Logical Foundations of a Self-Organizing Economy

By A.S.N. Misra B.A. (Hons) M.A. (Oxon).

© 2009. (All rights reserved).

Contact; mnmhnmisra@aol.com
Introduction. .......................................................................................................................................4

PART ONE: ...................................................................................................................................7

Elements of a Self Organizing Economy. ..................................................................................7

1. The Problem of Leads and Lags.............................................................................................7

2. A Quasi-Non-Discretionary Monetary Policy......................................................................10
3. Two Requirements of a Fully Mechanized Monetary Policy. .............................................11
4. 2008 – Economic Entropy? ..................................................................................................13
5. Transmitting Bond-Market signals into Interest Rates. .......................................................14
6. The Net Neutrality of Money. ..............................................................................................15
7. How to Escape a Liquidity Trap Without Making a Category Mistake...............................16
8. Why We should Stop Worrying and Learn to Love the Liquidity Trap. .............................18
9. The Irrelevance of the Lucas Critique..................................................................................19
10. The Law of Returns and the Principle of Balanced Budgets. ............................................21
11. Is there a Business Cycle?..................................................................................................24
12. The Commodity Theory of Money. ...................................................................................27
13. Logical Foundations of Keynes’ General Theory..............................................................29
14. Is Keynesianism a Special Theory? ...................................................................................32
15. Austrian Economics – the True Red-Wedge? ....................................................................34
16. Apriori Elements of a Symmetrical Economy. ..................................................................37
17. Atlas Shrugs or the Shirt of Nessus?..................................................................................39

Part 2: ...............................................................................................................................................41
The Science of Economic and Political Theory. ..........................................................................41

1. Economics as a Science........................................................................................................42
2. Some Implications of the Economic Calculation Problem. .................................................44
3. Primacy of Logic over Mathematics. ...................................................................................46
4. Is Socialism a Special case of Classical Liberalism?...........................................................47
5. Laissez-Faire as a Special Case of the theory of Natural Selection. ....................................49
6. Keynes the Neo-Classical Economist, (A Neo-Classical Macro-economics.).....................51
7. Marginal Utility and the Theory of Evolution. ....................................................................53
8. Subjective Utility and Entropy Maximization .....................................................................55
9. The Non-Classical Synthesis................................................................................................57
10. Free-Market Abuses: Raw Capitalism. ..............................................................................58
11. Free-Market Abuses: Plutocracy........................................................................................59
12. Free-Market Abuses: Monopoly. .......................................................................................60
13. Was Schumpeter a Crypto-Marxist? ..................................................................................62
14. The Unstable Telos of Liberalism......................................................................................65
15. The Dynamo of the Free-Market........................................................................................66
16. The Phenomenon of Social Externalities. ..........................................................................67
17. The Road To Muppetdom. .................................................................................................70
18. The Third Way Theorem. ...................................................................................................72
19. The Disutility of Government ............................................................................................74
APPENDIX: Towards a General Theory of Selection: ................................................................76

1. Introducing Cultural Selection. ............................................................................................76

2. Punctuated Equilibrium and Thermodynamics. ...................................................................78
3. A General Theory of Cultural Evolution..............................................................................80
4. Cultural Equilibrium. ...........................................................................................................82
5. The Fundamental Unit of Cultural Selection. ......................................................................83
6. The Principle of Entropy Maximization...............................................................................84
7. Thermal Equilibrium. ...........................................................................................................85
8. How Shannon’s Equation Objectively Contradicts the Gaia Hypothesis. ...........................87
9. The Birth of Macro-Biology. ...............................................................................................89
10. Evolution of the Arts. .........................................................................................................90
11. A Note on Natural Liberty and Ethics................................................................................92
Introduction.
The fundamental assumption of nineteenth century Classical economics and twentieth century
Neo-Classical economics is that, absent of external obstruction, free-markets always clear – that is,
they always revert to an optimum (full employment) equilibrium. In effect therefore perfectly free-
markets are invariant and self-organizing.
As we shall see this model of Liberal Economics is modified but not quite over-turned by the
Keynesian revolution. Indeed the work of the Keynesians strengthens and augments what I call
the Liberal model of economics as it effectively combines Neo-Classicism with an analysis of real
world imperfections.
On this definition however – and in contrast with explicitly stated Keynesian assumptions1 -
Liberal economics may still be said to rest on Neo-Classical principles of Say’s law and the
doctrine that individuals always seek to maximize subjective utility – thereby incidentally
generating optimal (Pareto) equilibria in perfect markets. 2
Thus the idea of Liberal Economics which I seek to promulgate in this paper is a synthetic one of
broadly Neo-Classical assumptions combined with the analysis of real world imperfections that
skew or interfere with these assumptions in various ways without thereby invalidating them.

The difficulty with the idealized Neo-Classical model in the context of twenty-first century
markets is that monetary policy – which directly impacts the equilibria of free-markets – is
necessarily determined by forces external to the free-market, i.e. by governments in the guise of
(relatively autonomous) central banks. In the post Bretton-Woods era of free-floating currencies,
untied to the commodity markets, external bodies (central banks) have the power to determine
interest-rates and money-supply. In essence this creates the following paradox: in order to function
optimally free-markets depend upon external discretionary forces to determine money-supply and
yet this situation contradicts the classical dictum of non-interference or Laissez-faire.
The fact that we have grown accustomed to this dichotomy (such that it is never noted as an issue
in its own right) is probably a legacy of the triumph of the broad Keynesian doctrine of
government intervention in order to negate the effects of imperfections or frictions in real world
markets. In truth modern monetary policy seeks to put into practice what Keynes advocated –
which is the counter-cyclical activity of governments in free-markets. All that has changed is that
– post Bretton-Woods – monetary policy has come to seem a much superior tool for demand
management whereas fiscal policy has (until very recently) come to seem antiquated in
comparison. The reason for this is because the currency market is no longer tied to gold as it was
in the era of Keynes and so is far more flexible as a result. But the doctrine of counter-cyclicality –
however it may be deployed in practice – does remain quintessentially Keynesian in character3.
The question simply addressed by this paper is whether this function (of counter-cyclicality) can
now – given the evolution to a fiat money system – be performed by free-markets themselves,

1
See for example Keynes, J.M. General Theory of Employment, Interest and Money. Books one and two. 1936.
2
Note however there are many examples of analysis in Classical and Neo-Classical economics which, though they do
not contradict the central doctrines of self-organizing equilibria and subjective preference maximization, are
nevertheless not valid – or else are incomplete. An example of this includes the so called labour theory of value in
classical economics, which has since been displaced by the marginal utility theory of value.
3
As does the idea of intrinsic imperfections in real world markets. It is the absence of this central idea which fatally
weakens the claim of Neo-Classical economics to be a comprehensive model. Conversely, it is the attempted,
somewhat inconsistent, abandonment of Neo-Classical assumptions which undermines the claims of Keynesianism to
be a true general theory.
notwithstanding supposed market rigidities. In the process of answering this question I will also
hopefully be able to demonstrate (in sections 13 and 14) how Keynesianism and Monetarism
represent special cases or applications of the Quantity Theory of Money.
The aim of monetary policy is of course to stabilize an economy going into recession – generally
by loosening the money-supply via interest rates, thereby stimulating economic activity.
Conversely monetary policy is also charged with preventing over-stimulation of a booming
economy – generally by tightening the money-supply via interest rates, thereby slaking future
economic activity somewhat. In toto therefore monetary policy serves the crucial function of
neutralizing the bi-polar extremes of the so-called “business-cycle”.
In practice however and for essentially political reasons, counter-cyclicality is weakly applied
during boom periods and strongly applied (commonly also incorporating Keynesian fiscal stimuli)
during recessions. It should be obvious, given a moments thought, that such imbalanced
deployment of what ought to be a net-neutral monetary-policy (not to mention the misuse of
fiscal-policy for inappropriate demand management purposes) is intrinsically asymmetrical. What
conceals this truth is that, in the short-run, such imbalances can be obviated as to their effects but
in the long-run it is apparent, apriori, that such asymmetries generate extreme levels of
disequilibrium periodically resulting in what might be termed “Super-cyclical downturns” or
alternatively “Super-fluctuations”.

It will be the purpose of this paper to demonstrate how, with only two minor adjustments,
monetary policy may be handled so as to make it fully mechanical in operation (and also fully
responsive to market forces) and hence invariant relative to the so called business cycle. This
would once again render monetary policy fully compliant with the Classical ideal of self-
organizing markets but without requiring us to surrender the real stabilizing benefits of
countercyclical money-supply advocated by Keynes. Such a state of affairs would represent, in
effect, the terminus-ad-quem in the evolution of economic theory and practice. This would be the
case because the old classical model, as Keynes first observed, is an incomplete one as it currently
stands whereas both the Keynesian and Monetarist alternatives (in as much as Monetarism is not
implicitly Keynesian in its assumptions) are alike incompletely self-organizing. The monetary
policy model I propose in this paper will hopefully be an ideal synthesis of the strengths of the
Keynesian and Neo-Classical approaches, obviating the drawbacks of both.
After explaining the above model this paper will then seek to explore the various elements which
– alongside invariant monetary policy – contribute to the maintenance of long-term economic
symmetry and the associated avoidance of super-cyclical disequilibria. This part of the analysis
will be done under the rational assumption that placing dependence upon monetary policy alone to
counteract all systemic structural imbalances in an economy is inherently unsound and leads
ultimately to super-cyclical imbalances. The key principle here will be that a balanced and
countercyclical monetary policy must be conducted in the context of a balanced economy and a
stable polity.
It will therefore be the purpose of this paper to uncover – in a hopefully apriori way – what
(alongside consistently countercyclical monetary policy) the logical elements of a balanced (and
hence self-organizing) economy actually consist of. The implication of this analysis will be that
these represent the elements of the approach that governments should at least aspire to in
conducting policy. They also represent, ipso-facto, the clear and idealized standards against which
governments may fairly be judged.
 In Part 2 this paper will discuss the logical foundations of economics as a science and will then
conclude with a discussion concerning what Liberal economics necessarily tells us about the
logical foundations of political theory and society. An appendix is also included which serves to
show the context in which economic analysis operates relative to the other sciences and in
particular relative to biology.
 PART ONE:
Elements of a Self Organizing Economy.
1. The Problem of Leads and Lags.

The practical problem with classical Keynesian demand management as identified by the Neo-
classical economists is that consumers and entrepreneurs come, in time, to anticipate the
interventions of the government thus vitiating the effects of fiscal expansions. Instead of being
lulled back into spending savers in practice increase their tendency to save due to the anticipation
of higher taxes at a later date to pay for the current fiscal expansion. This dynamic effectively
neutralizes the fiscal expansion, subsequently leaving the government with a larger national debt
and with demand and hence output and unemployment commonly reverting back to pre-expansion
levels.4
It was Milton Friedman in particular who extended this pessimistic analysis to the specific sphere
of monetary policy.5 Since monetary policy also only works with what Friedman famously
characterized as “frequent and variable leads and lags” it is, he argued, impossible to “fine-tune”
the stabilizing function of monetary policy just as it is impossible to fine-tune demand
management by means of fiscal policy.

Friedman’s proposed solution to this problem (which came to be known as Monetarism) was the
maintenance of a constant fixed expansion of the money supply, thus ensuring a permanent mild
inflationary pressure whilst reducing the overall “noise” in the economy that resulted from
constant attempts to second guess or fool investors and consumers.

4
This failure of fiscal stimuli was noted as early as the 1930s by the then United States Secretary of the Treasury
(admittedly not a Keynesian sympathizer) Henry Morgenthau:
"We are spending more money than we have ever spent before and it does not work. I want to see this country
prosperous. I want to see people get jobs. We have never made good on our promises. I say after eight years of this
administration we have just as much unemployment as when we started and an enormous debt to boot."
Morgenthau, Henry, Testimony before the House Ways and Means Committee, May 1939:
It was primarily the domestic and international demand for American products caused by the war and by the baby-
boom after the war which led to eventual economic recovery.
The other key example of the ineffectiveness of fiscal stimuli is that of Japan in the 1990s. Some commentators on
this failure, most notably Paul Krugman, are themselves Keynesians:
“But anyway, as a practical concern the main point about fiscal policy in Japan is that it is clearly nearing its limits.
Over the course of the past 7 years Japan has experienced a secular trend toward ever-growing fiscal deficits; yet this
has not been enough to close the savings-investment gap. One need not claim that fiscal policy is completely
ineffective: as Adam Posen has emphasized, fiscal expansion has pushed up Japanese growth when tried. But how
much fiscal expansion can the government afford? Between 1991 and 1996 Japan' s consolidated budget went from a
surplus of 2.9 percent of GDP to a deficit of 4.3 percent, yet the economy was marked by growing excess capacity.
When the Hashimoto government, alarmed by the long-run fiscal position, tried to narrow the deficit in 1997 the result
was a recession; now fiscal stimulus is being tried once again. But projections already suggest that Japan may be
heading for some awesome deficits - say 10 percent of GDP next fiscal year - with no end to the need for fiscal
stimulus in sight. Given that Japan is already in far worse fiscal shape than, say, Brazil on every index I can think of -
not just current deficit, but debt to GDP ratio and hidden liabilities arising from an aging population, the need for bank
and corporate bailouts, etc., one has to wonder where the fiscal-expansion strategy is leading.”
Paul Krugman Japan Still Trapped. 1998. http://web.mit.edu/krugman/www/japtrap2.html
Given comments like these (and associated statistics) concerning the two key historical examples of concerted fiscal
stimulus one has to wonder why it is still regarded as a viable approach to problems of deflation and deficient demand,
especially given the existence of more appropriate monetary alternatives.
5
Friedman, Milton (2008). Milton Friedman on Economics: Selected Papers. University of Chicago Press Journals.
Friedman, Milton (1971). Monetary History of the United States, 1867-1960. Princeton University Press.
 The problem with this solution is its arbitrary and inorganic character. In addition it would be
mildly pro-cyclical during a boom, which is of course undesirable whereas it would only partly
mitigate the effect of a more severe downturn – i.e. it would only be mildly countercyclical during
a downturn. It would obviate the aforementioned “white noise” problem and it would also prevent
the wholesale errors of monetary policy during the great depression but it would be nothing like
optimally flexible or sensitive.
In practice the targeting of money aggregates as advocated by Monetarism failed dismally when
put into practice during the early 1980s (notably in Britain and America) and was therefore
quickly abandoned in favour of the primary targeting of inflation instead. This latter approach has
remained predominant down to the present day. I think it is accurate to say that targeting monetary
aggregates was too autistic a focus since it failed to take into account the velocity of transactions
of the money-supply (which has a profound impact on output and hence employment) whereas
targeting inflation has worked because it implicitly takes into account both velocity of transactions
and total money-supply.
If this analysis is correct then it is an ironic fact that Monetarism failed in practice precisely
because it failed to take into account all elements of the mathematical equation for the quantity of
money on which it claims to be based. After all, one can have an infinite supply of money but
inflation and output will still remain at zero if no transactions are made with it.
2. A Quasi-Non-Discretionary Monetary Policy.

The question therefore arises as to why an essentially discretionary monetary policy primarily
targeting inflation has spontaneously evolved which works better than either the classical
Keynesian or the Monetarist alternatives? I think that the answer lies in the fact that in setting
interest rates and money-supply central banks were and are, to the best of their ability, taking their
cue from the markets themselves. They are, so to speak, following a quasi-free-market or self-
organizing monetary policy, one which is immensely flexible and free from the vicissitudes of any
one particular market – such as the market for gold or silver.
Furthermore this approach seems to have avoided falling foul of Friedman’s strictures concerning
leads and lags for two interconnected reasons. Firstly because money-supply is an inherently more
immediate and sensitive response to fluctuations in the economy than is fiscal policy – allowing
for greater tolerance to fine-tuning and secondly because inflationary and deflationary tendencies
commonly persist due to market imperfections (wage and price rigidities). Consequently monetary
policy has tended to be guided more by market signals than by vain attempts to fool the public. In
effect (being market driven) monetary policy has increasingly become discretionary in name only.
Thus in a sense it has come to satisfy the ambitions of both the Neo-Classicals (since it seems
market driven) and the Neo-Keynesians (since it is a stabilizing intervention). Both parties have
therefore laid claim to the approach – but the approach seems to have arisen organically as a result
of the eradication of the gold standard.
One can of course make the case that monetary policy only works at all because markets are
imperfect and subject to frictions. But the corollary of this criticism is that a less influential
monetary policy ipso-facto implies a more efficient economy. Changes in the money-supply are
more immediately offset by changes in prices (without influencing output or employment) in this
case. And this should be the ultimate aim of the system because countercyclical monetary policy
approaches redundancy only to the extent that the economy also approaches efficient stability or
Pareto-optimality.
It is however the contention of the Neo-Keynesians that such imperfections (which result in wage
and price rigidity) will always persist for fundamental reasons of human psychology.6 If this is so
(and we have no particular reason to doubt it) then countercyclical monetary policy will always
continue to have a residual influence on output and employment and not merely on prices alone.
Paradoxically therefore a discretionary monetary policy targeting inflation (of the sort advocated
by Neo-Keynesians) has succeeded in approximating to the classical requirement of non-
intervention in the economy. It has done so by, in effect, tracking the aggregate of markets and
taking its signals from this. Thus discretionary monetary policy – an imperfect solution for
imperfect markets – has become the de-facto approach to demand management, even though there
is no general theory (except perhaps the Neo-Classical Synthesis7) which specifically promotes it
as such.

6
Mankiw, N. Gregory, and David Romer, eds. New Keynesian Economics. 2 vols. Cambridge: MIT Press, 1991.
7
Samuelson, Paul A. (1955). Economics. 3rd ed.. Mcgraw-Hill. This synthesis represents the attempt to combine Neo-
classical Microeconomics with Keynesian Macro-economics. It has perhaps benefitted in recent year by the attempts
of Neo-Keynesians to trace the roots of macro-economic imperfections in micro-economic phenomena. It also
represents a reasonably sound basis justifying central bank interventions to the money-supply.
My work on monetary policy simply seeks to show how these adjustments may be signalled by the markets
themselves – because all endogenous and exogenous shocks are elegantly reflected by the bond-market. Thus in a
sense (my hypothesis implies) the (bond) market clearly signals the correct adjustment to market “imperfections” and
3. Two Requirements of a Fully Mechanized Monetary Policy.

It is reasonable to interpret the situation described above as a half-way house to a fully non-
discretionary monetary policy of the sort craved but never supplied (except in the form of the gold-
standard) by the Classicals and the Neo-Classicals. Current practice actually approximates such a
model very closely which is why it works more effectively than any of the alternatives (whilst still
retaining significant imperfections).
What is required to make the current approach more comprehensively mechanical (and reliable) is
only two relatively simple but crucial alterations to current practice. Firstly monetary policy needs
to take account of all markets in assessing aggregate inflationary and deflationary tendencies.
Given the intrinsic inter-relatedness of all markets central banks should err on the side of
completeness. This is probably most critical of the two since following too narrow a measure of
inflation (for example CPI) causes market interest rates to be set too low relative to real or natural
rates. (Natural rates being defined as those that obtain when broad inflation is fully allowed for).
Natural rates can coincide with market rates but the tendency (as Wicksell and Mises point out) is
for the latter to undershoot the former, thereby over-stimulating investment in the economy. This in
turn results in inevitable recession since the excess investment was made on the assumption of
savings that were never really there.8
Much of the volatility in the world economy since at least the time of the accession of Alan
Greenspan to the Chair of the Federal Reserve Board can be attributed to this cause – i.e. to the
setting of nominal interest rates artificially low due to the targeting of too narrow a measure of
inflation, excluding, for example, reference to house and broad commodity prices (RPI). The
current debacle in world markets is in particular traceable (as the Wicksell-Mises theory suggests
it should be) to various ramifications (particularly in the financial sector) stemming from this
fundamental cause. This debacle was not the consequence of a flexible monetary policy however
(if anything it illustrates how powerful flexible monetary policy truly is) but rather of targeting too
narrow a measure of inflation, thereby generating rates of interest substantially below the natural
or true equilibrium rates for a prolonged period of time.

The second key requirement in fully mechanizing monetary policy is to tie it to an objective
market signal. Since we have advocated the use of all markets to assess inflationary targets this
requirement would not appear to be achievable. However there is what might be termed a “meta-
market” within the system of free-markets which specifically responds to all inflationary and

other sundry phenomena – in essence it discounts all but the most egregious imperfections. Thus monetary and
ultimately even fiscal policy (indirectly) are determined by the market itself, notwithstanding the validity of the Neo-
Keynesian critique. But I am getting ahead of myself.
8
Wicksell, K. Interest and Prices. 1898.
Von Mises, Ludwig. The Theory of Money and Credit. 1912.
One can (as I have done) ignore much of the superstructure of this elaborate theory of business fluctuations. For
example – the erroneous Bohm-Bawerkian time theory of interest rates.
Interest rates are determined not by “time preference” (on the Austrian model) but by the demand schedule for
capital – which has no diachronic element. Investor demand for capital is determined not by time preference but by
anticipated return on investment. The same is true of the saver supply of capital. The Bohm-Bawerkian time element
is therefore decidedly secondary to the element of risk-preference.
But to understand the causation of liquidity preferences in a recession the neglected Wicksell-Mises theory of
business fluctuations – with its roots in the work of Karl Menger - is absolutely crucial.
deflationary pressures (both macro and micro scale pressures) and which gives intrinsically
forward looking signals and that is of course the bond-market.
Since second guessing the bond-market (given its comprehensive knowledge) is usually a fool’s
game it stands to reason that interest rate signals from the bond-markets should be automatically
followed by central banks, rather than being merely “taken into consideration”, as is currently the
case. Furthermore the forward looking and reflexive character of these signals – which even take
account of anticipated policy changes – effectively obviates the “long and variable leads and lags”
criticism made by the Chicago school (as well as the Lucas Critique) whilst still permitting, indeed
positively promoting, an uncommonly precise degree of fine-tuning. Thus the benefits of fine-
tuning and transparency are simultaneously maintained – a sort of coincidentia oppositorum or
“holy grail” of monetary policy.
4. 2008 – Economic Entropy?

The current economic and financial crisis, though rooted in artificially low interest rates, also has
a systemic character to it, implying a high degree of entropy across the economy and its many
elements, including government – resulting in congenital and chronic disequilibrium in the
economy. The complexity of the derivatives market for example indicates a comparatively recent
acceleration and intensification of this entropy. So too does the size and complexity of business
and social legislation as well as tax codes. It is precisely this complexity of the problem (including
derivatives but with many, many other elements as well) which makes effective regulation difficult
if not impossible.
Indeed, obviating chronic systemic entropy using legislation is akin to curing advanced aggressive
cancer with chemotherapy. No sooner do you think it might be beaten then it quite likely pops up
again somewhere else and the chemotherapy itself is deeply debilitating. On the whole therefore
much less (but more effective) legislation is required, more efficient and more stream-lined. But
entropy being what it is this is unlikely to occur.9
Striving to obey the apriori principles of economic symmetry (summed up in Part One section 16)
is the only way either to address or to prevent this type of systemic problem. What would work
most effectively as an initial step to cleaning out the stable would be to legally separate retail
banking from investment banking and to restrict the type of leverage (through deposit ratios)
accessible to the former. This would convert retail banking back to its original utility status and
allow us to perhaps neutralize chronic “to big to fail” syndrome in investment banking. After all, if
an investment bank (effectively a gambling house10) or any other business is “too big to fail” then
in what sense is it truly private anymore? And where is the protection to the public purse?

Instead of supplying the commodities of gas, electricity and water to the economy retail banks
would serve to supply the commodity of money. The analogy with the utilities sector is infact
quite exact due to the singular importance of the elements of this sector – indicating that, given its
unique national importance, this sector (properly including retail banking) can never be entirely
regarded as part of the private sector. After all, we would not be happy if the energy sector were
simultaneously heavily leveraged at the bookmakers, effectively holding the exchequer to ransom.
Thus this type of protective legislation (to protect the public purse from private interference) is
logically justified. But this is a special case applying only to the utilities sector – including retail
banks (which therefore warrant much stricter legislation). It should not be extended to the
investment banks or to other businesses which are not of national importance in the same way and
which therefore merit so called “lighter touch” regulation. The price paid for this “lighter touch” is
that no implicit or explicit claims on the public purse should be allowed on behalf of these (non-
utility) industries. This is therefore a key distinction and principle of a symmetrical or self-
organizing economy.

9
See Part Two for a more general discussion of this topic.
10
One with responsibility for pensions unfortunately, which is perhaps the flaw in the “separation solution” to the too
big to fail (aka financial blackmail) conundrum.
5. Transmitting Bond-Market signals into Interest Rates.

