*UPDATE2*My 10 Page Research Paper on Austrian Free-Market Economics That Received a PERFECT SCORE!

***UPDATE***
Thank you so much, everyone, for your wonderful comments. I am very glad you liked this paper, and I must say, I would not have been able to write this paper if it hadn't been for all the wonderful folks here on the Daily Paul giving me inspiration! I was expecting to have to bump the thread this morning, but to my surprise, it was already going strong! This makes me feel all happy and warm and fuzzy inside. It really is a r3VOLution!

**UPDATE2**
Oh WOW! Front page?! That is just epic. Thank you so very much, whoever put it there!

This is my final paper from my Advanced Composition class. It is about the Austrian Free-Market perspective on the current economic crisis. I guess I must have made an Austrian out of the proffessor since I got 250/250 points on it.

GRRR I was trying to post a link to my usual file hosting website but it is being stupid and not working correctly, so for now, if you would like to have a copy of the word file, send a request to me at (Remove the *s) Gale*Razorwind*(at)gmail*(dot)com (again, remove the *s and replace the (at) and (dot) with the appropriate symbols. It is an anti-spam thing.) Please make sure to specify whether you would like it in Word 03/Microsoft works format (.doc) or Word 2007 format (.docx).

Enjoy:
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The Austrian Free-Market Perspective on Current Economic Issues
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DeVry University, ENGL 135
Professor ****************
6/7/09
 
Starting in 2008, America has been dealing with a series of unprecedented economic calamities. First was the collapse of mortgage based securities, which led directly to the failure of large Wall Street investment banks and a cascading series of failures or potential failures. The Treasury Secretary and the Federal Reserve convinced the US Congress to create the $700 billion TARP program. Many other huge bailouts have led to direct government ownership of formerly privately held institutions such as AIG insurance. The institutions were called “too big to fail.” In the last several months, GM and Chrysler have been partially nationalized. China is concerned over the stability of the value of the dollar. Trillion dollar annual government deficits are predicted. Hyper-inflation is now a real fear. Tax increases on the rich are proposed to help reduce deficits. These actions represent the application of Keynesian economics on an unprecedented scale, but an Austrian Free-Market approach would end up with a better solution.

Keynesian economics is named after its founder, John Maynard Keynes, a British economist. His school of thought believes that the government should be actively involved in a free-market economy in order to protect against the consequences of booms and recessions. His ideas became widely accepted by the end of the Great Depression. Keynesian economics is the theory that is held by the vast majority of government economists and politicians. This belief leads to the entire system of federal control of money supply and interest rates, and the hope that manipulation by government will lead to better long term economic outcomes.

Austrian Free-Market economics believes in keeping government intervention in all aspects of an economy to an absolute minimum. The origins of Austrian Free-Market economics can be traced back to the 15th century, but in the 20th century, the ideas became widely known due to the writings of Ludwig von Mises, Nobel Prize winner Friedrich A. Hayek, and Joseph Schumpeter. Their feeling was that the individual actions of a large group of humans, if they were allowed to act in their own self-interest, would always lead to a superior economic outcome. Central planning would always lead to poor results, and failure of growth. A group of the leading thinkers in the field worked out of the University of Chicago, and their views became known as the Chicago school of economics. Milton Friedman was the most famous proponent of free-market economics during the second half of the 20th century, and won the Nobel Prize for his work. The Chicago school added complex mathematical models, and this was felt to be more “scientific” than theories based on inductive reasoning. However, the core beliefs of Austrian Free-Market economists is that human nature is too complex to create strict mathematical models and instead rely on logical deduction based on known axioms of human behavior.
Austrian economic ideas provide an interesting view of the causes and solutions to several aspects of the current crisis. These include the automobile company bailouts, the subprime mortgage collapse, the fractional reserve system, and tax increases to reduce the deficit.

