I admit to being at a complete loss as to what Rudd means by "free market fundamentalism" as he disdains to take the trouble of explaining his terms. Is an economist preaching "fundamentalism" when he expresses belief in the laws of supply and demand? Is he adhering to "fundamentalism" when he warns that minimum price controls create surpluses and that minimum price controls create shortages? Is it a case of "fundamentalism" if an economist argues that flooding a country with money is inflationary? Let us take it further. Are mathematicians practising "fundamentalism" when they insist that 2+2=4? Can the same be said of a physicist who teaches basic science?

"Free market fundamentalism" is a cheap rhetorical term designed to prejudice readers against free market economics. The same goes for "extreme capitalism" and "excessive greed". The former term is no more meaningful than "free market fundamentalism". As for "excessive greed", I know of no economist whoever argued in favour of greed, "excessive" or otherwise. If Mr Rudd knows of any I strongly suggest he name them.

According to Rudd the aforementioned vices are responsible for the global financial crisis, a crisis that calls

into question the prevailing neo-liberal economic orthodoxy of the past 30 years — the orthodoxy that has underpinned the national global regulatory frameworks that have so spectacularly failed to prevent the economic mayhem which has now been visited upon us.

So what is this dreaded "neo-liberal economic orthodoxy"? It is not until we are about a third of the way through his essay that we discover the minds behind this destructive "ideology" belong to none other than Ludwig von Mises and Friedrich von Hayek. He accuses Hayek of treating the market as a "game" "specifically a game of 'catallaxy'". Thereby dishonestly giving the impression that like all games it is one of winners and losers. What Hayek actually said is that the market process is

a wealth-creating game (and not what game theory calls a zero-sum game), that is, one that leads to an increase of the stream of goods and of the prospects of all participants to satisfy their needs, but which retains the character of a game in the sense in which the term is defined by the Oxford English Dictionary: "a contest played according to rules and decided by superior skill, strength or good fortune". Above all, it is a game which serves to elicit from each player the highest worthwhile contribution to the common pool from which each will win an uncertain share. (Friedrich von Hayek, Social Justice, Socialism & Democracy, Centre for Independent Studies, 1979, p.7).

He was making it abundantly clear that market itself is not a game, it is a process that left free from the hands of meddling politicians will raise society's living standards. That Rudd does not agree with this does not give him the right to distort Hayek's opinions. Hayek went on to emphasise:

It has of course to be admitted that the manner in which the benefits and burdens are apportioned by the market mechanism would in many instances have to be regarded as very unjust if it were the result of a deliberate allocation to particular people. But this is not the case.

What Hayek was endeavouring to explain is that the pattern of incomes and wealth in a free economy are not the result of arbitrary decisions taken at the expense of others. Bill Gates, for example, is not rich because he cheated, stole or used goons to exploit consumers: he is rich because he produced a commodity that satisfied consumer wants. Rudd would have the reader think that Hayek believed the functions of the state should be kept entirely to defense and the enforcement of contracts. I can only assume that Rudd has never actually read Hayek. In the Constitution of Liberty (First Gateway edition, 1972) Hayek favoured military conscription (p. 143), compulsory pension schemes (p. 286) and unemployment insurance (p. 301). (Readers should also take note of Hayek's prescient views on how a 'free health' system would eventually develop).

Rudd deliberately tried to mischaracterise Hayek's views on how the market actually operates by introducing the term "catallaxy". This term was first introduced into economic literature by Bishop Whately because he strongly disagreed with the name political economy on linguistic grounds, arguing that "it almost implies a contradiction".

The name I should have preferred as the most descriptive, and on the whole least objectionable, is that of CATALLACTICS, or the "Science of Exchanges" (capitals and italics in the original). (Archbishop Whately, Introductory Lectures on Political Economy, B. Fellowes, Ludgate St., 1832, p. 6).

