An Interview with Steven G. Horwitz
Free Market Mojo is proud to present an interview with Professor Steven G. Horwitz, the Charles A. Dana Professor of Economics at St. Lawrence University in Canton, NY.
Professor Horwitz is the author of two books, Microfoundations and Macroeconomics: An Austrian Perspective (Routledge, 2000) and Monetary Evolution, Free Banking, and Economic Order (Westview, 1992), and he has written extensively on Austrian economics, Hayekian political economy, monetary theory and history, and the economics and social theory of gender and the family. His work has been published in professional journals such as History of Political Economy, Southern Economic Journal, and The Cambridge Journal of Economics. He has also done public policy research for the Mercatus Center, Heartland Institute, Citizens for a Sound Economy, and the Cato Institute. His current project is a book tentatively titled Classical Liberalism and the Evolution of the Modern Family. Horwitz currently serves as the book review editor of The Review of Austrian Economics and as an academic advisor for the Heartland Institute and a contributing editor to Critical Review and Journal des Economistes et des Etudes Humaines.
He has been a visiting scholar at the Social Philosophy and Policy Center at Bowling Green State University and an Affiliated Senior Scholar of the Mercatus Center at George Mason University. He is a past recipient of three fellowship research grants from the Earhart Foundation and an F. Leroy Hill summer fellowship from the Institute for Humane Studies. From 1993 to 1998, he held the Flora Irene Eggleston Faculty Chair at St. Lawrence University, where he also was awarded the Frank P. Piskor Lectureship for 1998-99 and the J. Calvin Keene Award in 2003. From 2001 to 2007, he served as the Associate Dean of the First Year.
Horwitz has spoken to professional, student, policymaker, and general audiences throughout the US and Canada. A member of the Mont Pelerin Society, he completed his MA and PhD in economics at George Mason University and received his A.B. in economics and philosophy from The University of Michigan. Professor Horwitz also blogs for the The Austrian Economists.
As with our other interviews, the author’s views are his own and are not necessarily endorsed by either author of Free Market Mojo.
FMM: A particularly interesting statement from your presentation “The ‘Great Recession’” is
“Those who wish to blame greed for the crisis need to explain how and why it is that greed seems to causes crises only at specific times, despite the fact that it is omnipresent as a feature of human nature and market economies. … I would argue that the key is the set of institutions through which greed or self-interest is channeled.”
Can you discuss the nature of “greed,” how it is channeled, and how it can be used to benefit society?
SH: It’s over-simplifying a bit, but there’s two general ways to imagine improving the world: changing people or taking people as given and changing institutions. We know that changing people doesn’t work and leads to lots of ugliness. There are lots of reasons to think people will be what they are – generally self-regarding, especially when dealing with strangers where we can’t know what would directly help others. Given that, we’d like to have institutional arrangements that make it so that satisfying our self-interest forces us to simultaneously, if unintentionally, serve others. Markets do that.
Private property, the rule of law, exchange, markets, etc. all make it so that if we wish to improve our own standard of living, we have to do so by producing value for others in the market. That’s the idea of “institutions channeling self-interest.” The right institutions, e.g., the market, make it so that pursuing our self-interest is socially beneficial. The wrong ones, such as politics, undermine this. First, when politicians seek their self-interest, there is no process to ensure that it will benefit others. In fact, if anything, it’s the opposite: it harms others. Second, the interventions in the market that politicians create often cause the pursuit of self-interest there to be harmful. The Great Recession is an example of exactly that: various regulations and the actions of the Fed made the private sector’s pursuit of self-interest to be harmful. Thus it’s not self-interest per se that’s good or bad, but the institutional context in which it operates that is to be praised or blamed.
FMM: Many economists blame the Federal Reserve, in large part, for the Great Depression. You name the Fed as a culprit in the current recession. Are these simply cases of bad policy decisions, or is the Federal Reserve, as an institution, flawed?
SH: It is flawed through and through as an institution. As noted above, politicized institutions often lack the right incentives to align self-interest and social benefit. The Fed, like all central banks, faces a major incentive to err on the side of inflation, as it did in the boom that led to the current bust. Inflation benefits the inflator – namely the governments that control or run central banks. It benefits them by reducing the real value of their debt and by giving them a way to incur more debt by simply paying for it with dollars they create. Political self-interest leads to economic chaos.
