My first reaction to Pres. Obama’s speech last night was depression. Here were the Democrats giving the president standing O’s for completely converting the Republic into a social democracy. I mentioned that on Facebook, and one of my readers said it reminded him of Amidala’s line from Star Wars Episode III: “So this is how liberty ends…with thunderous applause.”
But on more careful review, I find that I am not, in fact, depressed over the long-term. Indeed, last night’s speech seems to me not to herald the beginning of a new era for big government and socialism, but rather the last gasp of a dying ideology.
We are, I think, at the cusp of a new era, but it isn’t the one that Pres. Obama and his acolytes in the Congress are thinking it is. Neither the Democrats nor the Republicans, it is clear, have any idea about what is happening. Very few people do. I am going to try and explain something very complicated, and do so very simply, and as briefly as I can. So, with the realization that all simplifications are inevitably wrong in some particular, let me explain.
“Ed’s dead, baby. Ed’s dead.”*
We stand now, I think, in a very historically similar position to the one described by Barbara Tuchman, in the beginning chapter of her monumental work on the outbreak of Word War I, The Guns of August:
So gorgeous was the spectacle on the May morning of 1910 when 9 kings rode in the funeral of Edward VII of England that the crowd, waiting in hushed and black-clad awe, could not keep back gasps of admiration. In scarlet and blue and green and purple, 3 by 3 the sovereigns rode though the palace gates, with plumed helmets, gold braid, crimson sashes, and jeweled orders flashing in the sun. After them came 5 heirs apparent, 40 more imperial or royal highnesses, 7 queens, and a scattering of special ambassadors from uncrowned countries. Together they represented 70 nations in the greatest assemblage of royalty and rank ever gathered in one place and, of its kind, the last. The muffled tongue of Big Ben tolled 9 by the clock as the cortege left the palace, but on history’s clock it was sunset, and the sun of the old world was setting in a dying blaze of splendor never to be seen again.
Four years later, the world order of 1815-1914 was drowned in fire and blood. The Age of Royalty was over, and the Age of Democracy had begun. I believe that Pres. Obama’s speech of last night may very well be the historical equivalent to Edward VII’s funeral.
Ever since it began in late 2007, a blog called Fabius Maximus has been arguing that we are watching the decline and fall–indeed, collapse–of our current economic and financial system. A précis of the argument can be found here, and a more comprehensive archive can be found here. Just as the black-clad crowds lining the streets of the capitol of the British Empire on the morning of May 20, 1910 might have found it inconceivable that their generation would witness the collapse of both the European geopolitical regime, and, ultimately, the British Empire itself, so it may be inconceivable to us that we are witnessing the collapse of the Post-WWII economic and political regime. But I believe it is nevertheless true.
“MONEY! Doesn’t it make you feel good just to say that, Jerry?”
Let me start by explaining what money is. Money is a medium of exchange, that is, it is an object of some kind that I can exchange for goods and service, rather than trying to barter with people to obtain what I need. It may consist of elaborately carved cowry shells, tiny beads painstakingly stitched to strips of leather, round pieces of metal with the image of guys named Julius or Claudius hammered into them, or little pieces of high-quality paper that say “Federal Reserve Note” on them.
But whatever it is, money has certain minimal characteristics. It must be convertible, i.e., if I do a job for you, I have to be willing to accept it as payment, and whoever I buy bread or clothes from has to be willing to accept it in exchange, too. It also has to be difficult to replicate, so that when I accept it, I am reasonably assured that it is the genuine article.
For nearly all of recorded history “money” has been synonymous with gold or silver. And right up till the late 18th century, it was more or les the perfect money. It was intrinsically valuable, in that raw silver or gold was as easily convertible as hammered or minted coins. It was also practically impossible to counterfeit, the best efforts of alchemist to convert dross into gold notwithstanding. It was also relatively rare, and it difficult to obtain new supplies of it without intensive–and extremely expensive–mining operations.
Additionally, there simply wasn’t much to buy. Most people grew their own food, produced their own clothes from flax or wool, and built their own houses by hand. Money was essentially a luxury, and it bought mainly luxury goods for fat cats. Kings could raise and equip armies with it. Merchants could buy nice clothes. But for the most part, money was a tool for use by the rich, and by the relatively few urban dwellers. And, as such, gold or silver was perfect for that level of economic activity.
By the 19th century, though, there were lots more things to buy, and lots more city dwellers, and that trend was increasing rapidly. Hard money became…problematic. The thing about having a hard currency based in gold or silver is that, at the end of the day, whether you run a fully convertible gold standard, or some sort of fractional reserve system, the size of the money supply is always constrained by the amount of gold or silver on hand.
If the economy takes off on a tear, it’s extremely difficult to expand the money supply to meet the demand. When the supply dries up, the economy just shudders to a quick stop, because nobody has enough spare money to fund more expansion. So the economy collapses until it reaches equilibrium with the available money supply, and the cycle starts again. Look at a chart of US economic activity in the 19th century and you see it’s a system of booms and busts, which were far steeper than any we’ve seen since the depression. So the fundamental problem with a gold standard is that it’s relatively inflexible when used by a vibrant, diverse economy. When everybody needs gold, and the demand is unpredictable, gold is very difficult to use unless you’re willing to live with severe booms and busts.
The Great Depression was the death knell for the gold-based world economic system. Those nations that jettisoned gold the fastest, recovered the most. Of course, WWII intervened in the depression, so it took a decade or so to get back to the business of commerce–as opposed to the business of building things to kill Nazis. But, by 1944, everyone–on the Allied side, at least–had recovered enough breathing room to meet at Bretton Woods, NH, and hammer out a new economic system.
What they came up with was a system of fiat currencies, all freely convertible in the FOREX market.