As we can see, it is an innocuous term completely devoid of any sinister connotations. I'm afraid Rudd's mischievous effort to use it in an attempt to malign Hayek falls completely flat. Now we must turn to Ludwig von Mises, another bet noir of social democrats. Rudd seems to think that there is something immoral about Hayek's insight that the market is a "spontaneous order". But this is to say no more than market arrangements are not the product of a single mind or a committee. Mises summed it up well:

The market in the broadest sense of the term is the process that encompasses all voluntary and spontaneous actions of men. It is the realm of human initiative and freedom and the soil upon which all human achievements thrive. (Ludwig von Mises, Economic Freedom and Interventionism, The Foundation for Economic Education Inc.,1990, pp. 36-37)

For the life of me I cannot see how any reasonable person can take moral offense at this definition, even if he were to disagree with it. Nevertheless, Rudd manages to do just that. On the other hand, maybe he is just pretending to have read these authors. This suspicion is strengthened by Rudd's statement that it is the "Hayekian view that a person's worth should primarily, and unsentimentally, be determined by the market." This really is outrageous. Hayek never said such a thing. What he has said is to be found in any standard economics textbook and that is that there will be a tendency for labour to receive the full value of its marginal product. If employers are forced to pay more then unemployment will follow. As for an individual's intrinsic worth:

. . . in most instances where we value what we get, we are in no position to assess the merit of those who have provided it for us. (Ibid. p. 98).

No economist would ever have made the claim that Rudd falsely attributes to Hayek. This brings us to Rudd's outrage that the market should treat labour as a commodity. But as Mises observed:

. . . the working of the capitalist system forces the entrepreneur to obey the orders issued by the consumers. He does not have the power to distribute bounties at the expense of the consumers. He would waste his funds if he were to use his own money for such a purpose. He simply cannot pay anybody more than he can realize in selling the product. Ludwig von Mises, Bureaucracy, Arlington House Publishers, 1969, p. 38).

Once again:

The height of wage rates is determined on the market in the same way in which the prices of all commodities are determined. In this sense we may say that labor is a commodity. The emotional associations which people, under the influence of Marxism, attach to this term do not matter. It suffices to observe incidentally that the employers deal with labor as they do with commodities because the conduct of the consumers forces them to proceed in this way. (Ludwig von Mises, Human Action, Henry Regenery Company, 1963, p. 593).

Mises and Hayek are not saying anything about labour services that cannot be found in any standard economics textbook, despite Rudd's endeavours to suggest otherwise. Rudd's insinuation that the state can raise labour costs above their market clearing rates is the sort of dangerous nonsense that social democrats are noted for. He then brings in the Hawke-Keating years as an example of how social democracy works. Oddly enough he omits to mention their failure to eliminate widespread unemployment.

The irony of the Hawke-Keating record on unemployment is that it confirms the orthodox (or as Rudd would say, the neo-liberal) view of labour being priced out of work. It is true that output and employment rose. However, it is also true that this was brought about by Keating's monetary explosion. From March 1983 — when Hawke was elected — to March 1996, when Howard defeated the Keating Government, currency rose by 221 per cent, bank deposits by 400 per cent and M1 by 337 per cent. It was this monetary boom that lowered prices and gave us "recession we had to have". Monetary expansion (aka inflation) is the means by which labour is priced into work. Keynes made this very clear:

Whilst workers will usually resist a reduction of money-wages, it is not their practice to withdraw their labour whenever there is a rise in the price of wage-goods [consumption goods] (The General Theory, Macmillan-St. Martin’s Press, 1973, p. 9).

A simple example will illustrate the point: if the cost of labour is 105 and the value of its product is 100, then monetary policy can eliminate the overpricing by raising the price of the product to 105 or higher. The process is complicated by the fact that monetary expansion could initially unlock resources in a way that would reduce the cost of labour with little or no effect on real wages.

By putting a floor under real wage movements, Labor's "Accord" (a social democratic triumph) with the unions ensured that widespread unemployment would be a permanent feature of the Australian economy for some time to come. This policy of pleasing unioncrats also resulted in large-scale suboptimal work as many of those excluded from full-time employment took up part-time and casual work, and even self-employment where possible.

Regardless of Rudd's contention to the contrary, economic laws are very real and no social democrat will ever succeed in repealing them. And when we think of economic laws supply and demand immediately spring to mind. The demand curve for labour consists of an array of declining marginal productivities in value terms. The point at which the supply curve for labour intersects the demand curve determines the wage rate. So whenever some social democrat comes along and raises labour costs above the intersection point unemployment emerges. The situation in Queensland in the 1920 presents us with a graphic example of this law at work. Professor C. Benham — who was lecturing in Queensland at the time — compared the average value of production against total labour costs (the real gross wage). The following table was the illuminating result.

