Nathan Lewis’s ‘The Magic Formula’

The economic discussion would be greatly improved if it were passably understood that what we call “the economy” isn’t some living, breathing machine that can be engineered. An “economy” is just people, it is individuals. And once it’s understood that it is individuals, understanding of how to achieve broad prosperity is exponentially simpler to grasp.

Reduced to people, no individual is made more prosperous if ever more of the fruits of his or her labor is taken in taxes. Just the same, individuals earn dollars. But in truth they earn the food, clothing, shelter, and luxuries that dollars can be exchanged for. Once this is understood, the absurd notion promoted by economists, politicians and pundits that “the economy” is improved by currency devaluation is quickly rendered absurd. And dangerous.

All of which speaks to the importance of Nathan Lewis’s 2019 book, The Magic Formula: The Timeless Secret to Economic Health and Prosperity. Some might wonder why a review in March of 2022 of a book released in March of 2019. For one, there’s never a bad time to write about an informative book about money and taxes. Particularly with regard to money, it’s wildly misunderstood at which point it’s essential to write about the very few books that bring understanding. For two, I was reading The Magic Formula in March of 2020 only for the lockdowns to begin. So profoundly awful and mindless were they that my focus changed, and did so in a major way. Lewis’s almost-finished book was put down, only to get lost in stacks of others. In March of 2022, I’m glad to resume it. While there are disagreements here and there, Lewis arguably knows more about money and its history than anyone else writing today. The Magic Formula is an excellent book that those interested in tax and monetary policy would gain a lot from.

Lewis’s title is perhaps a misnomer, and that’s not written as a critique. More realistically, the policies of “low taxes, stable money” that Lewis is promoting are the Common Sense formula. They are for the reasons discussed above. People are not improved when the fruits of their labor are taken from them. About this, let’s be clear that devaluation is a tax much like the more traditional ones that readers think of when contemplating taxation. Lewis seeks prosperity, which means he wants to reduce taxation. Amen to that.

To which some will say per Lewis that “High taxes are often justified as a ‘necessary tradeoff’ to finance” the programs meant to aid the have-nots. But as Lewis properly responds to this narrative, “the anemic economy caused by high taxes” is arguably the driver of the call for government programs in the first place. Lewis would prefer to skip the middleman. Just reduce the tax burden, watch the economy grow as a consequence, at which point the calls for programs will be greatly reduced thanks to the prosperity.

It’s all true, but with one minor quibble that Lewis himself likely wouldn’t much quibble with. The view here is that wealth creation is the facilitator of anti-wealth demagoguery. In other words, the Bernie Sanders, Elizabeth Warren and AOC types multiply as prosperity grows. Again, what wealth begets also begets opportunists who build careers around redistributing the wealth created.

Still, it cannot be denied that the original sin is the taxation. When you penalize work excessively, and in particular penalize the investment in production (capital gains), you get reduced production and innovation; thus sapping the economic progress that always and everywhere results in broad opportunity.

Crucial about all of this is that devaluation acts like a tax in much the same way that direct taxation does. Figure that capital commitments from investors enable entrepreneurs and businesses to be creative in ways that boost opportunity for everyone. Knowing this, it’s no surprise that currency devaluation inevitably brings on stagnation. When investors put wealth to work, the act of doing so indicates a desire for future returns in dollars, yen, pounds, euros, yuan, etc. Which means a devalued currency acts as an explicit tax on the investment without which there’s no progress.

Considering government spending and debt with the same devaluation in mind, it’s probably no revelation to readers of a review of a book like this that sometimes governments choose to borrow large sums for spending only to leave the bill with their subjects. It’s hopefully a reminder yet again that devaluation is a tax. It’s just another way for government to shift its costs to the people. Does this mean that deficits explicitly cause inflation? No. Devaluation is a policy choice. Per George Gilder, deficits don’t cause inflation, but socialism does. Devaluation is socialism, it’s a shift of costs. At the same time, it’s certainly true that sometimes governments erase their debts on our backs.

Which brings us to Lewis’s solution for the problem of devaluation, and untrustworthy money more broadly. Money is the agreement about value among producers that makes it possible for them to trade with one another, and in trading with one another, specializing. In Lewis’s words, “A stable monetary unit is necessary to organize this extended web of cooperation” that we call the economy. More pertinently, Lewis so importantly writes that “Nearly the whole world, it seems, is involved in the production of your daily bread.” Yes! The magic statement in a book about a magic formula.

