The instant the Fed announced QE3, an unlimited program of bond buying with fake money until the end of time, the speculation about what it would mean went viral.
Does this mean that recovery is around the corner? Or does it signal a coming hyperinflation? Or perhaps more deflation stemming from liquidation?
The reaction of the leaping gold market gives a clue. But let’s ask some more fundamental questions and return to the Fed’s actions when we are finished.
In general, what can we know about how the future will play out? Economists are forever swinging between two poles. Some assume that markets know all things worth knowing, but these “rational expectations” theorists are invariably proven wrong. World events, it turns out, are full of bad information, poor predictions, and surprises. Still others, like post-Keynesians who assume no fixed economic laws, are left inventing scenarios unbound by logic of cause and effect.
Reality as we know it takes the middle way. You have to know what that middle way is to make reasonable forecasts, so that you don’t find yourself tipped one way or another. So let us look at how predictions about the future play out in reality.
“Mayhem is coming,” warns the commercial for auto, life, and home insurance. It features a series of terrifying scenarios, freak accidents, bizarre events that come out of nowhere. An actor says he is a raccoon who destroys your house. He is a deer who jumps in front of your car. He is a thief who wrecks your motorcycle.
The advertiser hopes for this response: get insured and fast. Chances are that these things won’t happen, and the insurance company will make a profit from your premiums. But if they do happen, and it’s not something that’s due to your own willful negligence, you are paid out. It’s an economic exchange like any other, only it involves trading on the uncertainties of life. Insurance companies make it their business to know the future, so it makes sense that they are generally better at it than anyone else.
But notice what is not in these ads. You don’t see a guy at a Las Vegas craps table. You don’t see a commercial baker sitting there with no customers. You don’t see a person lighting a fire to his own house. You don’t see a kid playing online poker.
That’s because there is no insurance for these scenarios. Why are some events insurable and some not?
The question is absolutely crucial, especially in times when the word “insurance” is flung around recklessly to describe so many government programs that are actually just robbing some people to pay others. Medicare is not insurance. Social Security is not insurance. They are just called that to deceive the public with a gloss of commercial legitimacy.
Let’s take a plunge into some hard-core high theory, by visiting a chapter from Hans-Hermann Hoppe’s book The Great Fiction. The chapter in question is called “On Certainty and Uncertainty.” It deals with what is an insurable risk, what can and can’t be known about the future, and the failings of economic models that assume people know everything or nothing.
This chapter is an important reminder of why it is important to dig into serious books. They challenge your mind in a way that no Facebook post or Tweet ever can, and, in so doing, help you see through the fog of opinion and blather throw in front of us all day, every day.
What is an insurable risk? To be insurable, Hoppe explains, an event must be part of a class of random events that is outside an actor’s physical control. An example is a house fire. We can know that 1 in 10,000 houses will burn to the ground, but that says nothing about one house in particular. There might be features of the house that make it more or less likely to burn, and those probabilities are figured into the premium. Once all these are figured in, what’s left should be random and thus insurable.
What if a person burns down his own house?. You can’t game the insurer by having anything to do with causing the event against which you are insured. That’s called insurance fraud. See the film noir classic “Double Indemnity.”
An economically uninsurable risk is one over which the actor himself has full control. Consider a donut shop. The store can be insured against fire. But the shop itself can’t be insured against business loss because that has everything to do with the owner’s managerial discretion. If such insurance did exist, it would be silly because the premiums would be higher than any conceivable profit.
Another application is the case of gambling. The hand the gambler is dealt and the dice he rolls might be insurably random events. But the essence of the game is in the betting and strategy that is directly under the volitional control of the gambler himself. These are not random and hence not insurable.
What about flood insurance? The probability of a flood in a particular case can be calculated against a whole class of events. The premium is based on that. On a floodplain in which the event is nearly certain to happen, the premiums would be higher than the cost of declaring a total loss. In other words, no one would take the deal and hence it would not be offered.
So why are houses on floodplains insured? Only federal subsidies make it possible. This is what government specializes in: making the irrational part of reality. So every few years, we are supposed to cry and cry for the poor plight of homeowners living in places they would never be able to live with a market-regulated insurance sector.
Another example: health insurance. The event of sickness is very much in the control of the individual. The actuarial tables can reveal some pretty specific things about people’s likeliness to get sick. Randomness is hard to come by here. The only things that are really insurable are random health hazards. This is precisely why the idea — shared by both parties — that “preexisting conditions” should not be part of premiums completely contradicts economic reality.
Let’s take one more step into this thicket of thinking. What can we be certain about and what is uncertain. Hoppe begins his brilliant essay with a thought experiment. Here is the sweeping opening:
“It is possible to imagine a world characterized by complete certainty. All future events and changes would be known in advance and could be predicted precisely. There would be no errors and no surprises. We would know all of our future actions and their exact outcomes. In such a world, nothing could be learned, and accordingly, nothing would be worth knowing.”
Whoa. So there it is. The reason why we acquire information is to overcome a universal condition of life.
Of course reality is uncertain. But how uncertain? This is the core of Hoppe’s piece. “It does not follow from the proposition that human actors face an uncertain future that everything regarding our future must be considered uncertain.” Further: “it does not follow from the fact that we are capable of learning that everything about the future of human actions is unknowable.”
Let us now return to the Fed’s actions. What will be the effects? The laws of economics are not random. When you increase the quantity of money, and nothing else changes, no new wealth is thereby created; only the purchasing power of money will fall. When this will happen, what other sectors are affected, or what mitigating factors will cause this effect to reveal itself in unexpected ways…these are things we can’t know for sure.
In other words, we can make qualitative predictions with absolute certainty. But quantitative predictions are another matter. Those are born of experience, intuition, and good judgement.
More than likely, you are going to have a lot more success in your guesses if you know what is certain and hence not guesses. This is why it is enormously helpful to study economics. It gives us laws to trace and observe in real life.
Sometimes knowing economics can be a kind of curse. For example, anyone who has studied business cycle theory knew, with near-perfect certainty, that QE1 and QE2 would be flops. The same is true of QE3.
Another chapter in the Hoppe book speaks to this issue directly. It is called “Entrepreneurship with Fiat Property and Fiat Money.”
“States everywhere,” writes Hoppe, “have discovered a smooth way of enriching themselves at the expense of productive people: by monopolizing the production of money and replace real, commodity money and commodity credit with fiat money and fiat or fiduciary credit.”
The Fed ought to hang a sign above its door: Enriching Ourselves and Our Friends since 1913.
Whatever the grim results of E3, this is one result of which we can be 100% certain.