The current failure of General Motors and Chrysler, and the reaction of massive government intervention, provides an excellent example that can be analyzed using Austrian economic principles. Leading theorist Henry Hazlitt was prescient in his 1949 book, Economics in one Lesson. In the chapter, “Saving the X Industry”, he lays out the exact same arguments that are given currently about the need for government intervention, then goes on to explain why these interventions are misguided. “A government subsidy can be thought of as nothing more than the transfer of wealth or income to the X industry. The taxpayers would lose precisely as much as the industry gained” (Hazlitt, 1946). In the current situation, there is not an industry wide subsidy, but a subsidy to two specific companies. There have been large unsecured loans, and now government structured bankruptcies have wiped out shareholders.

Daniel J Mitchell of the free market oriented think tank, the CATO Institute, states, “Perhaps most important, though, is that a bailout would be bad for the long-term health of the American auto industry. It would discriminate against the 113,000 Americans who have highly-coveted jobs building cars for Nissan, BMW and other auto companies that happen to be headquartered in other nations” (Mitchell 2008). The workers at the successful US Honda and Toyota assembly plants have to pay taxes to help keep their competitors in business. Austrian Free-Market thinking would have favored letting GM and Chrysler go into Chapter 7 liquidation so that the capital and labor could be re-directed to more efficient manufacturers or to other industries. Daniel Ikenson states that, “Had Bush not funded GM in December (under questionable authority, no less), the company probably would have filed for bankruptcy on Jan. 1, at which point prospective buyers, both foreign and domestic, would have surfaced and made bids for spin-off assets or equity stakes in the "New GM," just as is happening now” (Ikenson, 2009). For an even better idea of how the government is inept at handling issues such as this, it should be noted that the man put in charge of dismantling GM, Brian Deese, “never set foot in an automotive assembly plant until he took on his nearly unseen role in remaking the American automotive industry” (Sanger, 2009).

Congressman Ron Paul, a strong advocate for the Austrian school, spoke before the U.S. House of Representatives condemning the auto bailout. Amazingly, it was November 21st, 1979, and the speech was about the 1979 bailout of Chrysler. “One of the things that bothers me most about this entire discussion is that it centers around only what is obvious. Saving 100,000 jobs at Chrysler is obvious; losing 100,000 jobs, one by one around the country is not obvious, but they will nonetheless be lost, should aid to Chrysler pass” (Paul 1979). Paul felt that the misallocation of resources and capital due to the money being used for the Chrysler bailout would lead to the subtle job loss. A major company going out of business always gets huge attention, and everyone wants to do something to save it. It is always pointed out that the suppliers will be hurt, and all kinds of people will be on unemployment and need other social services. However, these same costs will incur to the non-auto industry associated individuals who are indirectly unemployed. In a similar view, Daniel Ikenson states, “Let’s not pin on those of us who favor market processes the sin of ‘destroying the productive capacity of our largest U.S. auto manufacturer and forcing thousands of suppliers out of business.’ The managers of GM and the United Auto Workers did that all by themselves, by colluding in mismanagement and greed and then rationalizing their destructive behavior with the presumption that they were too big to fail and that the government would be there to clean up the mess” (Ikenson, 2009).
While Chrysler survived until its current collapse, the bailout kept it and major competitors like GM from making the changes needed to compete with foreign car companies on quality and price, so the bailout of 1979 led directly to enabling non-competitive union contracts and a continuation of inferior products. The earlier, smaller bailout backfired by preventing the changes the industry needed to suffer so it could succeed in the long run. The result is the current collapse of Chrysler and GM, which has lead to “temporary” 60% government ownership. To realize how dangerous this “temporary” ownership is, one only needs to look at the government takeover of Amtrak. The government control was only supposed to last a few years, but 40 years later, the government still owns and operates it at a loss, even though they have made it illegal to compete with it (Paul, 2009). If GM became another Amtrak, we could see a huge monopoly form that would prevent more efficient car companies from competing. The Austrian Free-Market view on this is that GM should get your money in one way and one way only: by selling you their product at a price you are willing to pay. If they cannot run their business this way, they should not be in operation.