Now, governments could adjust their money supplies appropriately by printing more money or less of it, and taxing their populations more leniently or more severely, as needed. This is the system most of us have grown up with…and it’s dying.
It’s dying because of something innate in human nature that the gold standard was better equipped to deal with: the urge to loot the system.
It’s an urge that has always been there. Sometimes it has been the result of intentional government action to cheapen the currency. If you were, say, the king of Persia, you didn’t need to consult the priests of Ahura Mazda to know that if you changed from using 10 grams of gold per coin, to using only 9 grams per coin, you could stretch your gold supply by 10%. You could then take the extra gold, and buy yourself a nice hat. Or use the extra gold to make one. Whatever.
Of course, people would notice this pretty quickly, and items that used to cost 9 gold pieces would cost 10 pieces–inflation!–but because gold had an intrinsic value, the same weight of gold could be exchanged. It was still pernicious, of course, but because gold had an intrinsic value–and because the supply of gold was relatively inflexible–it wasn’t usually seriously pernicious.
Sometimes, the urge to loot the system has been done by private individuals, who figured out that if they shaved a bit off the edges of their gold pieces, they could accrue enough gold shavings to buy themselves a nice hat, too. This, by the way, is why when we began minting coins instead of hammering them out. They were minted with milled edges, making shaving attempts immediately obvious.
By the 19th century, the looting attempts became widespread, populist movements, like the “Free Silver” movement. At the time, gold was real money. If you took a bunch of gold to a Minting facility, the mint would return you an equal weight in gold coins–minus a nominal minting fee. After huge silver deposits were discovered at places like the Comstock Lode, populist agitation began for minting silver in the same way, at a ratio of 20 ounces of silver for 1 ounce of gold. The massive amount of silver floating around would, of course, have made this an extremely inflationary policy, and the farming and borrowing interests would have benefited by paying off bills for less than they had borrowed…enabling themselves to use the extra saving to buy a nice hat.
But during the First Age of Money, the looting was always constrained by the fact that gold had an intrinsic value, and that the supply of gold was inelastic. There were, therefore built-in constraints to the looting impulse.
When the Bretton Woods Agreement launched the Second Age of Money, it solved the problem of the inelasticity of the money supply, and enabled monetary authorities to fine-tune the money supply in response to economic activity. That was a good thing in the sense that it flattened–although did not eliminate–the business cycle fluctuations.
But the bad thing was that it completely removed any physical restraint on the money supply. It depended on governments and monetary authorities to exercise self-restraint, rather than impersonal, externally imposed constraints. The result has been 65 years of continually expanding credit, more or less constant inflation to a greater or lesser degree, and unrestrained spending and borrowing.
Governments–and their democratic (small “d”) constituencies quickly learned that they could loot the system. Social insurance, medical care, military expansion…whatever the Big Idea of the minute was, we could have it. And if we didn’t want to pay the taxes to the government to pay for it–and, mostly, we didn’t–we could simply borrow it. We could obtain a whole bunch of little green pieces of paper now in exchange for a promise we’d pay back more little green pieces of paper sometime in the future. In the meantime, we could buy all the hats we wanted!
But now, we are obligated to pay back various people about fifty trillion pieces of green paper. Unfortunately, the entire household worth of everyone in the country is worth about forty trillion pieces of green paper.
How can the current economic and financial system possibly be considered solvent at this point? How will re-expanding the cycle of debt re-invigorate it?
No, we’ve had our fun. We got to loot the system for 65 years. Now, the hat bill is coming due.
I suspect we’ll pay the hat bill the same way that Germany repaid their war reparations debt after WWI. “Hey, you remember that reparations bill for 3 billion marks that we’re supposed to pay next week? Yeah. I just wanted to let you know that we’ve sent that order off to the printers, this week, and we should have that printed up for you by Tuesday.”
The result was massive hyperinflation, the collapse of credit, and 5 years of compete economic stagnation, serious economic pain, severe unemployment…and the ability to start over in the mid-20s with a clean balance sheet. Clean enough, in fact, that by 1936 Germany had more or less completely emerged from the Great Depression, while the employment rate in the United States hovered at around 18%.
What Pres. Obama is proposing may result in nothing more than additional spending that helps bring about the collapse of the Post-WWII economic regime, while at the same time providing–temporarily–a social safety net that will provide some help as we pass through a difficult transitional period.
“I was there at the dawn of the Third Age of Mankind…”
OK. Maybe it’s not that grandiose, but I think we are seeing the dawn of the Third Age of Money.
No one in the government realizes how the economic world is changing. So their proposed solutions are likely to be exposed over time as ineffective and, perhaps even counter-productive. The credibility of governments around the world is now invested in staving off an economic collapse. When their failures become evident, and their “solutions” are exposed as fantasies, that credibility will collapse. Who will want to buy government bonds, or use worthless government money? Who will trust the governments who lead us into the economic abyss?
Unfortunately, rather that realizing that we are entering a transition, and trying to discover how to shepherd us through that transition, they are invested in preserving the dying system of government-regulated money supply and credit. And even if they realized that we were in a transitional period, they would still do nothing about it because it would require voluntarily releasing their power over the economy.
Governments have always been in charge of money; determining what money is, how it will be exchanged, how new money will be created, etc. In part, this is traditional, in that only government had the resources and ability to fund and oversee mining and exploration activities, regulate what legal tender consisted of, and all of the other monetary functions. There simply were no other large organizations in existence to perform those tasks.
It wasn’t until the 17th century that organizations began to emerge that could begin performing those tasks, and not until the 18th century that it became practical. Private money of various types began to sprout up everywhere. 18th-century America was, for a time, replete every decent-sized bank issuing its own currency based on deposits.
