Today I want to use the idea of unemployment to explain many of the hopelessly confused ideas of modern economics.  We stand near the beginning of a new century, and it is my hope that the ideas of the 21^st will not repeat the terrible tragedies of the 20^th.  The men of the 18^th century (Adam Smith, Jeremy Bentham, Noah Webster) solved the problem of economics with the result that the 19^th and early 20^th centuries were periods of unimagined success and achievement.  Never had mankind reached such heights.  But the same period which saw these great achievements in the practical realm witnessed a disaster in the intellectual realm.  Crackpots and frauds dominated the field of economics from the 1920s to the present day, and unemployment was their most widely discussed concept.

          The newness of the concept is shown by the fact that English and American, although considered to be the same language (or dialects of each other), have different words for the concept: “unemployment” in American, “redundancy” in English.  Here in the U.S., the word dates from the 1870s.  Before that time there was not enough unemployment going on to invent a word for it.  Why is that?  And how had the people of the early and mid 19^th century solved this problem which we today cannot solve?

          Of course, when I ask a question about history, I am violating an unwritten rule of modern economics.  It is firmly taught in pretty much every economics class in the country (and, I suspect, the world) that one must, UNDER NO CIRCUMSTANCES, look at the facts for the answer to any question.  Why this should be I do not know.  Adam Smith, the founder of the subject, was very knowledgeable about facts.  All other sciences make an emphatic point of researching the facts and testing their theories against the facts.

          Why, I would like to ask, should there be any unemployment?  An unemployed good is one which is not used.  Go to your local market.  You see thousands of goods for sale.  And yet the amazing thing is that virtually all of them are used.  At the end of the day, week or month, the merchant has very few unemployed goods that he has to throw away.  All of the shoppers take their purchases home, and very little remains unemployed.  The reason for this is simple.  To leave a good unemployed is waste, and whoever wastes an economic good loses the wealth which it represents.  What we observe is that the very last ounce of rationality of which the human species is capable is exerted to minimize this waste.  Hence the unemployment is very small.  Why should things be different when we are talking about the unemployment of human labor?

          Probably the most important cause of unemployment is the over valuation of human labor.  We have seen that the word came into use in the U.S. in the 1870s.  What was going on in the U.S. economy at that time?

          When the Civil War started in 1861, the Union issued paper money (called greenbacks) to pay for troops and war supplies.  From 1861 to 1865, the U.S. price level doubled.  In 1866, there was a feeling that too much money had been issued, and a part of it was withdrawn.  Prices fell, and many of the war profiteers suffered losses.  (This was called – from the point of view of the war profiteers – the First Post War Depression.)

          In the early 1870s, an intense political battle was fought over the issue of whether the country should return to hard money.  President Grant vetoed a bill to post the resumption of hard money, and the 1874 elections showed that hard money sentiment was dominant in the country.  In early 1875, Congress voted resumption of hard money, effective 1879.  Furthermore, silver was demonetized so that the new American hard money system was based on gold alone.

          The result of these two steps (the elimination of the greenbacks and the further elimination of silver money) caused a long, severe contraction of the money supply.  Prices declined in the U.S. for 30 years, and an average $1.00 item in 1866 was down to 30¢ by 1896.

          I might add parenthetically that this was a period of repeated and severe “depressions.”  At the same time, it was the greatest period of economic growth in the history of any country in the world.  The period began with the Pony Express.  It ended with the telegraph, the telephone, motion pictures and the automobile.  This was the period when Wall Street came into its own as a force in American life.  The electric light and a host of other electronic inventions improved the quality of the life of the average American.  The airplane, radio and ultimately television were just around the corner.  If you meet a person who claims to be an economist, then please ask him for me, if there were so many depressions in this period, then how come it saw the greatest economic growth ever?

          But to go back to our study of unemployment, one of the things which happens in a period of falling prices is that wages do not fall as rapidly as prices.  Workers are misled by their nominal wage when they should be looking at their real wage.  For example, if both prices and wages are 100 and if prices fall to 90, then wages are likely to fall to something like 93.  The working man can buy more with his $93 than he used to buy with his $100, but this fact does not sink in with most working men.  They think that their wages are lower because they use the simple minded thinking that $93 is less than $100.  But in fact they can buy more goods with the $93 than they used to buy with the $100.

          The employers are more rational than their employees.  They know that they are paying wages which are too high, and they cannot afford it.  Since their workers are being stubborn and will not work for 90, they are compelled to let some of the workers go.  Hence there is unemployment.  This is the most important cause of unemployment.  Government reduces the money supply.  Prices go down.  Wages also go down but not as much.  So real wages (computed in terms of what the worker’s salary will buy) can buy more goods.  Wages are too high, and employers lay some of their workers off.

