Today I am going to deviate from my established pattern of pointing out the errors made on the conservative side of the aisle to get back to the original inspiration of this series, absurd statements by liberal thinkers. And so, rather than dither about with lesser lights, I am going to post a good companion to my quotes from John Maynard Keynes ("Stupid Quote of the Day (January 7, 2012)", "Stupid Quote of the Day (January 9, 2012 - Delayed)"), a set of quotes from the grandfather of the modern welfare state (assuming LBJ was its father), the man himself, FDR.

We shall start with a general quote, but one so patently false, you have to admire the brazen soul that could actually say it with a straight face:

It was this administration which saved the system of private profit and free enterprise after it had been dragged to the brink of ruin.

And,  to give us something that might allow for a bit more detailed commentary, let us follow that with this interesting theory on the economy, one, I shudder to admit, that has been followed by every subsequent presidency, and is now so enshrined in policy that I fear even some conservatives believe it makes sense:

If all employers in each competitive group agree to pay their workers the same wages... and require the same hours... then higher wages and shorter hours will hurt no employer. Moreover, such action is better for the employer than unemployment and low wages, because it makes more buyers for his product.

So, where to begin?

I suppose we should begin at the beginning, and point out that FDR, far from saving capitalism, actually did quite a bit of damage. But, even that is of secondary importance compared to pointing out that the crisis which he confronted was itself not a product of the free market, but of prior intervention, problems which time alone would have cured, had the government not chosen to prolong them under the guise of trying to solve them¹.

I know, I learned all the common stories in school just like everyone else. The Depression was just the worst example of the boom-bust cycle inherent in capitalism, the excesses and overspending and recklessness of the roaring 20's led to the collapse and the depression, and FDR put us back to work and solved the crisis. It is all nice and tidy, and it matches well with FDR's claim in our first quote. The only problem is, it is absolutely wrong.

Let us begin at the beginning. The "boom-bust cycle" is no part of capitalism. There is no inherent cyclical pattern of growth and recession. One need only look at the pattern from 1836, when the Second bank of the US died, until about 1880 or so, when the more intrusive measures of the "state banking system", predecessor of the Federal reserve, were put in place, and you can see there was not a hint of any such cycle. Or look at Scotland from the 1700's or so, until the Bank of England was forced upon that nation, creating fiat currency, fractional reserve and central banking. In both cases, there was not a hint of boom and bust cycles in a mostly free market. And a market, most importantly, dominated by free, independent, and competing banks².

The boom-bust cycle was born as the government centralized banks, allowing it to pile paper currency on top of a very small reserve of gold. Originally, each bank would issue, say, three times as much paper as they had reserves. However, the government created a multi-tier system, where local banks had to have reserves on deposit in regional banks, but could use regional bank notes as reserves, the same as gold, and then the regionals had to have money in the central New York banks, with the same deal. So, in short, a small amount of gold in the central bank could support ten times as much paper, or more.

But more damaging was the way this system made inflation uniform. In a private banking system, each bank decided how much paper to issue and when. So money supplies went up and down in small increments, and randomly, and banks had differing reserve ratios, some more stable some less. The central system allowed a single central bank's plan to inflate to then be passed up the pyramid, making all banks inflate. And thus began the boom-bust cycle, with inflation spurring growth, until eventually the rate of growth grew too great, and interest rates caused a collapse, or, especially in the early days, loss of confidence resulted in bank runs and brought the system down. A private, decentralized system could not support such a cycle, but this central system made it inevitable³.

The boom-bust cycle caused by the federally imposed "state banking system" was then used as an excuse to create the even more centralized Federal Reserve system, which then brought about the Great Depression, which, interestingly enough, was blamed on the free market⁴. And, even more interesting, the failure of this increased intervention, justified by the failure of earlier intervention, was used as an excuse for still more government, all while blaming the free market. And, even more amusingly, while claiming to save the free market from its own shortcomings.

But I have been through all this many times, and many links can be found in the notes and postscript for those interested in the details of inflation and intervention. So, let us leave aside FDR's most absurd and unsupportable claim and move to the more technical quote, as debunking it will help dispose of two related follies, the minimum wage and government job creation, as well as related foolishness such as "living wage" policies and the like.