Eventually, the Federal government cracked down on that private money, not so much from jealousy of the government’s role as the issuer of currency, but because private banks suffered from the same tendency to loot the system, issuing more and more inflated currency until it was worthless, and they ended up wiping out their depositors in the collapse as their obligations came due. There were some solid money banks of course, but the spectacular failures of so many private currency attempts led the government to tax them so heavily that private currency issuance became uneconomic. Governments may not have been perfect, but the constraints of the gold system meant that they didn’t fail as completely and spectacularly as private banks did.
What was missing in private currency of the time, and what has been missing in the current post-WWII financial system is feedback. Yes, there is some, but it takes a long time to filter into the monetary authority, and is derived indirectly from statistics on economic activity, rather than by any sort of direct observation. The Fed raises interest rates today, for instance, and it takes around eight months to observe the indirect effects of the monetary policy change. This is why the role of the Fed, has often been described as steering a car by looking through the rear-view mirror. Based on seeing where you’ve been, you make decisions about where you must go. That may be a form a feedback, but it is so separated in time from the inputs that it’s an inherently unstable system.
By the same token, what killed depositors in banks that issued private money was a lack of feedback. It wasn’t possible to see that bankers were looting the system in time to withdraw your money.
We call this lack of feedback asymmetrical information. We’ve never been able to even approach the ability to have full information about what a bank or government is doing that may affect the money supply, or economic activity as a whole. We’ve never been able to see all sides of the story, as it were. So, we’ve had to more or less leave it in the hands of government, simply because governments have been the only organizations with the size and scope to reduce, even partially, the problem of feedback.
So, it seems pretty hopeless, doesn’t it? The financial world we’ve grown up with is collapsing under the sheer weight of looting. If governments can’t do it, and a return to the gold standard can’t do it, then where are we? At the edge of another dark age?
I foresee the rise of private money once again, and returning in such force as to negate the government’s role in the economy. In fact, the pieces for creating the Third Age of Money are already there.
The Internet will be the platform for the new money. But it’s just the platform; the communications media. The actual objects that make up the Third Age of Money will almost be located in cyberspace.
First, there is encryption. In the not-too-distant future, you will go online with a persona, i.e., an online identity with a unique, highly encrypted digital signature. No more logging in with different user names and passwords at 100 different web sites. Your persona will be uniquely identified as you through the use of 4096-bit or 8192-bit public key encryption. Your persona will be impossible to forge or duplicate. It will be unique. Your “bank” and your “money” will be similarly encrypted.
Second, is your ATM/debit card. It won’t be exactly the same, of course. It will be far more secure, probably through the use of biological identification systems to verify authorization, such as retinal scans. It will be linked directly to your persona’s bank account.
Third, is the ability of all the major banks and credit card companies to do online transactions, and to convert one system of private money to another at a publicly known exchange rate. So, you can pay directly to your account–or withdraw from it–in Discover Dollars, or MasterBucks, or Credit Suisse Francs. Or perhaps there might even be a universally acknowledged unit of currency–the “Credit”–that all the private companies agree to use.
But, the most important element of creating a reliable private money system that is resistant to looting the system is feedback. The reduction of asymmetrical information. And that exists, too. eBay has been using it for years. Indeed, in no small way, the system implemented by eBay may be a key element of our future.
Imagine a system where, every time I do business with your persona, I rate your reliability, and it doesn’t matter of the persona is an individual or a bank…or a government. Every day, millions of people who do transactions in MasterCard can rate the reliability and value of the MasterBucks system. Private companies like Standard and Poors or Moody’s would not only rate MasterBucks, but consumers would rate the reliability of S&P or Moody’s judgments.
And not only are the bank’s persona’s being rated, but your persona is as well, by every one who does business with it.
Put them all together and you have a secure form of private money that’s convertible, impossible to forge, and is subject to constant feedback about its value and performance. Does MasterBucks have too high a debt ratio or too much exposure to non-performing loans at MasterCard? No problem. It’s instantly convertible to Credit Suisse Franks. And the conversion rate lowers MasterBucks reliability ratings even more, signaling the company to correct its course, or lose its depositors.
Think of the implications this has for taxation, especially income taxation. Keep all your money in Credit Suisse Francs, say, and the US government will never even be able to see a record of your deposits or withdrawals. How will they track your income? And who will want to pay governments that failed to prevent the collapse for…well…anything? Who will accede to the demand for money by governments that repudiated their debts, and destroyed the life savings of millions?
I can foresee huge implications for the future that are very pro-liberty. In the long term. In the short term, though, if I’m right, and the current financial system is collapsing we will be in for a very rough decade or so. Very rough indeed.
*Apologies to Quentin Tarantino.
Taxes, as the saying goes, in that both are certain to come to us all. The corollary is that once government spending outpaces tax receipts by a significant enough amount, then taxes will inevitably rise. Or, at least, that should be the corollary.
The first of several stimulus packages has just passed but it is just the beginning of our efforts to address our immediate and long-term economic problems.
After 2010, the federal operating budget will face trillion-dollar deficits as far as the eye can see. They have to be addressed for the long-term prosperity of our country and our future credit-worthiness in the world.
Eventually every American has to dig in and pay more taxes to help our country and our fellow citizens. We must put in place the laws and mechanisms to steadily increase taxes after 2010. We have to owe up to our massive public and private financial messes. Cutting federal earmarks and waste will not eliminate even half the annual deficits. The federal budget gap will require increasing taxes by over $500 billion by 2011. Fiscally irresponsible and spoiled children hate to hear this news but it’s our only choice for our collective long-term prosperity.
It is true that people don’t want to hear this, and I don’t think that is limited to “fiscally irresponsible and spoiled children.” Indeed, the inevitable raising of taxes was one of the arguments against the stimulus package, so I’m not sure to whom Pascal is referring.