The mechanism for transmission of bond-market signals into specific interest rates relates to the
probability of the maintenance or adjustment of a given level of interest rates at any particular
time. The bond-market will always be found to give a precise statistical probability for such
changes to take place and by how much. This probability is commonly expressed in percentage
terms. The proposal in this paper is to interpret these well-known indications not as running odds
concerning what the central banks might do (as is the present situation) but instead to interpret
these precise probabilities as indicating what the central banks should do – on the principle that
markets always know best and interest rates should ultimately be determined by the markets
themselves (thereby best approximating the true equilibrium rate of interest).11
In essence this is simply a reinterpretation of what the bond markets mean when they give an
anticipatory signal regarding future interest rate movements. My reinterpretation suggests that
forward looking bond-market signals should simply and invariably be translated into policy rather
than treated as merely indicative in character. In essence we have been misinterpreting what these
statistical indications are telling us for all this time and so have hitherto missed out on the perfect
opportunity to make interest rate setting perfectly transparent and mechanical.
To follow such a course would render the boards of central banks an irrelevance. It would also
make the current unsatisfactory system of random pronouncements and biases of these boards
superfluous. In essence a far more sensitive and complete commentary would be supplied and
perpetually updated by the markets themselves. And since traders could monitor and track bond-
market signals right up to the date interest rate changes are instituted - and since traders would
know that idiosyncratic decision making was no longer a possibility - this would work
considerably to smooth markets and to eliminate completely the fevered and unhealthy speculation
that surrounds anything to do with interest rate decisions.
Given that the whole process would be transparent and open at all times for all to see then this
alone would work wonders towards enhancing systemic market stability. The role of central banks
would in effect be replaced by banks of computers without any loss in efficiency. Idiosyncrasy and
human fiat would be forever abolished from the system which would then become classically self-
organizing, free of the taint of human interference.
And yet all it would take to achieve all of these bonuses would be for us to correctly interpret (and
act upon) signals that already freely and unambiguously exist in the bond-markets.

11
In cases where bond markets signal, for example, a 50% possibility of a 25 basis point cut in interest rates protocols
could be instituted which would always break such symmetries in a consistently conservative direction. In this case for
example interest rates would remain the same but the market would tinge this decision with what amounts to a
softening bias. Thus even biases would continue to exist under this regime but on a fully mechanical and transparent
basis.
6. The Net Neutrality of Money.

Such a system would make it impossible to sustain the classical criticism of all fiat money
systems – which is that they necessarily promote soft money and excess credit and that they
necessarily tend to inflationary confiscation of private wealth by governments. A fiat money
system that was objectively and transparently tied to bond-market signals and which targeted the
real or natural rate of inflation would automatically confer the benefits of sound money and
countercyclical flexibility. Most crucially it would be compliant of the classical requirement of
non-interference in market adjustments.
Unlike the 100 percent gold-system still favoured by many believing Classicists (due to its “hard
money” reputation)12 a fiat money system tied to the bond markets and to the natural rate of
interest would be able to adjust to deflationary pressures without entailing a prolonged recession –
simply by adjusting interest rates lower in response to deflationary signals from the bond-market.
This would soften the blow of market adjustments (similar to a shock absorber) but without
compromising the integrity of the money-supply. Adjustments would be purely counter-cyclical in
nature and would have (given the raising of interest rates during a boom), a net neutral effect on
the money-supply.
How can this be so? The answer is because when all “interferences” caused by the continuous
(market driven) expansion and contraction of the money supply are taken in toto (in terms of their
net inflationary and deflationary effects) they will be found to add up to precisely zero. Thus
although the nominal money-supply may indeed expand over time (due to periodic, market driven
bouts of quantitative easing) nevertheless the real effect of all these continuous adjustments will
still be net zero. The nominal expansion of the money-supply over time will merely reflect the
increase in economic activity over the same period – requiring a proportional expansion in the
nominal money-supply. The beauty of the mechanical description just described is that – in
contrast to Monetarism - it will automatically organize a proportional expansion in the nominal
money-supply without adulterating the real net-neutrality of money.
This description of course approximates to what already tends to happen in practice, but the
addition of the two adjustments described above would make the whole process smoother and
more effective and would obviate the legitimate “soft money” complaint against the current
system by the Classicists.

12
Paul, Ron; Lewis Lehrman (1982). The case for gold: a minority report of the U. S. Gold Commission. Washington
D.C.: Cato Institute.
Rothbard, M. The Case for a One Hundred Percent Gold Dollar. 1962. Mises Institute
7. How to Escape a Liquidity Trap Without Making a Category Mistake.

A liquidity trap is created when – due to severe deflationary pressures – real interest rates are
pushed below the zero-bound and into negative territory. Such a monetary event should be
interpreted in purely monetary terms as a demand for more liquidity by the economy and as
nothing else. In this situation bond-markets are in effect signaling that there is too little money
chasing too many goods. The solution in this special case (of negative real interest rates) is to treat
the printing of money (quantitative easing) as the correct proxy for the continued lowering of
interest rates.
The procedure in this case is always very simple and clear and quantitative easing should continue
in a strenuous fashion – without any commentary – until bond-markets supply the necessary signal
that interest rates should begin rising again. At this point and on this clear mechanical signal the
quantitative easing should cease since the liquidity trap will have been broken – thus removing the
purely mathematical disincentive for banks to lend and consumers to spend. 13
The point is to only follow this clear procedure and not to engage in fiscal solutions that have the
unintended effect of countering the easing process. Such attempts constitute what analytical
philosophers have called a category mistake since they represent the futile and counterproductive
attempt to solve a monetary problem (the liquidity trap) utilizing fiscal methods. Keynes
recommended these now outmoded fiscal methods only because modern monetary methods did
not exist at the time.

In general attempts to escape liquidity traps utilizing quantitative easing may fail for two reasons;
either because the easing is insufficient (central banks do not continue to ease until a clear
inflationary signal is received) or because large fiscal stimuli programs counteract the monetary
expansion by paradoxically stimulating saving by wary tax-payers and by causing huge deficits
that price out marginal investment by the private sector. The failure of quantitative easing in Japan
is attributable to both these causes; insufficiently determined quantitative easing coupled with a
counterproductive, essentially Keynesian fiscal policy.14 In Japan’s case these problems were
intensified by structural or supply side issues – summed up by observing that Japanese markets are
insufficiently free in character. In general flexible monetary policy only works optimally assuming
free-markets.
A critical by-product of a successful policy of quantitative easing is currency depreciation which
was also lacking in the case of the Japanese Yen. Currency depreciation makes an economy more
competitive by raising import prices and reducing the cost of its exports. It is also viewed as
presaging a healthy return of inflationary pressures to the economy since it is effectively importing
inflation and exporting deflation. It is clear that monetization is a valid proxy or continuation of
interest rate policy because it too generates currency depreciation if prosecuted correctly in a
viable free-market environment.15

13
Bank lending, like consumer spending, always dries up in a liquidity trap. This is not, as universally supposed (even
by economists who should know better) because of a failure of confidence in the economy but rather because a
mathematical disincentive exists (in the form of falling or sub-zero real interest rates). Thus the solution is not to coax
banks to lend or for government to lend directly to business but, rather, to break the liquidity trap (by stimulating
sufficient inflation) which generates the chronic disincentive.
14
Japan did experience weak growth for a record 69 straight months after September 2001 – but real interest rates
(natural rates) remained stubbornly below the zero bound (indicating insufficient money supply).
15
Contrast the still developing U.K. experience as of March 2009. The U.K, unlike Euro-Zone economies experienced
dramatic currency devaluation in the wake of a sustained easing policy, including quantitative easing. This is a healthy
 A number of commentators16 noting the failure of quantitative easing in Japan (despite a sizable
expansion of YM1 in 2001 of close to 50%) have suggested alternative variations around a
common theme of currency pegging. In essence they are advocating that the central government
should mimic the currency depreciation that ought to happen automatically as the result of a robust
and properly conducted easing program, thus achieving the same effect through market
manipulation that was not achieved by quantitative easing.
The promotion of such absurd and invasive schemes by supposedly professional, tenured
economists brings down a kind of shame on the profession. To reiterate the points made above; the
Japanese scheme failed because it was insufficiently intensive (the fact that authorities chose to
concentrate on expanding YM1 money aggregates instead of much broader YM3 should tell us all
we need to know on this score). Secondly, it is clear that the main focus of the Japanese authorities
was on solving the problem through outmoded and inefficient fiscal means. Not only was this to
commit a serious category mistake as described above – leading to a fatal distraction from the real
solution – but it has also had actively counter-productive effects for the reasons given. The fact
that Japanese national debt currently stands above 170% (Bank of Japan) should tell us all we need
to know on this score as well, especially given that real interest rates have remained below the zero
bound for most of the last two decades – an absurd and quite unnecessary state of affairs. Finally,
since a major part of Japan’s problem is structural – relating to insufficiently free-markets – the
proposal of a solution which further curtails market freedom (this time of the currency markets) is
frankly laughable – or would be if it were not so sad.

indication of a quicker exit from the crisis than might otherwise be expected. Helpful also is the avoidance of
excessive fiscal stimulus – though the forthcoming April budget may alter this situation.
16
See Lars E.O. Svensson (Fall 2003). Escaping from a liquidity trap and deflation; the foolproof way and others.
Journal of Economic Perspectives.
8. Why We should Stop Worrying and Learn to Love the Liquidity Trap.

Clearly then quantitative easing is just as mechanical and simple an element of the monetary
readjustment process as is the adjustment of interest rates. Indeed it forms a clear continuum with
this tool for dealing with real or natural interest rates below the zero-bound. But equally clearly
quantitative easing – like interest rate policy in general – presupposes freedom of markets and the
correct use of fiscal policy. All of these elements, I believe, are lacking in the case of Japan.
On the whole a liquidity trap should be regarded not as a crisis – since it is easily solved – but as
an opportunity. Specifically it is a huge free opportunity to monetize – in effect pay off – the
national debt – at least until such time as the money-supply must be contracted again. Economists
have in general realized that quantitative easing can be utilized to follow particular government
programs. Politicians for example favour the use of monetization to offset the cost of hare-brained
fiscal expansion programs. Ben Bernanke on the other hand, in a Friedmanite spasm, has
suggested that politicians might instead choose to use the money to pay for equally hare-brained
tax cuts. Even if the money multiplier effect is less than one it will still have a beneficial impact on
capital formation – he reasons17.
In the context of the 2008 credit crunch other analysts have suggested utilizing quantitative easing
to monetize the bad debts of struggling banks. This makes sense only if governments are
determined to save failed institutions due to earlier failures of separation (analysed in section 4
above) and do not mind transgressing the equilibrial principle of non-intervention to this end.
It is clear however that the correct and normal utilization of funds from quantitative easing should
always be to monetize the national debt since this debt acts as a drain on private savings and
investment (and hence on capital formation as well). Although the gain is not immediate it
ultimately boosts economic productivity and it also, by no coincidence, boosts national morale
unlike the other – ultimately counter-productive alternatives. This is presumably because it does
not bias, in a divisive way, on the supply or the demand side, (though it is also because less debt
equals less disequilibrium and less volatility in the system).
Given the potential benefits of monetization it is possible to argue that the failure of quantitative
easing to restore inflation and to reflate the economy is something devoutly to be wished for.
However, as Bernanke himself has observed (Ibid), a correctly conducted monetary easing process
(with Japan as its anti-model) will, if undistracted by alternative approaches, always succeed in
reflating any genuinely free economy.

17
Bernanke, Ben, Remarks by Governor Ben S Bernanke, Before the National Economists Club, Washington DC. Nov
21, 2002.
9. The Irrelevance of the Lucas Critique.

Tying interest rates to signals from the Bond market – either informally (as at present) or rather
more formally and explicitly (as I suggest) seems to work because it is market driven and
systematic. Although this approach is not designed to systematically fool the public its outcomes
are however only partly anticipated by them, due to the indeterminacy of markets. Because
markets are reflexive (forward looking) and highly sensitive it allows the response to signals to be
highly fine-tuned – and this is so even under a discretionary system. Ultimately it is this reflexivity
and sensitivity of the bond-market itself which allows monetary policy to obviate the Neo-
Classical Lucas critique – i.e. to implement finely tuned changes to the money-supply which
implicitly factor in the consequences of these changes (including any likely “leads and lags”.)
Of course upholders of the Lucas Critique may dispute that markets are forward looking (and
therefore tend to factor anticipated policy changes into their prices) but the facts of the matter
clearly seem to indicate otherwise – not least the fact that the current system of interest rate
adjustment has survived intact (inspite of the imperfections I noted earlier) for more than a quarter
of a century. If the Lucas Critique applied (which it should do as formulated) then this system
should not have worked better than any other.

Of course the Lucas Critique was formulated to account for the failure of Classical Keynesian
macro-economic policy in the early 70s.18 Keynesian policy started to fail at this time because of
the collapse in the empirical relationship (implying a convenient trade-off) between inflation and
unemployment as instantiated by the Phillips curve. In essence much of the Keynesian system
hung on the assumption that this curve depicted an invariant relationship whereas in reality it
merely depicted a transient empirical one instead. Although the oil crisis of the early 1970s dealt
the curve its final death blow it is likely (as the Lucas critique suggests) that the relationship it
depicted had already come under too much strain from the excessive weight that (Keynesian)
policy makers had placed on it.
In essence policy makers came to realize that there were two equal and opposite sources of
involuntary unemployment – severe deflationary conditions and severe inflationary ones. To
attempt to deal with these essentially opposite causations with a single expansionary approach was
therefore doomed to fail. Subsequently the focus of policy makers correctly shifted from the
targeting of unemployment (a second order phenomenon) to the targeting of inflation/deflation
(the first order phenomenon). In effect Keynesian theory (being a special case) was displaced by
the more general quantity theory of money. This has (correctly) remained the case down to the
present day.
In Britain at the same time as the Lucas critique a similar insight was formulated by Charles
Goodhart in the form of Goodhart’s Law. This succinct formulation states that;

Any observed statistical regularity will tend to collapse once pressure is placed upon it for
control purposes.19

18
Lucas, Robert (1976). "Econometric Policy Evaluation: A Critique." Carnegie-Rochester Conference Series on
Public Policy 1: 19–46.
19
Goodhart, C.A.E. (1975). "Monetary Relationships: A View from Threadneedle Street". Papers in Monetary
Economics (Reserve Bank of Australia)
This principle is worth mentioning here because the law (a close analogue of the Lucas Critique)
was formulated in reference to the operation of British monetary policy in the early 1970s. Its
existence indicates that the Lucas critique also applies quite strictly to monetary policy as well as
to fiscal policy. Indeed it is for this very reason that Milton Friedman and also many classical
economists distrust the control of monetary policy by governments and central banks. It is also the
reason why it is fair to say that any use of fiscal policy by governments for purposes of demand
management represents an apriori abuse of fiscal policy – but more on this topic later.

It seems likely that a combination of the freeing up of the currency markets combined with an
intuitive linkage of interest rates with the bond-market have enabled us to obviate the problems
implied by the Lucas critique and by Goodhart’s law – and without having to sacrifice the
flexibility of the money supply – or even the fine-tuning of it.
Certainly, given the adamant character of the critique and the law (and there is no reason to doubt
them since they merely assert the principle of arbitrage in policy theory) it is a paradox that
requires explanation and the only explanation I can find is that, given the aforementioned
alterations to monetary policy monetary policy is now effectively market driven (i.e. invariant in
character) and so obviates entirely the implications of these two analyses. Certainly there is no
doubt that central bank monetary policy continues to be a powerful and effective tool which
presumably it should not be if Lucas were correct.
Thus money-supply, being market driven is therefore part (or nearly part) of the autonomous self-
organizing free-market and this is the key conclusion of this essay. This happy situation also
obviates the need for complex econometric models of general equilibrium – which were the
secondary target of the Lucas critique (after Keynesianism itself). The market in general and the
meta-market in particular (the bond-market) is its own far more complex and sensitive working
model and indicates quite clearly what it is that monetary policy makers must do.
10. The Law of Returns and the Principle of Balanced Budgets.

Market driven monetary policy has a severely constricting effect on the latitude of
macroeconomic policy – and hence much of the need for econometric calculation is also
eliminated at a stroke. Ideally (according to Neo-Classical economics) there can be no such thing
as macroeconomic policy since the macro scale is simply a classically idealized aggregate – and is
therefore self organizing – from the ground up so to speak. In essence the economy, according to
this model (sometimes called Methodological Individualism), is a continuum and its activity is
autonomous.
But this is an ideal case that monetary and fiscal policy aims for. In practice there remain
imperfections and abuses that require constant monitoring and occasional legislation. Nevertheless
in the ideal case – which our new model approximates to, (hopefully better than previous Classical
and Neo-Classical models) – there would be no macro-economic policy any more, the economy
would self-adjust and Keynesian or any other interventionism would wither away.

This principle of invariance even extends, albeit indirectly and paradoxically, to fiscal policy as
well. Due to the law of returns – as it applies to tax yields – it follows, apriori, that there is an
optimal tax yield for any free economy, a principle which is sometimes given graphical expression
in the form of the often misunderstood and misused Laffer Curve.
In essence taxation below a given optimum will fail to maximize the tax yield (leading to
persistent budget deficits and disequilibrium) whereas taxation above this optimum (which varies
from economy to economy) will result in diminishing returns due to disincentivizing effects (of
over-taxation) or through dramatic shortfalls in compliance.
Although in practice this optimum point will be difficult if not impossible to precisely identify it
is nevertheless an important principle of the symmetrical economy that we acknowledge the
existence of such optima for all economies and that governments should sincerely endeavour to tax
at or around that optimal level (as indicated, in part, by econometric studies).
Secondly governments should sincerely endeavour to tailor their expenditure around this annual
allowance so as to avoid persistent and damaging deficit spending. In other words, the
applicability of the Ricardian law of returns (in principle) to the issue of taxation allows us to
confidently deduce that government expenditure should be defined by this objective and apriori
level afforded it, indirectly, by the free-market itself. Thus, in principle at least, fiscal policy is
objectively governed as to its magnitude (but not its latitude) by free markets.

In effect what we are advocating – especially given the discrediting of the (Classical Keynesian)
theory of demand management – is a return of the principle of balanced budgets to the center
ground of economic theory – in essence as part of the wider concept of economic symmetry or
equilibrium.
Indeed, granted the discredit of the demand management theory of fiscal policy (Classical
Keynesianism), there really is no excuse for not restoring the balanced budget principle to center
stage. What argument against it is there left other than the brute fact of the existence of more or
less wholesale government profligacy? And this is no argument except in favour of tolerance for
congenital infirmity. But without even an acknowledgement of the primacy of the principle of a
balanced budget then we can not even face the truth that we have a congenital problem (or
addiction) and hence will not take the initial steps needed to combat it.

It is true that tax receipts will fluctuate across the so called business cycle, but then monetary
adjustments will offset this effect to a considerable extent – as should occasional surpluses. By
running persistent deficits (for demand or supply side reasons) governments will ultimately
undermine the productivity of an economy by pricing out of the market the marginal private
investor.20 And if governments are not running deficits for either supply or demand side reasons
(because those reasons are illusory) then why are they running them? Thus for sound long term
economic reasons as well as for reasons of pure apriori logic it is vital that governments should
aim to balance budgets on a year on year basis and not on the basis of some vague and ultimately
non-existent business cycle.
Furthermore in having to balance budgets in this homely way governments would be taught (and
it pains me to say it) something of the value of taxpayers money. Indeed if this (apriori) principle
were accepted then the very re-election of governments would someday come to hang upon this
understanding (governments would hopefully have little else to do infact) and this would be no
mean benefit in its own right.
It is precisely because of the insupportable abandonment of the balanced budget principle (an
abandonment that was the chief corollary of Classical Keynesian demand management) that
governments since the war have gone on to develop such a bad name as poor managers and
distributors of public resources. In effect they are no longer held to financial account, they lose
real interest in the rudimentary (and for politicians boring) concept of value for money (politicians
would far rather change the world than engage in the harder task of managing things properly) and
this engenders super-cyclical disequilibrium in the economy over time.
Besides being a necessary corollary of a now discredited fiscal Keynesianism the abandonment of
this key principle of economic symmetry (although it could never be fully banished from the
public consciousness21) was justified on the grounds that adherence to the principle somehow
exacerbated or even caused the great depression of the 1930s. However, as I shall discuss later the
true cause of the great depression (as is now widely acknowledged) was monetary and not fiscal in
nature and the autonomous principle of balanced budgets neither caused nor aggravated the
problem – though it did supply a convenient scapegoat.

20
Running down infrastructure in order to pay for tax cuts that push receipts to the left of the Laffer curve optimum
will also undermine productivity and hence the national standard of living. Unlike monetary policy supply-side
solutions are heavily constricted (by the apriori law of returns) as to their flexibility; something American
“Conservatives” have only recently come to discover – the hard way.
Supply-side economists (Conservatives) and demand-side economists (Keynesians) are alike in dismissing or
ignoring the issue of balanced budgets. They represent, as it were, twin aspects of the same productivity undermining
malaise.
It is possible that a flexible flat tax, adjustable in the 30-40% range (with low income exemptions) besides
rationalizing horrendously complex tax codes of Western nations (the U.S. tax code alone runs to over nine million
words) and increasing compliance would also put an end to the whole sad issue of Supply-side Economics. It would
also make the optimum tax receipt implied by the law of returns easier to estimate in practice.
21
The symbol on the seal of the U.S. treasury (which features on dollar bills) is a pair of balanced scales – but the
founding fathers were (it is true) blissfully ignorant of the terrible twins - Keynesian Consumption theory and Supply-
side economics.
 As regards the current economic crisis (or super-cyclical downturn22) there is, by contrast, no
doubt whatsoever that a major causal factor has been the persistent deficit spending of Western
governments (for supply and demand side reasons) underwritten and made possible by the de-facto
abandonment of the unjustly maligned or otherwise neglected principle of balanced budgets. And
there is also no doubt that the major theoretical justification for this abandonment was and still is
provided by irresponsible supply and demand sided economists alike, however they (the Tweedle-
Dum and Tweedle-Dee of the economics profession23) might protest to the contrary.

22
Given the conclusions reached in the next section it is always more accurate to speak of magnitudes of economic
fluctuation rather than to business cycles and super-cycles. All that truly differentiates a so called business cycle from
a super-cycle is its magnitude. The correct analogy (since these phenomena are all governed by power-laws) is with
phenomena like earthquakes or storms, which differ from each other only as to magnitude and frequency – and have
no cyclical element, although the patterns of destruction they cause are repeated.
23
Since both generate persistent enervating budget deficits.
11. Is there a Business Cycle?

Ultimately the application of the law of returns to tax receipts coupled with the principle of
balanced budgets (both of which are apriori in nature) have the combined effect of making fiscal
policy invariant in character and autonomous of (equally invariant) monetary policy – thus
allowing fiscal policy to exert a consistently stabilizing and reliable element in a symmetrical or
equilibrial economy. Increased debt by contrast is inherently disequilibrial and ultimately
undermines national productivity and hence standard of living. Yet increased debt is what, in
practice, results from both supply side and demand side economics alike.
The purpose and effect of invariant monetary and fiscal policy is to minimize or smooth
fluctuations commonly associated with the business cycle. But if these fluctuations are caused, as
seems likely, by shocks to the supply and demand for the various factors of production (with a
special focus on capital), then the random character of such shocks should contradict the common
assumption amongst economists of a cyclical character to these fluctuations.
When shocks occur to the cost and availability of capital it is undoubtedly the case that these
shocks affect interest rate sensitive sectors (such as capital goods or the financial sector) more
severely and more immediately than other less sensitive sectors24. Observing this tendency
economists of almost all modern schools (since the time of Ricardo) have concluded that this is
evidence of a cyclical character to these fluctuations, but this conclusion merely reveals a basic
error of logic.
If a shock of some type strikes a system of some type it is likely that some elements of that system
will be more affected than others. Furthermore, this pattern of influence is likely to repeat itself
whenever shocks of a similar character affect the same type of system. The fact that a pattern tends
to repeat itself (with variations) whenever a system experiences a particular type of shock does not
render the shock itself any less random or any more cyclical in character. So it is with the pattern
of events that commonly distinguish business fluctuations.
The sensitivity to interest rates exhibited by particular sectors seems to stem from the speculative,
forward looking character of these sectors. The purchase of capital goods for example can often be
delayed if a recession appears to be looming or if interest rates seem to be abnormally high – or
conversely they can often be brought forward if business conditions seem to be improving. The
purchase of consumer goods by contrast tends to remain comparatively constant irrespective of
economic conditions and interest rates – their purchase rarely has a speculative character to it.
Thus the market for capital goods tends to be interest rate sensitive whereas that for consumer
goods tends not to be.25
Further confirmation as to the essentially random character of business fluctuations is provided by
the following two graphs26;

24
Interest rate sensitive sectors seem to have been a much less prominent part of the pre-industrial economy which is
why these types of fluctuation are associated with the industrial and post-industrial eras. These types of fluctuation
(driven primarily by shocks to the cost and availability of capital) were first noted by economists at the end of the
Napoleonic wars and quickly became a major topic of academic discussion.
25
Hence also the debilitating effects of artificially low interest rates on these very sensitive sectors as noted by
Wicksell, K Interest and Prices (1898) and Mises, L. The theory of Money and Credit (1912).
26
Hansen, Gary D. 1985. "Indivisible labor and the business cycle." Journal of Monetary Economics, 16, 309-327.
 The long term upward trend of United States GNP (at least in the second half of the C20th) is
clear and apparent from figure 1, but in the next graph it is equally apparent that deviations from
this strong trend (in essence corresponding to what we call business cycles) have a random, non-
deterministic, character. Indeed Fourier analysis on this and similar data definitively reveal there
to be no cyclic element at all to be present.27 Thus those economists and schools of economics
which assert or assume such a phenomenon as the business cycle seem to be guilty of both a
logical and an empirical solecism.28
And indeed just a moment’s thought should have revealed to these fine people and institutions
why this must be so. Since, were it not so then this would imply that an arbitrage opportunity
existed for profiting from the presence of such illusory cycles – in clear violation of the efficient
market hypothesis.
Now the efficient market hypothesis is not a perfect representation of real world conditions but it
is an accurate enough expression of the real state of affairs for us to be able to rule out once and
for all the meaningful reality of a business cycle as such. And if economists claim that they do not
refer to something cyclical when they refer to the “business cycle” then it seems reasonable to ask
them what exactly do they mean?