Queensland: Wages, Production and Unemployment
Year	Average Wages	Value of Production per worker	Per centage Unemployed
1916 1917 1918 1919 1920 1921 1922 1923 1924	£        d      60       4      65       5      69       6      78       7      91       6      96       8      93     10      94       2      94     11*	£ 287.60 325.19 316.62 305.40 362.57 338.91 339.84 370.00 424.78	5.8   7.0   9.3 11.1 13.3 15.5 10.0   7.1   6.4
*Average for nine months

He made the observation that unemployment rose as wages rose "relatively to the value produced per worker". In his own words: "It would be hard to find a clearer proof of our thesis. (The Prosperity of Australia, P. S. King & Son, LTD, Orchard House, Westminster, 1928).

Rudd provided us with more evidence of his historical and economic illiteracy when he opined that Franklin Delano Roosevelt was left "to rebuild capitalism after the Depression". Roosevelt kept America in depression by adopting Hoover's anti-market policies and then adding quite a few of his own. It was Nazi Germany and Imperial Japan who restored full employment in America, not Roosevelt's destructive economic policies. However, let us begin with Hoover, the man who is wrongly charged with a pursuing laisezz-faire ideology to the bitter end. Hoover detested "orthodox" thinking on wage rates, believing instead that living standards were a product of high real wages. He made his rejection of the "old economics" clear in a speech on 12 May 1926:

. . . not so many years ago — the employer considered it was in his interest to use the opportunities of unemployment and immigration to lower wages irrespective of other considerations. The lowest wages and longest hours were then conceived as the means to obtain lowest production costs and largest profits . . . The very essence of production is high wages and low prices, because it depends upon a widening . . . consumption, only to be obtained from the purchasing-power of high real wages and increased standard of living. (The Memoirs of Herbert Hoover Vol. II, The Cabinet and the Presidency, 1920-1933, New York, Macmillan, 1952, p. 108).

This was the "new economics" that Hoover and others now preached and which became the prevailing theory of the time. One could easily be forgiven for thinking that Hoover was a Keynesian before Keynes was. When depression struck in 1929, Hoover, as president, was now free to implement his interventionist (or should I say proto-Keynesian) schemes that gave the world the Great Depression.

He reacted swiftly to the crisis, persuading the country’s industrialists to maintain money wage rates at pre-depression levels. Alarmed by these interventionist policies, Secretary of Treasury Mellon urged him to allow the depression to follow its natural course as had all previous administrations. Not Hoover. He scornfully dismissed Mellon and his supporters as "leave-it-alone-liquidationists". On 3 December, 1929, Hoover marked his annual address to Congress by stating:

I have instituted . . . systematic . . . cooperation with business . . . that wages and therefore earning power shall not be reduced and that a special effort shall be made to expand construction . . . a very large degree of individual suffering and unemployment has been prevented.

Unemployment was then about 3 per cent. Two days later he convened a large conference of business leaders. Urging them to accept his policies he condemned as the "dog-eat-dog attitude of the business". (The Memoirs of Herbert Hoover: The Great Depression 1929-1941, New York, Macmillan, 1952, p. 44). Not surprisingly the AF & L (American Federation of Labor) hailed Hoover's policies and "new economics" as an advance of previous policies which had "intensified depressions". The AF & L also praised his 1930-31 policies of reducing hours of work for government employees without loss of pay; maintaining money wage rates on public works and buildings; raising wages for government employees, etc. In October 1930 William Green presented Hoover to the AF & L annual conference, declared that:

The great influence which [Hoover] exercised upon that occasion [the White House Conferences] served to maintain wage standards — to prevent a general reduction of wages. As we emerge from this distressing period of unemployment we . . . understand and appreciate the value of the service which the President rendered wage earners of the country.

Unemployment now stood at 7.8 per cent. So much for recovery. It is true that at the outset of the depression US Secretary Treasury Mellon advised Hoover that he should allow the depression to run its course. However, what Rudd didn't tell us is that Mellon changed his mind to the degree that in May 1931 he publicly supported Hoover's fallacious economic views on wage rates by stating the administration's determination to maintain the level of money wages. By the end of 1931 unemployment stood at 16.3 per cent.

