The Broken Window Fallacy

It is very usual in this economic crisis to hear about the beneficial effects on the economy of all sorts of “stimulus” measures, money printing, public works expenditures, subsidies, even the destruction of goods or war as a way to “improve” the economy. All of these measures so loved by Keynesians of all stripes are nothing more than variations of the so-called broken window fallacy, introduced by the french economist Frédéric Bastiat in 1850. The following video produced by Sam Selikoff and Luke Bessey is a very short and clear explanation of why you cannot create wealth by breaking windows or invading a foreign country. It should be evident to everybody, but it is not. Just ask Paul Krugman!

The parable of the broken window was introduced by Frédéric Bastiat in his 1850 essay Ce qu’on voit et ce qu’on ne voit pas (That Which Is Seen and That Which Is Unseen) to illustrate why destruction, and the money spent to recover from destruction, is actually not a net-benefit to society. The parable, also known as the broken window fallacy or glazier’s fallacy, demonstrates how opportunity costs, as well as the law of unintended consequences, affect economic activity in ways that are “unseen” or ignored.

Bastiat’s original parable of the broken window from Ce qu’on voit et ce qu’on ne voit pas (1850):

Have you ever witnessed the anger of the good shopkeeper, James Goodfellow, when his careless son has happened to break a pane of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—”It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?”

Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.

Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade—that it encourages that trade to the amount of six francs—I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.

But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, “Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen.”

It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.

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“They were too big to fail in 2008, they were too big to jail in 2009”

Bill Moyers interviews Neal Barofsky former Special Inspector General in charge of policing TARP (SIGTARP). Mr. Barofsky speaks with clarity about the roots of the present financial crisis, on why nobody has been prosecuted in Wall Street, on why another crash is inevitable, on why “playing ball with Wall Street” is the way to go if you want to succeed in the USA, on why big banks are back to their old tricks, on why they should be broken up and how difficult achieving this goal is going to be.

He does not mention America is now a feudal society, but that does not mean it is not.

Some excerpts either from Bill Moyers or from Neal Barofsky:

6:00 on why nobody in Wall Street has been prosecuted…“they were too big to fail in 2008, they were too big to jail in 2009”

7:30 “I thought, at the time, this was an incestuous orgy going on there, between inside players at Washington and inside players at Wall Street. Is that too strong?”…”It’s probably not too strong. It’s the fact that their ideology matches up. And look, one of the reasons why their ideology matches up is they all come from the same small handful of institutions. And the people I was dealing with on a daily basis came from the same financial institutions that helped cause the financial crisis and were the most generous recipients of bailouts, Goldman Sachs, Bear Sterns, which, of course, had been adopted by J.P. Morgan Chase. Goldman Sachs, Goldman Sachs, it seemed like every time I turned around, I bumped into someone from Goldman Sachs.”

9:20 “It was puzzling to outsiders like me that you had TARP money being used to concentrate further the size of these banks.”

10:30 “Are you suggesting that we could have another crash?”…”I think it’s inevitable. I mean, I don’t think how you can look at all the incentives that were in place going up to 2008 and see that in many ways they’ve only gotten worse and come to any other conclusion.”

12:40 “playing ball with Wall Street has become a novel way of life”

13:20 “And he said to me, he said, “Neil, you’re a smart guy. You’re a young guy. You’re a talented guy. You got your whole future in front of you. You’ve got a young family that’s starting out. But you’re doing yourself real harm.” And the reason why you’re doing yourself real harm is the harsh tone that I had towards the government as well as to Wall Street, based on what I was seeing down in Washington. And he told me that if I wanted to get a job out on the Street afterwards, it was going to really be hard for me.”

17:00 “And in some ways, it creates this false illusion that there are people out there looking out for the interest of taxpayers, the checks and balances that are built into the system are operational, when in fact they’re not. And what you’re going to see and what we are seeing is it’ll be a breakdown of those governmental institutions. And you’ll see governments that continue to have policies that feed the interests of — and I don’t want to get clichéd, but the one percent or the .1 percent — to the detriment of everyone else.”

18:30 “Based on the presumption of bailout, the banks get higher ratings from the credit rating agencies which means they can borrow money for less, because their debt is viewed by the credit rating agencies as being less risky. And they get these higher ratings on explicit presumption that the government will bail them out and make good on their debt.”

20:05 “If we really want to get to the point where we don’t have to bailout a bank, we have to make it so that no bank is so systemically significant and large that its failure could bring down the system.”

20:40 “And pressuring members of Congress to put pressure on the regulators, to water down the rules, to basically get as much back to the good old days where they would have free reign to print money, take advantage of their too big to fail status, bully and push out the little guys, take advantage of consumers. And that’s what all of these efforts area about are to preserve these very, very core profit streams that they had before.”