27
The same is true for other economic time series such as those relating to output, inflation, unemployment,
investment etc. (Hansen 1985. Ibid), which might be said to be elements of the second graph. Rather, as ought to be
expected, there is the character of a random walk or Brownian motion to all these time-series. Fluctuations can
however vary dramatically in magnitude and duration, indicating that these data sets obey a “fat-tailed” Levy
distribution rather than a normal Gaussian one. It also indicates that these fluctuations are governed by a Pareto
power-law inversely relating magnitude to frequency – something which seems to accord with observations; i.e. that
the deepest recessions are the rarest and the shallowest recessions are the most common.
Since Levy distributions exhibit infinite variance and are mean diverging (in contrast to Gaussian distributions) it also
implies the potential for recessions of such magnitude that they are not susceptible even to the most strenuous
monetary policy of the most symmetrical economy, recessions that outlast civilization itself. Presumably this might be
because of the finite character of resources.
28
Perhaps the most expansive instance of this fallacy in its most determinate form is the historical work of Marx and
followers such as Schumpeter which is given perhaps its strongest theoretical statement in the following remark by
Schumpeter;
“For if one thinks of business cycles as the typical form of capitalistic evolution and if one looks upon those long
time movements, which are sometimes called industrial revolutions, as one species of business cycles, it is but natural
to link up with the cyclical phenomenon practically the whole of the economics and sociology of capitalist society.”
Schumpeter letter to Homan, 2 Apr. 1938, in Hedtke and Swedberg, eds., Briefe, 309.
12. The Commodity Theory of Money.

The notion that shocks to the supply of money (commonly instigated by interest rates that are
persistently lower than their natural rate) are the primary cause of business downturns is a notion
which undermines the classical idea of the neutrality of money – which is the view that money is
something which facilitates the exchange of goods and services (due to the double coincidence of
wants) and which exerts no influence beyond this basic function.
Mill standardized this view of “money as a veil” in his great work Principles of Economics
(1856). Yet in that same work, as we shall see, Mill was also an early exponent of the view –
thought to have originated with Keynes – that downturns in the economy are caused by a scarcity
of money. Keynes of course, unlike Mill, suggested solutions to this state of affairs other than
leaving it to economic forces. I have suggested a synthesis which absorbs the Keynesian critique
but which still allows market forces to dictate corrections to the money supply – a situation which
is already de-facto the case anyway as I have sought to show. As I shall argue later this state of
affairs serves to contradict Keynes’ supposed refutation of what might be called the fundamental
principle of classical economics (that free markets are efficiently self-correcting) propounded by
him in the General Theory of 1936.
Mill therefore seems to express contradictory views regarding the theory of money, but, as we
have already seen (section 6), it is possible to restore a belief in the ultimate (net) neutrality of
money even today. Nevertheless the current view remains that (due to economic frictions) the
quantity and supply of money exerts an important psychological and material influence on the
operation of the economy over and above its more humble role as a medium of exchange. Despite
my (diachronic) “net-neutrality” theory there seems no reason to dispute this synchronic (non-net)
view so long as we recognize it to be an incomplete, purely synchronic analysis.
As Keynes realized, this (non-net) state of affairs contradicts an assumption of Say’s law which is
that money is (non-net) neutral. As Keynes further realized Says law is fundamental to classical
economics which can only be maintained assuming it.29
Say’s law which states that supply always generates its own demand underpins the theory of
supply and demand equilibrium as described by classical economics. Under a laissez-faire system,
due to the operation of Say’s law, adjustments should always erase imbalances that lead to an
excess of supply or demand. Thus Keynes is correct in targeting Say’s law as the lynch-pin of
classical economics.
Irrespective of Keynes’ analysis of the fundamental logic of Say’s law (and we shall discuss this
central issue in greater detail in the next section) it is clear that the theory of money assumed by
Say is somewhat naive or incomplete. Of particular significance is the fact – never acknowledged
by Say30– that due to fluctuating interest rates the storage of money may take on a speculative
character in its own right. In this case – highlighted by Keynes as the crux of his attack on classical
economics – money has ceased to act merely as a humble medium of exchange but has instead
become propelled to the center of the economic stage as the principle actor.

29
Keynes, J.M. General Theory. 1936. Book 1 chapter 2.
30
Say, J.B. le Traité d'économie politique 1803
 But is this lacuna in the analysis of money implied by Say’s law necessarily fatal to it as Keynes
assumes? Or is an adjustment possible in the light of Keynes’ critique? The fact that the hoarding
of money helps to precipitate a downturn implies - contra to the assumption made by Say - that
money is itself a good. This implies that money should be analyzed under the same assumptions
that might be used to analyze any other commodity – i.e. as something with its own independent
supply and demand conditions.31 In other words Say’s law also applies to money if we reinterpret
money as a commodity in its own right. Making this adjustment has the effect of resurrecting and
strengthening Say’s law in the wake of Keynes’ attack.
Granted this assumption we are then empowered to understand exactly why recessions take the
form of an excess demand for money over other goods. In essence an imbalance is created which
privileges the demand for one particular commodity (money) over that of all others. If market
forces are allowed to satiate this particular demand (using the flexible market driven mechanism
described earlier in this paper) then equilibrium will once again be restored to the economy in full
accordance with Say’s law and without Say’s law having once been violated.
Once again the irrelevance of the “fiscal expansion” solution to this highly specific monetary
problem is brought into sharp relief. But, more importantly, a means of rescuing the integrity of
Say’s law is presented to us. By adjusting our understanding of what money is (that it is also a
commodity as well as a medium of exchange32) it is apparent that Say’s law can be made to apply
to money (in the manner just discussed) in exactly the same way that it applies to any other
commodity. In doing so, the valid elements of the Keynesian critique can be absorbed without the
need to abandon Liberal economics.

31
We are assuming for the purposes of this discussion that money is fiat money – that is not directly linked to the gold
or silver markets. The analysis still applies to earlier monetary systems however, with all the necessary (but needlessly
confusing) qualifications.
32
As a point of theory all commodities (including money) have this double aspect (as potential objects of speculation
and as potential media of exchange).
13. Logical Foundations of Keynes’ General Theory.

Say’s law in essence assumes that supply always generates demand. This is because producers
produce in order to consume other goods and services which they obtain in exchange for their own
produce. This indicates to us the underlying psychological motivation of production – which is
consumption or demand. It also suggests that the ultimate source of purchasing power is real
production.
Keynes pointed to the production gluts of the 1930s as evidence that Say’s law was infact false
and that therefore involuntary unemployment could persist indefinitely as an alternative
equilibrium to that suggested by Classical economics. This conclusion led him to the fundamental
thesis with which he opens the General Theory;

“I have called this book the General Theory of Employment, Interest and Money, placing the
emphasis on the prefix general. The object of such a title is to contrast the character of my
arguments and conclusions with those of the classical theory of the subject, upon which I was
brought up and which dominates the economic thought, both practical and theoretical,
of the governing and academic classes of this generation, as it has for a hundred years past. I
shall argue that the postulates of the classical theory are applicable to a special case only
and not to the general case, the situation which it assumes being a limiting point of the
possible positions of equilibrium. Moreover, the characteristics of the special case assumed
by the classical theory happen not to be those of the economic society in which we actually
live, with the result that its teaching is misleading and disastrous if we attempt to apply it to
the facts of experience.”33

However our analysis of money redefined as a commodity in its own right (something one might
call the “coming of age of money”) and the associated reappraisal of Say’s law in the light of this
analysis causes us to balk at the idea that a prolonged downturn caused by rigidities in the money
supply can fairly be characterized as an alternative equilibrium to the classical (as Keynes sought
to characterize it). What it instead represents is a disequilibrium which, due to the rigidity of the
money-supply at that time, continued to persist for several years – just as classical economics
would predict that it should.
Probably the best way to explain the precise distinction between market equilibrium and market
disequilibria is with reference to the Neo-Classical concept of Pareto-optimality. On this definition
the economy may be said to be in optimal equilibrium when, by any given reallocation of
resources no one can be made better off without making someone else worse off- i.e. there is no
distributable surplus.34 This can be considered the equilibrium condition perfect markets naturally

33
Keynes, J.M. General Theory of Employment, Interest and Money. 1936. Book 1, Chapter 1.
34
Maurice Allais (1989) La Théorie Générale des Surplus. Grenoble: Presses Universitaires de Grenoble.
This definition of Pareto optimality seems to correspond closely to the definition of a Nash equilibrium. A Pareto
optimality refers to a set of allocations (in effect strategies) in a market which is a “best response” to all other possible
strategies of allocation. A Nash equilibrium arises when an agent cannot improve their condition by changing their
strategy of allocation. The market is perhaps best analysed as approximating a Bayesian Nash equilibrium (see
Harshanyi, J; ) – i.e a Nash
equilibrium with imperfect information. This analysis would seem to underpin the Classical theory of market
harmonics (see Bastiat, F; 1996 (1850). Economic Harmonies, trans. by W. Hayden Boyers; George B. de Huszar, ed.,
with introduction by Dean Russell.)
This implies that a Pareto optimum approximates or equals a special case of (Bayesian) Nash equilibrium – and thus
that economics itself (defined narrowly as the science of exchange and of the allocation of scarce resources by
preference maximizing agents) is a special case of Game Theory.
gravitate to except where imperfections or interventions exist to prevent it. All other (sub-optimal)
conditions may be said to be disequilibrial. 35
Thus the notion that a persistent downturn in the economy – even a severe one like the Great
Depression - invalidates Classical economics is a dramatic, even a bizarre assumption to make.36
On the subject of recessions Ricardo had long ago made the following pertinent point;

“Too much of a particular commodity may be produced, of which there may be such a glut in
the market as not to repay the capital expended on it; but this cannot be the case with respect
to all commodities.”37

Keynes presumed that the Great Depression refuted Say’s law and hence Classical economics
because it seemed as if the demand for almost all goods had collapsed simultaneously thus
contradicting Ricardo’s above statement in defence of Say’s law. However, given our appraisal of
money as a commodity in its own right it is apparent that the point made by Ricardo applies even
in the case of the Great Depression; a glut in material commodities was exactly counter-balanced
by a dearth in money. From which we must conclude that Say’s law is not overturned by this
instance, notwithstanding the extremity of the case.
As mentioned in the last section Classical economics had already noted the case that a general
depression might be brought on by a demand for money

“I have already described the state of the markets for commodities which accompanies what is
termed a commercial crisis. At such times there is really an excess of all
commodities above the money demand: in other words, there is an under-supply of money.
From the sudden annihilation of a great mass of credit, every one dislikes to part with ready
money, and many are anxious to procure it at any sacrifice. Almost everybody therefore is a
seller, and there are scarcely any buyers; so that there may really be, though only while the
crisis lasts, an extreme depression of general prices, from what may be indiscriminately called
a glut of commodities or a dearth of money. [Italics mine]"38

Thus the crux of the Keynesian criticism (stemming from the experience of the 1930s) had
already been noted by the Classical economists (who presumably knew a thing or two about
depressions), as had the putative solution; monetary expansion.
All that was lacking from the Classical model – even of the mid nineteenth century – was an
explicit analysis of money as an independent commodity in its own right – an analysis which it has
perhaps required the era of fiat money to supply. With this in place it is therefore clear that Say’s

35
Some important works on this central Neo-Classical concept are;
Vilfredo Pareto (1906) Manual of Political Economy. 1971 translation of 1927 edition, New York: Augustus M.
Kelley.
Hicks, John. Value and Capital. 1939.
Paul A. Samuelson (1947) Foundations of Economic Analysis. 1983 edition. Harvard University Press.
36
More bizarre still is the lack of serious challenge with which it was met – suggesting something of the confusion
and dismay that was generated by the Great Depression.
37
Ricardo, D. On The Principles of Political Economy and Taxation. Ch 21. 1817
38
Mill, J.S. The Principles of Political Economy. Book III, Ch 14. 1848.
In effect Mill is describing the devastating effect on credit and money supply of the sudden bursting of a bubble
economy with generally inflated prices – and the knock on effect on demand, output and employment. Suddenly
people switch from spending to saving, as if in a twinkling moment – due to the contraction of credit.
The economy can be reflated with monetary policy, but better not to have allowed credit conditions (artificially low
interest rates) to create the bubble in the first instance.
law and the associated fundamental principles of Liberal economics still obtain – notwithstanding
the analysis of extreme cases of the decline in effective demand made by Keynes.

Where does all this leave us with respect to Keynesianism as a doctrine? We must undoubtedly
downgrade the status of the General Theory from that of a valid alternative to Liberal economics
(it is certainly not this) to that of a partially valid “real world” critique of Classical and Neo-
Classical economics. It focuses more sharply on a specific case (relating to the under-supply of
money) which is insufficiently stressed by the classical literature, but which is nevertheless of
critical practical importance. This task of bringing the issue to center stage is brilliantly done by
Keynes and further extended in important ways by his successors, including the Monetarists, the
Neo-Classicals and the Neo-Keynesians. Indeed it is quite clear that Keynes sets the agenda in
economics down to the present day – even for his opponents.
Where Keynes goes amiss – and it is clearly apparent from the above quoted passage from the
General Theory – is in overstating his case. If Keynes had instead titled his work the Critique of
Employment, Interest, and Money and had placed this critique in a Neo-Classical context (as an
adjustment theory) then the work would have rested on much surer ground and resulted in much
less unnecessary controversy.39
Instead Keynes appears to have been misled by a fanciful analogy he saw between his own work
and the roughly contemporaneous work of Albert Einstein. This is clearly apparent in the language
he uses in the above quoted passage relating to the distinction between classical economics as a
“special” theory and his own theory as the more “general” case, which mirrors a distinction made
between elements of his own work on relativity by Albert Einstein (who did correctly deploy the
distinction). Sadly this is a case of self delusion by Keynes and of misplaced “physics envy” on
behalf of economics. And it perhaps underlies his misguided and unnecessary attack on Say’s law.

In essence, as stated earlier, Keynes confuses the concept of disequilibria (caused by market
rigidities and imperfections) with that of alternative equilibria. He assumes that the former are
really the latter and this leads him to overly grandiose claims that his critique is in reality an
alternative and more encompassing general theory. But Classical economics as we have seen and
as Keynes should have known was already familiar with the concept of market imperfections
(including those for wages and prices as discussed by Keynes) and was already well aware that the
persistence of such imperfections can result in chronic and persistent sub-Pareto-optimal
performance by the economy. After all, the evidence was continually around them.
But as soon as these imperfections are dealt with then Pareto-optimal performance will naturally
be restored (Keynes never refutes this idea because it is irrefutable). There is thus always a natural
gravitation to optimal equilibrium in an economy which can only be prevented by the appearance
of disequilibrium caused by rigidities (notably the gold standard in this case) and aggravated by
other imperfections in markets. Thus, contra Keynes, there can only be one equilibrium in an
economy, though there may indeed be (as Classical economics had already noted) many
disequilibria caused by various transient obstacles.

39
Also if he had placed the stress on monetary rather than fiscal policy solutions then this would also have been an
improvement, but this is a secondary issue already discussed by this paper. Besides, the ambit of monetary policy –
crucified on a cross of gold so to speak – was much less in his day, still less in Mill’s.
14. Is Keynesianism a Special Theory?

The practical implication of Keynesianism and its failed epigone Monetarism is the fostering of
mild inflation so as to overcome deflation and neutralize rigidities in wages and prices. It is based
on the assumption that involuntary unemployment is caused by above equilibrium wage levels and
since wages, like prices tend to resist classical corrections during a recession (for largely
psychological reasons) then wages and prices may be cut indirectly through inflation.40
This is the gist of the practice of Keynesianism and, like our analysis of theoretical foundations in
the last section there is nothing (other than a note about human psychology and the apparent need
to adjust for it) which contradicts the Classical model. The Classical model we may remember
asserts that markets always tend towards optimal equilibria unless some imperfection (which
might include aspects of human psychology) interferes with this tendency. Keynes, inspite of
noting valid practical reasons for intervention, does not refute this doctrine.41
Furthermore it is clear that all four approaches to monetary policy in the light of Keynes’ critique
(Keynesianism, Monetarism, Neo-Keynesianism and the alternative approach sketched out at the
beginning of this paper) are basically variations on a theme, that theme being classical counter-
cyclicality. I favour the fourth approach simply because it is more developed and is ultimately
interpretable as a function of the market itself – the market corrects even for its own endogenous
“imperfections”. It is also more efficient in all respects.
But, most importantly and as Friedman intuited in his own case, these approaches to monetary
policy are all implied as special cases of the so called Quantity Theory of Money. This I think can
be proven quite simply with special reference to the velocity of money equation at the heart of this
theory42;

MV = PQ

Where M represents the total money supply, V represents the total number of transactions (or
velocity of money), P represents general prices and Q represents the quantity of goods in the

40
Of course when labour became wise to this technocratic approach unions started to insist on tethering wage
increases to the consumer price index, thus neutralizing the benefits of an inflationary policy and opening the path, as
Milton Friedman predicted (Essays in Positive Economics. 1953. University of Chicago Press) to stagflation. Herein
lay the Achilles heel of practical Keynesianism.
41
Having said this, the optimal inflation rate is zero in a perfect or evenly rotating economy. This is because inflation
fosters consumption over savings and hence investment. The result is a progressively less sophisticated economic
structure than might otherwise have been the case. In extreme cases of hyperinflation savings are destroyed (what
Keynes famously referred to approvingly as the euthanasia of the rentiers) and hence investment is also destroyed
(since savings equal investments) and, ultimately, the structure of production itself. Thus the fostering of inflation –
which must accelerate over time to maintain the same effect - is not without its consequences and can be a myopic
policy to promulgate.
Conversely of course deflation, in as much as it creates unemployment (due to the paradox of thrift) also leads to a
contraction of the economy as Keynes noted. Thus the fostering of a very mild rate of inflation (fractionally above
zero) is indeed the logical practical policy (as Keynes implies) – since the economy is not perfect and evenly rotating.
Nevertheless, in practice, this is very hard to achieve given the acceleration effect just noted.
But an optimal lack of bias is something a self-organizing monetary policy would tend to deliver over time – hence
the greater benefit of the monetary policy recommended in this paper.
42
The quantity theory of money is in reality a tautology and has only been misnamed by mathematical economists
with limited understanding of mathematics. As an apriori tautology it in reality carries far more weight than a mere
theory. Perhaps physicists should envy economists now? I think so.
economy – all in a given period. In general PQ may be interpreted as representing Gross Domestic
Product or GDP.
The special case described by Keynes’ in the General Theory refers to a dramatic fall in effective
demand – this is in essence the inspiration behind his work. Now in terms of the above equation
this situation can be easily rendered (for simplicities sake) as a situation in which V (representing
the element of effective demand) has fallen off dramatically even though M (the supply of money)
may have held fairly constant. The out come of this is a dramatic fall in Q (given some assumed
rigidity in P). The situation, in other words is perfectly represented as a special case of the quantity
theory of money.
The same is true for the analysis made by Friedman43. In his work with Anna Schwartz, Friedman
takes issue with Keynes and argues that the true cause of the collapse in effective demand was a
dramatic fall in the money supply (due to outflows of specie caused by the trade deficit and due to
other factors such as hoarding). In reality the two accounts are complementary since the outflow of
gold (whatever the cause) would have exerted deflationary pressures on wages and prices. Given
the rigidity of these (discussed by Keynes) the inevitable result was prolonged involuntary
unemployment.
Nevertheless Friedman’s brilliant refinement of Keynes analysis can also easily be represented in
terms of the quantity theory of money. In this case both M and V (or possibly just M) suffer a
dramatic decline resulting in a dramatic fall in Q and a somewhat less marked decline in P.
Even the empirical figures seem to stack up since a decline of the money supply of around 25%
(estimated by Friedman) should result in a similar fall in output (QP). In reality it is commonly
agreed that the actual fall in output was something of the order of 30% - which implies that the
excess between the two percentages is made up for by a fall of around 5% in T or the velocity of
money.

In addition to diagnosis the quantity theory of money also perfectly describes the prescriptions
recommended by Keynes, Friedman and (latterly) by myself in severe cases like this one. Keynes
prescribed leading with a fiscal expansion designed to boost V in the form of government
spending. My own recommendation (ignoring the halfway house of the Neo-Keynesians for a
moment, inspite of its current dominant status) involves avoiding fiscal stimulus altogether44 and
concentrating instead on boosting the money-supply (M) thereby overcoming the liquidity trap
represented by negative real interest rates. This will in turn incentivize private spending by
consumers and investors and lending by banks – a preferable solution to less efficient and costly
public spending programs and more in keeping with the classical model so unjustly despised by
Keynes.
The point is that all these types of instance – their causes and putative solutions - are easily
expressible in terms of the quantity theory of money implying that yes these instances (as well as
all the less extreme cases experienced by the economy) and the theories associated with them are
indeed special instances of the more general (Classical) quantity theory of money.

43
Friedman, Milton and Schwartz, Anna (1963). Monetary History of the United States, 1867-1960. Princeton
University Press.
44
Except through the mechanical operation of automatic stabilizers in the guise of the welfare system – which
represent the legitimate ambit of fiscal expansion.
15. Austrian Economics – the True Red-Wedge?

We have discussed what might be called the combined Keynes-Friedman account of how a drastic
contraction of the money-supply (which Friedman believes always precedes a contraction of
output and employment) combined together with natural wage-price rigidities (identified as a key
aggravating factor by Keynes) to create and sustain the Great Depression.45
In Britain its effects were much less pronounced (there was no banking crisis for example)
because the government quickly devalued the pound relative to gold (without an associated fiscal
expansion) as early as 1930 – also, monetary policy had not been as lax in the 1920s as was the
case in the United States. In a sense therefore, counter-cyclical monetary policy does pre-date
Keynes who was possibly the first to theorize it however (although see the comment made by J.S.
Mill in 1848 and reproduced in section 13 above). It is a telling fact of history that America did not
experience a similar alleviation until it too devalued its currency relative to gold (by over 40%) in
1933.
These devaluations equate very closely to the use of quantitative easing under a so called “fiat
money” system. The primary benefit of such a system is that it is not tied to the random exigencies
or vicissitudes of one particular commodity, unlike the gold-standard. Money can therefore act, as
discussed earlier, as a commodity in its own right, unhindered by the independent and sometimes
crippling demand for gold as a commodity in its own right.