Trusted money is what facilitates the global cooperation among people that enables remarkable leaps in productivity. Remember the pin factory that Adam Smith observed in The Wealth of Nations? One man working alone could maybe produce one pin per day, but several specialized men working together in that same factory could produce tens of thousands of pins. Expand the global division of labor care of Lewis’s money line about the production of your daily bread, and the result is breathtaking levels of productivity. Money isn’t wealth, but when quiet as a stable measure of worth, money enables enormous wealth creation precisely because it expands the global division of labor. All that, plus it enables investment in production that relentlessly enhances the specialization of the “hands” (human and artificial) that comprise the economy.

Conversely, unstable loud money renders cooperation less likely simply because it’s a tax on cooperation. Money flows signal the flows of actual goods and services, but if money’s value is a moving target the predictably sad result is that winners and losers are created where there should only be winners. This explains Lewis’s assertion that “Changes in the value of the monetary unit can only be destructive.” Yes, of course. Money’s only purpose is to enhance cooperation among people, to move goods and services around and to higher uses, which is why “humans have always wished their money to be as stable and reliable as possible.”

What’s Lewis’s answer for money that is credible and quiet by virtue of it being a stable measure of value? His answer is gold. And his belief in gold as the definer of money par excellence isn’t faith based; rather it’s rooted in a market truth. Over the millennia, “the people recognized that gold and silver – eventually, gold alone – had a much more stable value than other commodities,” thus making it the ideal commodity when it came to imbuing money with the essential stability that would give it the properties of money. Markets chose gold.

Please think about the above paragraph, and then ideally think some more. Money once again isn’t wealth as much as its stability as a measure of worth is what facilitates the creation of wealth. This simple truth exposes as thoroughly idiotic the endless tinkering with the value of money that has been overseen by governments throughout time. It’s anti-wealth because it robs money of what makes it money: stability as a measure. Lewis writes that “For over 2600 years, humans suffered the problems that ensue when governments changed the amount of gold or silver in their coins.” Put another way, for 2600+ years humans have suffered the tax that has been unstable money. The certain result of governments changing the market worth of money has always and everywhere robbed humans of their production, shrunk the amount of exchange of production, shrunk investment in production advances, and by extension has shrunk the specialization that powers enormous leaps in terms of productivity.

Which brings up a few quibbles; ones your reviewer guesses Lewis wouldn’t much quibble with. He writes of how a “falling currency” can in the near term bring on an “’artificial boom.’” Except that it cannot. Lewis knows this. In his words, “You can’t make people richer by cutting the value of their wages.” No you can’t. Nor can you make them richer by taxing the very investment necessary to make them richer. There’s quite simply no “boom” to be had from that which makes money less like money. Lewis adds that “Owners of export-related industries, however, can be made richer” by devaluation, but that too is not true. Referencing an earlier passage from Lewis, “Nearly the whole world, it seems, is involved in the production of your daily bread.” Since everything produced is a consequence of global cooperation, exporters logically never gain from that which raises their production costs. Exporters gain from investment in their processes, and devaluation is a tax on that investment.

A few pages later Lewis crucially writes that “the goal of Stable Money is to allow prices to form freely without distortion by monetary effects.” Translated, Lewis seeks quiet money so that actual market prices can direct capital to its highest uses. Devaluation, and money-price instability in general, confuses the migration of precious capital. Which brings us to the Fed.

Lewis very puzzlingly contends that the answer to the decline of the dollar in the 1970s was Fed Chairman Paul Volcker. In his words, the 1970s inflation “was halted in the early 1980s by Paul Volcker at the U.S. Federal Reserve.” No, I don’t think he truly believes this. If we ignore that the dollar fell to then all-time lows during Volcker’s chairmanship (the view here is that the two are unrelated, but nonetheless…), what about raising an artificial rate into the double digits would arrest inflation? More important, Lewis is clear toward book’s end that when it comes to curing inflation, “No penitence is necessary for past policy error. Good policies produce good outcomes, right away.” Put another way, to fix inflation give money a standard, a peg, an anchor. He writes with dismay on the same page that monetary types have happened on the false notion that we require “very high interest rates” and “’a recession so severe that it will break the back of inflation’” as the cure. Ok, but the latter is what Volcker hagiographers claim Volcker did, only for Lewis to discredit the silly belief that “crushing central bank interest rate targets” are “necessary to support weak currencies.” At book’s end Lewis is very clearly and properly revealing the Volcker policy mix as at best a non sequitur, and at worst a highly unnecessary response to an inflation problem that could be fixed with a quick change in policy. And Lewis knows the change needed given his knowledge of the German hyperinflation of the 1920s. It ended in a week when German monetary authorities replaced the wrecked mark with a rentenmark defined in terms of gold. All of which explains why it’s hard to believe Lewis believes his assertion that Volcker solved the 1970s inflation model. He didn’t. Governments inflate, which means governments reverse inflation with standards.