In addition, central banks face the same sort of knowledge problem that all forms of government control do. How do central banks know in the absence of true market signals how much money to produce? Even if we could overcome the incentive problem noted above, the Fed would still be fairly blind to getting the money supply right. Together, the incentive and knowledge problems can’t be overcome by smarter economists running the Fed or by more data. These are structural problems in the institution itself.
FMM: If the Federal Reserve is flawed, can it be fixed or should it be replaced by an entirely new monetary system?
FMM: How would your ideal monetary system function?
FMM: What are your thoughts on a Hayekian system of competing currencies, issued by private firms and subject to the laws of supply and demand?
FMM: Is it possible and practical to return to a pure gold standard?
SH: I’ll tackle these four together. I think the Fed cannot be “fixed.” Ideally, I would like to see us move to a completely privatized monetary system. Such a system, as best outlined in the work of Lawrence H. White and George Selgin would involve banks competing to offer both checking accounts and hand-to-hand currency to the public for its use. Importantly, both would be redeemable in some commodity that had value outside the banking system. This might work best with gold as that commodity, but there have been other possible systems proposed. My own view is that gold is the way to go.
But notice a few important things: 1) This is not a “pure” gold standard, if by that one means a 100% reserve system along the lines proposed by Murray Rothbard and others. Banks in this “free banking” system would operate on fractional reserves, just as banks have for pretty much the history of banking. Fractional reserve banking is only a problem when you have a central bank or other government regulations that prevent the competitive market process from working effectively. When banks truly compete, fractional reserves are not a problem. This sort of system is not inflationary (or deflationary) and will not trigger business cycles.
2) A 100% gold reserve system would have problems of its own. On my view, it is unethical from a libertarian perspective as it prohibits banks and their customers from making certain kinds of voluntary contracts, namely those that involve fractional reserves. It also would hinder economic growth severely. Under fractional reserves, it is much easier for the financial system to intermediate more savings and investment without fraud than it is under 100% reserves. In a 100% reserve system, less capital would get created and growth would be much lower. Such a system is also prone to the problematic form of deflation when faced with a rising demand for money. I don’t have the space to develop this argument here, but interested folks can read my 2000 book for more.
3) A White-Selgin type free banking system would be different from Hayek’s proposal. His version had no redemption commodity (or “outside money”). It was a proposal for competing fiat monies. Without an outside money, there’s no assurance at all that inflation will be kept in check. Hayek thought reputation would do it, but many other folks don’t think that’s sufficient and that only some outside money like gold can “anchor” the system.
FMM: If the U.S. transitioned from the current Fed-controlled monetary system to a new, more laissez-faire system (be it the gold standard, competing currencies, or any other system), by what process could such a transition successfully occur?
SH: There would be two possible ways that I can see. One is the evolutionary path. As it stands, more and more of the money people use every day is privately produced as debit cards replace currency and as checking account dollars comprise about 80% of the total money supply. Paper currency is fading. So that’s getting us there slowly. The harder part is getting the Fed out of the business of creating reserves. Technology might make private alternatives more feasible than in the past.
The more revolutionary process is further growth in the Fed transparency movement and other rumblings about the Fed. I think for this to work it needs to cross ideological boundaries. I’ve written some things about the way in which central banks make it easier for nations to engage in militarism and imperialism, and how they are undemocratic. My hope is to engage the left on these issues in a more serious way. Getting a broad coalition that sees central banks as destroyers of economies and funders of imperialism might embolden more politicians to take a serious look at the Fed.
FMM: Returning to “The Great Recession,” it is interesting that you, essentially, charge the SEC with creating adverse information problems in securities markets.
“In the late 1960s, after some investment scandals, the SEC created a cartel by authorizing only a limited number of these agencies to be officially-designated raters. With that government-created cartel in place, the agencies slowly shifted from serving investors to serving the issuers of bonds.”
Can you elaborate on the nature of the SEC-created cartel and in what ways it is serving the issuers of bonds rather than the investors?
SH: The SEC authorized those agencies to have privileged status in the wake of some financial problems in the late 60s and early 70s. The thinking, I guess, was to more closely oversee the officially approved firms. The SEC then said that banks could only hold fancy securities rated by one of these three agencies. Once that happened, the big shift occurs. Before that, the agencies served the buyers by, like Consumer Reports, giving them information and ratings about the instruments. But once their approval was needed in order for the securities to be marketed, the sellers started going to them to get the ratings they wanted. The raters then had an incentive to provide good ratings so as to not lose the business to their other two co-cartelists. They also then had reason to eliminate the costs of inter-firm competition by coming to more agreement on how to do things. The results, as you can see, were not pretty.
