is what the activity called for. So we can start applying machine learning to this data to start driving inferences. Maybe what we should be doing is detecting when the classroom gets noisy, and then we could have the head of the school, who is also an educator, stop by your classroom and participate and help.”

The meta-philosophy of modern education is control, the schooling agenda is a by-product of the aim to control others. The desire to control the schooling environment seems to be what is behind the focus on applying technology to surveil and measure the students and their activities.

AltSchool is not disrupting anything as far as I can see. From my understanding of what education is and what education isn’t, I don’t see a place like AltSchool meeting my needs, but that does not mean it won’t be successful in terms of the paradigm of mainstream education, within which I believe it is situated.

Thoughts On Mergers, Acquisitions And Conglomeration From Rothbard And Buffett

In reading David Merkel’s third posting on Warren Buffett’s latest shareholder letter, I came across the following:

it should be no surprise that as BRK grew, given Buffett’s desire for owning as much of great businesses as he could, that BRK became a conglomerate, albeit one dominated by its leading insurance businesses.

David’s making a particular point using the language of “conglomerate” in a specific way– the idea of a company operating in multiple industries, none of which are necessarily related or complimentary to the other businesses in the portfolio. He’s observing Buffett’s behavior from the standpoint of acquisitions and trying to arrive at a meaningful interpretation of why and how Buffett has acquired as he has, resulting in his business representing a conglomerate.

It’s a worthwhile consideration but I want to try standing Merkel’s perspective on its proverbial head with the help of my friend Murray Rothbard, and see if some new insights aren’t arrived at. This is from chapter ten of his opus, Man, Economy and State, discussing “Cartels, Mergers and Corporations“:

What happens when a partnership or corporation is formed? Individuals agree to pool their assets into a central management, this central direction to set the policies for the owners and to allocate the monetary gains among them. In both cases, the pool­ing, lines of authority, and allocation of monetary gain take place according to rules agreed upon by all from the beginning. There is therefore no essential difference between a cartel and an or­dinary corporation or partnership.

Before you start getting upset (you who are having your worldview challenged here), read on:

Yet clearly the only difference between a merger and the original forming of a single corporation is that the merger pools existing capital ­goods assets, while the original birth of a corporation pools money assets. It is clear that, economically, there is little difference be­tween the two. A merger is the action of individuals with a certain quantity of already produced capital goods, adjusting themselves to their present and expected future conditions by cooperative pooling of assets.

I think this can be taken a step further, even, by saying that mergers don’t actually exist, there are only acquisitions. The reason I say this is because after every merger, “of equals” or otherwise, someone is left with de facto, if not technical or legal, control over the combined entity.

When two public corporations “merge”, the minority capital owners can de-merge (or escape acquisition) by liquidating their shares in the market. Their financial capital is freed to be placed elsewhere but their physical assets (the property of the merged corporation) remain. In this sense, clearly what has occurred is an acquisition of real capital goods, not a “merger”.

Does this logic apply to liquid investment partnerships, such as hedge funds, as well? By my definition, a hedge fund is not a “merger” (temporary, at that) because mergers don’t exist… it’s an acquisition by the portfolio manager. But there is no physical capital involved at this level, it is all liquid financial assets which represent claims to real, physical capital. And if the “merged” partner decides to de-merge, the portfolio manager has to sell a corresponding number of securities and financial assets to liquidate him, the control of which he does not hold onto going forward, unlike the corporation in which investors are made liquid not by the corporation but by outside investors.

I’ll have to think about that one a bit more. In the meantime, I’ve got another Rothbard quote on the subject, from the same chapter:

a merger and the original forma­tion of a corporation do not, as we have seen, essentially differ. The former is an adaptation of the size and number of firms in an industry to new conditions or is the correction of a previous error in forecasting. The latter is a de novo attempt to adapt to present and future market conditions.

Why mention this? What does any of this have to do with David Merkel’s article, Buffett and corporate conglomeration?

Merkel notes that Buffett has talked a lot about acquisitions over the years for a good reason: all investors are acquirers. Great investors are great acquirers (and tend to be extremely acquisitive, as well as extremely conscious of their status as acquirers). Buffett, as arguably the greatest investor of all time, is also one of the greatest acquirers of all time.

Many people talk about the investment process as one of efficiently and profitably allocating capital, and they talk of Buffett as an especially talented capital allocator. Few of these people realize how close they are to the profound, in this sense. Acquisitions and mergers are part of the capital allocation process. Acquisitions decide who will make future capital allocations with regards to a current pool of capital as well as its anticipated future capital yield.

Before Buffett was the head of a big time corporate conglomerate, he was a small investor. But even then, he was still an acquirer and involved in constant corporate acquisition, just like you, me and anyone else who makes small investments periodically. Every time we purchase a security, even if it is a fractional interest in an enterprise, we are acquiring that real capital and adding it to our own enterprise, corporate or otherwise. We are expanding our own personal domain as it pertains to the total pool of capital in the economy (local, national, global) and simultaneously someone else is either transferring their domain or relinquishing it in favor of consumption.