Furthermore, as Lewis makes plain in his discussions of money, “For over 2600 years, humans suffered the problems that ensue when governments changed the amount of gold or silver in their coins.” In other words, governments once again devalue money. Period. The Fed has been around since 1913, after which the first major devaluations of the dollar after 1913 occurred in 1933 and 1971; both devaluations occurring against the recommendations of Fed Chairmen Eugene Meyer and Arthur Burns who were powerless to stop Presidents Roosevelt and Nixon from devaluing. As Lewis writes on p. 187, FDR’s devaluation “had little to do with the Federal Reserve.” Lewis is right. So incensed was Meyer by FDR’s decision that he resigned.

Lewis’s focus on the Fed in his gallant pursuit of stable money reads to this reviewer as an odd detour. Worse, it’s one that furthers the false narrative about the Fed as dollar croupier; capable of expertly managing so-called “money supply” on the way to a stable dollar price. No, the Fed logically can’t do that. My source? Lewis himself. He’s long decried the “PhD Standard” in favor of a market-price standard care of gold. No disagreement there. When money is tethered to what is stable, money price stability ensues. It’s a reminder that the Fed couldn’t put us on a gold standard even if doing so were part of its policy portfolio, which it isn’t; thus calling into question Lewis’s assertion that Fed Chairmen Volcker, Greenspan, and Yellen had us on a “dirty gold standard” of some kind over the years. Really? How?

These quibbles are expressed amid admiration for Lewis. His knowledge of money and its history is unrivaled. That it is explains the desire of your reviewer to convince Lewis that his growing focus on the Federal Reserve is a distraction at best. In Lewis’s words yet again on p. 102, “Governments have always debased, devalued and floated their currencies.” Yes, they have. So why waste time on the Fed? Better to ask what happens if the Fed doesn’t exist. Would devaluations cease? The question answers itself, and is clearly answered by Lewis in The Magic Formula: governments have been devaluing for 2600+ years. To bring up central banks when contemplating currency devaluation brings muscular meaning to non sequitur.

Taking the monetary discussion further, Lewis very happily discredits the popular notion that England’s decision to re-peg the pound to the gold price that prevailed before World War I, and France’s decision to peg the franc at the post-war inflated price caused a severe downturn in England and averted one in France. According to the narrative, England’s monetary authorities created a deflationary downturn and France’s didn’t. Lewis’s evolution has him rejecting what never made too much sense. He writes that the oft-bruited notion “had an inherent assumption of tax rates that were too low to matter very much. Consequently, they tended to overemphasize monetary effects upon the economy.” What Lewis means here is that at least before WWI, tax rates in broadly liberal countries just weren’t that high, and since they weren’t, there wasn’t much value in focusing on them. Conversely, taxes rose quite a lot in liberal countries in WWI, only for the rates to remain high in the aftermath. As such, the post-WWI error in England wasn’t monetary as much as it was rates of taxation that were way too high.

Which brings us more firmly into the 20^th century for the purposes of Lewis’s book, and to the taxation analysis that will close this review. Lewis writes that the horrific headline tax rate of 91% that prevailed in the U.S. in the 1950s and 1960s “was moderated by a bouquet of exemptions.” Without excusing the control exemplified by the tax code, Lewis writes that “the average effective rate of income taxation on the top 1% of earners was 16.9% during the 1950s.” The rate was still too high, the federal government should be – by far – the smallest taxer versus city and state in a perfect world, but it’s a reminder of why the U.S. economy of the ‘50s and ‘60s didn’t implode.

On the other hand, it’s easier to see why England struggled so much in WWII’s aftermath, and in particular during the 1970s. The former economic powerhouse had a top income tax rate of 83% that “affected all income over a very modest hurdle of L24,000.” Combine the nosebleed penalties placed on work with a 98% tax on capital gains or “unearned income,” and readers can see where this was going….And that’s not all. Lewis crucially adds that during the inflationary 1970s brought on by the U.S. severing the dollar’s link to gold, “the German mark, Japanese yen and Swiss franc rose against the declining dollar.” Yes, they did. Notable here is that precisely because they didn’t follow the U.S.’s ruinous path, there were no “oil shocks” in the countries mentioned in the 1970s. Unfortunately, England’s pound policy mirrored its direct taxation policy. Lewis writes that the “pound slipped yet further” against the dollar, “taking the lead position in the global race to the bottom.”

Basically, England in particular exemplified the opposite of Lewis’s Magic Formula, with predictable results. It’s really so simple. “Low taxes” and “stable money” are the path to prosperity, which is really Lewis’s important, common sense way of saying that LOW TAXES are the path to abundance. This essential book and history shows the way. Thank goodness for Nathan Lewis, and thank goodness for his increasingly frequently writing partner in Steve Forbes, who writes the foreword to The Magic Formula. They’re showing readers the way to a much better world.