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 George Reisman's Blog on Economics, Politics, Society, and Culture

October 2010

This blog is a commentary on contemporary business, politics, economics, society, and culture, based on the values of Reason, Rational Self-Interest, and Laissez-Faire Capitalism. Its intellectual foundations are Ayn Rand's philosophy of Objectivism and the theory of the Austrian and British Classical schools of economics as expressed in the writings of Mises, Böhm-Bawerk, Menger, Ricardo, Smith, James and John Stuart Mill, Bastiat, and Hazlitt, and in my own writings.

The contents of the blog are copyright © 2009 by George Reisman. All rights reserved. Permission is hereby granted to reproduce and distribute individual articles below electronically and/or in print, other than as part of a book. (Email notification is requested). All other rights reserved. George Reisman, Ph.D., is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics.


Wednesday, October 27, 2010

Natural Resources and the Environment

 There is a fundamental fact about the world that has profound implications for the supply of natural resources and for the relationship between production and economic activity on the one side and man’s environment on the other. This is the fact that the entire earth consists of solidly packed chemical elements. There is not a single cubic centimeter either on or within the earth that is not some chemical element or other, or some combination of chemical elements. Any scoop of earth, taken from anywhere, reveals itself upon analysis to be nothing but a mix of elements ranging from aluminum to zirconium. Measured from the upper reaches of its atmosphere 4,000 miles straight down to its center, the magnitude of the chemical elements constituting the earth is 260 billion cubic miles.

This enormous quantity of chemical elements is the supply of natural resources provided by nature. It is joined by all of the energy forces within and surrounding the earth, from the sun and the heat supplied by billions of cubic miles of molten iron at the earth’s core to the movement of the tectonic plates that form its crust, and the hurricanes and tornadoes that dot its surface.

Of course, in and of itself, this supply of natural resources is largely useless. What is important from the perspective of economic activity and production is the subset of natural resources that human intelligence has identified as possessing properties capable of serving human needs and wants and over which human beings have gained the power actually to direct to the satisfaction of their needs and wants, and to do so without expending inordinate amounts of labor. This is the supply of economically useable natural resources.

The supply of economically useable natural resources is always only a small fraction of the overall supply of natural resources provided by nature. With the exception of natural gas, even now, after more than two centuries of rapid economic progress, the total of the supply of minerals mined by man each year amounts to substantially less than 25 cubic miles. This is a rate that could be sustained for the next 100 million years before it amounted to something approaching 1 percent of the supply represented by the earth. (These estimates follow from such facts as that the total annual global production of oil, iron, coal, and aluminum, can be respectively fitted into spaces of 1.15, .14, .5, and .04 cubic miles, based on the number of units produced and the quantity that fits into one cubic meter. Natural gas production amounts to more than 600 cubic miles, but reduces to 1.1 cubic miles when liquefied.) Along the same lines, the entire supply of energy produced by the human race in a year is still far less than that generated by a single hurricane.

In view of such facts, it should not be surprising that the supply of economically useable natural resources is not something that is fixed and given and that man’s economic activities deplete. To the contrary, it is not only a very small fraction of the supply of natural resources provided by nature but a fraction that is capable of substantial enlargement for a considerable time to come. Mining operations could be carried on at 100 times their present scale for a million years and still claim less than 1 percent of the earth.

The supply of economically useable natural resources expands as man increases his knowledge of nature and his physical power over it. It expands as he advances in science and technology and improves and enlarges his supply of capital equipment.

For example, the supply of iron as an economically useable natural resource was zero for the people of the Stone Ages. It became an economically useable natural resource only after uses were discovered for it and it was realized that iron could contribute to human life and well-being once it was forged into various objects. The supply of economically useable iron was one thing when it could be mined only by means of digging for it with shovels. It became substantially greater when bulldozers and steam shovels replaced hand shovels. It became greater still when methods were found to separate it from compounds containing sulfur. And so it has been, and can continue to be, with every economically useable natural resource. Their supply has increased and can continue to increase for an indefinite time.

The fact that the earth is made of chemical elements that man neither creates nor destroys implies that from the point of view of physical science production and economic activity can be understood as constituting merely changes in the locations and combinations of the chemical elements. Thus, for example, the production of automobiles represents a movement of some of the world’s iron from such locations as the Mesabi Range in Minnesota to the rest of the country and, in the process, the separation of the iron from elements such as oxygen and sulfur and its recombination with other elements such as chrome and nickel.

The changes in the locations and combinations of the chemical elements that constitute production and economic activity are not at all random but rather are aimed precisely at improving the relationship of the chemical elements to human life and well-being. Iron in automobiles and appliances and in the steel girders that support buildings and bridges stands in a far more useful and valuable relationship to human life and well-being than does iron in the ground. The same is true of oil and coal when brought into a position in which they can be used to heat and light homes and provide power for man’s tools and machines. The same is true of the relationship between all chemical elements that have come to constitute the material stuff of products compared with those elements lying in the ground.

Insofar as the essential nature of production and economic activity is to improve the relationship between the chemical elements constituting the earth and man’s life and well-being, it is also necessarily to improve man’s environment, which is nothing other than those very same chemical elements and their associated energy forces. The notion that production and economic activity are harmful to the environment rests on the abandonment of man and his life as the source of value in the world and its replacement by a non-human standard of value—i.e., the belief that nature is intrinsically valuable.