The first problem with the entire quote is the assumption that employers simply "set" wages, that they decide what to pay arbitrarily, and that they can adjust the salaries they offer at a whim.  In addition, it errs by treating every firm as if it were a sole proprietorship, where arbitrarily setting or changing wages can be done at the discretion of the employer, without thought of obligation to stockholders, bondholders or creditors who expect the company to earn a competitive rate of profit. Of course, these pale in comparison to the larger errors, such as the failure to understand how the market sets wages, the failure to understand Say's Law and the simple ignorance of how the market works in general.

So, with so many errors to examine, I suppose we should get started.

I have discussed it many times⁵, but let us start at the beginning. Employers want to make a profit, and so in general would pay as little as possible, and do pay as little as they can. However, there is another force at work. Other employers are also looking for a profit making opportunity, as well as those not presently employing anyone, but who would open a firm if they saw an opportunity, and investors who would back them. Thus, if an employer tries to pay too little⁶, a competitor, or potential competitor, would see the opportunity and hire those workers away from the first employer, by offering a small raise, and make a profit by pocketing the difference between the higher wage and their productivity. Of course, if they paid too little as well, trying to make too much profit, then they would be out bid by another competitor, and so on and so on, until employee wages come to rest at the market level, most often just slightly less than the amount of value a given worker produces⁷.

This is important for the quote above, as it also works in reverse. If all existing employers took FDR's plea to heart, and raised wages 50% and cut hours 50%, effectively giving their employees a 200% raise, there would be several consequences. First, there would be a tremendous decline in profits. And it would be directly proportional to the amount of labor used. Labor intensive industries would be bankrupted, less labor intensive would suffer tremendous losses, and jobs employing few workers would suffer minor losses. Of course, in all cases, the firms would begin to see overseas competition edge into the market, as even with transportation costs, and likely less productive foreign labor, such an increase in wages would result in overseas production becoming much more attractive⁸.

But we do not need to consider overseas competitors, as there is an even more immediate fix. Even if every existing employer colluded to raise wages, that would not bind newcomers. Seeing wages so horribly elevated, it would be easy for a competitor to break into the market, paying a reasonable wage, and making tremendous profit. Of course, he could not steal labor from the employers overpaying employees, but as I said, many of those would go bankrupt, so even if there was little free labor at the moment, soon labor would be available in considerable quantities, allowing the newcomers to earn a reasonable profit, while undercutting the others and taking over a huge market share. Only by closing out competition, as is done today with minimum wage, could this be prevented⁹.

The only way to make FDR's scheme work would be to not only raise wages, but to also raise all prices the same percentage, effectively to inflate everything. But, if that were done, there would be no difference. If everything that was $1 was now $2, it would be as if nothing changed. Yet that is the only way to make such a policy work.

This explanation should make clear why FDR's claim his plan would produce new consumers is imply absurd, but there is another logical problem with his proposition. Raising wages does not create new goods. If a man makes 100 shoes a day, and is paid $10, or if he makes 100 shoes a day and is paid $20, there are still only 100 shoes in the economy. As Lord Say argued, goods exchange against good. he can only buy what his 100 shoes will support. If he is paid more, then other prices will rise. So even if this policy did not result in economic collapse, the most likely outcome would be a tremendous rise in consumer prices, which would make the "new consumers" argument pointless, as they could buy only as much as the old consumers.

I could probably go on about this for days, as it such Keynesian nonsense, embodying so many of the fallacies of interventionist beliefs that it begs a rebuttal in detail. But I doubt anyone wants to sit through such a lengthy piece. At least not anyone reading my "Stupid Quote" series. Perhaps later I will return to this concept and discuss it again. But for now, I think I have shown quite well why these particular quotes are wrong, and why it is a good idea to take claims about FDR fixing the economy with a grain of salt.

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1. It is not precisely on point for this essay, but I do want to dispel one more myth, often offered by FDR's critics, the theory that FDR did not end the depression, World War II did. In fact, war does nothing to improve the economy, and thus there is no way World War II fixed anything. To be completely accurate, some of the effects of World War II may have prevented FDR from making things worse, and the distraction of the war prevented him from following up on his dangerous intervention, and so indirectly solved the problem by allowing the market to fix itself, but the war in itself did not end the depression. See  "War Stimulates the Economy? Let's Nuke San Francisco!".