Two courses were open. We might have done nothing. That would have been utter ruin. Instead we met the situation with proposals to private business and to Congress of the most gigantic program of economic defence and counterattack ever evolved in the history of the Republic. . . . For the first time in the history of depression, dividends, profits, and the cost of living, have been reduced before wages have suffered . . . They were maintained until the cost of living had decreased and profits had virtually vanished. They are now the highest real wages in the world . . . We determined that we would not follow the advice of the bitter-end liquidationists ["orthodox economists"] . . . (William Starr Myers and Walter H. Newton, The Hoover Administeration A Documented Narrative, Charles Scribner's Sons, LTD London, 1936, p. 249-250).

By this time Hoover’s dangerous belief in the purchasing power theory of wages had driven unemployment up to 24.9 per cent. Hoover lost the election to Roosevelt who, nevertheless, continued with Hoover’s policies. The result was the longest and deepest depression in US history. Yet Hoover, the man who denounced proponents of “economic orthodoxy” as “reactionary . . . bitter-end liquidationists”, who supported fixed wage-rates, implemented public works, established the Reconstruction and Finance Corporation, restrained competition, drastically raised taxes and government spending; the president who intervened in the economy on an unprecedented scale, breaching every tenet of laisezz-fair economics, is still accused by historically illiterate journalists and politicians of having created the Great Depression because he adhered to the "economic orthodoxy of the day".

And what was the effect of attacking profits and dividends? In 1929 the two-way division between employees and corporations was 81.6 per cent and 18.4 per cent respectively and the unemployment was 3.2 per cent. Thanks to his meddling the employees share had shot up to 99.4 per cent by 1933 resulting in payrolls falling from $32.3 billion to $16.7 billion, helping unemployment to reach a horrifying 25 per cent.

A few more facts should cast further light on the economic conditions of the time. In 1929 pre-tax corporate profits were $9,770 million and post-profits were $8,337 million, for 1930 they were $3,225 and $2,348 respectively; for 1931 they were —$846 million and —$1,365; 1932 they were —$3,100 and — $3,489. And 1933 was ridiculous; profits reached a meagre $99 million only to be reduced by taxation to —$444 million. In 1932 the St. Louis Chamber of Commerce was driven to state:

When governments seek to maintain the high levels of taxation they reached in good times in these days of seriously impaired income the impending specter of higher taxes constitutes one of the chief deterrents of business recovery.

Hoover was the real father of the "New Deal", not Roosevelt who relentlessly continued with Hoover's policies. The result was the longest and deepest depression in US history. Yet Hoover, the president who intervened in the economy on an unprecedented scale, breaching every tenet of laisezz-fair economics, is still accused by the historically illiterate journalists and politicians of having created the Great Depression because he adhered to the "economic orthodoxy of the day".

I have already stated that it is a fundamental law in economics that if you raise the price of any product above its market clearing price a surplus will emerge. This law holds for the services of labour (which are a commodity) just as much as it holds for any other commodity. This suggests that the unemployment rates that characterised the Great Depression should also be accompanied by labour costs that exceeded the value of labour's marginal product. The following chart shows exactly that.

Source: This chart is designed so that a constant percentage increase would appear as a straight line. The values of product and wages are both expressed in dollars of constant buying power. The data for product are for the private sector, and are from the series by John W. Kendrick in his paper, National Productivity and Its Long-Term Projection (National Bureau of Economic Research, May 1951), brought up to date by the National Industrial Conference Board. For the data on wage rates, see Chapter 1, p. 11.

The grey area in the chart represents the gap between productivity and wages. As we can see, the gap is a significant one. Therefore this period of high unemployment is one marked by real wages greatly exceeding productivity, just as the theory of marginal productivity predicts.

It was Roosevelt's anti-recovery industrial codes combined with destructive union activity that finally sent the American economy into a vicious tailspin. While leftists write of unions fighting to maintain wages they omit the salient fact that in 1938 real wages were 29 per cent higher than the 1929 rate. More importantly, productivity-adjusted wage rates exceeded the 1929 rate by 14 per cent. (See Richard K. Vedder and Lowell E. Gallaway's Out of Work, New York University Press, 1997, p. 103).