In effect the gold standard represents apriori government interference in the smooth running of the
free market system because it artificially pegs the value of one particular commodity (gold)
relative to all others. This blatant government interference generates an unsustainable strain in the
free-market system as a whole leading eventually to an inevitable crash (unless aggregate output
remains as inelastic – i.e. stagnant - as the supply of gold). This is precisely what happened in the
1930s.
It is also probable that the continued difficulties of the U.S. economy in the late thirties is linked
to a continued rise in the demand for gold even after the devaluation – since this is a common
tendency of the gold market: to act as a natural hedge against uncertainty. But of course it is
precisely this tendency which makes the gold standard such a dangerous system for governments
since it may dramatically aggravate the conditions during a financial crisis. Even if wages and
prices did not exhibit a certain inflexibility they would definitely have trouble adjusting to the
speed and magnitude of price moves in the underlying gold market – unless that market were
artificially pegged – at enormous cost – by the government. But of course, such a market system is
hardly a free one anymore is it?
So called “gold bugs” favour this system because it artificially converts the currency into what
amounts to a free call option on the gold market of unlimited duration, underwritten by hapless
governments. Gold-bugs know that if they stock up on gold (even if they must do so early in order
to avoid government restrictions on the gold market) then the highly inelastic character of the gold
market combined with the highly elastic character of aggregate output in the economy will doom
45
For a complete general account of primary causes one should also apply the Wicksell-Mises theory (briefly
described in section 3) to describe the period of loose credit which preceded the crisis; notably the artificially low
Federal Reserve discount rate from 1925 onwards combined with extremely lax regulation of the entire financial
sector during the 1920s. This meant that the credit contraction (relative to prevailing wages and prices) when it finally
did come was all the more severe and dislocating. The parallels with 2008 are in fact quite startling.
the gold-standard du jour to inevitable destruction at which point they will receive a clear and
unambiguous profit taking signal.46 The gold-bug will then (after counting his or her guaranteed,
government supplied profit) accuse the eternally wicked government of having caused the crisis by
willful (in fact unavoidable) inflationary policies, sagely exhorting an immediate return to an even
stricter gold standard as the only possible means of ensuring future fiscal rectitude.

The underlying problem with a gold standard (however constructed) is that it represents artificial
government intervention in the self-organizing process of free-markets. Ordinarily this might be
sustainable, but in a modern economy the increasingly elastic character of output clashes violently
with the highly inelastic character of the gold supply. Again this might not be unsustainable except
that due to natural market rigidities the natural downward adjustment of wages and prices cannot
happen – thereby generating a permanent deflationary liquidity trap and a situation of persistent
involuntary unemployment – which is infact what happened in the 1930s.47
This is why the advocacy of a strict gold standard combined with an equally strict adherence to
the principle of Laissez-faire always inadvertently acts as a potential wedge for Marxist agitation –
because of the dreadful economic conditions they inevitably combine to give rise to. And it is
precisely these two ultimately self-contradicting principles (since a gold standard, however
configured, is intrinsically not Laissez-faire) which constitute the primary economic prescription
of the Austrian school.48
In a truly free-market system by contrast (one which is sustainable) currencies – like other
commodities – would not be pegged relative to one another or relative to one artificially exalted
commodity (gold or whatever) but would instead float freely relative to each other and to all other
commodities in general dynamic equilibrium.
Indeed it is precisely this completely relativistic character of all free markets (including gold)
which accounts for their peculiarly Zen-like tendency to mutual self-adjustment.49 Furthermore,
these adjustments act like a continuous running commentary on the performances of governments
and individual firms which further serves to promote greater stability in the truly free economy.

Thus a fiat money system, provided it rigidly reflects the broad rate of inflation is always a
superior, more independent vehicle than a fiat gold standard. However, the power for harm of a
fiat money system set to track an artificially narrow definition of inflation can clearly be seen in
an analysis of the economic history of the 1990’s and the 2000’s. This is exactly why the

46
When Bretton-Woods collapsed in 1971 for example the price of gold rapidly rose tenfold above the price at which
it had been artificially pegged ($35). The profit potential for the gold bug is enhanced because the highly convenient
and guaranteed profit taking signal (i.e. the collapse of the gold-standard du jour) always comes at or around times of
maximum economic crisis – thus ensuring that the price of gold is at a highly elevated price level. In reality the
guaranteed profit enjoyed by the gold bug is due to market inefficiencies caused by the very existence of a gold
standard which artificially pegs the value of gold by government fiat. They are in effect acting as profiteers in times of
general crisis.
47
It is interesting to speculate to what extent the repeated depressions of the nineteenth century are also traceable to
the rigidities of the gold-standard.
48
True Classical economics sets up an implicit critique of the (intrinsically un-free and damaging) gold standard
system. Modern Liberal economics makes this critique explicit.
Although Austrian economics deviates from Liberal free-market economics in this respect it is a serious enough
deviation to cause the permanent marginalization of an otherwise highly productive and thought provoking school of
Neo-Classical economics. What they fail to grasp is that Keynesianism always trumps them for this one reason which
is why a subtler approach to the theory of money is required.
49
Gold itself would be liberated allowing it to serve as the great economic barometer it truly is (second only to oil
these days), instead of needlessly bringing the system to the point of nervous collapse. Gold-bugs could still speculate
in it on this basis, but on a level playing field, not with a huge government supplied advantage.
consistent - ideally mechanical - tracking of the broadest possible measure of inflation is a key
principle of a sustainable invariant economy. Once embraced the public and entrepreneurs would
have little choice but to accept the manifest logic of such a policy – thus making it politically
easier for successive governments to consistently adhere to. Thereafter money would enjoy the
benefits of complete soundness and flexibility and money-supply would be de-facto free, for the
first time in history perhaps, of government interference.
16. Apriori Elements of a Symmetrical Economy.

The principle of symmetry or invariance is equivalent to that of dynamic general equilibrium in a

self organizing economy. An economy will migrate naturally to classical equilibrium if the
following seemingly apriori conditions of economic symmetry are met;

1). All markets without exception are free to adjust relativistically.50 We assume here that the
concept of individual freedom has an apriori or intrinsically rational character to it and that this
character logically extends to the concept of free-market production and exchange. (This
hypothesis will be demonstrated in Part Two).51
2). Optimization of legislation regulating business. Compliance would apply to three main areas;
protection of workers rights, protection of the environment and prevention of competition abuses.
The apriori law of returns would appear to apply to this element also, hence its inclusion as an
apriori element.
Incidentally the paucity of discussion on this topic inspite of its being a key supply-side issue
points to the lack of good faith amongst many upholders of so called Supply-Side Economics. The
optimization of business legislation (since it impinges on the concept of free-markets) is really a
critical and a difficult issue which we shall discuss later in greater depth – particularly as it
pertains to forces of entropy that threaten to eventually strangle the free-market system.
This optimization would imply a radical overhaul implying the need for greater streamlining of
legislation and bureaucracy on the bland principle that less is more.
3). Interest rates are logically set relative to the broadest most inclusive possible measure of
inflation; so as to prevent a situation arising wherein interest rates are set permanently below their
true natural rate (such as happened in the era leading up to the present). This in turn prevents a
situation of disequilibrium caused by the generation of excess credit and debt.
4). Interest rates and money-supply are free to adjust to bond market signals; (preferably
mechanically) in a consistently counter-cyclical way. This is apriori since it is really a special case
of 1.

50
Assuming that markets are free and that there are no internal or external barriers to investment and trade then the
true key to future productivity growth and growth in standards of living of any society (developed or undeveloped) is
the levels of savings and investments in that society. But these should never be artificially engineered by governments
(due to hidden costs of this) and so do not feature (directly) on this list.
The only way for governments to naturally boost savings and investments is the hard way – by taxing at or around the
Laffer optimum and by consistently balancing their budgets. But which governments these days wish to do these
difficult things?
51
The application of this principle to the labour market has interesting consequences for immigration and
demographics and yet its application to the labour market seems to be a natural corollary of Liberalism and the
associated theory of comparative advantage – both of which are quite clear on this issue; that nations benefit from well
regulated but liberal labour markets – even when other countries do not adopt them.
From a genetic perspective too it is very apparent that the distinctions between people are very much a matter of what
Freud has called the narcissism of small differences and that what sometimes appear to be sizable surface differences
between people are ultimately traceable to transient cultural and environmental variations. Thus the arguments against
the free movement of labour seem to be reactionary rather than rational in character – which does not alter their reality
unfortunately.
5). Tax-yields are set to approach, as far as possible, the optimum implied by the apriori law of
returns – which is given a clear visual form by the Laffer-curve. Supply-side measures are
objectively limited in what they can accomplish by the law of returns – they cannot endlessly
repeat early successes.
But monetary adjustment, by contrast, has unlimited flexibility for handling inflation and deflation
alike. Interest rates may be raised to infinity to fight inflation and money may be printed to infinity
to fight deflation. Monetary policy is therefore only limited by the magnitude of the problem faced.
The benefits of supply side measures tend to be one off or highly infrequent affairs by contrast.
6). Budgets are consistently balanced on an annual basis subject to the restriction implied by 5.
This principle effectively asserts the logical autonomy of fiscal policy from demand management.
Annual fiscal expenditure should logically be restricted to the sustainable maintenance of social
and physical infrastructure and should therefore be autonomous of other concerns – thereby
encouraging greater prudence. This implies annual balancing of budgets.
7). Deficit spending is restricted to long term intergenerational projects; of the positive sort (major
infrastructural developments) and the negative sort (wars for example). Positive projects could, in
principle, be brought forward during a recession – thereby approximating to a Keynesian fiscal
stimulus – but this should not be their primary justification. This element therefore represents the
valid exception to 6, as does the maintenance of appropriate welfare stabilizers during economic
fluctuations.
8). Maintenance of a rational foreign policy. The adherence to 6 and 7 seems to logically entail
this element as does the key principle of Classical Liberalism; that countries, like individuals,
should enjoy freedom without engaging in or being subjected to coercion and interference.52

Economies will still be robust, even if the above principles are transgressed, but will work more
efficiently (tending to the Classical case as if to a mathematical limit53) when there is less
transgression.
Although it is clear that the logical elements of a symmetrical economy have major political
implications of various sorts it is equally apparent that the maintenance of these optimal conditions
indicates political theory ultimately to be a zero-sum affair with respect to Right and Left – and
this too is an intriguing result of the apodictic concept of invariance as it is applied to economics -
since it implies that Liberal politics is an epiphenomenon of Liberal economics. Again we shall
discuss these issues in greater detail in Part Two.
It is equally clear that the above eight conditions represent an ideal case which governments
should nevertheless aspire towards and upon which they may be continuously and objectively
assessed. The fact that an ideal cannot always be reached in life (for example an ideal weight when
dieting) does not invalidate the existence of the ideal or the rationale behind seeking to at least
approximate it, on a continual basis, to the best of our abilities. Indeed such an aspiration would
itself appear to have a logical character to it.

52
See Mill, J.S. On Liberty 1859 for the classical statement of this principle as it applies to individuals.
53
In this case, as we shall discuss in Part 2 (sections 6 and 7), the more general theory, as Keynes never quite grasped,
is the subjective utility theory of value – which represents the true micro-economic foundations of macro-economics.
17. Atlas Shrugs or the Shirt of Nessus?

Even if the world economy itself were to conform to conditions of economic symmetry outlined
in the last section a new problem would probably arise out of this very equilibrium - as a function
of globalization. In essence what we find is that if global markets decline then the world economy
necessarily deflates. However, if the global market appreciates then commodity prices
(particularly oil) inflate catastrophically – which was not formally the case. It is unlikely that a
viable equilibrium exists between these two extremes, although there might exist some latitude of
flexibility.
Arguably an example of this entire cycle was encapsulated in the world economy in the years
from 2003 to the present. This possible phenomenon of world markets – which may already be a
permanent state of affairs – I have christened the Shirt of Nessus problem, after the notorious
constricting garment that slowly killed Hercules.54
In effect this is the reemergence of the debate originated by Thomas Malthus in the early C19th55
– concerning the finite nature of basic resources - and the same arguments continue to apply on
both sides of the debate along with new issues relating to environmental and other externalities of
the global economy. The primary difference is that globalization has demonstrably made this into
an urgent issue once again.

Thus it has been observed that in the energy crisis;

“We have a classic case of exponential growth against a finite resource.” 56

The problem of exponential growth (i.e. of periodically doubling consumption) raises the specter
of sudden and unexpected resource collapse from a situation of apparent plenitude.
The simplest example of the problem raised by exponential growth is the famous one of the
grains of rice on a chess board which double with each successive square; thus one grain of rice on
32 64
the first square rises to a total of 2 grains by the penultimate square and 2 grains by the last
square.
As such the discovery of new energy resources – even in enormous amounts – is quite
insignificant when confronted by an exponential growth problem. And yet most scientific experts
regard the supply of new undiscovered energy resources as being extremely limited. There is of
course an enormous literature disputing the issue in fine detail, but the real point is that even if all
these experts are wrong (and there is two, four or even eight times the amount of total recoverable
reserves we currently know about – and there almost certainly isn’t) it still makes very little
difference to the exponential growth problem.

Thus in the case of a modest annual growth in consumption of 2% of non-renewable energy

resources a doubling of consumption will occur every 35 years. If the annual growth in demand is

54
Made famous in the remarkable tragedy written by Sophocles The Women of Trachis. The Shirt of Nessus is
possibly a mythological reference to the constellation of the Hyades. See De Santillana G and Von Dechend H
Hamlet’s Mill (chapter 11) 1969. Non Pareil Books. for similar references in cognate myths.
55
But the specific point of the hypothesis relates to the predicament faced by the global bourse relative to the
commodities market (especially the fluctuating price of oil).
56
James R. Schlesinger (U.S. Secretary of energy) Time Magazine. April 25th 1977, p27.
5% (well within historical norms) a doubling of consumption will occur every 14 years.
Consequently, sudden resource collapse constitutes a mortal yet largely hidden danger to us,
almost irrespective of the amount of recoverable resources still available.

As in Malthus’ time however the solution, if there is one, does not lie with planning and
centralization, but with innovation and free markets. For example, if the Shirt of Nessus problem
as it affects all commodities, is an epiphenomenon of looming peak oil (as seems likely) then a
solution to this specific problem (of peak oil) would equally likely have a decisive effect on the
other elements as well, including the wider environmental problem.
One possible line of research that would decisively solve this central energy problem is research
into nuclear fusion which seems to have arrived at a critical mass in recent years, with
simultaneous projects in laser fusion and more traditional tokomak fusion reaching a very
advanced stage. Thus there is perhaps the realistic possibility of abundant commercially available
nuclear fusion later this century, coinciding very conveniently with the developing (seeming) peak
oil and related commodity crisis. Hercules might yet live awhile.
 Part 2:

The Science of Economic and Political Theory.

1. Economics as a Science.

Discussion of the practical issue concerning the very viability of modern economic life (see
previous section) touches also upon issues concerning the conceptual foundations of economics
itself and I would like to devote the second part of this work to discussing these.
Economics on the whole has a bad name amongst the general public who, agreeing with Thomas
Carlyle, tend to see it as a “dismal science” from which little good and much harm has ever
sprung. Indeed, many people do not see it as a genuine science at all, classifying it, perhaps, with
sociology or psychology - as a vale of necessarily conflicting and unsystematic opinions about
human nature. This state of affairs is not helped by the fact that the public tend to hear about
economics only when something goes wrong or when economists are in dispute with each other on
some issue. But this is akin to only considering the science of mechanics whenever our cars
breakdown or only when mechanics are in dispute with each other about the causes of a
mechanical failure.
One might argue that the above analogy is not exact because there is really only one mechanics or
one science of physics about which, from a theoretical perspective at least, there is no dispute. But
this is a naive or idealized view of the hard sciences since even today there are enormous disputes
concerning the interpretation of quantum mechanics for example or results in cosmology. Just as
with economics there is only one true science of physics – but we do not fully know all its
lineaments yet and there remain genuine grounds for dispute and interpretation at a practical and a
fundamental level as a result.
In the case of economics the analytical foundations would seem, if anything, to be more solid than
in the case of physics. This is because a lot of economic theory traces its roots to hard
mathematical logic such as the theory of comparative advantage57 and to accounting identities
such as that between savings and investments or the quantity theory of money. It is thus more
tempting to suggest axiomatic foundations to economics than to other sciences such as physics or
biology. This indeed is why I have given in to the temptation in this paper to suggest, with some
degree of confidence, an apriori or analytical character to all of the elements I believe constitute a
symmetrical or equilibrial economy (see Part One section 16 for these). This would not be a viable
approach in physics however, though it would be, up to a point, in mathematics.
As with mathematics and physics therefore, economics, utilizing the exact same methodology (of
deductive and inductive analysis), has generated a hard won body of knowledge of immense
practical and theoretical value which is usually taken for granted, unfairly, even though it is the
significant backdrop to all of our lives.
For this reason (i.e. that economics is a hard science, utilizing the same methodology as the other
hard sciences) I do not accept Friedman’s artificial division of economics into “positive and
normative” categories. I see no more justification for such a distinction in economics than I would
for the same distinction in mathematics or physics. Neither category carries any true meaning
particularly given that the methodology of the sciences (since Popper) can no longer correctly be
characterized as “Positivist”.58

57
From which apriori general theory we may logically deduce the special theory of the specialization of labour. One
imagines that even hunter-gatherer societies have primitive forms of labour specialization. The theory of comparative
advantage is therefore not synonymous with so called Capitalism. Marxist arguments against the specialization of
labour are, on the other hand, ipso-facto arguments in favour of subsistence living – albeit even hunter-gatherers, let
alone subsistence farmers, operate specialization of labour. Indeed, even ants do.
58
Popper, Karl. The Logic of Scientific Discovery. 1934.
 A distinction between empirical and analytical approaches might be valid however – for example,
the use of econometric studies to attempt to determine the optimum system and level of taxation
might be characterized as an empirical approach (econometrics) to an analytical goal (that of
determining the optimum level of tax returns).

As Kant suggested in the Critique of Pure Reason empirical and analytical analysis (deduction
and induction) combine together, inextricably, to generate much of science. Some limitations of
the Austrian School of economics for example may be traced to its rejection of the Kantian
critique of Rationalism.59
Against these types of Rationalist assumptions consider the Tarski, Gödel and Church theorems
concerning truth and logic. They indicate the intrinsic indeterminacy of truth and the inherent
incompleteness of logic and mathematics. Thus no complete system on purely Rationalistic (or
empirical) grounds can ever exist. And this is an irrefutable mathematical fact – transcending even
the Kantian synthesis.60
Thus Ludwig Von Mises’ analysis of economics imputes a degree of completeness to deductive
logic which is unwarranted by the facts. 61 In reality the inherent incompleteness of economics
accords with our interpretation of it as a genuine science (i.e. subject to falsification) and not
merely as a set of prejudices closed to any further debate in the light of experience.
This is not to say however that we cannot accord a more fundamental status to deductive,
analytical theories (such as Comparative Advantage) compared to more transient empirical
observations (such as the Phillips curve). But economics cannot justifiably exclude evidence of the
latter – inductive - kind (as Austrian economics has done) without thereby marginalizing itself
unnecessarily. This is because, as we have seen, even apriori truths (such as the law of returns as it
applies to tax receipts) must be interpreted, on a case by case basis, in the light of uncertain
empirical (i.e. econometric) data.

59
An equivalent Kantian antinomy in economics might possibly pertain to monetary policy and the choice between a
100% gold-standard (as advocated by the Austrians) and the variant of the fiat money system described in this paper.
However, if Austrian economists accepted that all forms of gold standard ipso-facto relied on government
intervention in the free market then it would follow that the only system that could logically be supported would be an
anarchistic free-banking model or else the sort of “fiat money” system described by this paper. Thus this latter system
perhaps has an apriori character to it lacking for other monetary systems.
60
My work Logic and Physics (freely available at scribd.com) conducts a thorough analysis of these and related
theorems and their full implications for logical philosophy.
61
“Reasoning is necessarily always deductive” (Mises, L Human Action, p18. 1949 San Francisco: Fox & Wilkes).
Mises here is reiterating a fundamental assumption of Rationalism. A Kantian however would argue that reasoning
also includes induction or inductive reasoning – an assumption which makes empirical science possible. At the very
least empirical data is required in order to apply logical reasoning.
2. Some Implications of the Economic Calculation Problem.

At the crux of the aprioristic interpretation of economics (which I identify with – allowing
empirical analysis as a useful but subordinate ancillary) are two concepts which it is important to
ensure. Firstly and most fundamentally there is the concept of the sovereignty of the individual
over his or her own actions and secondly there is the attendant concept of private property. If both
concepts are granted as apriori in character (as Classical Liberalism argues) then the sovereignty of
the individual incorporates not merely freedom of action (freedom from coercion) but also the
freedom to own and to dispose of property (for example through free exchange) as they deem fit.
These are infact common assumptions and tenets of Classical Liberalism and so called
Libertarianism alike. But, though they might seem to be broadly rational assumptions are they
also fundamentally apriori (logically coherent and necessary) as well?
It is Ludwig Von Mises who, not for the first time, sheds the clearest light onto this problem,
albeit in an indirect way. In his famous work on the so called Economic Calculation Problem62
Mises argued that the efficient allocation of resources (both of the means and the factors of
production) is dependent upon the existence of some form of objective valuation mechanism.
Since valuation is an intrinsically subjective phenomenon (involving shifting individual
preferences) then this mechanism can express itself only indirectly or in a second order fashion.
By far the best and most sensitive and possibly the only such mechanism for expressing subjective
valuation or preference objectively is the price mechanism. The sensitive information provided by
the price mechanism – objectively derived only by means of free exchange – is thus the most
efficient means to allocate resources. An attempt to allocate resources by any other means
therefore has to first address this problem of objective calculation.
Having made these general points Mises then goes on to point out that forms of central planning
intrinsically lack access to any such mechanism except in the degree to which they compromise
with the principle of free-markets. The more centralized the ownership of the means and the
factors of production become the less access a society has to an objective mechanism of economic
calculation (derived through free exchange of goods and services) and hence the less efficient will
be the allocation of resources in that society.
Socialist commonwealths, of whatever stripe, would congenitally lead, Mises predicted, if not
necessarily to famine and dearth then at least to stasis and stagnation. 63 The hidden hand of the
free-market is effectively transformed into the dead (if well intentioned) hand of the central
planner, with a commensurate loss in liberty for all concerned. The market system by contrast,
following the Zen-like logic of the hidden hand, is simply a more efficient allocator of resources,
albeit via the medium of the subjective individual. Socialism however is like a violent reaching
after unripe fruit. It preempts the natural telos of Classical Liberalism.64
It therefore follows from these considerations that the most uncompromisingly rational mode of
social organization is the one most completely grounded in the superficially chaotic principle of
free exchange. Indeed, given the relative irrationality of the range of alternatives it implies that the
62
Mises LE 1920 Economic Calculation in the Socialist Commonwealth (O.O.P.), But also see Mises Human Action,
1949 San Francisco: Fox & Wilkes.
63
Mises made this prediction, on purely logical grounds, prior to the huge wealth of empirical evidence supplied by
the twentieth century.
64
Socialism is always stalking or snapping at the heels of open-markets, seeking to wrest-away the fruits of creation to
some noble yet simplistic planned social goal. It is, so to speak, the inefficient yet seductive shadow of free-markets.
principle of free-markets must be apriori in character. Furthermore, since free-markets necessarily
imply property rights and the freedom of individuals it follows that these must be apriori as well.
As a final point, political democracy itself would seem to be the ultimate rational extension from
this Misesian line of thought since free markets imply free societies and free societies imply
democracy. It should therefore be no surprise that Democracy has its origins with the Rationalistic
Greeks of the fifth century BCE.
3. Primacy of Logic over Mathematics.

Thus the foundations of economic and political science are clearly Rationalistic in character, but
do not therefore entail the abandonment of empirical methodology to shed light on and support
these foundations. Certainly, since the time of Keynes, because of his misrepresentation of
Classical economics and because of the practical challenges addressed by his system, the central
issue of logical foundations has been for the most part neglected by mainstream economics
including the dominant forms of neo-classical thought – such as the Chicago school. Because of its
outright rejection of empirical tools (even in a secondary role) and because of its irrational
adherence to the theory of the (government maintained) gold-standard, Austrian school economics
(even in the time of Mises who permanently lost tenure after the war65) has been progressively
marginalized. Thus the profoundly Rationalistic character of Economic theory has come to be
forgotten by the Academies.
Notwithstanding this state of affairs however if economics is indeed fundamentally an exercise in
logic as Classical economics implies and as the Austrian school explicitly maintains then it
necessarily follows that the mathematical approach (too easily used to lend all conceivable policy
ideas a spurious air of scienticity) be demoted from its current preeminence.
Logical analysis necessarily has precedence over mathematical analysis which in turn has
precedence over empirical analysis – though (contra the Austrians) all three have their place. This
point is inescapable, notwithstanding Kant who – in his effort to be inclusive - mistakenly sought
to imply the equality of these three elements66.
It is thus pointless to be proliferating mathematical models if the theoretical (in effect logical)
substructure is false or otherwise ill-founded. Elaborate mathematics is no substitute for logical
rigour since logical rigour may indicate to us that the theoretical substructure is in actual fact false
– thereby allowing us to economize on much useless, yet beguiling mathematics.
Perhaps the best example of this relates to the extensive mathematical analysis of the multiplier
effect deriving from Keynes’ General Theory. If we can establish apriori – i.e. using logical
arguments – that fiscal stimuli are always and everywhere an abuse of fiscal policy (because
demand management is not the legitimate use of present and future tax receipts) then it follows
that much of the elaborate and often inelegant mathematics that has been expended on the analysis
of the multiplier-accelerator has (to the extent that it was intended for purposes of demand
management) been a demonstrable waste of effort. And this we can show without deploying a
single equation – precisely because logic always and everywhere enjoys epistemological
supremacy over mathematics – however clever and demonstrative the latter may sometimes appear
in practice.