The corporate conglomeration is the natural, logical outcome of a track record of successful, long-term serial acquisitiveness, aka “investing”. In fact, it would be extremely odd to find a successful investor who hadn’t assembled a conglomerate. No, it would be impossible!

“What about a Buffett-contemporary like Walter Schloss?” you might be asking. He didn’t assemble a corporate conglomerate.

True, Schloss did not possess the precise econo-legal structure of the corporate holding company that Buffett did. But he was still a conglomerator– he acquired small pieces of many different businesses and essentially pooled their assets under his control.

Even a person who has concentrated their investing into ONE firm over their entire career is essentially an acquirer and a conglomerater, assuming this firm grows profitably. Through profitable growth, the firm generates retained earnings which are essentially internal corporate savings that the firm can use to ACQUIRE new capital goods and assets. Cornelius Vanderbilt, the steamboat and railroad magnate of the 1800s, is a good example of this. Even though he did not acquire a number of other firms, he acquired additional assets such as steamships, railroad cars, raillines, etc., from suppliers and thereby put these capital goods under his direct control. John D. Rockefeller is an extreme example of the acquisitional behavior of an investor-entrepreneur– he acquired into his oil empire not only oil equipment and oil reserves but entire capital good suppliers related to his business, such as railroads, warehouses and service stations.

Returning to Buffett, as Merkel says:

Once BRK got big, that meant becoming a conglomerate, albeit a special one, was the logical outcome.  And I could be wrong, but that is the final corporate form for BRK.  There may come a day in a post-Buffett era when it may do many things, such as spin off companies, or centralize functions.

I don’t think conglomeration had anything to do with hitting a size threshold. I think it is related to Buffett’s long-term success as a capital allocator, which is dependent upon his ability to acquire the right assets over time. I think Merkel is correct that this will be the final corporate form of BRK.

And, I think Merkel is onto something when he says there could come a day when BRK spins off companies or otherwise transforms itself, particularly in the post-Buffett era. As we learned in our reading of Value: The Four Cornerstones of Corporate Finance, a particular asset will have numerous “best owners” over its entire lifetime. Looking at a collection of assets in the form of a contiguous business, this business will have numerous “best owners” over time, as well. From start-up, to growth, to maturity and eventually decline, ownership of the business will naturally transfer to those who are best positioned to maximize value (that is, future cash flows) from the business in its present form and at that particular stage of its lifecycle. The general trend is increasing acquisition of assets until the terminal point is reached at which point assets are divested and spun-off as the business declines and ultimately fails or disappears via merger/acquisition into the total control of another enterprise.

Merkel makes an important observation about the above-average ownership period of the average Buffett investment:

BRK is the acquirer of choice for those that want to cash out, but don’t want the unique character of their organizations to change, which Buffett points at in the present Shareholders’ Letter as a unique competitive advantage.

Buffett finds himself to be the “best owner” of various assets he has acquired for periods that seem much longer than most others because he has determined that committing himself to this role gives him a competitive advantage in convincing the previous owners to allow him to acquire the assets in the first place. Although Buffett as a capital allocator (acquirer) may have no particular advantage in managing businesses and assets involved in any particular late-phase lifecycle such as maturity and decline, by creating a credible belief that Buffett will preserve a business he aims to acquire, he is granted opportunities to acquire that might not exist for anybody else due to non-financial (such as emotional or prestige) reasons.

So far, this strategy has proven to be a good one, and a unique one for the most part. But it remains to be seen how this strategy will hold up when Buffett himself is no longer around, and many more of his businesses have entered the maturity/decline phases. After all, Buffett eventually sold off his textile mills, albeit for pennies on the dollar, though, it could be argued, not before extracting from them substantial free cash flows he was able to allocate into better businesses.

As investors, we’re all in the acquisition game. Like Buffett, whether we’re buying public or private companies, whole businesses or tiny slivers, we’re constantly acquiring (and sometimes divesting) pools of real capital.

How does acknowledging this fact change your perspective, and your behavior?

Post-script

There is nothing inherently efficient about the corporate conglomeration as an entrepreneurial structure. In fact, the conglomerate form (in the more traditional sense in which Merkel uses it) is generally found to be less efficient because it causes management to make decisions about business activities it may have substantially less expertise in, while simultaneously dividing total management attention and thereby causing distractions.

Frankly, there is no reason why a company like BRK, which owns candy confectioners, insurance companies and railroads, should necessarily have any special ability to compound wealth merely because of the corporate combination of these assets and businesses. If it were true that the corporate conglomeration was inherently more efficient and profitable, this business form would be vastly more prevalent than it currently is, if not entirely dominant.

The reality, however, is that most conglomerates are not specially profitable. They are not specially efficient. They suffer from bureaucratic operation, distracted management and huge internal calculational problems as they grow in size.

In that sense, Buffett (and Munger, to some extent) is the unique competitive advantage that BRK as a corporate conglomerate is blessed with. And it is for this reason that I believe the death of Buffett will be devastating to BRK’s market value and will most likely result in massive divestitures and the eventual break-up of the entity.

One final note, which I couldn’t help but to mention: the totalitarian state is the penultimate corporate conglomeration. And it suffers mightily as an economic entity, as a result.