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Bastiat's Paradox, Broken Windows, Deficit Spending And War

Economics / Economic Theory Mar 05, 2014 - 02:40 PM GMT

By: Andrew_McKillop

Economics

Frederic Bastiat's early 19th century paradox is easy to recycle today. If the West, we mean a certain small number of gung-ho steroid-fed European politicians and their lookalikes in the USA, decided to borrow and spend what it takes to “call a war” with Putin's Russia to defend the Crimea against the violation of Ukraine's territorial integrity, would the net economic result be win-win or lose-lose?


Bastiat used the rhetorical question: “What would become of the glaziers if panes of glass were never broken?". If they weren't broken, the business of glaziers would be impaired, even destroyed, and mucho Keynesian money printing would be needed to make up for the lost turnover, activity and jobs (and bolster the stock price of glaziers). Keynesians including John Maynard Keynes himself, referred to the “Bastiat paradox” in the 1930s, about 80 years ago..

 What would happen to the Ukraine if nobody outside the country thought it was worth a war? Especially a nuclear war – which Russia has no problem at all delivering, when or if its bluff was called. Without a war, the glass panes would not be broken. Inside what is left of the Ukraine, the local players could get down to gung-ho local fighting, after a few more Flash Mob get-togethers in public places. Or they could do other things. Nobody outside Ukraine would care less, but for Keynesians this would have been a lost-golden opportunity.

Neo Keynesian Paradoxes

Bastiat asked how we'd react if it was discovered that the local glazier hired a little boy to break windows and paid him 1 French Franc (of 1810 value) for every window he broke. Despite any talk about organized crime, the glazier benefits first, relative to other businesses like the baker, the tailor, the candlestick maker. And of course the weapons makers, who weren't included in Bastiat's paradigm but they would get more turnover if it was decided that Ukraine was “the red line in the sand” as a certain American politician has been gurgling. If this war really wasn't worth the candle, the fighters' uniforms and the bread to keep them fed in the trenches would not be needed.

Bastiat argued that “at the end of the day” society endorses activities which are morally equivalent to the glazier hiring a boy to break windows for him. Money printing and deficit spending, for wars or anything else are an excellent-bad example.

His paradox and linked theory was that the “the stock of wealth” in a society depends, also, on how much is destroyed and why it is destroyed. An exact modern civil and peacetime equivalent is “Cash for Clunkers”. Under this barbarous scheme, Consumer Citizens are incited to arise from their couched-potato sofas, trade-in their often perfectly serviceable car to have it smashed, and buy a subsidized diesel-fulled sedan car. In many countries “concerned about energy and climate” they also get subsidized diesel fuel sold cheaper than gasoline knowing full well (Couched Potatoes can learn this) that diesel fumes are cancerous. Either breathed or ingested, according to the UN WHO's Cancer Research Institute in a July 2012 report, diesel-related cancers cause about 250 000 deaths in Europe. Every year. The business of morticians is therefore also aided.

Never mind! The cancers due to sniffing and swallowing diesel fumes also create an excellent business opportunity for oncologists and the world's pharmaceuticals corporations “fighting to mitigate cancer” with high-priced drug therapy, the same way diesel car makers (at least in Europe) tell us they are “fighting.climate change” with their cancerous products. Monsanto and its lookalikes do the same with Miracle Agriculture toxic chemicals in so-called “modern farming”. You are what you eat. You are what you breathe.

Bastiat is sometimes called an Austrian-type economist, because he was arguing that Keynesian-type “anti-thrift” demand creation is artificial – and immoral. By the time of Keynes, his circle of admirers could sputter the question “How can we be so stupid as to let people succumb to the idea of thrift, especially during economic downturns when so many will become unemployed?”. One person's destruction is another person's job and wealth, therefore by increasing the destruction – we increase the wealth. Could anything be clearer?

Unused Money is Nothing

John Law returned to a devastated Scotland in 1705 from long work-and-pleasure sejours in Paris and Amsterdam mingling his tastes for fine wines, women, gambling and business projects – creating credit “due to an insufficiency of money in circulation”. Scotland had suffered what historian John Prebble says was probably Scotland's worst-ever disaster, the Darien project in Panama mingling colonization with trading and of course gold mining, rapidly ending up with nothing. In 1705 money value, Scottish investors lost at least 400 000 pounds according to Prebble. The same year, Law published “Money  and Trade Considered with a Proposal for Supplying the Nation with Money”. Basically he argued that when there is not enough money in circulation, for any reason, credit notes can and should appear and these will be used to pay for products and services. So a country short of money or with fast-growing debt like Scotland, only has a few options. One remedy is to mine more gold or silver and mint more coins, but if the nation has no such mines, like Scotland, credit notes are the best solution. Law wrote that when more money is required you don't need a gold mine, you need a bank, brokers and traders.

Scottish lawmakers were wary about Law's proposals, for reasons including an already-impressive spate of bank failures, especially of Amsterdam-based banks and credit houses. The lawmakers then took the real default solution of voting the Union with England in 1707, which as I note in another article, was basically an International Debtors Union.

