Mental Mistakes
"In theory," says a stock market reporter on television, "splitting a stock should make no difference to demand. You take every share of stock and split it into two shares, each costing half as much. So the same amount of money buys the same amount of the company."
Then there's the shrug that says what dummies traders are. "But small investors like the smaller price, so the stock can go up."
That is a good example of the principle that markets create value. A stock split lowers the price of admission. It prevents a booming stock price from getting so high that traders cannot afford to spread the risk by buying a lot of different stocks. So it becomes more valuable to them, and the price goes up. Or, if it makes the price too low, suspicion could make the price go down.
People often say, "In theory, the market should....…" Then they do the shrug. The idea is to form an elaborate theory which, by an astounding coincidence, predicts that the market will do what they think it should do. Then, when the market does whatever voluntary traders actually do, the result can be called "market failure."
Pretend you are Isaac Newton staring at an apple tree. Now that apple there, swaying in the breeze, is about to fall. You can tell. It is getting ready to fall off the tree. In a moment, it will break free. But it refuses. It hangs there. It is apple failure.
On the other hand, that other apple looks secure below its branch. It can use more ripening, so it will stay there and not fall. But it suddenly falls. More apple failure.
If you think that elaborate theories of "market failure" are less silly than apple failure, compare them to the flea market. Notice that all market theories must boil down to voluntary exchange by individual choice. If they ignore the basic principle that trades are voluntary, then the theories are not about markets, but about the machinations of should committees.
The price of admission for objective theorizing about markets is the recognition that trades are voluntary by definition. Subjective theorists refuse to pay admission. They talk about "mandated trading", and "involuntary exchange". Then they feel silly calling non-trades trades, and non-exchanges exchanges. So their theories grow more opaque.
The 1996 Nobel prize in economics, as reported in The Economist (10/12/96, p.86), was awarded for theories of how to optimize tax revenues, which was shown to be "far trickier than had previously been imagined." That's because of the "economics of asymmetric information." One recipient's "most important insight was that an optimal tax system must be what economists now call 'incentive compatible'."
Surprise! People don't tell you what you need to know in order to steal from them. You tell them; they don't tell you. That's asymmetric information. If you reward a confession, that's incentive compatible. Note that the grudging inclusion of volition is called an insight.
Subjectiman looks at Passiveman, and says, "You don't have free will. Show me if I'm wrong." Passiveman feels that he does have free will, but since he does not use it much, it is not very real to him. So he guesses that his economic choices are determined by his society, or his class, or his heredity. When he buys a car, it seems to him that he really did insist on making all the choices himself, and having it his way. But then his buddies tell him that the salesman got the better of him, so he guesses those free will choices were illusionary, and he wanted a red car because he liked fire engines as a kid, and all his choices were determined some way or other. The question he cannot answer is: exactly what is the fundamental free will choice that cannot be traced to some previous choice?
Thanks to philosopher Ayn Rand, Activeman can answer easily. It is the choice to think or not. When the phone rings in the middle of the night, and you struggle to get your mind in gear and focus on the meaning of a communication, you are directly aware of exerting your free will. You are deciding to handle reality by the use of your mind. To do that, you need methods so you can see differences and find relationships. You need reason. The price of admission to the realm of human cognition is reason.
Passiveman "kinda" knows that, but it seems more of a distant goal than a method. He is capable of making the journey to that goal of vivid thought and effective living, but he must buy a ticket and pay a price. The price is full, conscious, unremitting exercise of his free will. He must trade effort for achievement. He must put his mind in gear and keep it in gear.
That is what the market demands. When Passiveman goes along with Subjectiman's demands for protection from market cheats and bad deals and tricky trades, he is trying to get the benefits of the market without keeping his mind in gear. He wants to reap the rewards without paying the price.
To see if he can, go back to the flea market. "I am willing to pay the two bucks to get in," you say to the proprietor. "But I insist that you guarantee that I will not be cheated, or taken advantage of, or sold something faulty."
"You expect all that for two bucks?"
The proprietor could hire people to do your thinking for you, and make sure any trade you try will be honest. But he would have to charge you twenty dollars admission instead of two. Most people would rather pay less to get in, and do their own thinking. After all, cheating is not that big a problem anyway.
Subjectiman, however, demands the service and refuses to pay the admission. He turns to government. He tries for a law ordering the flea market operator to hire extra police. If he succeeds, two things happen. The admission price goes up, and the presence of so many police discourages people from trading in the flea market. So the market closes, unless Subjectiman can persuade his city to subsidize it "for the public good." If the city agrees, then it looks for places to steal the necessary money. It increases Subjectiman's tax. He accepts this, however, because everybody else has to pay also, even if they hate flea markets.