A number of prominent publicly-minded millionaires and billionaires including Warren Buffet have recommended higher income taxes on themselves and their friends for several years. Certainly Mr. Buffet has been right more than most politicians and it’s time to effectuate his recommendations. Their altruistic economic view may simply be a rational response for their long-term preservation and that of the nation as a whole.
Actually, their view is not altruistic at all. The very rich, with the financial means to hire the very best in tax advice, are quite skilled at arranging their affairs so as to minimize their tax burden. When Warren Buffet clamors for raising taxes on the rich, you can be sure that he does not intend to pay as much as he possibly can to the federal government. However, those in the middle income brackets surely will. Buffet and brethren simply hope that those taxpayers will somehow be mollified by the fantasy that “the rich are paying their share too.”
On to the plan:
The Bush tax cuts should expire by their own terms by 2010 and marginal income taxes will return to the rate of 39% for incomes over $250,000. Additionally, and instead of capping executive pay, we should create a new marginal tax rate of 49% for earning over $1 million.
That is actually a somewhat more reasonable plan than some that have be floated, but still a pipe dream in terms of raising tax revenues to cover the trillions in spending contemplated (and as yet revealed) over the next four years. Even if the rich were to pay every possible penny of their income above $1 Million in taxes at that rate, how long to do you suppose they would do it for? If you had a choice of living quite comfortably and making around a million dollars, knowing that you’d keep something close to 70% – 75% of the money, would you really continue working hard enough to earn more than that if you knew you would only receive 50 cents on the dollar?
If there are any short-term tax cuts, they should be combined with long-term tax increases. The 2009 FICA payroll tax for social security is a 6.2% tax rate on every dollar earned up to a gross annual income of $106,800. For more than a decade, everyone has agreed that to save social security (without increasing the retirement age, the tax rate, or lowering the average monthly benefits of just under $1,000 per person) the best solution is to raise the taxable income limit so the wealthy contribute more to the entire system. We could provide both a short-term economic stimulus to the majority of Americans and save social security for the long term.
Let’s lower the FICA social security tax rate for rest of 2009 and all of 2010 to 5.5% but raise the income limit to $250,000. In 2011, let’s raise it to 5.75% and set the income limit to $500,000. By 2012, the rate would be 6% and the taxable income unlimited. This would simply parallel the 1.45% FICA tax for Medicare and Medicaid imposed on all earned income. Its rate will probably have to be raised to 2% after 2010 to pay for existing programs and any expansions of benefits.
Again, not an entirely unreasonable plan considering the alternatives. But what’s never mentioned when someone suggests raising the income level for FICA is that, while more tax revenue would be raised, federal liabilities would also be increased. That’s because the government is simply taking more money now and promising to pay more benefits upon retirement. That does nothing to reduce the burden of current spending, which was supposed to be the point of the tax increases.
As near as I can tell, this part of the plan would have the effect of hastening the looming entitlements crisis in exchange for perhaps pushing the current one off down the road a bit. The end result looks more like a perfect budgetary storm as the bills we’re racking up today and the entitlements we’ve promised in the future, begin to overlap.
Across the political spectrum, most people agree that our various transportation, water/sewer, and electrical grid infrastructures have been long neglected. Infrastructure spending is the best use of government stimulus money because more jobs are created both quickly and over the long term. Just to modernize our existing infrastructures systems will cost at least 2 trillion dollars over the next 10 years. Furthermore, we must also invest in new energy technologies, mass transit and high speed rail lines – all of which will cost billions more. We can’t put off such spending and we have to be honest about paying for them over the foreseeable future without resorting to further borrowing.
This is a part of the supposedly Keynesian argument that government spending provides a greater multiplier than private spending. Of course, as Bruce has pointed out before, if that were the case then why have private spending at all?
Furthermore, I really don’t understand how government spending on infrastructure and energy technologies creates jobs.
In the infrastructure realm, once a government project is done, then the job disappears. If the job is done quickly, efficiently and completed on time then it’s not government work the job just disappears that much more quickly. And after that? How does a brand new bridge create a job after it’s built? Even worse, what happens if the project turns out like the Big Dig in Boston (which seems to be much more likely)? Sure people will have jobs for longer, but the supposed benefit of the structure will shoved further into the future and the taxpayers will be on the hook for a lot more than they signed on for. How does that sort of project stimulate the economy?
With respect to new energy technologies, I’m all for it. But with the government choosing which technologies to fund, how do we know we’re getting the best there is to offer? That’s not typically the case where government picks winners and losers. And just because something is “green” does not mean that it is efficient, beneficial to the economy, and/or capable of saving anyone money in the short (or long) term. In fact, it probably means the opposite of one or all of those things. Instead, why doesn’t government get out of the way and allow nuclear power plants to be built, thus saving taxpayers billions of research dollars. That’s technology that we already have, and it’s green. Otherwise, these sorts of proposals are little more than a massive wealth transfer from one group of people to the politically favored few. There is nothing stimulative about that.
Across Europe, the average tax per gallon of gasoline ranges from $4 to $6. The U.S. federal gasoline tax is a paltry 18.3 cents per gallon with each penny raising $850 million to $1 billion per year depending upon how much Americans drive. Only when gasoline hit $4 a gallon during last summer did we start taking mass transit, buying hybrids, shunning gas guzzlers, demanding more energy-efficient cars and buildings, and seriously considering alternative solar, wind and nuclear power, and our own oil and gas reserves. The best and only way to ensure long-term energy independence is to have a serious financial incentive that hits everyone.
OK, if we accept the premise that less fuel consumption is better for Americans, then Pascal has a good point here. Of course, I’m not sure why gas station owners or truck salesman are any less deserving of being stimulated than other Americans, but that seems to be a staple of these plans. Moreover, Pascal’s plan doesn’t look all that much different than how transportation projects are already funded at the federal level.