Law moved back to Paris and got lucky – firstly in gambling, then with women, and then spectacularly with creating credit, but he first needed a trip to Italy. In Turin, Law's ideas came to the notice of Duke Victor Amadeus of Savoy, who was so impressed that he tried to get his circle of conservative Savoyard bankers to adopt it, but they were adamantly opposed to Law's stock exchange-based credit creation plan. Amadeus of Savoy recommended Law to his brother-in-law, Philippe II, the Duc d’Orleans, who had recently become Regent of France acting for the new but underaged King Louis XV. Law set off for Paris with a duke's recommendation in his pocket. This was his big chance.

France of the time, like today, was mired in state debt (the state being the royal family and its circle of courtisan freespenders), but Law promised Philippe II “I will devise a scheme that will astonish Europe by the advance it will make in France’s favour, alterations more radical than those procured by the discovery of the Indies”. He added  “Or those procured by the introduction of credit”.

By 1716 Law was given the right to found a bank in Paris, the first-ever to print and circulate paper money. His not-so-modestly named Banque Royale was a wildfire success. Law had succeeded in creating money out of nothing, charming the Duc d'Orleans and the King's Court – and its creditors – with banknotes used to pay off government debt. This had an initial galvanising effect on French society because people now had more money, and spent it. The miracle seemed real. France quickly began to rouse itself from its pastoral slumbers, more manufactured good were produced, and Law's new banknotes proved so popular that people began bringing coins to the Banque Royale and demanding notes in exchange. Law was forced to print more. His credit notes became the preferred way to pay taxes, Law's printing presses went into overdrive.

As we know, Law then founded the Mississippi Company on the belief, or rather hope that what was then called “Louisiana”, named for King Louis and extending north as far as the Great Lakes, was simply stuffed with gold – not alligator infested swamps and unfriendly Indians. In “Lousiana” his Company prospectus said (not hinted) there was as much gold as the Scottish, ten years earlier had thought might be found in Darien. Printing and selling shares in the Mississippi Company directly led to a frenzied speculative bubble on the recently-founded Paris stock exchange. The Banque Royale for a short while roughly doubled the entire stock of money circulating in France, every year, and prices for everything from food and soap to diamonds unsurprisingly increased at around 75 percent-per-year.

By Spring 1720 a now rattled and nervous John Law recommended to Philippe that a flat devaluation of at least 50 percent for his fiat money banknotes and Mississippi Company shares was urgently needed, with the banknote devaluation staggered, to protect or limit the inevitable loss of confidence in the funny-money. In fact mass psychology took over. Both banknotes and shares were dumped, as inflation skyrocketed. This was the first modern stock exchange collapse. Law's friends and admirers soon turned hostile and he was now a hunted man, forced to literally run for his life – but he was given a hero's welcome when he visited the UK because he was “The Scotsman who bankrupted France”.

Alternate Solutions

Some historians argue that France was so comprehensively ruined by the Law Crash it at least temporarily lost the will to make war, but at least since the time of Keynes, following World War I, war spending is imagined (although not often openly) to be a “feasible alternative” to civil-type deficit spending. In March 2013 however, the US Watson Institute for International Studies released its estimates for the combined costs, to end-2012, of the Afghanistan and Iraq wars. After calculating that between 158 000 and 202 000 persons had been killed in these two wars, and “spillover deaths” in Pakistan, the institute’s estimate of the total cost of the two wars came to just under $4 trillion. Back in 2002 however,  the administration of President George W. Bush heard from Lawrence B. Lindsey, then Chairman of the President’s Council of Economic Advisers, that a new Iraq war would cost $100 billion, maybe $200 billion at a maximum.

The White House saw that estimate as “shockingly high”. The President quickly dismissed Lindsey and many observers saw his war cost estimate as a major reason. Later that year, Mitchel E. Daniels Jr., then head of the Office of Management and Budget, told the 'New York Times' that $50 to $60 billion would be a “more realistic figure”, that is the same or less than the cost of the 1991 Gulf War.

Much of the 2013 estimated total costs for both wars was in fact not directly military. Huge amounts were needed for war veterans, and vastly more than that spending, on the mushrooming costs of Homeland Security. Interest payments on war debt to end-2012 were calculated by the Watson Institute as about $254 billion, and it also estimated that combined war spending and war debt, for these two wars, represented about 20% of total US Federal debt. The opportunity cost of these wars can be figured any way that is wanted, as alternate spending on butchers, bakers, candlestick makers – or even glaziers - but the logical conclusion of Bastiat's paradox, like John Law's French banking and finance scam is starkly proven by the USA's “military adventures” since 2001.

Modern wars cost more and more, and their benefits are increasingly small or imaginary – like the value of a John Law banknote or a share in the Mississippi Company that he launched. Avoiding wars is therefore a modern application of Bastiat's paradigm where, sooner or later, the boy paid to break windows decides to “industrialize” his activity. Small time organized crime becomes big time, even an affair of the state, quickly bringing in new and determined associates – and rivals.

When that stage is reached it is already too late, making the implosion of fiat money and paper value a sure and certain result. To be sure, scapegoats like John Law will be vilified (instead of treated like heroes), war criminals will be identified and pursued, even rogue glaziers can be sanctioned but in overall terms society will have suffered a setback. Fake prosperity is for criminals and the stupid.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2014 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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