A core belief of Austrian Economics is that companies and businesses can be considered to be one of two types of wealth machines: creators or destroyers. A successful business, one that produces the best products for the lowest price in the most efficient way possible, is a wealth creation machine, while a poorly managed or operated business that cannot produce in the same way as a successful business is a wealth destruction machine. When you invest capitol or resources into a successful business, you can create more wealth. However, by investing capitol or resources into an unsuccessful business, you can only destroy wealth. GM and Chrysler are obviously failing; therefore they are a wealth destruction machine and pumping more money into them will only result in the loss of more wealth. There is no true benefit from an industry bailout, either to individuals or to society.
Austrian economics disagrees with the fractional reserve system. This is true from a small town bank all the way to the Federal Reserve banking system, whose very name conveys that it is based on the reserve concept. Reserve lending is a policy that states that a bank must maintain a certain percentage of its money as a reserve when it lends money. By using a fractional reserve system a bank can lend out significantly more money than it is required to hold on site. For example, with a ten percent reserve a bank that holds one hundred dollars in deposits could lend out one thousand dollars. If the money is lent out at twenty percent a year, the bank can make two hundred dollars a year by holding the one hundred dollars in deposits. The problem with this system is that the banks are lending money that not only do they not actually have, but that doesn’t even exist. The money appears out of thin air. This may seem like a good deal for everyone, because the bank makes a lot of money, and a lot of money is available for loans. However, there are three main risks to this system. First, if money is in extreme excess compared to the output of goods and services, it is a direct cause of inflation. Second, since the bank is only required to hold a fraction of the money that it lends. Should a significant number of the bank’s depositors all decide to withdraw their money, the bank may not be able to pay them all back. The biggest risk is in the event of hard economic times, when a larger than expected amount of borrowers start defaulting on their loans. When depositors realize that the bank’s loans are not getting repaid, they will for the first time understand that their money is at risk.

On a larger scale, this is what happened in the subprime mortgage meltdown. Large bundles of mortgages were assembled into complex interest paying securities. Since, by definition, subprime means that the credit status and payment reliability of the borrowers are not as good as average, the investments were inherently risky. The plan worked as long as housing prices continued to rise. If an individual borrower defaulted, the bank could just sell the property, and get more than the value of the loan. When housing prices started to fall in 2007-2008, this scheme collapsed. As more and more foreclosed homes went for sale at below normal prices, this dragged down the prices of all homes. Austrian economics holds that most financial disasters are caused by government intervention in the free market. Looking into the root causes of the subprime situation, there are many layers of well intentioned government intervention. First was the Community Reinvestment Act, passed in the Carter administration. This required banks to make a certain percentage of their loans to low income home buyers. As this group’s credit is usually poor, the banks would never have done it unless they were forced. Over time, subsequent changes to the law demanded higher and higher percentages of loans to be to the subprime group. Over the same period, the loans came to be guaranteed by the quasi-federal agencies known as Fannie Mae and Freddy Mac. Because the agencies were believed to have the implicit backing of the Federal Government, investors bought shares of Fannie and Freddy, which paid handsome dividends until the mortgage market collapsed. The taxpayers ended up paying a huge bailout to save Fannie and Freddie. According to Mitchell in an LA Times editorial, “These government-sponsored enterprises were created explicitly to distort the flow of capital and encourage over-investment in residential real estate. Responding in part to campaign contributions (a clear conflict of interest), politicians dramatically expanded the power of Fannie and Freddie in recent years, thus creating widespread systemic risk because of the implicit (now explicit) government guarantee” (Mitchell, 2008). O’Driscoll in the New York Post argued: “Because the government was universally believed to guarantee their debt, Fannie and Freddie could borrow at better rates than true private-sector firms - and accumulate far greater risks. The politicians and regulators that should've reined them in did not - because the giants bought influence, and because of their apple-pie image as "promoting home ownership” (O’Driscoll, 2008). If the government had just let individual banks decide who it was safe and sensible to loan money to, then the entire subprime disaster would have been prevented.