While we should not enact excessive gasoline taxes, we can at least impose an additional and modest oil import fee on foreign barrels of oil.
More importantly, we should increase the federal gasoline tax from 18.3 to 75 cents per gallon, by monthly increments of about 5 cents per gallon over 12 months. The overall U.S. gasoline price per gallon by the end of 2010 should still be around $3.00 but the U.S. would have $70 billion a year to pay for our many needed transportation and energy infrastructure projects. This would be the responsible, mature, and intelligent solution for raising the necessary funds for these projects.
Presumably, Pascal means that we would charge this import fee to the American refiners who distribute gasoline in the country. And Pascal does suggest that he thinks this would be a tax on everyone, which in addition to the increased gas tax it would be. Strangely, this is the sort of protectionist measure one sees where domestic industries are beset by low-cost foreign competitors, yet domestic production is practically forbidden. Instead, Pascal wants to drive demand for gasoline down, so he advocates raising the costs of gasoline indirectly. Would that have the effect of increasing demand for more domestic oil? Perhaps. But it would certainly raise costs for all Americans, whether we all buy hybrids (which are much more expensive) or not, and again I don’t see how raising prices is stimulative.
Overall Mr. Pascal’s tax proposal is not altogether outlandish, and certain elements of it are almost certain to come to pass. What’s so horrible is that these sorts of plans are only necessary (and inevitable) because the government has been spending far more than it takes in for quite some time now. Even if you think that the Bush tax cuts “cost” the federal government money, you have to admit that the one thing that every administration has had in common, whether Republican or Democrat, is that federal spending never decreases. Regardless of whether tax-and-spend is better/worse than cut-taxes-and-spend, the situation we find ourselves in today is precisely because spending never seems to drop, not because tax rates go up and down.
To be sure, there is nothing evil per se about deficit spending. Whether it’s bad or not depends on where the money is going, and how the costs are intended to be recouped. But at some point the piper must be paid, and when that time comes one would hope that all the spending had created some wealth with which to pay him.Obviously taking money from Peter and giving it to Paul (minus a transfer fee, of course) won’t accomplish that goal. And neither does building a new bridge from Paul’s house to Peter’s. Indeed, unlike people, the government can’t work harder in an effort to “do something” and create wealth, because that’s not what governments do. The only things that government is any good at is making rules and enforcing (some of) them. Although those two actions can protect wealth and the opportunities to create wealth, neither action actually creates wealth.
Thus, we’re left with the unshakable propositions that (1) government spending necessitates taxes, (2) deficit spending necessitates tax increases, (3) tax increases necessitate higher prices, (4) higher prices produce less consumer spending, (5) less consumer spending results in less business revenues, (6) less business revenues means fewer jobs and less wages, (7) fewer jobs, less wages and less business revenues means less tax dollars, and (8) fewer jobs, less wages, less business revenues and less tax dollars means … more government spending is necessary?
If you believe that last one, then I have a bridge I’d like to build you. It will be ready for use immediately upon the check clearing.
“The principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.” – Thomas Jefferson
Here is a look at the Dow Jones since January 20th, when Barack Obama assumed the presidency. I’m not saying this is all his fault, but it’s clear that his mortgage bailout plan and the “stimulus” package have been met with skepticism on Wall Street.
In fact, this is the worst January on record for a president in a century:
[F]rom Nov. 4, 2008 through Feb. 12, 2009, the DJI overall fell 18% — a larger drop than during the Sept-Oct plunge. In January, when the Obama plan, promising far greater deficits than the two much smaller “emergency stimulus” plans signed by Pres. George W. Bush in 2008, was unveiled, the market tanked – the worst January performance in 113 years.
More pointedly, key political victories for the Team Obama spending plan have not been viewed as buying opportunities on Wall Street. A string of negative market reactions began with the December 18 announcement of a stimulus bill of $700 billion (Dow down 2.5%), continued with the January 7 announcement that the actual plan would be “on the high side” (-2.7%) and continued with last week’s 61-36 Senate vote supporting the Administration’s fiscal plan. The White House victory and the new bank bail-out plan announced the following day by Treasury Secretary Geithner were met with a 5% wipe-out in the DJI, and a decline in Treasury bond yields, indicating a “flight to quality.”
Markets don’t react well to a president saying things like, “Potentially we’ve got trillion-dollar deficits for years to come.” Investors realize that deficits matter:
If historic U.S. budget deficits are any indication, the economy is already “stimulated.” The predicted 2009 federal deficit stood at 8.3% of GDP before Obama’s package sent it to about 12%. This is a stunning level of debt, double the previous post WWII high when Reagan’s 1983 budget deficit amounted to 6% of GDP.
We do, however, know the accounting trends: our government faces massive new spending increases as Baby Boomers retire and their Social Security and Medicare bills come due. Market investors are wary of new spending, guaranteeing either future tax increases or inflation, as a run-up to the demographically guaranteed spending spiral. The quest for “shovel-ready” projects makes one think, Where’s Senator Ted Stevens when we need him? In any event, this fiscal bridge to nowhere is not spurring markets.
Government deficits are nonetheless being sold as doctor’s orders, an elixir that – while it looks ugly and tastes bitter – will propel us back to economic health. Yet the best forecast currently on the table is the one made by investors risking their own money. They are shorting the “stimulus.”
As the CBO has already predicted and common sense would indicate, whenever you take a dollar out of the economy through spending or borrowing, it is one less dollar that can be invested. Economists call it “crowding out” because it lessen the money available to the private sector for investing and borrowing, which can result in higher interest rates if the deficit is large enough or inflation if the Federal Reserve is printing money to offset economic problems, which they are today, as Steven Entin noted in a presentation on Keynesian economics at the Cato Institute.