65
Hayek retained control of the London School of Economics after the war, but only because he embraced the new
empirical and mathematical techniques. Interestingly Hayek won the Nobel Prize in 1974 (immediately upon the death
of Mises) for work largely originated by the strangely neglected Mises.
66
See the sister work of this paper Logic and Physics (at scribd.com) for further analysis of this issue. The work may
be interpreted as a modernization and refocusing of Kant’s philosophy.
4. Is Socialism a Special case of Classical Liberalism?

Liberalism, rooted as it is in the apriori principle of individual liberty and associated property
rights, has the global effect, as Adam Smith first observed, of “keeping prices low and goods
varied”. This, we may note, fulfills at least one of the objectives of socialist central planning – i.e.
the efficient allocation of resources. But it entails abandonment of the cherished aim of socialism
which is state ownership of the means and the factors of production.
However, as some enlightened socialists have occasionally proclaimed it is the ends which
ultimately matter more than the ideology. Therefore if abandonment of the principle of state
ownership of the means of production can nevertheless act as a preliminary to the achievement of
more fundamental professed goals then – given the theoretical and empirical evidence – this
abandonment ought to be deemed a necessary course of action for theoreticians of Socialism.

Smith’s work seems to imply that even if the factors and the means of production are concentrated
in private hands they nevertheless continue to serve the well-being of all society – but with the
added benefit of more efficient (because self-interested) management. Free-markets can therefore
not help but serve social ends – no matter how selfish private owners might happen to be67. This is
because of the forces of competition amongst these owners – driving down prices and keeping
goods varied. This serves the supposedly Socialist end of promoting the greatest good of the
greatest number – but without employing the Socialist means of suppressing natural (i.e. apriori)
liberty.68
Even if land ownership is concentrated in private hands the produce of that land will nevertheless
become available to all and the same is true of other forms of ownership of the factors and the
means of production. Thus it does not matter if ownership of capital stock is concentrated into
private hands because the aim of the owner is to produce goods for the mass market. Thus the
capital stock, like the land, ends up serving the many even though it is owned by the few – just as
Adam Smith suggested it would.69
This principle even applies to the most intractable and (in the eyes of the socialist most
impecunious) case of all – the concentration of capital in the hands of private individuals. Even
this money – though it may sit forever in the bank accounts of the world’s greatest miser – will
have an exceptional public utility value as implied by the classical equality of savings and
investments70. In other words this money will be used unbeknownst to the miser – for the purposes

67
Trade generates social utility because both sides commonly get something they desire. Trade (so long as it is freely
entered) is therefore, potentially at least, a win-win solution in contradiction of Mercantilist and Socialist theory.
68
Smith, according to Keynes, posited the effective unity of Socialism and Egoism, a unity mediated through the
mechanism of the hidden hand (Keynes, J.M. The End of Laissez-faire. 1926). Another way of putting it is that society
is an epiphenomenon of the individual self.
69
Smith, Adam, The Wealth of Nations. 1776.
70
Savings equal investments because supply equals demand. This is because savings represent the supply of capital
whereas investments represent the demand. Where these two lines cross on the demand schedule determines the
equilibrium rate of interest for capital. Thus supply and demand for capital (savings and investments) cannot (allowing
for minor frictions) fail to be in equality. If they were not in equality rates of interest would simply adjust until they
were.
Interest rates are thus also determined not by “time preference” (on the Austrian model) but by the demand schedule
for capital – which has no diachronic element. Investor demand for capital is determined not by time preference but by
of investment and capital formation to the benefit of society as a whole. Hence the general truth –
usually forgotten by deficit prone Keynesians – that saving is a public good since it is the ultimate
foundation of improvements in productivity and hence in standards of living.71
Socialism by contrast, purporting to promote the exact same ends, merely destroys the subtle
relations by which these ends are truly promoted. Socialism in fact always destroys the social telos
of Classical Liberalism – it is, to this extent, inadvertently anti-social.

anticipated return on investment. The same is true of the saver supply of capital. The time element is decidedly
irrelevent to this description.
This incidentally is a good example of Say’s law in action, with rates of interest adjusting so that a given supply of
capital always generates an equal demand. This is one of the reasons for Keynes’ ultimately irrational attack on the
classical theory of interest rates in the General Theory (Book 4) - i.e. because it confirms Say’s inconvenient law.
Keynes’ own alternative “theory”, by contrast, is completely irrational, bizzare and without merit (Ibid).
71
Government should do nothing that discourages the promotion of savings at all levels of society – including
avoidance of deficit spending – confident in the knowledge that flexible monetary policy will negate the paradox of
thrift and liquidity trap arguments promoted by Keynes.
This will do more than anything else to foster long term growth in productivity and standards of living. Government
should not however force people to save as this amounts to supply management.
5. Laissez-Faire as a Special Case of the theory of Natural Selection.

The essence of the traditional criticism of the model of economic Liberalism is that it tends to
foster monopoly and plutocracy – i.e. what might be termed raw capitalism. In its extreme form it
might even be said to foster civil and international conflict. Indeed nineteenth century critics came
to see the theory of Laissez-faire as coterminous with (or a special case of) the theory of natural
selection. As Keynes observes;

“The economists were teaching that wealth, commerce, and machinery were the children of
free competition - that free competition built London. But the Darwinians could go one better
than that - free competition had built man. The human eye was no longer the demonstration of
design, miraculously contriving all things for the best; it was the supreme achievement of
chance, operating under conditions of free competition and laissez-faire. The principle of the
survival of the fittest could be regarded as a vast generalisation of the Ricardian economics.
Socialist interferences became, in the light of this grander synthesis, not merely inexpedient,
but impious, as calculated to retard the onward movement of the mighty process by which we
ourselves had risen like Aphrodite out of the primeval slime of ocean.”72

However, by way of warning, he adds;

“Economists, like other scientists, have chosen the hypothesis from which they set out, and
which they offer to beginners because it is the simplest, and not because it is the nearest to the
facts. Partly for this reason, but partly, I admit, because they have been biased by the traditions
of the subject, they have begun by assuming a state of affairs where the ideal distribution of
productive resources can be brought about through individuals acting independently by the
method of trial and error in such a way that those individuals who move in the right direction
will destroy by competition those who move in the wrong direction. This implies that there
must be no mercy or protection for those who embark their capital or their labour in the wrong
direction. It is a method of bringing the most successful profit-makers to the top by a ruthless
struggle for survival, which selects the most efficient by the bankruptcy of the less efficient. It
does not count the cost of the struggle, but looks only to the benefits of the final result which
are assumed to be permanent. The object of life being to crop the leaves off the branches up to
the greatest possible height, the likeliest way of achieving this end is to leave the giraffes with
the longest necks to starve out those whose necks are shorter…

72
Keynes, J.M. 1926. The end of Laissez-Faire. Hogarth Press.
Keynes’ comment here is particularly apt when we bear in mind Darwin’s own admittance that his theory of natural
selection was ultimately inspired by the work of the economist Thomas Malthus on scarcity and human population.
Darwin may even be viewed as the economist as biologist – generalizing the implications of the scarcity of resources
to the wider animal kingdom. His work therefore represents the point at which Liberal economics transcends itself.
Hence, perhaps, the parallel evolution, (since Ricardo and Darwin) of economic theory and evolutionary theory to
ever higher degrees of specialization – each expanding in complexity around a core classical theory with a common
root.
I have included an appendix with this work which seeks to explicate the broader theoretical setting in which
economics and all other cultural production sits. The intention of this is to properly contextualize economics in
relation to the biological sciences.
 If we have the welfare of the giraffes at heart, we must not overlook the sufferings of the
shorter necks who are starved out, or the sweet leaves which fall to the ground and are
trampled underfoot in the struggle, or the overfeeding of the long-necked ones, or the evil look
of anxiety or struggling greediness which overcasts the mild faces of the herd.” (Keynes
Ibid)73

As noted previously however Liberal Economists of the C19th never doubted the existence of
Market imperfections74. All that was doubted was that the mere existence of these analyzable
imperfections somehow validated the formulation of an alternative theory of economics (be it
Marxist, Keynesian, Schumpeterian or any other). Rather they took the more rational view that
these imperfections should be analyzed and addressed with a view to neutralizing them as and
when they emerge, or adjusting for them if nothing else were possible. In wonderfully facile
English idiom this approach is called “not throwing the baby out with the bath-water”.
Finally and bearing in mind his extensive critique of real world economic imperfections Keynes
concludes:

“For my part I think that capitalism, wisely managed, can probably be made more efficient for
attaining economic ends than any alternative system yet in sight, but that in itself it is in many
ways extremely objectionable. Our problem is to work out a social organisation which shall be
as efficient as possible without offending our notions of a satisfactory way of life.” (Keynes
Ibid)

However Keynes in his promotion of an agenda of “light touch” Socialism or Socialism-lite

ignores the fact that Laissez-faire represents only one element (the economic element) of the
broader project of Classical Liberalism75. Although apriorism leads us to affirm the validity of
Neo-Classical economics (notwithstanding imperfections in real markets) it will also be seen to
take us further as well.

73
Compare also Schumpeter’s similar warning from that era;
“We have rediscovered what, from different standpoints (and, so I believe, on inadequate grounds [he is referring to
Marx]), has often been discovered before: there is inherent in the capitalist system a tendency toward self-destruction”
Capitalism, Socialism and Democracy. p.162 (1942)
Schumpeter cites intellectual opposition and creeping public and private sector bureaucracy as the cause of this
eventual collapse rather than the resentment of the proletariat cited by Marx. In essence Schumpeter is predicting the
demise of Capitalism through transcendental forces of entropy. But see section 27 below for a critique of this idea.
74
It is easy to forget that perfection is aphenomenal. Thus if markets were truly perfect they would not exist. Thus it
follows that Keynes’ critique of classical theory – that it does not describe real world phenomena must ipso-facto be
true, even though it misses the point.
My view contra-Keynes is that we should always seek to adjust so as to eliminate perceived imperfections which
hinder the operation of markets – classical theory thus describes an ideal or limiting case to aim towards, not
something that must either happen automatically or else be abandoned in favour of some other theory – as Keynes
implies. There is a third way.
75
Contemporary critics should always bear in mind the character of the world in Keynes’ time. Menaced by twin evils
of German hyper-inflation and American hyper-deflation (Scylla and Charibdis so to speak), economic forces
appeared to be summoning forth demons of untold ferocity on the right and on the left of the political spectrum.
Meanwhile, what free-markets did exist were severely undermined by the rigidities of the gold-standard. As said
before in this paper, problems of imperfection sometimes require imperfect solutions. It is unfair and too easy for
moderns to play the Idealist – as I myself sometimes do - to Keynes’ pragmatist, necessarily at his expense.
6. Keynes the Neo-Classical Economist, (A Neo-Classical Macro-economics.)

The marginal utility theory of value is the defining foundation of Neo-Classical economics – so
much so that even Keynes should be counted as a Neo-Classical economist irrespective of his
divergence from other Neo-Classical schools. Strangely Keynes does not anywhere discuss the
issue of Neo-Classicism or of the implications of his theory for it – which is peculiar since his
analysis stems from a Neo-Classical perspective – i.e. from Marginalist assumptions. Thus
Keynes’ constant baiting of an already redundant Classical model gives his work an odd
impression of already being behind the times.
Nevertheless given his constant focus on the practical implications of market imperfections there
is no doubt that the General Theory does indeed constitute a critique of the well known over
Rationalization and Scholasticism of some schools of Neo-Classical economics. But this fault with
these schools is nothing fundamental to Neo-Classicism per-se, only to overly narrow assumptions
of what its foundations actually are. In the next section we will hopefully correct some of these
damaging fallacies.
Undoubtedly the true macro-economic implications of Neo-Classical economics are that; in
perfect markets, aggregate value preferences lead to Pareto optimal equilibrium in the economy as
a whole76. Keynes’ adjustment of this Neo-Classical model is really very minor indeed although it
has consequences in extending that model.
In essence Keynes observes what was already known; which is that real world imperfections
sometimes interfere with the process and prevent the Pareto-equilibrium from naturally
manifesting itself. The question which Keynes’ work then gives rise to is what is the source of
these imperfections? In the case of the Great depression which was broadly analyzed in Part One
of this work we discovered that the primary imperfections were of a transitory and avoidable
character and related to hindrances that could ultimately be removed from the economy. Most
immediate of all in this respect was the problem of constriction caused by the gold standard. The
gold standard was not the underlying cause of the recession but it was responsible for deepening
and prolonging it so severely. One might almost call it the Gold Standard Depression.
Secondly we discovered that the primary cause of the recession was the perennial one highlighted
by the Wicksell-Mises theory – to wit prolonged excess credit generated by artificially low interest
rates instigated by the Federal Reserve Bank. This ultimately generated the credit crisis and thus
the subsequent downturn in the economy.77
Now neither of these problems are insoluble and we might think that the Gold-Standard problem
at least has been permanently solved. Yet Keynes’ General Theory did not highlight or even refer
to either of these two problems even though its impetus was the Great Depression. Perhaps Keynes
realized that neither cause could be said to overturn Classical economics.

76
And Pareto-optimization in turn (for the sake of completeness) leads to the central phenomenon of entropy
maximization. This is, as it were, the missing element of the Neo-Classical analysis – wither does it all tend? (Hint;
thermal equilibrium).For an analysis of the full implications of this please see the appendix to this work.
77
Incidentally, repressing the just primacy of the Wicksell-Mises explanation of business fluctuations – which is what
the Keynesian and Chicago orthodoxy alike have done – makes endless repetition of “2008-like” events and other
lesser recessions much more likely, inevitable even. It is thus deeply irresponsible to disregard and blithely disrespect
this absolutely crucial theory in the way they have consistently done. Repression of the truth always has consequences.
 Instead Keynes homed in on a third element of imperfection which was the primary focus of his
diagnostics. This was the more intractable case of human nature itself – particularly as manifested
in the resistance of workers to accept pay cuts in a recession and of producers to accept lower
prices. Keynes saw these alleged tendencies as, in effect, overturning the validity of the Classical
analysis and thus of the principle of Laissez-faire. These and similar tendencies – intractably
rooted in human nature and thus not self adjusting – prevented the Classical system from
achieving what it claimed it would achieve – to wit full employment. Hence the justification, as
discussed earlier, for governments to intervene in the creation of mild inflationary effects in order
to offset the problems caused by human nature to the free-market system. Sic Keynesianism.
Part of the problem with this analysis is that the problems of human nature exist during all phases
of the economy and yet it is clear that absent of severe shocks the adjustment processes do occur
naturally. In other words, the Great Depression was caused by specific rather than intrinsic human
failings – viz interest rates and viz the gold-standard. Intrinsic human conservativism (viz wage-
price stickiness) may have been an aggravating factor (economists still debate this) but it was
certainly not a causal factor as Keynes’ work may be said to imply. After all, if it were, then why
was there not a great depression in the 1910s and the 1920s as well? Indeed why, prior to the
coming of Keynes, was there not a perma Great Depression?
Thus Keynes’ analysis of the role of wage-price stickiness may be considered to be somewhat
beside the point since the locus of the Great Depression, as of lesser recessions before and since,
can be clearly seen to lie not in something intractable or inherent in human nature but rather in
correctable elements of monetary policy.
And so in Part One I sketched out those elements of policy which in toto have the effect of
negating supposed market imperfections – of the real, correctable sort (such as poor monetary
policy) – and of the illusory sort such as wage-price stickiness. In reality, as I have shown, wage-
price stickiness and similar transient effects are really epiphenomena of money-supply problems
(analogous to problems which arise from under or over lubrication of machinery). They are not
cardinal in character. Thus if money-supply is accurately self-adjusting to market conditions (and I
show how in Part One) then these ancillary “stickiness” problems are naturally lubricated away –
thereby restoring the integrity of the (Neo-)Classical system.
7. Marginal Utility and the Theory of Evolution.

Preference maximization (derived from the non-classical Marginal Utility Theory of Value) is a
theory which transcends purely economic motivation incorporating motivations and preferences
which, to an outside observer might appear positively irrational and counter-productive to the
interests of the agent. And - since preference maximization could even be said to apply to other
mammals and animals - it forms perhaps the crucial logical point of connection between
economics and biology mentioned in the preceding section. It is the narrow bridge, in other words,
between economics and wider biology.
The only difference between human agents and other sentient creatures is that the horizon of
choice is much wider for humans, leading to more unpredictable outcomes. But other creatures
may at least make utility maximizing choices when selecting a mate for example or when foraging
for sustenance or else when choosing to fight or flee.
In the case of non-sentient creatures, including plant-life, utility maximization may be said to be a
function of genetic programming. The outcome of these utility maximizing decisions in the animal
kingdom is evolution, but in the human sphere it is society, culture and the economy. Ultimately it
could be argued that all utility maximization is a function, not of ultra-rational individual agents as
neo-Classical economics currently assumes, but of the replicator itself – i.e. the gene. The broader
implications of this interpretation – particularly regarding entropy maximization and macro-
biology - are discussed in the appendix to this work.

Society and the economy and, ultimately perhaps, the evolution of Man himself, is thus simply the
outcome of the process of utility maximization (in the broadest subjective sense) by individuals in
uncertain environments. Utility maximization however has an inherently subjective character and
Hume perhaps best sums up the sometimes perverse nature of the pursuit of happiness or utility
maximization;

'Tis not contrary to reason to prefer the destruction of the whole world to the scratching of my
finger… Tis not contrary to reason for me to choose my total ruin to prevent the least
uneasiness of an Indian, or person totally unknown to me ... Reason is and ought only to be the
78
slave of the passions, and can never pretend to any other office than to serve and obey them.'

Since subjective preference or utility maximization is not always intrinsically rational and is often
simply driven by the perverse or even self destructive passions of the moment how can the rational
science of economics assume it to be at its very foundation – as the source of absolutely all
objective valuations (i.e. prices)79?

78
Hume, D. An Enquiry Concerning the Principles of Morals, section LX. 1751.
79
Although the marginal utility theory of value is 100% subjective its outcome (i.e. prices) is 100% objective. This, in
a sense, is its great beauty, its magnificence. And it is surely one of the greatest of all the great achievements of the
human spirit.
The theory of value also accounts for the often erratic and seemingly anomalous aspects of market prices – because of
their wholly subjective origins. Of course individual subjectivity may freely disagree with aggregate outcomes or
 The answer relates to the non-classical or statistical character of the Marginal Preference or
Utility Theory of Value.80 Although utility maximization incorporates altruistic, irrational and
even self-destructive motives as special cases (since these accurately describe the motives of some
agents) the bulk of actions driven by this principle will nevertheless tend to be of a “rational” and
self-serving nature – just as current Neo-Classical theory assumes.
As a result broadly rational outcomes will tend to prevail consistently over time – leading to the
evolution (out of private subjectivity) of the complex modern economy along the lines predicted
by Adam Smith and Vilfredo Pareto.
The problem with the current orthodox Neo-Classical interpretation of the Marginal Utility
Theory of Value is that it fails to understand the inherently statistical and relativistic (not to
mention subjective) character of this profound theory and as a result ties itself up in seemingly
absurd logic concerning omniscient agents acting with perfect rationality one hundred percent of
the time.
Such a needless misinterpretation of the beautiful Utility Theory of Value (see for example the
extreme over-rationalizing tendency of the Theory of Rational Expectations81) could be corrected
simply by seeing this extremity of Rationalism merely as a special or limiting case (particularly
applicable to Homo-Economicus) of the more realistic subjective interpretation of utility given
above. Thus the subjective and the objective (Neo-Classical) interpretation can and indeed must
coexist in a complementary relationship, with the latter as a special case of the former.

valuations (i.e. prices) but even this subjective divergence manifests itself objectively in the decision of individuals to
purchase or not to purchase.
80
This statistical character and the reinterpretation it forces upon us connects economics to changes in theoretical
physics over the same period (i.e. the statistical mechanics) as well as to reinterpretations of the theory of natural
selection as a statistical rather than as a classical theory – i.e. survival of the fittest is a statistical tendency not a
classical certainty.
81
Hanish C. Lodhia (2005) "The Irrationality of Rational Expectations - An Exploration into Economic Fallacy". 1st
Edition, Warwick University Press
8. Subjective Utility and Entropy Maximization

The roots of the correct subjective interpretation of preference maximization seem to lie with Karl
Menger.82 Unfortunately it has not been understood how the dominant objective interpretation of
utility maximization exists as a special case of the subjective Mengerian interpretation. As a result
most modern textbooks give an incomplete and absurdly Rationalistic impression of Economic
Theory and catch nothing of its true beauty and power.
It is however perfectly possible to assume utility maximization without also assuming, as
orthodox Neo-Classical economists do, strictly rational preferences (whatever this means) and
perfect knowledge (?). In this case the contemporary (and incomplete) Neo-classical model would
correctly be interpreted not as a true model of reality (since it patently isn’t) but as a useful special
case of the more general subjective interpretation of utility maximization described in the last
section and pioneered by the first and arguably greatest Neo-Classical of all – Karl Menger.
This would be both a more accurate but also a more useful model since it might then be possible
to trace the micro-origins of some market imperfections in the residuum of subjectivity that exists
between the special case represented by the Neo-Classical model and the general or realistic case
represented by the subjective model (wherein cost-benefit analyses of individual agents have a
purely subjective, arational or relativistic character).
The economy would be most efficiently and usefully modeled by the former but with noise or
interference coming from the latter, more general (subjective) source. More noise would translate
into less efficiency in the economy. But the ultimate source of this noise would be individuals
maximizing their arational subjective utility preferences. This then would be the true General
Theory that displaces C19th Classical economics – not Keynes’ incorrect take on Neo-Classicism.
Such an interpretation also brings out the specifically Non-Classical implications of the Marginal
Utility theory of value – which are indefensibly and absurdly repressed by the contemporary
orthodox Neo-Classical theorists. These implications include the unpredictability of agents and of
preferences – the presence of randomness or statistical entropy in any system. This is why the
orthodox Neo-Classical interpretation is fundamentally and indisputably flawed – since it has no
statistical dimension. Orthodox Neo-Classicism must be a special case of the non-classical
(subjective) interpretation of Neo-Classical economics – it simply cannot logically be the other
way around! Orthodox Neo-Classicism is therefore an incomplete and thus outdated model. But
Neo-Classicism per-se is the correct general theory.
Of course, if the statistical interpretation of Neo-Classicism offered here (and based on Menger’s
subjective interpretation of utility maximization) is correct – and it certainly is – then the very term
Neo-Classical must be a misnomer. The correct terminology for theories stemming from it is Non-
Classical – which connects economics with contemporaneous revolutions occurring in physics and
logic and mathematics and other features of the culture. I stick with the term Neo-Classical
throughout this work (for clarity’s sake) but with extreme reluctance for it is wrong.83

82
Principles 1871.
83
And the importance of this point, which passes economists by, cannot be overstressed.
 A final advantage of this more general subjective interpretation of marginal utility is that it opens
up a connection between utility maximization (of all kinds) and the phenomenon of entropy
maximization, the latter being an outcome of the former. This is because aggregate subjective
utility maximization leads, statistically, to the most efficient allocation of resources which in turn
fosters Pareto optimality and hence (sigh!) entropy maximization. This is true in the natural world
(where it translates into reproductive success of agents) but is even more true in the special case of
the Liberal economy.84

84
See appendix for a fuller discussion surrounding this important issue, including strictly relevant mathematical
descriptions.
9. The Non-Classical Synthesis.

(1). I have clearly demonstrated that Keynesian demand management is a special case of the
mathematical and apriori Quantity Theory of Money which is a Classical theory (see Part One
section 14 for this derivation). Thus the pretensions of Keynesianism to be a non-classical theory
or to overturn Classical economics (notwithstanding his use of Neo-Classical terminology) are
ipso-facto fallacious.

(2). In a symmetrical or evenly rotating economy (see Part One section 16) wage-price inertia
(what Keynes calls “stickiness”) exists as a natural feature and is automatically lubricated by self-
adjusting money-supply as described in Part One.
Wage-price inertia is only a factor when there is a severe dislocation in the economy (a rigidity
like the fiat gold-standard for example or else a crisis caused by persistent artificially cheap credit)
and therefore cannot be regarded as a true or intrinsic imperfection as Keynes assumed.

(3). The Quantity Theory of Money is, in its turn, a special or limiting case of the Marginal Utility
Theory of Value which (notwithstanding the misuse of the term Neo-Classical to describe myriad
schools adhering to this theory) is intrinsically non-classical (see the previous section).
Consequently it would be correct to characterize my own humble synthesis (given in this paper)
or syntheses along similar lines with similar foundations as the Non-Classical Synthesis.