Roosevelt's New Deal that Rudd admires so much ensured that unemployment never fell below 14 per cent and that the process of capital accumulation — the very thing that raises living standards — went into reverse. It has been estimated that New Deal policies caused net private investment to by $3.1 billion. (Jim Powell, FDR's Folly: How Roosevelt and His New Deal Prolonged the Great Depression,, Three River Press, 2003, p. 86).

Despite this dreadful record his latter-day disciples are bizarrely arguing that the New Deal was a success. The Democrats own the Great Depression, a fact that is being confirmed by economic and historical research.

The likes of Rudd see the current financial crisis as an opportunity to burden the economy with greater regulations by blaming "unchecked capitalism" for the mess. To this end he directs his criticism at von Mises and von Hayek and in doing so he completely betrays his ignorance of the history of economic thought. First and foremost Mises and Hayek are members of the Austrian School of economics, as I am. And it was the Austrians who warned that the central banks' loose monetary policies — and not so-called "unchecked capitalism" — would lead to a financial crisis. Using Austrian analysis I warned way back in 2004 that there would be "another recession in or around 2008". (US economy: storm clouds ahead).

The Austrian view is pretty straightforward. Central banks let loose with the money supply in the form of credit expansion. (From October 1997 to January 2009 the US money supply expanded by about about 120 per cent. This is where the speculative frenzy and malinvestments came from). This policy forced down interest rates and created masses of malinvestments that will have to be eventually liquidated. This excess credit flowed across national borders, distorting the pattern of international trade and creating large amounts of idle deposits that were misinterpreted as "surplus savings". In short, world-wide inflation created a world-wide boom that in turn created the current financial crisis. Don't blame capitalism. Blame the lousy economics that central banks practise.

Rudd expressed outrage at the Reagan administration's repeal of the Glass-Steagall Act of 1933. The idea that this act prevented "Main Street commercial banks from being exposed to the vagaries of Wall Street" is a myth. The begin with, as I have shown, it is the central bank's loose monetary policy that destabilises the markets by flooding them with credit. The first Glass-Steagall Act of 1932 was bound to encourage a loose monetary policy by widening the classes of assets eligible for the banks to rediscount at the Fed enabling it to expand credit further.

The 1933 Act did absolutely nothing to stabilise markets. Forcibly separating commercial from investment banking was economically absurd and largely designed to bash the Morgans. (If any of Mr Rudd's advisors wish to dispute this they are free to submit a refutation which I would be only to pleased to publish).

One of the unfortunate effects of a lengthy and heavy credit expansion is that it inflates asset prices. This in turn fuels speculation that feeds on itself to the extent that sometimes even reasonable men fall prey to it. Benjamin M. Anderson referred to a speech on this very subject that was made in 1929 before the New York State Chamber of Commerce

which discussed, among other things, the phenomena of a mob mind which had been so manifest in the year and a half that had preceded the crash. The speaker made the generalization, familiar to social psychologists, that the more intense the craze, the higher the type of intellect that succumbs to it. (Benjamin M. Anderson, Economics and the Public Welfare: A Financial and Economic History of the United States 1914-1946, LibertyPress, 1979, p. 203).

To those of us who have taken the trouble to research this subject it is perfectly clear that inflation is highly corrosive of moral values and that it subverts business ethics and engenders an irresponsible attitude to savings and speculation. Constantino Bresciano-Turroni found this to be the case. As he wrote in his definitive study of the Weimar inflation:

At first inflation stimulated production . . . [then it] annihilated thrift; it made reform of the national budget impossible for years. . . it destroyed incalculable moral and intellectual values. It provoked a serious revolution in social classes, a few people accumulating wealth and forming a class of usurpers of national property, whilst millions of individuals were thrown into poverty. . . . it poisoned the German people by spreading among all classes the spirit of speculation and by diverting them from proper and regular work, and it was the cause of incessant political and moral disturbance. (The Economics of Inflation: A Study of Currency Depreciation in Post-War Germany, John Dickens & Co LTD, 1968, p. 404).