With man and his life as the standard of value, the environment is improved when it is filled with houses, farms, factories, and roads, all of which serve directly or indirectly to make his life easier. When nature in and of itself is seen as valuable, then the environment is harmed whenever man creates any of these things or does anything whatever that changes the existing state of nature, for he is then destroying alleged intrinsic values.

A final inference that may be drawn is that a leading problem of our time is not environmental pollution but philosophical corruption. It is this that underlies the belief that improvement precisely in the external material conditions of human life is somehow environmentally harmful.


Tuesday, October 26, 2010

Boom-Bust in Microcosm

The essential features of the boom-bust business cycle can be understood by viewing them in terms of the financial circumstances of a single individual.

Thus, imagine that an ordinary person has been going about his life more or less living within his means. And now, one day, he receives a registered letter from a major bank. The letter informs him that he is the sole heir of a distant relative who possessed a substantial fortune, and that he should come into the bank’s main office in his city to sign the necessary documents and receive all the necessary authorizations to henceforth dispose of this fortune as he sees fit. Naturally, he quickly goes in and takes possession of his new-found fortune.

Whether the fortune in question is $100 million or $10 million, it is certain to have a major impact on this individual’s life from this point forward. For it opens up new worlds to him by enabling him to now afford to buy things he could never dream of buying before. He can now afford a new home, perhaps a mansion. He can buy a whole new wardrobe, travel the world, quit any job that he currently has and does not love. If he is in business, he can expand his business in major ways. If he is not in business, he can start a significant-sized business. And he can now afford to invest and speculate in the stock and real estate markets as well, inasmuch as his new-found wealth makes it possible for him no longer to fear losses of mere hundreds or thousands of dollars; indeed, it appears that he can now afford to lose even a million dollars and still be very rich.

This is the boom period for our individual. His life is easy. He can do so much more than he had ever been able to do before. And his prospects appear limitless. For the rest of his life, he will back upon this period with the greatest fondness and ardently wish to relive it. It is “the good times.”

The Bust

What puts an end to our individual’s life of ease is a second letter. This letter explains that it has now been proven that the relative whose fortune he’s received had obtained it by criminal means. Thus the fortune did not in fact belong to that relative and therefore could not properly be passed on by him to anyone else.

As a result, the bank concludes, our individual is obliged to return the fortune. Accordingly, all of his accounts with the bank in question have been frozen and court orders have been obtained prohibiting him from spending any more of what he has thought of as his inheritance and demanding the return of whatever is left.

Our individual now finds himself buried in a mountain of debt that he cannot repay. He must sell his home or mansion, most likely for less than he had paid for it. (If for no other reason, this will likely be the case simply because of the payment of brokerage fees and the inability to wait very long for the right buyer.) Selling the clothes and many of the other goods he had bought will likely yield only pennies on the dollar. All that he had spent in travelling the world will be a total loss, as will be his expenditures on many other forms of luxury consumption. As for his investments, they may be profitable or unprofitable. However, given our individual’s lack of great financial success prior to his receipt of his inheritance, it is more likely than not that they will have been unprofitable.

The upshot of all this is that our individual’s receipt of his “inheritance” has turned out to be a financial catastrophe for him. By leading him to make massive purchases in the mistaken conviction that he owned a fortune, when in fact he did not, it has led him to live far beyond his means and to squander much or all of the wealth he had prior to his coming into his “inheritance.”

Boom-Bust in the Wider Economy

The pattern of boom-bust in the wider economy is essentially similar to what has been portrayed in the case of this individual. In both cases, the boom is characterized by the appearance of great new and additional wealth that does not in fact exist. The bust is the aftermath of the economic behavior inspired by this illusory wealth.

In the boom-bust cycle of the wider economy, the illusory wealth does not take the form of false inheritances but of newly created paper bank credit that is confused with capital representing real, physical wealth. At the instigation and with the support of the Federal Reserve, in the most recent boom banks created several trillion dollars of new and additional money which they lent out. On the foundation of this fictitious capital, the economic system was led to proceed as though corresponding new and additional physical wealth had come into being. The result, among other things, was the construction of perhaps as many as 3 million new houses for which people could not pay.

In reality, the capital actually available in the boom is insufficient to support the projects that are undertaken on the foundation of the credit expansion. Instead of creating new and additional capital, credit expansion serves to drive up wage rates and the prices of capital goods. This reduces the buying power of capital funds. Ultimately, it creates a situation in which those who normally would have been in a position to lend money find that they cannot lend, or cannot lend as much, because they need the funds to finance their own, internal operations which now must be carried on at higher wage rates and prices of capital goods. At the same time, for the same reason, borrowers find that the funds they have borrowed are insufficient. Thus borrowers need more money while lenders can only lend less. The upshot is a “credit crunch,” in which firms go bankrupt for lack of funds.

In the boom phase, massive debts have been accumulated. As these debts become unpayable, the capital of the firms that have lent the funds is correspondingly reduced. In the process, the capital of the banks that have created the new and additional credit can be wiped out, creating the potential for bank runs and an actual decline the quantity of money in the economic system. The mere specter of such events creates a major increase in the demand for money for cash holding, with the result that spending in the economic system starts to decrease even without an actual fall in the quantity of money.

The conclusion to be drawn is that the key to avoiding “busts” is to avoid the credit expansion and “booms” that cause them. Booms are not periods of prosperity but of the squandering of wealth. The longer they last, the worse is the devastation that follows.


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