(4). And bearing in mind our analysis in the Appendix to this work it is quite logical to consider
this synthesis of economics to be a special case of the Neo-Darwinian Synthesis – i.e. considering
the replicator or gene, in a precise way, as the primary agent that maximizes (non-classical) utility.
The value of this interpretation – besides its precise and undeniable accuracy – is the further
reduction it affects in the isolation of the sciences.
However, this conclusion depends on a Mengerian (i.e. a correct general) interpretation of Utility
maximization. The current orthodox Neo-Classical interpretation of utility maximization is only a
special case of the Mengerian interpretation. Therefore accepting one does not entail ditching the
other.
10. Free-Market Abuses: Raw Capitalism.

Much of what is meant by the term “raw capitalism” actually refers to abuses which represent a
hangover from the earlier proto-capitalist or Mercantilist era.85 This was an era in which trade was
fostered by the expansion of European empires and was often conducted at the point of a gun. But
it should be immediately obvious that such trade, whatever it is, is not free-trade. It may have been
a shameful precursor or inheritance of the era of international free-trade but it represented a
transgression of the apriori and non-negotiable Liberal principle of freedom from force or fraud
which is at the foundation of truly free markets.
Certainly it is a fundamental element of the symmetrical or evenly rotating economy that nations
as well as individuals refrain from the use of force or fraud. In as much as this Classical principle
is universally applicable (on account of its apodictic status) it would seem to carry with it the
entire panoply of international law and the applicability of these laws to all nations – also apriori.
Finally, as a special case of itself, Liberalism also logically implies the equal Rights of women and
minorities.86 These are not, as it were, special contributions from Socialist theory as is sometimes
portrayed.
Correctly viewed then, although free-markets and classical Liberalism have their origin in an era
of empire and coercion (the Mercantilist era), they nevertheless have an irrefutable logical (apriori)
telos culminating in universal peace and harmony. Free-trade (and the associated theory of
comparative advantage) therefore in effect render Imperialism redundant. This too has been one of
the fruits of Liberalism which Socialism has clumsily sought to pre-empt or seize.
Certainly by the time of the Second World War many of the domestic abuses of proto-capitalism
were already dying out as a consequence of the evolution of social and business legislation. This
represented part of the slow process of the spread of Liberal values. Internationally Imperialism
and Mercantilism continued to be prominent but, interestingly, were least aggressive in those
advanced nations – Britain, France and the United States for example – which were most imbued
with the spread of Liberal values. After the Second World War this spread became even more
pronounced and in a sense is continuing to this day – with many struggles still being waged at
home and abroad.

85
Capitalism is a term of abuse created by Marx to contrast with Communism. This terminology has been naively used
by almost all Liberal economists ever since. The true opposite of Marxism and Communism is not Capitalism but
Liberalism, including Liberal economics.
86
Humanism fosters but is not synonymous with Liberalism and is best seen as a precursor of the latter. Hence the
paradox of the highly cultured Nazi camp commandant – who troubles our intelligentsia even to this day (many of
whom are also not Liberals of course). But had our Humanist been a Liberal then – short of coercion – he could never
also have been a camp commandant.
Liberalism, we may conclude from this, implies a basic form of ethics, ipso-facto.
11. Free-Market Abuses: Plutocracy.

One of the frequently remarked features of free-markets is the phenomenon of increasing wealth
inequality. It is sometimes thought that this feature is behind the reduction of rates of productivity
growth in recent years87. It is not however clear why this should be so since future productivity is
ultimately most dependent upon current levels of saving.
What has perhaps undermined saving more than anything is the fostering of an ethic of debt and
consumption – not least by the government itself in its own finances. This has undoubtedly been
the primary drag on the rate of productivity growth in recent years (the ballooning of public and
private debt) rather than Krugman’s left-wing shibboleth of income inequality. This is because
increased public and private borrowing puts up the rate of interest on all borrowers, thereby
pricing the marginal investor (upon whom future productivity growth depends) out of the market.

It is simply an apriori fact of nature that increasing real GDP results in increasing wealth
inequality. Although Plutocratic abuses in the political system may and probably do enhance this
effect it would nevertheless exist even independently of such abuses – abuses which should be
dealt with wherever possible through means of democratic legislation (since they are not an
intrinsic element of the Liberal philosophy).
Plutocracy is always a bad thing but inequality of wealth is not necessarily so since, as Pareto has
shown, it is an apriori feature of nature. This is because income distribution in modern societies
always displays features associated with the operation of an apriori Pareto distribution.88 Since
such distributions display characteristics of infinite variance it therefore follows that as real GDP
grows so too must real income inequality. This is simply unavoidable in a successful free society.
The question is whether it is necessarily a bad thing.
As mentioned in Part Two section 4 of this work the concentration of wealth in private hands will
tend in a free society to benefit the majority, notwithstanding growing wealth inequality. The
concentration of capital and capital stock in just a few hands can nevertheless lead to general
increases in prosperity by virtue of fostering greater productivity upon which general standards of
living depend. Doubtless this should not be so (as Socialists would be first to point out) but sadly it
is and so we must find ways of adapting to it – through a rational tax system for example - rather
than denying it.
The thing therefore is to distinguish between natural inequalities of free societies and
dysfunctional Plutocratic tendencies – i.e. the abusive subversion of political power by the
interests of a wealthy minority. One such abuse is the avoidance of the increased tax burden that
beneficiaries of the free-market system naturally incur.
It is the – in principle – increase in real tax yields which represent an important argument in
favour of allowing the system to remain unchecked notwithstanding the inevitable growth in
wealth inequality. Therefore, if legislators permit the persistent avoidance of the just burden of
taxation (either because of plutocratic tendencies or because of the maintenance of irrational tax
codes) then this will undermine an important stabilizing feature of the entire economy and polity.

87
See for example Krugman, Paul. Peddling Prosperity. Ch 4 and 5. 1994. Norton and Co.
88
See for instance Mandelbrot, B. The (Mis)Behaviour of Markets. p152-5. 2005. Basic Books ltd.
12. Free-Market Abuses: Monopoly.

In general cartel or monopoly pricing can only be considered in relation to firms which experience
elasticity of supply combined with inelasticity of demand for their service or product. Such entities
may therefore sometimes enjoy greater latitude in how they price their service or product and so
may elect to restrict output in order to achieve higher prices. However such an anomalous
circumstance will tend, in the context of free markets, to incentivize the emergence of competition,
or else to alter patterns of consumption. The effect of competition or changed consumption
patterns in such circumstances will then be to narrow the latitude which producers enjoy in price
setting. Thus free-markets naturally tend towards eliminating the phenomenon of cartel or
monopoly pricing.
We might legitimately ask in what circumstances this natural tendency of free-markets to
eliminate monopoly prices may fail to operate. In genuinely free-markets it may fail to operate
only when a particular firm or cartel entirely dominates the provision of a particularly distinctive
good or service. In such theoretical circumstances however the consumer will have the option of
economizing on a product or service or else seeking a close analogue to it elsewhere (substitution).
Thus free-market pressures against the operation of cartel or monopoly pricing will always
continue to exist.
Furthermore it might be argued that in cases where entities enjoy a latitude for pricing their goods
or services then it is a natural function of price-discovery in free-markets for firms or even for
cartels to set prices as suits them, bearing in mind that future circumstances may change the terms
of competition as a result of such actions and bearing in mind that the consumer may start to look
elsewhere to service a particular want.89
Thus there is a strong argument to be made that in free-markets there is no such thing as cartel or
monopoly prices and hence there is no need for associated anti-trust legislation of an inevitably
arbitrary type. The market will simply eliminate such perceived abuses by processes (on the
supply side and the demand side) of natural adjustment. However, this conclusion is based on the
Neo-Classical assumption of perfectly free-markets. Thus in practice there may be scope for
legislation in extreme cases – but these cases are, I suspect, much rarer than is currently assumed.

Economist Murray Rothbard in particular makes a powerful case against the real existence of
cartel or monopoly pricing in perfectly free-markets;

“In no case therefore, on the free-market can a monopoly price be conceptually

distinguished from a competitive price. All prices on the free-market are
competitive.”90

Rothbard also makes the point that both cartels and monopolies are intrinsically unstable entities,
particularly the former as more efficient members of any cartel are more likely to experience
pressures that cause them to break away from the cartel. Furthermore, firms which expand beyond
a given optimum (but indeterminate) organic size will commonly tend to fragment or even

89
Attempts at cartel or monopoly pricing in the context of free-economies also tends to generate ill-will against such
firms.
90
Rothbard, M. Man, Economy and State. Ch 10 p803. 1962. Ludwig Von Mises Institute.
implode due to the generation of internal inefficiencies. Firms of an optimal size however will tend
to take advantage of economies of scale in order to maintain low prices so as to avoid instigating
competition.
Perhaps the high-point of Rothbard’s outstanding analysis of this topic is his application of the
economic calculation problem to the concept of a “perfect” monopoly;

“The myth of the evil cartel has been greatly bolstered by the nightmare image of
“one big cartel.” “This is all very well,” one may say, “but suppose that all the firms
in the country amalgamated or cartelized into One Big Cartel. What of the horrors
then?”
The answer can be obtained by referring to chapter 9, pp. 612ff above, where we saw
that the free market placed definite limits on the size of the firm, i.e., the limits of
calculability on the market. In order to calculate the profits and losses of each
branch, a firm must be able to refer its internal operations to external markets for
each of the various factors and intermediate products. When any of these external
markets disappears, because all are absorbed within the province of a single firm,
calculability disappears, and there is no way for the firm rationally
to allocate factors to that specific area. The more these limits are encroached upon,
the greater and greater will be the sphere of irrationality, and the more difficult it will
be to avoid losses. One big cartel would not be able rationally to allocate producers’
goods at all and hence could not avoid severe losses. Consequently, it could never
really be established, and, if tried, would quickly break asunder.
In the production sphere, socialism is equivalent to One Big Cartel, compulsorily
organized and controlled by the State. Those who advocate socialist “central
planning” as the more efficient method of production for consumer wants must
answer the question: If this central planning is really more efficient, why has it not
been established by profit-seeking individuals on the free market? The fact that One
Big Cartel has never been formed voluntarily and that it needs the coercive might of
the State to be formed demonstrates that it could not possibly be the most efficient
method of satisfying consumer desires.” 91

These Mises inspired considerations lead Rothbard to conclude that the only true monopoly or
cartel is one which is created by fiat of the state – a phenomenon which was rife in the England of
the C16th and C17th but which is hardly to be found in pure form today. Thus unless the state
colludes in someway in legitimizing it a monopoly is simply a non-sequitur in the context of a free
market, whereas a cartel always exists on inherently shaky ground:

“Economic analysis, in conclusion, fails to establish any criterion for separating any
elements of the free-market price for a product. Such questions as the number of
firms in an industry, the sizes of the firms, the type of product each firm makes, the
personalities or motives of the entrepreneurs, the location of plants, etc., are entirely
determined by the concrete conditions and data of the particular case. Economic
analysis can have nothing to say about them.”92
91
Rothbard, M. Man, Economy and State, p659-60 1962. Ludwig Von Mises Institute.
92
Ibid p726. To emphasize my earlier comment; Rothbard’s analysis presupposes perfect free-markets. The absence
of such leaves scope for corrective legislation against abuses (as it does in other areas such as the minimum wage). It
is important however not to confuse size and dominance with monopolistic abuse since the former does not
necessarily imply the latter – and so legislative intervention should be avoided where possible.
13. Was Schumpeter a Crypto-Marxist?

The sentiment expressed by Rothbard in the passage just quoted – a sentiment which indicates the
invariance of Neo-classical economic analysis of perfect markets (notwithstanding evolving
empirical circumstances) is of particular significance when discussing the developmental theories
of Joseph Schumpeter.
As with the work of Karl Marx, Schumpeter’s analysis emerges squarely out of historical and
empirical study rather than apriori theoretical assumptions. This I believe is a fundamental error
since it places empirical results ahead of analytical considerations in the formation of theory. This
in turn leads Schumpeter, like Marx before him, to make predictions of a decidedly non-apodictic
nature.
In his earlier work93 Schumpeter had noted the absence of an account of the dynamic role of the
entrepreneur, of innovation and the profit motive in the fundamentally static Neo-Classical
analyses of general equilibrium94. This dynamic element, Schumpeter observed, generates the
force of what he termed creative destruction which powers the dramatic and complex changes –
always understandably opposed by conservative forces and vested interests – which characterize
the development of Capitalism through various developmental stages.95
Thus, briefly speaking, Schumpeter succeeds in correcting a lacuna in the classical or Liberal
description of economics. The analysis indicates something lacking in the classical description –
that “Capitalism” appears to be going somewhere, appears to be developing, appears to have a
telos.

In the major work of the second half of his career96Schumpeter expresses profound pessimism
concerning the future of Capitalism based on observed trends of the time. Schumpeter claimed to
observe the ongoing decline of the figure of the entrepreneur in favour of the large corporation and
what has come to be known as “big business”. However Schumpeter does not see this as leading to
a reduction in the innovative power of Capitalism since corporations typically fulfill this basic
function by means of large-scale research and development projects.

Rothbard unfortunately does not analyse the case of imperfect (i.e. real world) markets. His work is always
conducted only from the ideal perspective, indicating the limits of purely rationalistic analysis of the Austrian school
and of Neo-Classical economics as currently conceived.
93
Schumpeter, J. Theory of Economic Development 1911.
94
Classical or Liberal economics of course does not claim that equilibria are undisturbed by internal or external
shocks, only that all of these are naturally adjusted for. Schumpeter does however show that perhaps the most
fundamental shock of all is that produced internally in the form of innovation – driven by the profit motive.
95
“Capitalist evolution spells disturbance… is essentially a process of (endogenous) economic change.”
Creative-destruction he argues leads to an accelerating rate of innovation and turnover of Capital equipment – driven
by the ever diminishing surplus value represented by the profit motive. Possibly this process of acceleration (of ever
greater productive efficiency) reaches a maximum at the equilibrium stage of the development of Capitalism (see Part
2 section 14)?
96
Schumpeter J. Capitalism, Socialism and Democracy.1942.
 Consequently what Schumpeter seems to have detected through his enormous detailed empirical
research is a shift in the key role of supplier of innovation from individual businessmen to ever
larger corporations. 97 But the central point surely is that this key function underpinning
“Capitalism” is preserved – not that its bearer in one particular era is.
That the primary source of Schumpeter’s pessimism stems from the alleged decline of the
entrepreneur, even if this decline were real, thus comes to seem more like a case of nostalgia than
it does a meaningful proof of the inevitable demise of “Capitalism” as predicted in his later
work.98 In any event it is apparent, over sixty years later, that though the large corporation has
become the dominant factor in the field of research and development the entrepreneur is still very
much alive and well – thus indicating an augmentation in the range of “Capitalism” brought about
by the expansion of large corporations rather than a diminution brought about by the (mythic)
euthanasia of the entrepreneur.

Perhaps the only apposite ground for pessimism mentioned by Schumpeter which rings true today
is his view that “Capitalism” would eventually find itself strangled by the accumulation of
bureaucracy of all kinds not merely in the public sector but in the private sector as well (unlike
bureaucracy-free Socialism presumably). The importance of this issue has already been stressed at
some length in this paper and it is clear that the phenomenon of entropy of all kinds in the late
development of the free-market economy and its associated liberal society is a serious concern
sadly neglected by most economists.99
Nevertheless it is not obvious that this alone is sufficient to lead to the spontaneous shift to
Socialism unaccountably predicted by Schumpeter. What is much more plausible is reform and
renewal of an endogenous character or else decline into sub-optimal ossification brought about by
intractable imperfections from this transcendental source.100 There is ultimately no alternative to
free markets as Mises has shown and as Schumpeter should have known. 101
At any rate Schumpeter’s argument of a spontaneous shift to Socialism arising from this particular
source (or any other for that matter) certainly seems like special pleading to me.102 As long as
individuals remain free to pursue the profit motive then what Schumpeter calls Capitalism is likely
to remain secure. It is possible however that due to their increasing abundance the marginal utility
of consumer goods will fall ever closer to zero resulting in more real wages being taken in the
form of leisure time. If this proves to be the ultimate telos of Liberal societies – alongside,

97
Schumpeter J. Business Cycles .1936.
98
And surely something with such an evil name deserves to decline?
99
One of the effects of over-legislation is to stifle competition by deterring new entrants into heavily legislated
markets.
100
But a good analogy for the possible evasion of such degeneration through bureaucracy is the manner in which the
D.N.A. of evolving species accumulate large and increasing amounts of entropy over time (in the form of redundant
D.N.A.) and yet the D.N.A. as a whole continues to function in a perfectly optimal manner even though most of it is
junk.
In other words, just as molecular organic systems adapt around the problem of accumulating entropy (even of a
chronic type) so it seems likely that the quasi-organic system that is our Liberal economy and polity will successfully
adapt (i.e. adjust) to increasing bureaucracy (the equivalent of junk D.N.A.) also.
101
Contrary to what Mises had already demonstrated Schumpeter (1942. Op cit.) argues keenly that Socialism can
work.
102
Like Marx Schumpeter disingenuously liked to claim that his predictions were just of a descriptive, non-normative
character.
perhaps, the withering of the state - then the work of Thorstein Veblen may come back into
fashion again.103
It is apparent at any rate that Schumpeter grossly underestimates the inherent power of self
renewal (precisely through the process of Creative-Destruction) of the Liberal society as well as
the Liberal economy.104 Indeed he seems to think that the two are intrinsically separable – i.e. that
Liberal democracy will turn against the Liberal economy in favour of coercive Socialism. In other
words he posits a kind of institutional schizophrenia. He does not recognize the contradiction
inherent in the existence of a free society alongside an un-free economy.
In essence this lacuna stems from Schumpeter’s failure to see the deeper roots of what he calls
“Capitalism” in the apriori Liberal concept of natural liberty. This lacunae leaves “Capitalism” (as
an analytical concept) dangerously exposed to the critique of Socialism – which is precisely the
effect sought by Marx when he conceived of this term. Schumpeter merely echoes this mistake.
Separating the concept of free-markets from the concept of free peoples (even though the latter
necessarily implies the former) leads to the kind of erroneous critique we see over and over again
in the history of Marxism and other species of Socialism. Ultimately Capitalism, Socialism and
Democracy instantiates yet another example of what might be termed Liberalism envy in the
history of Socialist thought.
If however we remain optimistic about the future of human liberty – because it is the firm
foundation of social and economic theory – then we must also remain optimistic about the powers
of self renewal and the long-run future not only of a free society but of a free economy as well.

103
Veblen, T. The Theory of the Leisure Class. 1899.
104
The fight-back against the processes predicted by Schumpeter may be said to have begun in the reaction against
Keynesianism in the 1970s which culminated in the Regan-Thatcher reforms of the 1980’s. Indeed we should interpret
Keynesianism itself as the first wave of defence against the Siren-like pressures of Marxist-Socialism and the re-
emergence of various forms of Neo-Classicism as the second wave of the defence and self-renewal of Liberal society.
Like Keynes, Frank Knight, of the first Chicago school, seems to have regarded the free-market as a good in its own
right not because of its always leading to perfect outcomes (as the second Chicago school later maintained) but more
fundamentally because it was a necessary corollary of Natural Liberty. This made the free-market, in Knight’s view,
non-negotiable. It is also the reason why Schumpeter, Marx and other Socialist analyses are inherently wrong.
Of all the great economists of the C20th Frank Knight’s position on the spectrum is perhaps most similar to my own,
lying as it does midway between the ideological extremism and idealization of the Second Chicago school on the one
hand and the anti-Laissez-faire ideology of Keynes on the other. I therefore like to think of him as representing an
optimal balance between idealism and pragmatism.
14. The Unstable Telos of Liberalism.

The type of equilibrium or Pareto-optimality fostered – or rather approached as a limiting case -

by a symmetrical economy (see Part One section 16) is of a very different kind to the concept of
thermal equilibrium (or its geometrical equivalent) in physical systems, which is brought about
when entropy in any system reaches its maximum. Nevertheless the two are ultimately linked, as
Heraclitus would say, by a back-strung connection.
In effect the economy comes to operate with ever greater efficiency (Pareto-optimality) even as
entropy becomes maximized in the wider environment – economic symmetry in other words
fosters entropy maximization in the wider environment, it expresses it infact.
Given speculations and proofs given in the Appendix to this paper the conclusion I have therefore
reached is that Pareto or quasi-Pareto optimality as instantiated by Liberal societies fosters entropy
maximization – indeed this conclusion is inescapable. And the effect of entropy maximization, as I
demonstrate mathematically in the appendix to this work, is accelerating macro-biological
instability of the sort which (including possible climate change) we have already observed
empirically.
15. The Dynamo of the Free-Market.

Schumpeter’s concept of creative-destruction seemed then to unlock the mystery of the energy at
the heart of the Capitalist modes of production. It seemed to depict the forces at work in the
process of evolution itself as it pertained to the development of society and the economy.
Schumpeter argued that Capitalism had (creatively) destroyed (i.e. replaced) earlier forms of
socio-economic organization by the operation of this force and that creative-destruction is also
what underlies the power of endogenous self renewal of Capitalism.105
However, as we have seen, his failure to locate the source of this energy in the expression of
Natural Liberty, caused him to become pessimistic about the future of Capitalism, in effect to lose
faith in the power of Liberal societies and Liberal economies to perpetually renew themselves in
the light of new challenges. In a sense therefore Schumpeter’s analysis falls at the last hurdle,
though we are better placed now to correct its focus so to speak, to salvage what is valuable, to
extend it and to ditch the rest.106
In essence, and much as nineteenth century Liberal philosophers had done, Schumpeter detected a
clear dynamical continuum between natural selection and free-market competition – with the latter
being, in effect, a special case of the former. No wonder then that liberal society has shown such
tremendous powers of self renewal since it is essentially tapping into the same processes that
underlie the rich evolution of life on earth, in all its intricacy, power and beauty. No wonder also
that, as long as Liberal societies cleave to their founding principle of liberty, we need not doubt the
intrinsic power of these societies to overcome obstacles and to defeat perennial pessimism
concerning their destiny.107
No wonder also that we should encounter philosophers, from the nineteenth century to the present
day, who seek to push the principle of liberty and freedom from government interference –
freedom from government itself infact – to an absolute extreme. It is at least logical of them to
explore this direction of thought.

105
Unfortunately this strength is also the source of the much remarked homogenization of world culture. But this
process of creeping homogenization is not the fault of economics or American Imperialism (!) rather it is the result of
historico-physical forces leading to the socio-cultural equivalent of thermal equilibrium (cultural homogenization).
Ultimately Liberalism points to the future collapse of border and labour restrictions.
106
Very much in the spirit of creative destruction.
107
Hayek for example makes the point that innovation and progress are entirely predicated on human liberty. (Hayek,
F, Constitution of Liberty 1960. University of Chicago Press.) Thus it is utterly wrong to interpret liberty as the means
to some more important economic goal – it should always double as end and means as Frank Knight also realized.
Proudhon also referred to Liberty “as the mother not the daughter of order.” But this order, being indeterminate in
nature, superficially resembles disorder - just as highly repressive states always conceal deep disorder beneath a
superficially ordered surface.
16. The Phenomenon of Social Externalities.