Sounds like the 70’s all over again.
Most economists agree that America has enjoyed unprecedented prosperity, based primarily on excessive debt. Thus, any healthy correction would necessarily involve serious deleveraging and a severe recession. After a lot of pain, the economy would rebuild with healthier fundamentals. Infrastructure improvement would aid, but not cause, the eventual recovery.
Recession is the natural cure for the politically inspired profligacy that America has enjoyed for almost 40 years. Unfortunately, the side effects of this medicine, namely the rapid reallocation of labor resources and deflationary damage to debtors, are still unpalatable to pandering politicians.
The Washington regime, particularly members of the Democrat persuasion, leans towards a socialist solution of avoiding recession at any cost. After all, the bills are paid by others, such as taxpayers and holders of US dollars. This results in an increasing amount of other people’s money being spent on “public” works that would in other times carry the label “pork barrel”.
Washington is choosing to pursue the policy of continued and ever-increasing false prosperity, financed eventually by hyper-taxation, hyper-debt and hyper-inflation accompanied by a gradually eroded standard of living. The jobs created by the bill are by and large non-productive and will divert resources from the private sector and rob consumers of their power to make free choices in the marketplace.
Pain avoidance drove the call for stimulus. Politicians are naturally for that because it ensures their future. But in reality it isn’t pain avoidance at all, but simply a form of pain management. And since that management will be spread over many years, those who will lose under it will be less likely to notice that loss over the years than they would if that loss happened all at once. But there’s a price for that, and it will become apparent eventually. That gradual loss won’t allow the recovery to the previous standard of living because government will have supplanted much of the private sector and many of those options (and resources) for regaining that level are no longer available.
Of course, the good news for the present crop of politicians is that realization of loss won’t happen on their watch. And as far as the political class is concerned, that’s all that matters.
Let the good times roll!
You’ve just witness the unimaginable – Congress passes a 789 billion dollar pork-laden spending bill disguised as a “stimulus” bill and they may be contemplating “Unimaginable II”:
Despite the enormous size of the $787 billion stimulus plan, some economists worry that it won’t make a big enough dent in unemployment and that lawmakers will have to work on another stimulus in short order — something members of Congress are loathe to discuss.
“That’s possible,” said Alice Rivlin, a former Clinton administration budget director. “I think the economy is getting worse quite rapidly and this may not prove to be enough.”
And why is that, Ms. Rivlin? Why might it not be “enough”?
The stimulus got “less stimulative,” Rivlin said, as it passed through the Senate and some of the things that offered “the biggest bang for the buck” were scaled back, such as more money for food stamps.
You mean it was exactly what those mean old Republicans said it was – more relief than stimulus. More social spending than jobs? That, in fact, any stimulative part of the bill was watered down or eliminated in favor of special interest spending on programs which are either years in the future or will provide no immediate jobs with which to help get the economy moving?
You mean, despite all the rhetoric and nonsense to the contrary by Obama and the Dems, we are on the road to repeating the mistakes Japan made that brought them their “lost decade”?
And I doubt many would call Ms. Rivlin a right-wing reactionary economist spouting Republican talking points, would they?
So now that the Dems have fulfilled their 40 year social program spending spree, it appears they may now try to actually stimulate the economy with a few more hundred billions of your great, great, great grandchildren’s money.
More future theft.
“Son of Stimulus”, coming to a wallet near you soon?
Since the inception of the current downturn, free market capitalism has taken quite the bashing. Supporters of significant government involvement in the economy deride the horrors of “unfettered capitalism” and a “free market run amuck.” Frequently, deregulation of capital markets is singled out as the most dastardly culprit, to which Pres. Obama seems to be alluding when he blames “relying on the worn-out dogmas of the past,” and “too little regulatory scrutiny.” Yet, after the last eight years in which we witnessed Sarbanes-Oxley, No Child Left Behind, Medicare Part D, and numerous attempts to reign in Fannie Mae and Freddie Mac shoved aside by legislators, evidence of unregulated economic activity being the source of our crisis seems rather scant.
The idea that “deregulation” was somehow responsible for the mortgage meltdown is a particularly shaky proposition. Shannon Love explains why:
Leftists have to answer a question: if greedy, irresponsible, unregulated etc. capitalism caused the housing bubble, why didn’t we see a similar bubble in commercial real-estate markets which operate under even less regulation than the residential markets? Why does the politically neglected and unregulated commercial real-estate market exhibit much milder swings?
The differences between residential and commercial real estate provide the means to test the hypothesis that government intervention or the lack thereof caused the housing bubble and subsequent collapse of the financial system. We can compare the two markets because the same institutions ultimately make residential and commercial loans. They make loans in the same communities and regions. Changes in the economy affect both types of real estate at the same time and to the same rough degree. The only major difference between the two markets lies in the degree of government intervention.
After dispensing with some obvious questions about the comparison, Love highlights how the residential market was essentially turned into a Lemon’s Market:
As Love points out, the commercial real estate market has no such mechanism muddying its waters, and information is comparatively less asymmetric. Without the government interference, commercial mortgage lenders let the potential for bad outcomes drive their decision making:
More than any other policy, the creation of Freddie Mac and Fanny May distorted the residential mortgage market in a way that the commercial market escaped. The FMs exist solely to induce lenders to make residential loans that the free market judged too risky. The FMs buy up residential mortgages from primary lenders and bundle them together in securities. They do so precisely in order to short-circuit the free-market feedback system that communicates to banks when the financial system as a whole has lent out as much money as it safely can. That feedback system worked like a governor on an engine. It kept the system from running away and lending more money than it could recoup, but also prevented people with poorer credit from getting loans.