TYR 26 October 2012 reads

The SAME Unaccountable Government Agency Which Spies on ALL Americans Also Decides Who Gets ASSASSINATED by Drones @ Washington’s Blog The world that is coming…or perhaps is already here.

David Einhorn Explains How Ben Bernanke Is Destroying America @ Zerohedge explaining how the Fed’s policies are not only not helping the economy, they are now actively destroying this country.

The Dark Age of Money @ Counterpunch “Beginning sometime around 1970 the U.S. and most of the ‘free world’ have diverged from traditional “free market capitalism” to something different.  Today the U.S. and much of the world’s economies are operating under what I call Monetary Fascism: a system where financial interests control the State for the advancement of the financial class.  This is markedly different from traditional Fascism: a system where State and industry work together for the advancement of the State.”

TYR 22 October 2012 reads

Lessons In Fiat Reality: “Why I Learned To Trade Less And Love The Farm” @ Zerohedge Hedge fund manager Stephen Diggle argues for farmland as the best risk-adjusted invesment for the next decade. Central bank generated inflation, a slowdown in agricultural productivity, a still growing global population and a global trend towards meat consumption in human diet underpin his thesis. The thesis looks solid.

IMF’s epic plan to conjure away debt and dethrone bankers @ The Telegraph Ambrose Evans-Pritchard comments a controversial and revolutionary paper published by the IMF this last august, in which Jaromir Benes and Michael Kumhof defend that: At the height of the Great Depression a number of leading U.S. economists advanced a proposal for monetary reform that became known as the Chicago Plan. It envisaged the separation of the monetary and credit functions of the banking system, by requiring 100% reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this plan: (1) Much better control of a major source of business cycle fluctuations, sudden increases and contractions of bank credit and of the supply of bank-created money. (2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt. (4) Dramatic reduction of private debt, as money creation no longer requires simultaneous debt creation. We study these claims by embedding a comprehensive and carefully calibrated model of the banking system in a DSGE model of the U.S. economy. We find support for all four of Fisher’s claims. Furthermore, output gains approach 10 percent, and steady state inflation can drop to zero without posing problems for the conduct of monetary policy. Can not get much more controversial than that.

“… the ongoing assurances of central bank liquidity seem to ensure an eventual crisis beyond the liquidity capacity of central banks”

Doug Noland, one of the few financial analysts that foresaw the 2008 crisis before it happened, this week, in his weekly Credit Bubble Bulletin, “celebrates” the 25th anniversary of the October 1987 crash. The complete article here, some excerpts here:

“Portfolio insurance played an important role in the precipitate sell orders that overwhelmed and helped crash the market.”

“The “twin deficits” were a major concern.”… “Our Current Account deficit jumped to $39bn in 1983, $94bn in 1984, $118bn in 1985, and $147bn in 1986.  By 1987, the U.S. was running quarterly Current Account shortfalls the size of its annual deficit from only four years earlier.”

“I’ve often contemplated where I might “officially” pinpoint the beginning of the prolonged U.S. and global Credit Bubble.  … I’ll instead propose October 20, 2012 as the 25 Year Anniversary of the Great Credit Bubble.   It was, after all, 25 years ago, on the Tuesday following “Black Monday,” that a statement changed history:  “The Federal Reserve, consistent with its responsibilities as the Nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.””

“Federal Reserve largess ensured that fledgling areas of excess throughout the system actually gathered critical momentum.  These included the Drexel Burnham junk bond scheme, the Wall Street “Gordon Gekko” M&A boom, and real estate lending excesses, especially on both coasts. ”

“When that Bubble phase eventually burst in the early nineties, eighties period excesses were referred to as “the decade of greed.”  In the name of fighting the scourge of deflation and depression, the Greenspan Fed responded even more aggressively.  The Fed went from guaranteeing marketplace liquidity to ensuring a steep yield curve (short-term rates pegged significantly below market bond yields).”

“Furthermore, the Fed’s activist policies spurred rampant growth in non-bank Credit, including MBS, ABS, GSE balance sheets, “repos” and Wall Street finance more generally.”

“The Greenspan Fed’s 1987 promise of market liquidity was the precursor for today’s zero rates, the Fed’s almost $3 TN balance sheet, and recent promises of “open-ended” quantitative easing (QE).”

“Especially after the ’87 Crash, the Federal Reserve and other regulators should have moved decisively to nip the derivatives boom in the bud, especially in the area of the dynamic hedging of myriad market risks…  Instead of the Crash destroying this market fallacy, the Fed’s day-after statement validated the view that derivative contracts could be written and risk-strategies pursued on the belief that policymakers would be there to counterbalance market illiquidity and neutralize “tail risks” and system shocks.  This fundamentally changed finance, the pricing and trading of risk instruments, and risk-taking more generally.  The unprecedented proliferation of market risk insurance took the world by storm and played a pivotal role in runaway Credit excesses and associated global imbalances and economic distortions.”