2. The US government actually began to regulate banks even before the Civil War, and so there was some pressure toward this cycle, and we can see a minor cycle developing in the 1870's and 1880's. In addition, thanks to the introduction of the inflationary "greenbacks" during the Civil War, there was some nationwide monetary meddling, but it was eliminated shortly after the war, when Grant retired the last greenbacks, returning the nation to a mostly private gold standard. (Though early "free silver" agitation did threaten inflationary pressures to come, which had a bit of impact as well. Sadly, it is hard to find a truly free economy in US history, every period I choose as an example needs a half page of qualifiers.)

3. It is remotely possible a private banking system could cause a short-term boom-bust cycle in two ways. If all banks inflated at the same time, they could induce a boom-bust cycle, but it is doubtful they would continue to do so for any length of time. In addition, if a single bank were large enough to dominate a region, it could cause a single boom-bust cycle on its own, but the resultant collapse would likely liquidate that bank, causing competitors to dominate the market. (See "The Inflation Engine", "Derivatives and Other Investments", "Inflation and Uncertainty", "Living Large During the Good Times", "Those Greedy Bankers" and "Explaining Past Crashes".)

4. See "How To Blame the Free Market", "The Endless Cycle of Intervention", "Perverting Self Interest ", "Slieght of Hand", "Recipe For Disaster" and "Government Quackery".

4. See "Exploited Labor", "Capital Investment",  "Fairness and the Free Market","The Harm of Closed Shops and Collective Bargaining", "Pro-Labor Cannibalism, A Look At The Union Food Chain" and "Why Do They Earn So Much For Playing a Game? ".

6. Recall wages are not just money, but also benefits, taxes contributed by the employer (such as matching social security contributions) and other non-monetary payments, such as leave time, training and anything else paid per employee.

7. The productivity of the worker is dependent on capital investment, and also varies by tasks. So, for example, a skilled shoe maker might be much less productive if hired by a mine, and so his wage would be much lower. In addition, a firm with a large capital investment in machinery will see higher productivity from workers (provided they can operate the machinery) and so can pay more. All of this needs to be kept in mind when discussing productivity and wages, as too much discussion treats all employees as unskilled labor operating without any capital investment.

8. This is the reason so many interventionist governments were involve din extensive protectionist legislation. Without cutting off foreign competition, it is simply impossible to enact laws that ignore economic laws. The laws still have destructive effects, but with the foreign markets excluded it takes longer for the ill effects to become obvious. ( "Smaller Government , Fair Weather Friends and Special Cases", "Cheap Lighters, Overseas Dumping and Monopolies", "Jobs, Jobs, Jobs, and More Jobs", "Protectionism", "Protectionism Right and Left", "Fear of Trade",  "The Inevitable Corruption of Protectionism", "Simple Evidence")

9. The minimum wage illustrates my point well. Why is so much low-profit farm work done by illegals? Because it is not profitable if minimum wage is paid. Actually, it is also why illegals have spread to so many other jobs, they simply cannot be done at minimum wage. (Especially as illegals also do not require the other benefits, taxes and so on legal workers must have paid by law.) This is not the only reason for the spread of illegals, but the minimum wage has created many ills. See "A New Look At Intervention", "Exploiting Workers?", "Fairness and the Free Market", "Capital Investment", "Exploited Labor", "What Is Fair? or, How Game Theory Leads Us Astray, "Pay Disparities", "When Help Hurts", "How Democrats Keep the Poor Poor" and "Hope You Like Unpaid Internships".

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POSTSCRIPT

For some very simple discussion of inflation and monetary policy in general I suggest reading "Monetary Issues Made Simple Part I", "Monetary Issues Made Simple Part II ", "Inflation and Uncertainty", "Bad Economics Part 7", "Bad Economics Part 8", "What Is Money? ", "What Is A Dollar?" and "The Gold Question, Not "Why?" But "When?"".