Politicians who wanted the engine to run faster created the FMs to bypass the governor in order to get higher performance in the short run. Since the FMs would buy up almost any mortgage, lenders could make riskier and riskier loans without suffering any negative consequence. The FMs replaced the self-interested secondary-market buyers with people playing with government money and a mandate to induce more and more lending. Special dodgy accounting rules allowed the FMs to hide the risk behind the securitized mortgages they sold.
Tellingly, no such intervention occurred in commercial markets. The FMs’ charters expressly prevented them from buying commercial mortgages. As a result, the commercial mortgage market functioned with a free-market governor. When lenders made too many risky loans, free-market secondary buyers stopped buying their mortgages and the system cooled down. As a result, commercial markets saw no runaway boom and subsequent colossal bust.
Although I think that laying the crisis solely at the feet of the residential mortgage market is overly simplistic (for example, what was up with the ratings agencies?), Love does point to a very apt comparison as to how government intervention in the market changes incentives and behavior. If you guarantee risks against bad loans, and subsidize the debtors, then more of such loans will be made. Remove such a guarantees and subsidies and market forces will severely punish improperly compensated risk taking.
The trade off, of course, is that free markets do not allow much opportunity for rent-seeking. Which is why Love’s final lament is so true:
Sadly, experience suggests that mere empiricism has no place in political economics.
That’s because empiricism does not buy votes.
Apparently the Brainiac known as John Kerry is again displaying his wit an wisdom for all to see. Mary Katherine Ham caught him on the floor of the Senate pontificating about why tax cuts were bad:
I’ve supported many tax cuts over the years, and there are tax cuts in this proposal. But a tax cut is non-targeted.
If you put a tax cut into the hands of a business or family, there’s no guarantee that they’re going to invest that or invest it in America.
They’re free to go invest anywhere that they want if they choose to invest.
If you feel like you’ve just been hit in the solar plexus, welcome to the club. While technically true, his statements are so stunningly ignorant it’s hard to fathom how one could actually articulate them with a straight face.
This man who wanted to be president is sure that only government can “invest” these dollars properly – like the first half of the TARP funds, some of which went toward buying banks in China – but that the majority of Americans would “invest” them ignorantly or not at all.
Per Kerry you can’t be trusted to spend your money the way John Kerry wants it spent – on bike paths and Frisbee Golf Courses or other misbegotten projects he finds preferable. The poster boy for rule by the elite, Kerry manages in three sentences to underscore why this travesty of a bill will fail. The economic ignorance embodied by his words, and the fact they fairly represent the dominant thinking in the dominant party and their lackeys is amazing but true.
With people like Kerry in charge, it is going to be a long, debt-ridden and impoverished 4 years, folks.
It’s been interesting to watch the left attempt to paint the right as obsessive about tax-cuts, to the exclusion of any other method of stimulating the economy. Josh Marshall called it “tax cut monomania”. Of course careful readers who’ve followed this debate know that’s absolute nonsense. The Republicans have bought into the premise that some level of government spending is necessary, except that it should be tightly targeted and provide immediate stiumlus.
Instead they’re faced with this bloated piece of garbage legislation derisively called the “2009 Spend Your Grand Children and Great Grand Children into Debt bill”.
I noted Marshall’s appeal to authority (the sacred macroeconomic texts) yesterday and his claim that macroeconomists couldn’t exactly run controlled experiments to prove their point. But upon reflection, I thought, that’s not precisely true. While it may not fit the classic definition of a “controlled experiment”, Japan’s 2 decade long struggle to revive its economy is about as close as we’re going to get.
And you know what – the lessons learned from that say we’re about to commit the same mistakes they did. President Obama claimed, last night, that spending on infrastructure was the way to go – that it would create jobs and stimulate the economy. But Japan spent $6.3 trillion on construction-related public investment between 1991 and September of last year, and it did nothing of the sort. Nope, paving over Japan accomplished little in terms of stimulating a down economy.
In the end, say economists, it was not public works but an expensive cleanup of the debt-ridden banking system, combined with growing exports to China and the United States, that brought a close to Japan’s Lost Decade. This has led many to conclude that spending did little more than sink Japan deeply into debt, leaving an enormous tax burden for future generations.
In the United States, it has also led to calls in Congress, particularly by Republicans, not to repeat the errors of Japan’s failed economic stimulus. They argue that it makes more sense to cut taxes, and let people decide how to spend their own money, than for the government to decide how to invest public funds. Japan put more emphasis on increased spending than tax cuts during its slump, but ultimately did reduce consumption taxes to encourage consumer spending as well.
Trade and tax cuts along with spending targeted at banking system was how Japan finally pulled out of its doldrums. We already have 700 billion aimed at our banking system, with only half of it spent. That leaves what, if you’re interested in not repeating the mistakes of an economy which has already gone thorugh this sort of thing?
Well it’s certainly not a huge NRA style spending spreed on public works. Japan spent trillions on public works and infrastructure and it didn’t do what all the economists said it would do. Instead Targeted spending on the banking system, tax cuts and the development of trade turned the tide.
Given the present bill it appears we’re going to “Buy American”, refuse tax cuts and spend hundreds of billions on roads and bridges. The Republicans objections to this mammoth pork and relief fest have nothing to do with “tax cut monomania”. It has much more to do with understanding the lessons learned from the Japanese experience and not wanting to repeat them. Democrats, in their arrogance, seem to believe that they can do the same thing as Japan but have a different outcome.
Many progressives thought that Pres. Obama had abandoned them after the election, but I’ll bet they’re singing a different tune today:
President Barack Obama on Wednesday imposed a $500,000 cap on senior executive pay for the most distressed financial institutions receiving taxpayer bailout money and promised new steps to end a system of “executives being rewarded for failure.”