“The Fed’s statement on October 20, 1987 commenced 25 years of serial (and escalating) booms and busts around the world.  We’re nowadays in the midst of “melt-up” Credit debasement, a “blow-off” top in global speculative excess, and complete policy capitulation in hope of holding the downside of the global Credit cycle at bay.  For a few years now, I’ve referred to the “global government finance Bubble” as the granddaddy of them all.  What started as excesses at the fringes of U.S. bank and junk bond finance back in the late-eighties eventually made its way to terminally infect Treasury and related debt at the core of our entire monetary system.  Global excesses, having fueled precarious Bubbles in Japan, SE Asia, Europe and the emerging economies over the years, afflicted China with its estimated population of 1.3 billion.   Today’s historic Bubble phase risks the loss of market trust in sovereign debt.  The current global “inflationist” policy regime risks being completely discredited.  And the historic Chinese Bubble risks a precarious post-Bubble day of reckoning. ”

“Unlike the 80’s and 90’s, there’s no longer any attempt at a coordinated strategy to deal with global excesses and imbalances.  Policymakers have thrown in the towel – and these days have no strategy beyond reflation and Bubble perpetuation.  U.S. policymakers pay little more than lip service to incredible federal deficits.  This, however, is actually more than is paid to the massive Current Account Deficits that have been the root cause of now deep structural global imbalances and economic impairment.  More than 25 years later, our nation’s policy prescription for unmatched global imbalances is even looser monetary policy and added stimulus for all nations, everywhere, all-the-time.”

“And the way I see it, the Fed, ECB and global central bankers today fight a losing battle.  The mountain of global debt, securities, and derivatives, along with this destabilizing global pool of speculative finance, just inflate larger by the year – and after each policy response.  And the more outrageous the policy measures implemented to try to resolve each crisis, the more these desperate measures further inflate the global Bubble.  Ironically, the ongoing assurances of central bank liquidity seem to ensure an eventual crisis beyond the liquidity capacity of central banks.  Happy 25th Anniversary..”

Leaning on the Everlasting Arms

Leaning on the Everlasting Arms is a hymn published in 1887 with music by Anthony J. Showalter and lyrics by Showalter and Elisha A. Hoffman. Showalter said that he received letters from two of his former pupils saying that their wives had died. When writing letters of consolation, Showalter was inspired by the phrase in the Book of Deuteronomy 33:27 “The eternal God is thy refuge, and underneath are the everlasting arms”.

It has been used in several movies, including The Human Comedy (1943), The Night of the Hunter (1955), Phase IV (1974), Wild Bill (1995), “Next of Kin” (film)1989, and True Grit (2010).

The version below is from Iris Dement for “True Grit”

What a fellowship, what a joy divine,
Leaning on the everlasting arms;
What a blessedness, what a peace is mine,
Leaning on the everlasting arms.
Leaning, leaning, safe and secure from all alarms;
Leaning, leaning, leaning on the everlasting arms.
O how sweet to walk in this pilgrim way,
Leaning on the everlasting arms;
O how bright the path grows from day to day,
Leaning on the everlasting arms.
What have I to dread, what have I to fear,
Leaning on the everlasting arms;
I have blessed peace with my Lord so near,
Leaning on the everlasting arms.

TYR 15 October 2012 reads

How the neo-liberals perverted Adam Smith @ www.ianfraser.org Mr. Fraser argues that our present brand of capitalism has distorted the ideas of its intellectual founder Adam Smith (AS), whose ideas were cherry-picked  by the likes of Milton Friedman and the ‘Chicago School’ in the 1960s and 1970s and, with the help of political followers such as Ronald Reagan, Margaret Thatcher and their successors, spread their market fundamentalism throughout much of the rest of the world. Sadly however such people focused exclusively on Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations (1776), ignoring his earlier work, The Theory of Moral Sentiments(1759), where AS gives the “invisible hand” a moral context: AS argues that the beginnings of morality are innate, in the sense that our connection to other human beings makes us sensitive to their needs and sentiments. The article could have gone well beyond the denunciation of global crony capitalism and dealt with wider concepts, such as neo-feudalism…and its roots.

Will central banks cancel government debt? by Gavyn Davies @ blogs.ft.com (requires free registration) where Mr. Davies hints at the possibility of western central banks cancelling the huge amounts of government debt sitting in their balance sheets and the inflationary risks involved by that policy. What is most remarkable is that such radical and potentially catastrophic ideas are gaining mainstream status in some academic and government circles. The intellectual underpinnings of these proposals can be found in a, until now, obscure monetary theory: Chartalism. Under Chartalism, government expenditure is financed not by the issue of government bonds to the private market, but by the issue of currency. Scary.