In the absence of free entry into this market, there was no way to correct the mistakes of the cartelists. There was no Hayekian learning process in place.
FMM: A phrase currently en vogue among politicians attempting to expand government power is “systemic risk.” Does such risk exist? If so, where does it occur and what (if anything) should be done to protect against it?
SH: It exists, but it’s largely created by government! The biggest systemic risk is when government policies cause firms to be tied together in ways that are problematic. The implicit guarantees to Fannie and Freddie created huge systemic risk that markets never would. Same with “too big to fail” in general, as well as Greenspan’s promise that the Fed would clean up the results of any asset bubble. Those policies created risks that run through the whole system.
FMM: Do you vote?
SH: I don’t. Although my objections to voting decrease the more local the election is and are less if the issue is a referendum rather than a candidate election. Most of the time, voting for a candidate is about as effective as rearranging the deck chairs on the Titanic. The problems are institutional, structural, and intellectual. Voting does little, especially when the two major US parties have much more in common than differences.
FMM: Over the past several months, there have been various reports of potential moves by other nations to replace the U.S. Dollar as the “world’s currency.” What is the likelihood of such a move occurring? If it did occur, what would be the consequences for the U.S. economy?
SH: I’m not enough of an international trade person to say much here. I’d say the likelihood is increasing and will really increase if inflation in the US spikes in the way I would expect it to given all the bank reserves the Fed has created in the last year or so. I’d still put it at less than 50%, but it’s not tiny. The consequences would be a fall in the value of the dollar which would throw import and export markets into a tizzy, and damage growth in the process.
FMM: The end of the Great Depression is often credited to either The New Deal or World War II (sometimes both), do either of these events deserve such credit? If not, what were the actual causes of the end of the depression?
SH: Neither one does. The most recent research on the New Deal indicates that it actually prolonged the Great Depression by interfering with the market processes that were trying to generate recovery and by scaring private investors away from the market through inconsistencies in policy and ongoing threats to private property from the various programs and talk of socialism etc..
The war didn’t solve things either, at least not in terms of the private economy. Sure unemployment fell, but that will happen when you draft a few million young men! And GDP rose, but, again, making stuff just to blow it up adds to GDP without improving the real standard of living of the citizenry. Recent studies have shown that private investment continued to languish during the war and that average consumption levels of US households were also stagnant. Remember too that all of the macroeconomic data from that period is distorted thanks to the various price and wage controls in place.
What got us out was the ending of the war. That not only removed a whole bunch of wartime controls that interfered with the market, but also brought President Truman to power over a peacetime economy where he was much less hostile to markets than FDR. Those things together, along with the return of lots of productive male labor, was able to generate real private growth by 1947 or so.
FMM: Do you believe an economic recovery is already underway or approaching? What steps are needed to bring about a recovery and a subsequent period of growth?
SH: I think we are beginning to see a few signs of a very slow recovery. However, the recent GDP report way overstates it because most of that change in GDP was due increases in G, which is not about recovery at all. Real recovery is when private investment comes back. The data there are not so reassuring in that it has been very low for several quarters. This may reflect a Great Depression-like hesitance to invest given the uncertainty around policy, especially health care. Unemployment continues to be bad, but it’s almost always a lagging indicator during recoveries. It’s worth noting that unemployment right now is over a percentage point higher than the Obama Administration said it would be without a stimulus package. Many of us said the stimulus would make things worse, and it appears we were right.
What steps are needed? Stop taking steps! Repeal the rest of the stimulus already passed but not spent and don’t pass another one. Vote down the various health care reform proposals. Stop bashing the private sector for being responsible for the crisis. Stop talking about capping executive pay. Sell off the government’s shares in banks and the auto companies. Bottom line: get out of the way and let the market heal itself. It was government intervention that got us in this mess in the first place and history suggests more of that will not solve the problem.
You don’t cure a hangover by starting to down the very drinks that caused it.
We would like to thank Professor Horwitz for his time and wish him well in his future academic pursuits.
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5 comments
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Good to see this interview, well done.
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