Nevertheless it is equally clear that this process of creative-destruction (so eloquently and
exhaustively described by Schumpeter) is also responsible for placing great strains on society –
strains reflected in the emergence of the Socialist movement in the nineteenth and twentieth
century. These strains also stem from the phenomenon of creative destruction which, as
Schumpeter observes, always generates opposition from elements that stand to lose out as a result
of specific changes that are brought about. This opposition is like the Newtonian force of inertia as
described in physics. Its political equivalent, on the right at least, is Conservativism.
But more than this I think it is possible to observe that the analogy with the process of natural
selection carries with it an important corollary – which is that creative destruction always has a
downside (as the name implies) which can sometimes be equal to or greater than the potential
benefit that is to be derived. Indeed, in the short run this is almost always the case since the
destructive aspects of change generally manifest themselves first and often in overwhelming ways
– sometimes (as is well documented in the annals of socio-economic history) with entire
communities suffering devastating alterations to their lives.
This logical corollary of free-markets is indeed analogous to the processes of extinction in the
natural world – processes of extinction and/or destruction which seem to be an inevitable by-
product of the dynamo of competition for scarce resources.
And this is why the strains felt by Liberal societies are so particular and so acute. The process of
creation naturally generates entropy and great creation generates great destruction.108 And this
analysis of the incidental effects of free-market Liberalism applies not just to the physical
environment but to the social environment as well.
What this implies is that there exists a phenomenon of social costs or externalities (costs not
internalized but passed on by businesses) associated with free-markets which exist on the same
lines as do physical and environmental externalities (which latter have been studied by economists
since the time of Pigou). In other words free-markets generate not just an excess environmental
cost which has to be factored into analysis, but an excess social cost as well.
To argue, as Libertarian philosophers have done, that free-markets should be universalized
without also taking social externalities and other imperfections into account is effectively to argue
for a free-lunch, not a free-market – which is against natural morality.109
Walter Block for example characterizes the theory of the welfare state as a Robin Hood argument
– meaning that redistribution, no matter how well intentioned, constitutes a form of theft. 110 But

108
The entropy generated by the Liberal society is infact measurable as I hope to show in the appendix to this work.
109
It is interesting to note that those who most vehemently oppose the state often live in the largest and least sensitive
democracies – that persistently breach principles of economic and social symmetry. Part of the problem is what has
been called a “democratic deficit” in such states. The answer is surely to make these states more democratically
sensitive, not more totalitarian or more plutocratic (which, as we shall see, are really one and the same thing).
110
Block, W. Hayek’s Road to Serfdom. 1996. Journal of Libertarian Studies 12:2 (fall) 339-365.
In this work Block objects to Hayek’s support of various rational adjustments of markets by government intervention
(for instance worker protections) on the grounds that these interventions are not compatible with Laissez-faire. But
since markets are never perfect it is indeed rational to make such adjustments – even independently of the social
externalities argument.
Externalities combined with intrinsic market imperfections make rational adjustments obligatory and seem to indicate
that government is indeed a natural epiphenomenon of free-markets – as a regulating mechanism. The Libertarian
analysis by contrast is manifestly incomplete and hence irresponsibly biased in the direction of Plutocracy.
The responsible approach of Libertarianism would surely be to argue for greater democratic sensitivity (but that would
hardly be as much fun). So ultimately the only thing that divides Liberals from Libertarians is that the former
the fundamental argument for the welfare state does not stem primarily from theories of
redistributive justice but rather it arises from the issue of social externalities discussed in this
section – even though the end result is the same. In addition to this and apropos of Block’s
argument it might be pertinent to observe that we are all in a sense massively free riders at the
expense of past workers and tax payers.

Libertarians therefore commit the fallacy of restricting themselves to a synchronic analysis of the
morality of taxation issue. By suppressing the diachronic dimension of the issue they come to the
conclusion111 that taxation always generates a winning group (the poor) and a losing group (the
rich) and that this is ipso-facto unfair. But in reality the accumulated physical and social
infrastructure of society benefits everyone to a far greater degree than is reflected in their tax bill
(even if only indirectly) and its statistical tendency is to benefit people in proportion to their
wealth and earnings.
After all, (to provide only one general example), large scale producers and distributors of goods
make considerable indirect use of social infrastructure (e.g. the use of the education system) and
considerable direct use of the physical infrastructure of society (e.g. the use of highways).
Therefore it is fair that this should be reflected, albeit only proximately, in the tax system.
In arguing against this the Libertarians are in effect arguing for greater Plutocracy and hence
instability in society. Why is not clear – possibly for a love of the rich and successful but more
likely through an incomplete analysis of the concept of free-markets which suppresses the issues
of social externalities and real-world imperfections. Like the second Chicago school the
Libertarians are naively idealistic.
Furthermore, if Libertarians wish to opt out of the “coercion” imposed by the state in these
matters then they should be allowed to do so provided they agree to forgo the use of social and
physical infrastructure and also forgo the employment of labour that makes use of these things –
since they have been laid down by centuries of taxation. It is apparent that no remotely rational
Libertarian (and they seem to be an overtly rational bunch) would agree to opt out on these fair
terms (since it would involve them leaving the country112) and therefore it is ipso-facto true that
neither they nor anyone else in a Liberal state can fairly consider themselves “coerced” by it in any
way, quite the opposite.
In essence, for a free society to be sustainable, the physical and the social detritus generated by
the free-market system (by, in effect, the economic extension of natural selection) has to be paid
for – and this is a large part of the logic justifying not merely the system of taxation but the
panoply of social and welfare services as well. It is only then that the Liberal (as distinct from
Libertarian) society may be said to have a truly stable or sustainable foundation.

recognize that government is an apriori concept. Thus Libertarianism may be characterized as an incomplete version
of Liberalism.
111
A good example of this common fallacy is the following;
“The necessary result, then, of the unequal fiscal action of the government is to divide the community into two great
classes: one consisting of those who, in reality, pay the taxes and, of course, bear exclusively the burden of supporting
the government; and the other, of those who are the recipients of their proceeds through disbursements,
and who are, in fact, supported by the government; or, the effect of this is to place them in antagonistic relations
in reference to the fiscal action of the government. . . .For the greater the taxes and disbursements, the greater
the gain of the one and the loss of the other, and vice versa.”
Calhoun, J.C. A Disquisition on Government. P16-18. 1953. New-York: Liberal Arts Press.
112
Though who knows where to? Mars perhaps?
 The fact that these services also act as fiscal stimuli in their own right (especially during
downturns113) is therefore secondary to the fundamental moral argument in favour of free-markets
paying – through the system of taxation – for the social damage they inadvertently cause as well as
for the social and physical infrastructure they advertently use.114
And it is for this reason that it is hard to see how Liberal Society will be able to exist without a
fairly expansive form of government any time in the near future. There are certainly ways in which
these social issues might be addressed without involving extensive government involvement but it
is hard to see these free-market solutions being practicable or achieving popular consent. The fact
that Liberal democracies have rarely if ever opted for them indicates that they, like the ideas of the
Libertarians generally, lack political consent – notwithstanding Libertarian complaints concerning
the alleged “tyranny of the majority.” Therefore to impose these things on the public would
constitute an act of “coercion” in its own right.

113
Apart from self justifying long term capital projects this is the only valid form of fiscal stimulus.
114
It might reasonably be supposed that the amount of social entropy created by firms and their employees is
approximately proportionate to the size of these concerns. Thus the tax system may be said to broadly reflect these
costs in the form of business, capital gains and income taxes. These taxes therefore may be said to already reflect
elements of a Pigou tax on (social) externalities. The specifics of the relation of a tax system to these social costs is
not important (except very broadly) only the moral principle.
17. The Road To Muppetdom.

The essence of Libertarian arguments against the state are two fold. Primarily, that the state
represents an infringement against natural liberty in that it enforces various transactions on
individuals, often of a redistributive kind, without necessarily obtaining their agreement – in short
it is coercive. Secondarily they argue, by extension of the economic calculation problem, that such
resources as the state does obtain (by implied force) are always utilized less efficiently than would
have been the case otherwise – thereby reducing overall social utility. These two arguments are to
some extent summed up in the following remark by Rothbard, who is perhaps “Libertarian in
chief” of the post war era;

“We may say that all cases of subsidy coercively penalize the efficient for the benefit of the
inefficient [his italics].”115

Although the logic of these arguments (particularly the second) is powerful they do not address
the issue of social externality raised – I think for the first time – in the previous section. In a
Libertarian world a situation of free competition, akin to natural selection, would operate across
society generating an enormous amount of social entropy that would have to be born by perhaps an
increasing mass of humanity (given Pareto income distribution effects).
Whilst charity in the form of lese majesties would undoubtedly be abundantly forthcoming from
the small apex of winners at the top of society it is equally certain that there would remain a
significant shortfall in the amount required to sustain the social damage generated by such a
society. Whole new classes of pauper’s would form who would be entirely without formal
education, forming the bedrock, as it were, of a new ancien regime. This combined with the strict
adherence to a 100% gold standard (notwithstanding the chronically random movements of the
underlying gold market) as advocated by Rothbard116 would thus set the scene for Marxist
agitation along the lines discussed in Part 1 section 15.
For, like Schumpeter, Rothbard and the Libertarians are, in reality, Crypto-Marxists. But they are
coming at the problem of convincing the rest of us from the opposite direction. They seem to say
to us: “So you don’t like the idea of state ownership of the means of production do you? Very
good, then how about trying no state at all? You’d like that wouldn’t you? Sure you would. Makes
perfect sense…”
But the two extremes are really the same thing of course. Just by getting rid of government and
the tax system we will not eliminate coercion! Liberated tax payers might go off and count their
shekels and bless their great good fortune and the restoration of perfect market harmony but
meanwhile, in the shadows, Genghis Khan – the ultimate free man117 – will be massing his
forces…

115
Rothbard, M. Power and the Market. p1255. 1962. Mises Institute.
116
Rothbard, M. Man, Economy and State. Ch 11. 1962. Mises Institute.
117
Expressing a more general non-classical freedom. Ironically the classical doctrine of Liberty is highly constricting
– since it implicitly calls upon us to free others from the tyranny of our local control. But if we do so and others don’t
then we stand to lose out. Thus the doctrine of Liberty gives rise to the free-rider problem (of which the Genghis Khan
example is but one variant) – which is the reason why the Libertarian political system is unlikely to work. What I have
called natural liberty in this paper is thus but a special case, underwritten by the enlightened state, of a more general
non-classical description.
 In short, all that happens is that we revert to a more primitive, less consensual form of the same
state of affairs (after some good old fashioned blood-letting of course). And the fundamental
reason for this is because – government or no government – there is always a conservation of
coercion!118
Thus the “government as coercion” argument of the Libertarians has no merit – even were it true
(which it is not). Government and taxation cannot be eliminated by any method – nor would it be
desirable that they should be – but they can be whittled down and allowed to wither, as conditions
allow, towards ever more efficient minima. This indeed is the essence of good responsible
government. But the point about this is that it would be a slow, even a tortuous process and it
certainly could not be done in the revolutionary manner advocated by the various brands of
Marxists and Crypto-Marxists.

118
Rothbard argues that private security forces would keep one another in check – but what’s to stop them combining
forces (as a cartel) against the rest of us? Also, it would be the natural instinct of many individuals to economize in
these areas (meaning defence agencies would be undersubscribed). This would leave the state dangerously exposed
with weak internal and external security.
Incidentally the principle of the conservation of coercion could also be called the conservation of government.
18. The Third Way Theorem.

One might then argue that the points made in the last section against Libertarianism represent an
argument in favour of Minarchism – limiting taxation so as to only permit expenditure on internal
and external security.119 This is, as it were, Libertarianism-lite. However it is not obvious, using
the logic of their own arguments, why Minarchists should believe that it is fair that taxes
coercively obtained should be redistributed for the benefit of only a few. If they argue that state
provision of a security force represents a benefit to all – and therefore should be “coerced” into
existence - then it equally follows that so too does state provision of a health service of some kind
not to mention the whole panoply of the social and welfare services currently provided by wealthy
and enlightened states. Thus we arrive back at square one. Unlike Minarchism at least Rothbardian
Libertarian-Anarchism has the benefit of logical consistency.
But the fundamental criticism of Minarchism, as mentioned earlier is that a modern state generally
requires some form of consent from those being ruled. In other words the defense of the state,
(including defense against the kind of unrest generated by societies of the type advocated by the
Minarchists and the Libertarians), also depends upon popular support. If social externalities of the
type generated by free-markets are not compensated for in some way (probably requiring some
form of government) then, quite justly, this popular support will simply not be forth-coming.

Thus we arrive at the fundamental apodictic principle which is that the so called Third Way - of
government combined with free-markets is apriori inevitable. This is because the issues just
discussed demonstrate the intrinsic instability of Libertarianism whereas the proof offered a
century ago by Mises (concerning the economic calculation problem) indicates that a pure form of
Socialism is equally unsustainable.120 Ergo, some form of the so called Third Way of government
is inherently unavoidable.
The Third Way is briefly defined as a flexible mix of government directed social and welfare
programs and the free-market. The idea is neatly summed up in the view that there should be no
limit to the heights to which an individual might aspire, but there should be a limit to the depths to
which they might fall. Another way of expressing the same idea is that there should be very basic
social safety nets (designed to protect individuals but not to disincentivize the search for work)
alongside the existence of free-markets and effectively paid for, as an externality, by the latter.121

119
Walter Block makes precisely such a case in his essay on Hayek’s supposed Socialism; Block, W. Hayek’s Road to
Serfdom. 1996. Journal of Libertarian Studies 12:2 (fall) 339-365.
120
Hayek in his great essay Why I am Not a Conservative (1958) shows apodictically why Conservativism also is not a
viable force, since it always defines itself negatively in reaction to developments brought about by Liberalism. In
essence, Conservativism (correctly understood) stands in defense of past gains won by Liberalism and in opposition to
future gains in the making. It cannot therefore be a meaningful program in its own right.
This is true inspite of the tendency in recent years – particularly emanating from the United States – to turn all this
political terminology on its head and also to mix it all up confusingly and in a deeply subjective manner. But this is a
separate problem relating to a general ignorance of the history and significance of political thought and is therefore not
a principle concern of this paper.
121
The social safety net of course also helps mitigate situations where people become so derelict that they are no
longer able to enter the job market – and also prevents whole families from falling into such dereliction.
 Certainly disincentiviztion is a major criticism of the third way principle (and there must always
be some such residual effect created by even the best engineered system) but it is very far from
being an adequate criticism in its own right since it misses the fundamental point. The third way in
essence allows us to balance two important opposites – the creative dynamism of free-markets on
the one hand and the stabilizing force of social equity on the other. For a modern society to
achieve broad based support therefore, it is an indispensable concept – quite apart from its
aprioricity. Libertarianism and Minarchism by contrast are simply to narrow in their bases to form
a stable society.

Now in practice the scope allowed by this principle of the third way is surprisingly large –
allowing for Soviet Socialism at one extreme and possibly a working form of quasi-Minarchism at
the other. This may sound paradoxical but in truth, as Mises and Rothbard have pointed out, Soviet
Socialism was able to survive – even in its grossly inefficient form – because it was able to make
some sort of economic calculation, which it derived, in a parasitic manner, from the objective
markets of the free-world.122 Thus so long as the Soviet system is not global in its extent even it
can survive and be accounted an example, albeit an extreme one, of the third way.123
Although there has never been anything even remotely resembling Minarchism in practice it is
also reasonable to assume that more minimalistic forms of government than currently exist could
survive. The point that I am simply making is that the so called third way is a broad and flexible
church.
But despite this the value of identifying it as an apodictic principle is very great indeed. Firstly it
can be used as a logical weapon against extremism of all types - as we have just seen - and
secondly it can be used to entrench the logic of Rational, even Aristotelian values of government
and political theory in Liberal society. 124 The realization that, in some form at least, the balanced
Third way of political discourse is unavoidable or logically necessary is therefore very valuable
indeed.

122
See Rothbard, Mises, L. Human Action. pp 698-699. 1949. (Mises Institute). And Rothbard, M. Man, Economy and
State ch12, p 960. 1962. (Mises Institute).
This insightful argument of Mises also inadvertently demonstrates why Liberal governments need not be hopelessly
inefficient since they are in an even better position to look over their shoulder at what the free-market is doing than the
Soviets were. This fact, combined with increasing democratic sensitivity may make the (unavoidable) activities of the
Liberal state ultimately approach levels of free-market efficiency.
But this can only be a possibility as long as the state restricts itself to a limited and manageable sphere of operations.
In such a situation it may be reasonable to interpret government as a special or limiting case of the free-market – given
the apriori character of the third way.
The natural restriction imposed by the Laffer-curve on the one hand and the strict principle of balanced budgets on
the other (see Part One section 16 etc) should ensure that Liberal governments will always remain within market-
rational bounds and that such governments will always experience a political incentive to increased efficiency.
123
The Economic Calculation Problem identified by Mises also demonstrates why the ideas of Left Libertarianism
and Leftist Anarchism must necessarily be non-sequiturs. Private property is a logical corollary of freedom per-se. to
remove it would be to remove both liberty and the means of rational calculation – this is the gist of Mises’ epochal
critique of Socialism.
124
See Aristotle’s Nichomachean Ethics for a general discussion of the invaluable concept of the Golden Mean.
19. The Disutility of Government

Not that adherence to the principle of the Third Way commits us to any specific form of socio-
political and economic organization. But then this is the beauty of the idea – it allows each society
to find its own particular level or set of socio-economic equilibria that are specific to it at any
given time. Some nations may favour a more consensus form of Social democracy (along lines
predicted by Schumpeter infact) others a more market orientated approach. Liberalism does not
prejudge which is best since the decision is a relativistic one – but Liberalism does embrace all
such approaches and forms of compromise implied by the apriori Third Way – so long as they
enshrine at their core the apodictic principle of individual or classical liberty.
In his work Rothbard, like other Libertarians, likes to contrast the concept of coercive
government, (founded on involuntary exchanges such as taxation), with that of market harmony,
which is rooted in the phenomenon of voluntary exchange underpinning all transactions on free
markets.

“On the market all is harmony. But as soon as intervention appears on the scene conflict is
created.”125

The concept of market harmony originates with the C19th French economist C.F. Bastiat and
instantiates the idea that all free-exchanges on the market place are un-coerced and therefore, ipso-
facto increase social utility.126 The problem with this idea is that it only applies ex-post ante, since
subsequent events may generate the phenomenon of “buyer’s remorse” in one or both parties.127
Whilst there is always the possibility of adjusting in the light of misjudged transactions this option
is of limited value to an entrepreneur who has already gone bankrupt because of some
miscalculation or other, or just through sheer bad luck.
Consequently, though the concept of non-coercive market harmony (equilibrium) is a very
important and valuable one it is critical to view it in relation to the dissonant phenomenon of
Creative destruction which seems to arise directly out of it.
As such the idea that an entire society may be run simply as a set of harmonic markets is clearly a
flawed basis for a political theory – even from a purely logical point of view – since it presupposes
that people will tolerate the uncompensated losses (dissonances) this harmonic system sometimes
hands to them.

Conversely, though market harmony may mask deeper theoretical discordances so too may the
invasive and resented activities of government (such as taxation) mask a deeper harmony. The
symmetry is indeed quite precise – since the converse of the Libertarian angel (markets) being not
so angelic as it first appears is that the Libertarian devil (government) is not so demonic as it
appears on the surface either. After all, the fruits of prior and future government spending (on

125
Rothbard, M. Power and the Market. p881. 1962. Mises Institute.
126
Thus the appearance of anarchic markets in reality conceals unplanned, un-coerced global order – as Adam Smith
suggested. It therefore seems likely that the more the state withers the more orderly (Pareto-optimal) society will
become, (since, conversely, the Totalitarian State is – in the ideal case - the locus of coercive chaos masquerading as
outward order.)
127
There is also the related problem of “Caveat emptor” to consider as a possibility in free-exchange.
social and physical infrastructure) are the lifeblood of all types of entrepreneur – even if they may
not realize it.

Thus whilst markets create a harmonious surface to participants – much as a fly trap does to a fly
– so too does government present a coercive appearance to shallow thinking individuals (taxing
this, proscribing that, ordaining the other). Yet the fruits of all this ceaseless dissonance and
negativity would seem to be worth more than the price we pay for them. Thus we arrive at the
concept of what might be called the disutility of government, possibly as a special case of the well
known phenomenon of the disutility of labour. If the fruits outweigh the hardship then we will
accept a government just as we will accept a particular line of work. Nevertheless, as with our
employers, we may never stop projecting all our difficulties and demons onto government. But as
to the reasons for this attitude – they lie outside the domain of economics and in the realm of
subjective psychology.
So there we have it. Non-Classical Economics (incorporating a self-adjusting money-supply,
guidelines of economic symmetry and a critique of real world market imperfections and social
externalities) set in a broader context of Non-Classical Liberalism (expressed as some
democratically responsive yet flexible form of the Third Way). This is our general model for a
truly self-organizing economy in a self-organizing polity.
APPENDIX: Towards a General Theory of Selection:

1. Introducing Cultural Selection.

The theory of evolution has led to the expression of a principle (sometimes called Gall’s law)
which states that complex forms or structures always evolve or develop out of earlier, simpler
forms.128 Natural selection and the associated Neo-Darwinian synthesis explicates how this
principle is enacted in the natural world; but should there not be an equivalent theory which
scientifically explains the similar emergence of complex forms and structures in the cultural
world? Do these not also, in some sense, evolve?
Thomas Kuhn seemed to think so;

“The process described in section 12 as the resolution of revolutions is the selection by

conflict within the scientific community of the fittest way to practice future science. The net
result of a sequence of such revolutionary selections, separated by periods of normal research,
is the wonderfully adapted set of instruments we call scientific knowledge. Successive stages
in that developmental process are marked by an increase in articulation and specialization.
And the entire process may have occurred, as we now suppose biological evolution did,
without benefit of a set goal, a permanent, fixed scientific truth, of which each stage in the
development of scientific knowledge is a better exemplar. [My italics.]”129

Karl Popper, perhaps inspired by the above passage, gives a still more explicit account of the
same process of selection and suggests that it might be generalized to give us a complete empirical
theory of knowledge;

“All this might be expressed by saying that the growth of our knowledge is the result of a
process closely resembling what Darwin called Natural Selection; that is the natural selection
of hypotheses: our knowledge consists at every moment of those hypotheses which have
shown their (comparative) fitness by surviving so far in their struggle for existence; a
competitive struggle which eliminates those hypotheses that are unfit… this statement of the
situation is meant to describe how knowledge really grows. It is not meant metaphorically,
though of course it makes use of metaphor. The theory of knowledge which I propose is a
largely Darwinian theory of the growth of knowledge. From the amoeba to Einstein the
growth of knowledge is always the same; we try to solve our problems and to obtain, by a
process of elimination, something approaching adequacy to our tentative solutions.[His
italics]”130

128
Gall, John, Systemantics. 1978. Pocket.
“A complex system that works is invariably found to have evolved from a simple system that worked.” P71.
129
The Structure of Scientific Revolutions. Thomas Kuhn. 1962. University of Chicago Press. P171.
130
Popper, Karl, Objective Knowledge. P261. 1972. Routledge.
And more recently Henry Plotkin has observed;

“If the primary heuristic {biological evolution} works by selectional processes, which it most
certainly does; if, as will be argued in the next chapter, culture works by selectional processes,
which is fairly widely agreed to be the case; and if that other embodiment of the secondary
heuristic that deals with our uncertain chemical futures, namely the immune system, works by
selectional processes, which is now universally agreed: then why should one be so perverse as
to back a different horse when it comes to intelligence?”131

Certainly the general process of Selection with human judgment rather than the natural
environment as the principle agent or locus of selection, is, it will be found, sufficient to explain –
at least as a special case of natural selection – the development of all elements of human cultural
production whatsoever (not just scientific knowledge, as Kuhn argues and not just human
knowledge, as Popper argues).

The key concept in the evolution of all cultural traditions, institutions, ideas and technologies (as
well as modes of behaviour) is the concept of Selection by means of trial and error. Both Kuhn
and Popper fail to develop their ideas beyond these brief statements whereas the one general
treatment of cultural evolution (Dawkin’s The Extended Phenotype) suffers from various faults
including a tendency to metaphysical reification.
These failures are regrettable since the theory of knowledge implied by the empirical concept of
Selection is of the utmost importance when it comes to fulfilling the ambition of placing the whole
of the social sciences – and axiological philosophy - on a fully empirical and unified foundation. It
would, (albeit only in general terms), represent the completion of the project of the sciences and of
logical empiricism – such that nothing would anymore lie outside its unified purview. Thus it is an
important idea for us to pursue – albeit only imperfectly in my case.
As stated before the stress in such a theory must fall on the idea of a selecting agent, in this case
privileging the analysis of human behaviour over that of environmental pressures, but only whilst
always implicitly recognizing the former as a special case of the latter.
Human behaviour is, after all, dependent upon a combination of inherited genetic causal factors
and a variety of environmental pressures. This is true and widely accepted as a general description
but the distinction is only a relative one. This is because genes themselves are, from their earliest
origins, products of environmental pressures. They may be said to have been caused by complex
thermodynamic flows. Thus the genetic theory of causation (viz human behaviour) can only be
said to exist as a special case of the theory of environmental causation.

131
Plotkin, Henry C. Darwin machines and the nature of knowledge. Cambridge, MA: Harvard University Press.
(1994). P172.
Heinz Pagels has also made a similar observation to these;
“ Perhaps our thinking exemplifies a selective system. First lots of random scattered ideas compete for survival. Then
comes the selection for what works best--one idea dominates, and this is followed by its amplification. Perhaps the
moral . . . is that you never learn anything unless you are willing to take a risk and tolerate a little randomness in your
life.”
Pagels, Heinz. The dreams of reason New York: Simon & Schuster (1988).
2. Punctuated Equilibrium and Thermodynamics.