A striking but generally overlooked effect of credit expansion is its effect on financial transactions. We find a peculiar situation arises where not only do the number of these transactions rise but a number of new financial activities and intermediaries emerge. It appears that more and more financial activities have less to do with the creation of wealth and more to do with its transfer from one group of people to another group. (The Cantillon effect). Naturally, greatly expanded financial dealings require more labour. The number of bank employees in Germany jumped from 100,000 in 1913 to 375,000 in autumn 1923. (Ibid. 216). As Bresciano-Turroni observed:

The increase in banking business was not the consequence of a more intense economic activity. The work was increased because the banks were overloaded with orders for buying and selling shares and foreign exchange, proceeding from the public which, in increasing numbers, took part in speculations on the Bourse. The banks did not help in the production of new wealth; but the same claims to wealth continually passed from hand to hand. (Ibid. 216).

The growth in banking activity was extraordinary. In 1914 the number of newly-opened banks was 42; in 1923, at the height of the inflation, there were more than 400. (William Guttman and Patricia Meehan, The Great Inflation, Saxon House, 1975 p. 193). Bresciano-Turroni's study of the malevolent effect of inflation on the pattern of incomes and wealth under an inflationary regime led to him to lament:

Inflation was always a terrible instrument for the redistribution of wealth (Ibid. 286).

The only regulation that can stop these financial booms and busts is one that imposes a 100 per cent reserve on the banking system and also forbids the central bank from meddling with interest rates. (This would raise the question of why a central bank is needed). Rudd blamed "unchecked capitalism" for the sub-prime meltdown. But this situation had been created by Democrats who had bullied banks into lending to those who should never have been in the market. Moreover, it was Bill Clinton who loosed lending controls on Fannie Mae and it was Bush who warned about the consequences. But Rudd is an ideologue and ideologues have no time for facts.

I'll finish with Rudd's assertion that the argument for freeing financial markets rests on the "neo-liberal" belief in the "efficient-markets hypothesis". This is sheer nonsense. The thinking behind this "hypothesis" actually rests on the concepst of neutral money and perfect competition. Austrians adamantly reject both concepts. Time and time again the Austrians have stressed that because money is not neutral expanding it will have the effect of distorting the structure of relative price. Adherents of the "efficient-markets hypothesis" deny this. Yet Rudd takes the Austrian view which he calls "neo-liberalism — without troubling to define the term — and stands it on its head. (Stock market troubles and Macbeth’s witches explains why the "efficient-markets hypothesis" is a fallacy).

To put not too fine a point on it, Rudd and his intellectual mentors don't know what the hell they are talking about.

Rudd's essay is an opening salvo against free market thinking and deserves to be taken seriously. Ideas have consequences, particularly bad ideas. So far there have been several responses but no rebuttals. Tony Abbot, formerly minister for employment and workplace relations in the Howard government, responded with an article that contained nothing of substance. Someone should tell him that to assert something as being true does not make it so. (Misguided, would-be messiah, The Australian, 7 February 2009). He gets an F.

Julie Novak, a research fellow with the Institute of Public Affairs, responded in the same vein as Abbot, only hers was somewhat shorter. (Rudd throws out the baby, The Australian, 4 February 2009). She too gets an F.

The Institute of Public Affairs posted a juvenile response. If there was such a thing as triple F they would get it.

Peter Hartcher of the Sydney Morning Herald is another who is thoroughly deserving of a triple F. According to this expert on the history of economic thought that "as a policy prescription, Rudd's new essay is sensible and thoughtful. (Surrounded by killer tomatoes, Rudd reaches for the ketchup, Sydney Morning Herald, 31 January 2009),

Former former treasurer Peter Costello fired off a broadside that — as expected — contained nothing but blanks. A triple F

Note: Being short of time I was unable to thoroughly detail Rudd's fallacies and historical fictions. Nevertheless, I hope I have dealt with them at sufficient length to make the reader aware of just how misleading Rudd's essay is. Finally, I have said nothing in this article that I have not said before. It is a great pity that Brookesnews is the only publication in Australia where this kind of material is to be found.

I have warned numerous times that if anti-capitalists fallacies are not immediately refuted they will take root and multiply. Our self-appointed guardians of the market treated my warnings with their usual disdain. The result is that we now have a Labor Prime Minister announcing himself to be an anti-capitalist warrior who intends to capture the moral and intellectual high ground and hold it. And this happened while our right slept on the job.

Rudd's "growth gap" myth

Prime Minister Rudd launches attack on capitalism — and his rightwing critics crumble

Kevin Rudd’s economic illiteracy and his attack on Hayek

Kevin Rudd promises us economic planning

Gerard Jackson is Brookesnews' economics editor

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