          Here is our first lesson about unemployment.  Unemployment is caused by the fact that real wages rise above their fair market value, and employers cannot pay the high wage.  This rise in real wages is caused by the fact that government shrinks the money supply.  This causes a fall in prices.  But worker irrationality stubbornly resists a corresponding fall in nominal wages.

          What happened in the 1870s (and subsequent “depressions”) was that the workers finally realized that their wage demands were too high.  They lowered their demands (grudgingly), and the high unemployment disappeared.

          What caused the “depression” of the 1930s was that the U.S. money supply fell by about 30% from 1930-1932.  There was a corresponding 30% fall in prices.  We do not have good wage data, but wages must have resisted the fall in prices.  With wages too high, the nation’s employers laid workers off.

          However, in the 1930s the government went berserk intervening in the economy.  One of the first New Deal programs was to plow under crops and kill pigs.  If the nation had been in a depression, then how would it have helped to destroy food?  (Ask Obama, his solution to the current economy is to destroy cars.)  They then indulged all sorts of labor irrationality (such as giving one class of workers the  legal right to get higher wages by beating up other workers, thus forcing these workers into unemployment).  Thus the unemployment of the 1930s was not really reduced until the rise in prices of the 1940s led to a drop in real wages.  This eliminated the over valuation of wages and permanently solved the unemployment problem of that era.

          Of course, today (meaning the period from 1940 to the present) we have the opposite problem.  Instead of destroying money, the government continually creates money.  In this case, the opposite occurs.  (Nominal) wages do not rise as fast as prices, and real wages decline.  (Real wages in the U.S. peaked in 1972 and have been declining ever since.  We are the first generation of Americans to be poorer than our fathers.  Thank you Richard Nixon.)  This labor problem was understood by the Loco-Focos of the 1830s.  (A loco-foco was a friction match, a new invention of the time. when Tammany Hall tried to take over a meeting dominated by this new group by dousing the lights, they whipped out their loco-focos, lit lanterns and carried on as before.  It was a way of saying that they were friendly to new technology and knew how to put it to practical use.  From that day, they called themselves the Loco-Focos.  They were the first practical political group to organize around the idea that the bankers should not have a right to create money.

          The Loco-Focos summed up the above problem as follows:

“When the currency expands, the loaf contracts.

When the currency contracts, the loaf disappears.”

In short, if the government increases the currency, the worker’s loaf of bread contracts (which happened through most of the latter 20^th century).  And if the government decreases the currency, then real wages rise.  This makes employers unable to pay some of their workers, and for these workers the loaf of bread disappears.  If we want a society where virtually everyone is employed making a fair wage (for the value they create), then the government should simply keep the (per capita) money supply stable.  This is what was accomplished by the American gold standard (with minor exceptions when the money supply was disturbed as above).

          Unemployment became an important political issue when the U.S. went off the gold standard.  The paper aristocracy wanted to depreciate the currency resulting in the first Loco-Foco principle (a decline in real wages).  They, of course, did not want to admit that they were anti-labor because that would have cost them the votes of the working class.  They falsely argued that they were pro-labor because they were against unemployment.  Once this was put over, they began to deliberately create unemployment so that they could lower it by further depreciating the currency.  Getting union workers to beat up other workers and deny them jobs was one of their tactics.  Another was the tactic of enacting forbidden-to-work laws (fraudulently labeled “minimum wage laws”) in which workers with low labor value were forbidden from making employment contracts.  Later they actually paid people to remain unemployed. and imposed special punishments on employers (such as health insurance for older workers).   In the U.S., during the late 19^th century, workers averaged a 60% increase in real wages per 30 year period.  The country became a massive job creating machine.  Historical Statistics of the United States, Colonial Times to 1954 reports unemployment for 1906 as 0.8% and for 1907 as 1.8%  America at this time was a giant job-creating machine, and millions of immigrants from diverse parts of the world were drawn here to get those jobs.

          Since 1972, the first part of the Loco-Foco warning has been particularly true.  The cur-rency has expanded, and the loaf has contracted.  Real wages have fallen for the first time in U.S. history, and the average working man is getting poorer.  We will soon have another dramatic illustration of this truth due to the Bush-Bernanke expansion of money in the autumn of 2008.

          The above illustrates a few of the lies upon which our society today is based.  The Democratic Party in the U.S. (and left-wing parties around the world) won the votes of the working man by reducing his wages and threatening him with unemployment.  Almost everything you have been taught is a lie.  As for myself, I am trying to spread a little economic truth and to this end I publish an economic letter, The One-handed Economist ($300 per year).  It helps you to combat these lies and protect your earnings from the paper aristocracy.  Visit my web site, www.thegoldspeculator.com.  I also blog on political and social issues.  This week’s blog (www.thegoldspeculator.blogspot.com) continues my discussion of Newsweek’s proposal to kill your granny (no charge).

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-- Posted Monday, 5 October 2009 | Digg This Article