Since every trade is an exchange of value, with money as an intermediary, passing out more money makes more of it get used in each trade. That is, passing out more money makes prices go up. But this flea market example shows another reason why prices go up. Subjective thinkers demand protection from various real and imaginary ills, and the protection has to be paid for. So taxes go up until even passive people object, and then further taxes get hidden in the prices of everything in the market. The flea market admission does not go up to twenty dollars, but that amount is made up in the increased prices of everything else.
Activeman knows that things have to be paid for, so he wants to pay for having his rights protected, and take care of the rest by using his reason. He wants to avoid being forced to pay for other people's demands. Passiveman would like that too, as long as it didn't take any effort; but since it does, he goes along with being forced to pay for Subjectiman's demands. Does this make Subjectiman the winner? Is it good for him to have his demands satisfied at other people's expense?
"I want to thank you," says your kidding friend, "for your help in paying for my kid's education."
"You're welcome, and thank you for helping pay my way on public transit."
This makes your friend's smile fade. As you compare notes, it occurs to both of you that it would be cheaper in the end if you paid the whole price for your transportation, and your bike trails, and your beach parks, while he paid the whole price for his kid's education. Not only would it be cheaper, but he would get better education, and you would get better transportation.
Since everything has to be paid for, only Passiveman claims that he actually pays less when he shares costs with everybody else. And even he secretly knows the truth. He is pretending to himself that in the sharing, others come out worse than he does.
Subjectiman knows that when costs are shared through the government, lots of waste is added to the bill. He knows that he is not economically better off. But he feels emotionally better off. Since his method of living is making demands, he knows that he does not have much value to bring to the market. He hates the market. He is willing to pay a big price for admission to the power club of government coercion.
The problem is Russia. There it is, that enormous country that got rid of the market entirely. They hated it, they got rid of it. Then western nations propped them up for fifty years while state planners studied Sears Roebuck mail order catalogs to get prices so they could make economic calculations. There they are, shooting the first man into space while millions starve. And there they are in full collapse, splintering into many countries, pleading for help to stave off chaos.
And then there is North Korea, where hungry market-hating citizens dine on other market-hating citizens. Subjectiman averts his eyes, and feels very frightened.
To get rid of his chronic terror, Subjectiman must grow up. He must realize that even a phony, managed market demands value for value. When there are no values in the phony market, then trade shifts to the underground market. Since all trade is voluntary, only those trades are done in the managed market which in some way benefit the trader. Even the phony market must be "incentive compatible".
Subjective government's conceit that it controls the market is based on the fact that phony markets produce phony prices. By attempting control of the market, the government robs itself of truthful information. It pushes interest rates down, and says, "Look! People expect prosperity, since interest rates are down." Passive people are fooled. Active thinkers find other ways to get paid for putting off spending in favor of lending. There are as many ways of getting around imposed prices as there are traders.
Subjectiman reads the paper and crows. "Look at how low unemployment is! You cannot claim that the minimum wage has done any damage at all." What goes unnoticed is an article on the next page about small businesses that used to be run with hired help, and are now run by families with enough children to provide unpaid help. There are as many ways of getting around minimum prices as there are traders.
The law that all trades are voluntary is not a hypothesis, or a theory to be tested by academics. It is the conceptual essential by which we know that something is a trade. To say that a trade is involuntary would be like saying that a cube is round. It would be a self-contradiction.
In the same way, the law of supply and demand is not a graph, a curve, or an approximation for text books to refine. It is a straightforward application of the principle that all trades are voluntary. If there are more traders in the market than goods to trade, trading will bid the price up as traders find out how highly they value the good. If there are more goods to trade than traders, then trading will lower the price to see at what value all the goods can be traded. To say otherwise is to say that traders don't trade, or trading goods are not traded. It is a contradiction.
Subjective thought has trouble with these principles, because it gets essentials wrong. Supply and demand refers to traders who trade, and goods that are traded. But subjective thought is referring to traders who might possibly, if they feel like it at some moment, trade—and goods that might, if the price is right, and the impulse strong, be traded. If there are such people in a real market, then they are not traders until they trade. If there are such goods in a real market, then they are not trade goods until they are traded. Saying no to a trade is not a kind of trading; it is not trading.
If markets are complicated, then supply and demand works itself out in a complicated way. Analysts devise theories to predict final prices, so they can trade more efficiently. That is, they figure out how the law of supply and demand applies to particular cases. These are not new theories of supply and demand. They are applications.
One way for Subjectiman to grow up would be to accept the law of supply and demand. Then he could stop pretending that when the market puts a low value on his effort, the market has failed. He could seek to pay the admission price—to increase the value of his effort, or the awareness of its value. He could find his wish list getting in the way. He could discover that wish lists are not nearly as immutable as he thinks.
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