Another main theme of Austrian economics is that government efforts to redistribute income always backfire, and end up making the poor worse off. Efforts by the “rich” to escape punitive taxation rates lead to misallocation of capital, and fewer jobs are created or preserved. As the need for funds becomes more desperate, the definition of rich always goes down until those in lower income levels are heavily taxed. Those who earn high wages, such as professional couples, are hurt more than those who have investment income, which can be sheltered in vehicles such as tax free bonds.

One of the most famous examples of an effort to redistribute income is the concept of minimum wage laws. The (as usual) well intentioned idea is that if you force employers to pay more than what they freely would choose to pay, this will lead to a better wage for workers. However, interventions always have unanticipated consequences. “A wage is in fact a price…this has kept people from recognizing that the same principles govern both (Hazlet, 1946). Higher minimum wages make it unattractive for employers to invest the time and effort to train unskilled workers. Sometimes they are replaced by machines. Sometimes the higher wages cause the company to be non-competitive or to fail. Then everyone who worked for the company loses their job, not just the minimum wage workers.

Regarding the hiring of low wage immigrants, Ruart wrote: “by helping their employer, (by taking a low wage), they also helped themselves. Instead of paying for expensive schooling…they got on the job training…Once they learned the language, trade, and customs, they could create much more wealth than before (Ruart, 1993). Ruart meant that the employee could now get a higher wage job because they were willing to work initially for what they were worth, which would surely be less than an arbitrary minimum wage. With a minimum wage law, the unskilled immigrant would not have gotten hired. Carried to an extreme, Congress should just make the minimum wage $100 an hour. We would all be rich! At least until we noticed that a Whopper burger cost $20. The truth is that any artificially elevated wage causes the same distortions, though perhaps on a less obvious scale.

The Austrian Free-Market perspective on the current economic crisis, its causes, and the solutions for it is not always popular, but it is the truth. We can see that our current policies are not only not working, but are causing immense damage to the economy and to the freedom of America’s people. That is why we must relinquish our Keynesian economic philosophy of government intervention and move to the ideals and principles of the Austrian Free-Market.

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References:
Ikenson, Daniel J. (2009, June 4). Automakers That Can't Compete Deserve to Disappear. Retrieved June 11, 2009, from The Cato Institute Web site: http://www.cato.org/pub_display.php?pub_id=10275
Ikenson, Daniel J. (2009, June 3). What Was the Point of Bailing out GM? Cato Institute.
Hazlitt, H (1946). Minimum wage laws. Economics in one lesson (134). New York:
Crown Publishers

Hazlitt, H (1946). Saving the X industry. Economics in one lesson (98-102). New York:
Crown Publishers
Mitchell, Daniel J. (2008, October 14). Who Are the Villains of the Mortgage Mess? Los Angeles Times
Mitchell, Daniel J. (2008, November 13). Say No to the Auto Bailout. Retrieved June 11, 2009, from The Cato Institute Web site: http://www.cato.org/pub_display.php?pub_id=9787
ODriscoll, Gerald P. (2008, September 9). Fannie/Freddie Bailout Baloney. New York Post
Paul, R. (2009, June 8). GM, Amtrak and an Increasingly Fascist America. Texas Straight Talk. Retrieved June 11, 2009, from Ron Paul’s house website: http://www.house.gov/htbin/blog_inc?BLOG,tx14_paul,blog,999,...
Ruwart, M.J. (1992). Destroying Jobs. Healing our world : The other piece of the puzzle
(27). Kalamazoo Michigan: SunStar press

Sanger, D.E. (2009, May 31). The 31-Year-Old in Charge of Dismantling G.M. New York Times.

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Thank you for reading this. A lot of work was put into it!