As is the case in the theory of natural selection the central ordering phenomenon at the heart of
cultural selection is that of equilibrium.132 This relates all biological and cultural activity alike to
the central ordering principles of Thermodynamics – thus explaining why analysis of the process
of selection may ultimately explain phenomena in both disciplines. What this means in practice is
that breaks in the status quo – i.e. breaks in equilibrium - of a given natural or cultural
environment are likely to generate bursts of activity – in essence bursts of selection – which lead
to the extinction of old forms and the emergence of new or better adapted forms.133 These forms
will then remain dominant until the next major disturbance in environmental equilibrium.
This approach to the analysis of natural selection in the light of Thermodynamics is a special
development in evolutionary theory – still resisted somewhat by the dominant Neo-Darwinian
Synthesis – called the theory of Punctuated Equilibria. It was driven by distinctive evidence (of
long periods of evolutionary stasis) which emerged from the specialization known as
Paleobiology.134 As Darwin himself states in a later edition of the Origin of Species;

“Many species, once formed, never undergo any further change; … and the periods during
which species have undergone modification, though long as measured by years, have probably
been short in comparison with the periods during which they retain the same form.”135

As such the tendency has been for the proponents of the Neo-Darwinian synthesis to accept the
analysis of Punctuated Equilibria Theory whilst at the same time trivializing its significance.136
The reason why this attitude is demonstrably wrong is because Punctuated Equilibria theory,
besides accurately describing the actual phenomena in a more precise and useful way (which one
might consider trivial perhaps) also indicates in a precise way – albeit only incidentally - the
correct relationship between the theory of evolution and the underlying or still more general theory
of Thermodynamics, of which the theory of evolution is but a special case. This, though perhaps
unintended by Gould and Eldredge, is a non-trivial outcome since it serves to reduce isolation
between the sciences.
Thus if we accept that the theory of cultural selection is a special case of the theory of natural
selection then we may also accept that the theory of natural selection is, in turn, simply a special
case of the general theory of thermodynamics– particularly as expressed in the two laws and in the

132
Which is why analysis of the conditions for maintaining and breaking equilibrium are at the heart of all scientific
disciplines – including the social sciences.
133
A process of Creative-Destruction.
134
Niles Eldredge and Stephen Jay Gould, 1972. Punctuated equilibria: an alternative to phyletic gradualism In
T.J.M. Schopf, ed., Models in Paleobiology. San Francisco: Freeman Cooper. pp. 82-115. Reprinted in N. Eldredge
Time frames. Princeton: Princeton Univ. Press. 1985
135
Charles Darwin, 1869. On the origin of species by means of natural selection. London: John
Murray. 5th edition, p. 551.
136
Richard Dawkins, 1996. The blind watchmaker. New York: W. W. Norton, p. 227.ff
The point is if we ignore some of Gould and Eldredge’s other ideas and combative stance there is – as Darwin’s own
words quoted above indicate – no reason why the central hypothesis of punctuated-equilibria – cannot be more
formally ordained as a canonical element of the Neo-Darwinian synthesis. Indeed, Dawkins has implied that it always
was a part of this synthesis.
instantiation of the principle of equilibrium. 137 Ultimately all theories in the social sciences exist
in relation to and as articulations of aspects of this principle of equilibrium.

137
Thermodynamics is, in its turn, simply a special or limiting case of the non-classical or statistical theory of
quantum mechanics (see my work Logic and Physics – currently available at scribd.com). Thus ends the chain of
reduction in the natural and human sciences – and thus also begins the analysis of logical foundations (Ibid).
3. A General Theory of Cultural Evolution.

External events or new discoveries cause a break in the status-quo or equilibrium of a given
culture or tradition thereby engendering rapid evolution in that field, which, as Kuhn suggests,
appears revolutionary but is in reality explicable through a generalization of the Darwinian
mechanism of selection. A “revolution” is thus simply a pulse in evolutionary selection, with stasis
as the norm.
As Gould and Eldredge point out simpler species are less susceptible to even sometimes dramatic
changes in their environment and so are capable of remaining in stasis for hundreds of millions of
years in the case, for example, of certain marine genera like the coelacanth and the horse-shoe
crab. In the case of single celled organisms from before the pre-Cambrian explosion (which gave
rise to multi-cellular organisms of all major phyla some 600 million years ago) stasis may even
obtain for billions of years. Thus stasis or equilibrium is overwhelmingly the norm and phyletic
gradualism (evolution as described by Darwin) is very much the exceptional or special case.
The stasis of single-celled life forms was first broken in the late Proterozoic era roughly 700
million years ago by the emergence of Multi-cellular organisms (composed of colonies of single-
celled life138). As more complex species have evolved periods of intervening stasis have become
progressively briefer (particularly for more exposed land species) such that the development of
some species (including hominids) has progressed towards an extreme case of almost continuous
evolutionary turnover which Darwin, who primarily concerned himself with such types,
mistakenly took to be the norm. These rare instances of continuous cycles of allopatric adaptation
and speciation (as described by population genetics) are however a limiting or special case of a
more general theory described by punctuated equilibrium.

Similarly in the field of cultural analysis we also find that stasis is the norm and for much the
same reasons. Isolated cultures commonly evolve rapidly in a cultural equivalent of the
mechanism of speciation as described by population genetics and then retain relative stasis in their
new environment for substantial but indeterminate periods of time until new pressures emerge –
for example, the end of the period of isolation.139
Equally, pulses of cultural evolution caused by changed environmental equilibria may coincide
with decline or mass-extinction of other cultures. Thus often in history empires will emerge (or
just new ideas and technologies) and push aside the old order, often replacing it, in effect making
it entirely extinct. This is a process we have encountered elsewhere as creative-destruction.140
One may pursue the implications of this idea (of cultural selection and punctuated equilibria)
through the annals of history and cultural innovation (as I once foolishly attempted) but one will
simply find its applicability to be universal in describing all forms of cultural life in all eras. It is,

138
Note also the evolution of the eukaryotic (or complex) cell at a still earlier phase in this process (endo-symbiosis).
Knoll, Andrew H.; Javaux, E.J, Hewitt, D. and Cohen, P. (2006). Eukaryotic organisms in Proterozoic oceans.
Philosophical Transactions of the Royal Society of London, Part B 361 (1470): 1023–38.
In altering the composition of the environment over billions of years (making it oxygen rich) photosynthetic cells
(prokaryotes) paved the way for the diversification of multi-cellular organisms and hence to modern biodiversity. This
was perhaps the first and greatest example of life fundamentally altering the biosphere.
139
The same is also true for the evolution of languages, which also follow an allopatric model.
140
See my work Logical Foundations of a Self Organizing Economy. Part two. 2009. (Currently available at
scribd.com)
in a sense, a uniquely invariant empirical theory of culture. As such this pursuit is really the proper
subject of a full-scale academic research project and so cannot be conducted here. One thing is
certain however is that this idea is the correct empirical alternative to the chronically metaphysical
study of the philosophy of history as it has been instantiated from Hegel and Marx through to
Fukuyama and others.141

141
See for instance Fukuyama for a recent example of this tradition. Fukuyama, F The End of History and the Last
Man. 1992. Free press.
4. Cultural Equilibrium.

A major pulse in cultural evolution was caused by the recession of the Wurm glaciation some
10,000 years ago which helped to trigger conditions allowing for the development of agriculture
and urban civilization. Thereafter cultural evolution has moved according to the extended model
suggested by punctuated equilibria with many cultures experiencing long periods of relative stasis
or even decline between often brief periods of intense cultural development and transformation.142
However in the case of what might loosely be called the mainstream of cultural evolution since
the Wurm glaciation periods of stasis have become progressively briefer culminating (as on the
analogy of natural evolution described in the last section) in a phase of accelerating continuous
development and innovation since the time of the Renaissance.
Just as continuous turnover, becomes the norm in natural evolution (effectively marginalizing
stasis), so too the same can be said about cultural evolution, notably driven by the endogenous
powers of self-regeneration possessed by Liberal societies as discussed in Part 2 of my work
Logical Foundations of a Self Organizing Economy (op cit.).
Equilibrium in such a case stems only from the maximization of scientific and technical
knowledge – after which must come a fall off in cultural innovation and a concomitant return to
equilibrium. This stage has obviously not arisen yet in today’s globalized culture, but could
presumably do so at any time.
As discussed in Part 2 of Logical Foundations of a Self Organizing Economy Liberalism is the
best apriori means of controlling and channeling the inevitable rise in social disorder – i.e. entropy
– as history progresses towards the global equilibrial society which is the cultural equivalent of
thermal equilibrium.

142
This is not to say that cultural evolution on the extended punctuated equilibria model did not exist before this
period, as it most certainly always has done. Witness especially the astonishing cultural transformation associated with
the Aurignacian and Magdalenian periods in Western Europe beginning three hundred centuries ago. This cultural
development (around four hundred centuries ago) was only brought to a halt, we might suppose, by the unfortunate
onset of the Wurm glaciation.
R. Dale Guthrie, The Nature of Paleolithic Art University Of Chicago Press, 2006.
5. The Fundamental Unit of Cultural Selection.

As the evolutionary biologist Richard Lewontin first observed the fundamental unit of natural
selection is neither the individual nor the group (nor any higher order of taxon) but rather the gene
itself.143 This is because as evolution takes place soma bodies (individuals, species etc. –
sometimes referred to as the “vehicles” of the replicator) emerge into and disappear from existence
whilst only the replicator survives as a constant and usually increases in complexity. This is why
the Neo-Darwinian synthesis treats the gene as the fundamental unit upon which natural selection
acts.
By a development of this argument it is appropriate to treat cultural forms – all of them – as
passing “vehicles” of the replicator as well, since none have a fundamental or abiding character.
Culture is thus interpretable simply an extension of the soma-body or genotype. It follows from
this analysis therefore that there can be no fundamental unit of cultural selection as hypothesized
by Richard Dawkins144. Culture is simply an extension of the soma-body, like a snail-shell.
There are thus no metaphysical and ill defined memes in cultural selection, only rising and
decaying cultural forms of a more or less objective character. The concept of the meme is a
metaphysical construct145 or hypostatization based on the misconception that culture must have an
independent unit of selection. In reality the unit of cultural selection is the same as the unit of
natural selection – it is the gene.

143
Lewontin, R. C. (1970). The Units of Selection. Annual Reviews of Ecology and Systematics 1: 1–18.
144
Dawkins, R. The Extended Phenotype. 1982. Oxford University Press.
145
Metaphysics per-se never belongs in science. As I have laboriously demonstrated (Logic and Physics 2009.
scribd.com) the true sphere or limit of metaphysics – as a scientifically valid phenomenon – is logic and mathematics
and nothing else. The rest of so called metaphysics (see much of the history of philosophy) is simply a failure of
focus.
6. The Principle of Entropy Maximization.

D.N.A. – out of which the gene is composed – is simply a highly ordered form of information.
Although in quaternary form D.N.A. is constructed out of a species of digital code which is
therefore fully translatable into binary or computer code (hence the human genome project).
Information theory, as developed by Claude Shannon146 has succeeded in precisely linking
information, such as D.N.A. to entropy using an adaptation of Boltzmann’s geometrical
interpretation of entropy. The resulting law of information theory tells us that changes in
information (DI) are proportional to changes in entropy (DS) where k is Boltzmann’s constant;

∂S
∂I =
k

In other-words increases in information are exactly proportional to increases in entropy.

This implies of course that as life evolves entropy must increase in lockstep. This entropy
necessarily expresses itself as increasing environmental destabilization and disequilibrium which
in turn engenders new waves of evolutionary adaptation. In its extreme form this feedback loop
culminates in the limiting case of continuous allopatric adaptation and speciation first observed by
Darwin.
Cultural evolution simply takes this process to the next level as it too develops in an accelerating
fashion for the same underlying reason. This leads us to the following general conclusion; life on
earth maximizes entropy – thereby generating a negative feed-back loop with the environment
which, since it has a transcendental character, cannot be reversed. This maximization tendency is
expressed through the process of natural and cultural evolution. Mankind at the present time
merely stands at the apex of this transcendental process.

146
C.E. Shannon, A Mathematical Theory of Communication, Bell System Technical Journal, vol. 27, pp. 379-423,
623-656, July, October, 1948.
7. Thermal Equilibrium.

As the replicator increases in complexity its code may be measured in terms of the growing
number of possible microstates which it may inhabit – in line with Boltzmann’s equation
(S = k.LOGe.W). As this figure increases so entropy in the surrounding environment must increase
proportionately – i.e. as a function of the growing complexity of the replicator or gene in a
dynamic feedback loop. In other words; as the complexity of the replicator increases so too does
entropy in the environment which in turn triggers greater (adaptive) complexity in the replicator.
This explains how life on earth has dramatically changed the environment (even the very
composition of gases in the atmosphere) many times prior to the arrival of man.
One might think that the entropy generated by cultural evolution would be harder to gauge due to
the absence of an independent unit of selection like the gene. But cultural evolution also expresses
itself as inherited information – in the form of human knowledge – which is therefore also, in
principle, expressible in the form of binary code and so subject to the Shannon version of
Boltzmann’s equation.
What is clear however is that this inherited form of information represents, indirectly, a massive
and accelerating increase in environmental entropy and hence disequilibrium of the sort that seems
to be manifesting itself – by common scientific consent – at the present time.
It is also apparent that entropy maximization cannot simply be equated with destructionism since
civilization – particularly modern civilization – is a far superior vehicle for entropy maximization
than mere barbarism, even of the worst kind, could ever be. This is because of the complex and
persistent character of civilization.
This in turn makes it hard to see how what is after all a transcendental process with its origins in
the very earliest life forms (indeed, in thermodynamic flows pre-dating life itself) can possibly be
arrested. To identify this process with man alone is simply naive as is the idea that, merely through
good will and human intelligence we can somehow alter its course. What this means in practice is
that improvements in environmental awareness and action (which are undoubtedly necessary) are
destined, in the long run, merely to improve our efficiency in the process of entropy maximization.
Negative feedback mechanisms from a changing environment may halt the process by making
mankind extinct but this seems unlikely since the process of accelerating entropy is primordial in
nature – it is not intrinsically unstable. 147

147
But consider the Doomsday argument made by Brandon Carter – a purely statistical prediction of the imminent
demise of the human species. Firstly it predicts with 95% percent confidence that we are not among the first 5% of
humans ever to have existed and with 90% confidence that we are not among the first 10% of humans ever to have
existed – and so on. Secondly it assumes that, given the exponential rate of expansion of human populations that the
time taken to complete the last 50% of people who will ever exist will be exponentially faster than the time taken to
complete the first 50% of people who will ever exist. In essence it is an argument based on a combination of Bayesian
statistical analysis and the mathematical phenomenon of exponential growth.
Using these two methods of analysis statisticians have come up with the conclusion that – assuming current population
growth rates and assuming an estimate of around 60 billion as the number of humans ever to have existed hitherto -
that there is a greater than 50% chance that the last human birth will occur prior to the 23rd century.
Carter, B. (1983). The anthropic principle and its implications for biological evolution. Philosophical transactions of the Royal
Society of London. A310: 347–363.
Although the figures surrounding this argument are indeterminate the mathematical logic is not open to dispute. What
is disputable is that the human species will maintain an exponentially expanding population to the end of time – which
contradicts what we know from biology about population mechanics.
 Thus it is probable that we shall adapt more rapidly than our changing environment – thereby
allowing the intrinsic process of entropy maximization (culminating in thermal equilibrium) to
continue with greatest efficiency. Presumably the ultimate telos of this process – long after man
has passed away – is for our atmosphere to evolve into a close analogue of those on Mars and
Venus, both of which are currently in a happy state of thermal equilibrium.

Assuming instead that humanity in decline has a “long tail” then two things follow; firstly, the timeline for the demise
of the species will be greatly extended. Secondly, classic conditions of small, isolated populations will exist allowing
for the mechanisms of allopatric speciation to operate.
8. How Shannon’s Equation Objectively Contradicts the Gaia Hypothesis.

As we saw in sections 6 and 7 the application of Shannon’s equation of information theory

demonstrates inescapably that the evolving complexity of the replicator and hence of life on earth
is exactly proportional to increasing entropy in the surrounding environment. This conclusion is
mathematically inescapable and as we also saw is entirely translatable to the study of the effects of
cultural evolution on the environment as well.
This tells us, in effect, that equilibrium in any system – including ecosystems and the biosphere
itself – must breakdown over time except where entropy reaches a maximum (i.e. at thermal
equilibrium). In essence therefore life on earth exerts a constant and growing pressure on any and
all equilibria that may happen (as they must) to spontaneously form in the natural environment.
This is due to the phenomenon of competition for scarce resources which incorporates strategies
of cooperation only as a special or limiting case.
Eventually this pressure may reach a tipping point triggering disequilibrium and the spontaneous
formation of less stable and hospitable conditions – in effect a phase-transition. This break in
stasis is thus likely to coincide with rapid evolutionary pulses in some species and mass-extinction
in others as elements of the eco-system struggle to adjust to the new situation and as a new less
hospitable and less stable equilibrium (or homeostasis) is discovered. As we discussed previously
this process of change to ever less stable and hospitable equilibria is only likely to accelerate over
time at least until full thermal equilibrium is reached – like a clock winding down.
And, indeed, this picture presented to us by the application of the second law of thermodynamics
accords with the history of evolution of life on earth which began in sub-glacial slowness and has
(on average) only accelerated in pace and bewildering complexity down to the present time –
transforming the biosphere (always in the direction of greater instability) along the way.
The problem with the Gaia hypothesis (even giving it its most generous definition148) is that it
tends to exaggerate the phenomenon of equilibrium (which it calls homeostasis) but
underestimates or else totally misses the rest of the picture as sketched above – i.e. the intrinsic
instability of homeostasis. This in turn leads to a rosy description of supposed “self-regulating” or
stabilizing processes whereas the reality is indisputably that of continuous adjustments (by
species) to ever changing equilibria. It also leads to the patriarchal and moralistic need to naively
depict mankind as some kind of unique stage villain in this whole primordial process to which he
is in reality only a relatively innocent late comer.149 And (sin of sins) it leads to the confusion of
biodiversity with homeostasis instead of with entropy – which Shannon’s equation proves to be
false.

148
For example consider Lynn Margulis’ bland identification of Gaia with the biosphere:
Margulis, Lynn (1998). Symbiotic Planet: A New Look at Evolution. Weidenfeld & Nicolson, London.
If this were all that Gaia theory consisted of then there could be no controversy. Equally the existence of phenomena
of interdependence and equilibria are not controversial since they require no more than natural selection and
thermodynamics to explain them. Only where Gaia departs from reality into suggesting the existence of self-regulating
eco-systems does it depart also from orthodoxy.
The biosphere is best understood as a single thermodynamic system (composed of many interactive sub-systems) in
unstable and decaying equilibrium. According to Lynn Margulis this is what Gaia must therefore be! What an about
face for a theory!
But see also Lovelock for the original definition some thirty years previously and which clearly demonstrates the
anthropomorphic character of the theory.
Lovelock, James (2000) [1979]. Gaia: A New Look at Life on Earth (3rd ed. ed.). Oxford University Press.
149
Lovelock, James. The Revenge of Gaia. 2007. Basic Books.
 Gaians might riposte that phenomena of homeostasis (i.e. equilibrium) need accounting for. But
this is a fundamentally flawed assumption since we know that environments are inherently more
stable in the absence of life. It is the presence of life on earth which, as my application of
Shannon’s equation proves and which the history of evolution examples, rushes the planet into
ever less stable equilibria. It helps to hasten the progress of the planet towards the same fate
already shared by Mars and Venus – complete thermal equilibrium.
9. The Birth of Macro-Biology.

Given our analysis of Biospheric scale fluctuations in the preceding section and given our new
definition of the Biosphere as a single thermodynamic system (composed of many interactive sub-
systems) in unstable and decaying equilibrium and also our analysis of the application of
Shannon’s equation and the theory of Punctuated Equilibria over large time scales it may occur to
us that we have perhaps the correct conceptual foundations for the birth of a new discipline of
macro-biology, for which the hopelessly anthropomorphic Gaia hypothesis was but a proto-typical
approximation. But again, as is the case with the outlines of the theory of cultural selection
described earlier it is for others, more expert in the field, to pursue the myriad details.
10. Evolution of the Arts.

It has often occurred to me that the distinction between form and content in the arts is, though
eminently practical, also somewhat misleading. It seems to posit a distinction which, in other
contexts, does not have an absolute character. To take a simple example, the content of a painting
is itself a type of form or collection of forms. Even in literature, where the distinction is most
solid, one might imagine the content of literature to be animated as form. Indeed, in the case of
drama, this is exactly what does happen – the content is transformed into form. Finally, in music,
sometimes considered the purest of the arts the distinction between form and content all but
collapses and the content becomes the form.
This state of affairs is little commented upon in Western aesthetics and yet it lies very much at the
heart of Eastern aesthetics and notably Buddhist aesthetics. Perhaps its finest expression is given
in the Heart Sutra;

“Form is empty. Emptiness is form. Emptiness is not other than form;

form is also not other than emptiness…
“Shariputra, likewise, all phenomena are emptiness; without characteristic;
unproduced, unceased; stainless, not without stain; not deficient,
not fulfilled.
“Shariputra, therefore, in emptiness there is no form…”150

Here the observation concerning the unity of form and content is taken a step further to suggest the
perception of nihilism or indeterminacy which characterize Buddhist philosophy151.
However for our purposes it is sufficient to make the point that a fundamental unity between
aesthetic form and content (form-content) exists which perhaps parallels (by way of analogy) the
famous space-time unity posited by Einstein in the General theory of Relativity.

This form-content unity, if it be allowed by the reader, allows us to posit the following hypothesis;
which is that all the arts may, at some level, be interpreted as expressions of geometrical form,
albeit indeterminately and may therefore have Boltzmann’s geometrical interpretation of entropy
applied to their collective evolution.
And if this is so then it follows that the development of artistic traditions (by processes of cultural
selection152) from simple origins to higher levels of complexity (or diversity) and specialization
represents, ipso-facto, the evolution of geometrical entropy in these systems. Furthermore this

150
Heart of Prajnaparamita Sutra. George Churinoff (trans). Foundation for the Preservation of the Mahayana
Tradition, 2001.
151
These philosophers seemed to have grasped that perfection – i.e. equilibrium without entropy - is aphenomenal.
152
The canon is, after all, selected, even if only by default. Even individual works of art may be considered the
products of a large number of selection processes of various kinds, (often occurring almost instantaneously in the
creator’s brain), leading to the relative equilibrium of the finished product.
The correct understanding of collective and individual psychology is in terms of adaptations leading to equilibria with
changing circumstances. Culture, science, the arts, even dreaming are all examples of adjustments leading to new
equilibria. But in the process entropy is generated. This is the fundamental thesis of this work.
hypothesis suggests the evolution of the dominant world traditions of the high arts towards
cessation or silence – the equivalent of thermal equilibrium. And this, in the form of Minimalism,
is what we have perhaps already seen in these traditions.
11. A Note on Natural Liberty and Ethics.

One perceptive philosopher, I forget who, once spoke of “freedom… without meaning, without
purpose” as though it were the duty of society to supply us with existential fulfillment as well as
everything else. But the point about meaning and purpose is their purely relative character,
meaning that one discovers these things for oneself in ones private or public endeavours – this is
why we value freedom. After all what is the alternative that brings with it meaning and purpose?
Slavery perhaps?
Kant famously suggested that we should fill the void cruelly opened up by natural liberty with self
slavery (i.e. the categorical imperative153). Others have commended a broad range, even a
spectrum of alternatives, from self-enslavement through to extreme hedonism.154 But the point is
that ethical alternatives have a relativistic character whereas natural liberty, which does not
determine between them, has an apriori character.155 Natural Liberty is the field in which human
choice is enacted and so is a good in itself, transcending the specific choices that might be made –
or the ethical systems that might determine such choices.

A more calculating person than my self might choose to interpret the study of the whole field of
ethical choice simply as a subdivision of game theory. Any particular ethical system would then be
interpreted as a strategy (a life strategy) with certain rules and possible costs and benefits – some
of which might be said to exist not from the point of view of the individual but from the deeper
perspective of the replicator itself.156 Again this approach (which could be called meta-ethics)
might be considered a special case of the analysis of the much broader range of strategies used by
species in the natural world. The implications of this are, again, that cultural selection (in this case
in the discipline of ethics) is a special case of natural selection.

April 2009.

153
"Act only according to that maxim whereby you can at the same time will that it should become a universal law."
Kant, Immanuel; translated by James W. Ellington [1785] (1993). Grounding for the Metaphysics of Morals 3rd ed..
Hackett. pp. 30.
154
I myself prefer to cultivate Pyrrhonism and also the spirit of Zen, but I am far from strict about these things. For me
they are perhaps just an extension of hedonistic indulgence – a special case of hedonism if you like. Perhaps all such
choices in the direction of austerity are.
155
See my work Logical Foundations of a Self-Organizing Economy. (2009) scribd.com – for a fuller analysis of the
concept of natural liberty.
156
See Hamilton’s Rule in regard to explaining the genetic causes underlying altruism on the one hand and selfish or
spiteful behaviour on the other;
Hamilton W.D. (1964). The genetical evolution of social behaviour I and II. — Journal of Theoretical Biology 7: 1-16
and 17-52
This analysis might be extended to account for the full spectrum of ethics as well – thereby handing over yet another
limb of classical philosophy to the domain of logical empiricism.