The limit would apply to top-paid executives at the most distressed financial institutions that are negotiating bailout agreements with the federal government.It also would apply to other banks that receive aid, but they could get around the limits by publicizing to shareholders plans to exceed the salary cap.
The “most distressed financial institutions” will not include those which have already received TARP funds, such as AIG and Citigroup. However, those firms are already subject to caps on executive pay under the statute authorizing the bailout last Fall. And because these companies have all come to the government “with hat in hand,” in Obama’s words, not too many people outside of Wall Street are upset. Yet, Obama does not seem content to stop with these “distressed” companies:
The administration also will propose long-term compensation restrictions even for companies that don’t receive government assistance, Obama said.
Those proposals include:
• Requiring top executives at financial institutions to hold stock for several years before they can cash out.
• Requiring nonbinding “say on pay” resolutions — that is, giving shareholders more say on executive compensation.
• A Treasury-sponsored conference on a long-term overhaul of executive compensation.
This is exactly the sort of creeping socialism that many of us were worried about with Obama’s election. Mind you, McCain would not have been much better, but this sort of heavy handed government interventionism would not have been proposed by his administration, much less tolerated by most Republicans in Congress.
Obama’s proposals are somewhat tolerable with respect to the bailed out companies since they are being funded with tax payer dollars. If these companies are going take the money, then they should have to abide by whatever rules are attached to the funding no matter how onerous. But trying to impose such draconian restrictions on companies that are not being bailed out is nothing more than a direct assault on freedom.
Even if you think that no executive should be paid more than $X more than the lowest paid employee of a firm, or are just angry at the seemingly wasteful and lavish life styles of Wall Street bankers, you still have to find this sort of proposed legislation abominable. Why? Because no matter what you think about executive compensation, the owners and operators of these companies think otherwise. It’s their decision to make about how their companies are run and how well their employees are paid. Unless, of course, you would just fine and dandy with some government bureaucrat deciding that you are overpaid for your position, and that no matter how hard you work you can never make more than $Y.
The only people who would ever agree to such slavery are those who have no ambition and little, if anything, to offer the world in terms of work product. They are not the people who invent the items, create the ideas, or provide the services that make our lives better over time. That is not to say that their efforts are not appreciated, nor that they shouldn’t be rewarded. But neither should we base the engine of wealth creation on their hopes and dreams of sinecure.
Beyond the egregious assault on freedom these proposals represent, there is also a huge question as to their efficacy, regardless of whether the firms are troubled or not (my emphasis):
Compensation experts in the private sector have warned that intrusions into the internal decisions of financial institutions could discourage participation in the rescue program and slow down the financial sector’s recovery. They also argue that it could set a precedent for government regulation that undermines performance-based pay.
“One of the big questions is whether it will make it more difficult to recruit and retain executives at these companies,” said Claudia Allen, chair of corporate governance at the Chicago-based law firm of Neal, Gerber & Eisenberg.
The $500,000 cap “is a very tight limit,” she said.
Timothy J. Bartl, vice president and general counsel for the Center On Executive Compensation, said the president’s actions are a unique situation given the government’s role bailing out troubled institutions.
“We do not view it as something that ought to be extended beyond this circumstance,” he said.
I don’t think there’s any legitimate doubt that these will be the effects. Indeed, here are some of the reactions to Obama’s proposals:
Goldman Sachs said yesterday it wants to repay $10 billion it got from Treasury under the TARP to signal the firm is healthy and to escape limitations that came with that infusion of money. “Our financial condition is sound and, subject to approval from regulators, we hope to repay TARP money as soon as practicable,” said Lucas van Praag, a spokesman for New York- based Goldman Sachs.
JPMorgan CEO Jamie Dimon said Feb. 3 that the firm didn’t need capital and didn’t ask for TARP funding. The lender accepted the $25 billion it received from the first capital injection at the request of the government and to help stabilize the banking system, he said.
Goldman has to get permission to repay the government? Does that make sense? Only if the reason the funds were distributed in the first place was to give the federal government control over the market place. I think that’s exactly what Bush (“I’ve abandoned free-market principles to save the free-market system”) and Paulsen had in mind with TARP, and I think Obama is prepared to carry the ball even further into socialist territory.
As far as retaining talented executives, why would any of them stay? If you were making $10 Million per year including your bonuses (not uncommon), why would you stay somewhere that’s forcing you take a 95% pay cut? Of course, many will say good riddance to bad rubbish, and perhaps their right. It’s not like a firm that goes crawling for a federal handout was performing all that well. Except that (a) it’s far from clear that bad management led to the current crisis (although, surely that had something to do with it), and (b) even if it were clear, not every executive or potential executive was responsible. If you are a rising star in your investment bank who has put in exhaustingly long hours to get ahead in hopes of a big payday in the future, why would you stick around where you know your options are limited? These are very smart, industrious and capable people. There are plenty of places where they can go and not be subject to such pay strictures, and that is where they will end up.
Moreover, a part of the proposed regulations practically eliminates the fabled “golden parachutes” for executives:
Obama said that massive severance packages for executives who leave failing firms are also going to be eliminated. “We’re taking the air out of golden parachutes,” he said.
This displays a fundamental misunderstanding of what golden parachutes are. Contrary to popular belief, they are not generous giveaways to failed executives, but instead incentives for failed executives to get out of the way and allow new management. Without these sorts of incentives, management becomes entrenched and complacent. If a proposed takeover threatens to take away the goodies they can vote themselves, then they will forego such proposals and keep cashing in. In order to align management’s interests with the shareholders, golden parachutes were introduced to incentivize firm managers to sacrifice their jobs when the best interests of the company warrant it. Since one of the major problems that everyone seems to have with Wall Street is the failure of effective management, one would think the new rules would make it easier to bring in new blood, not harder.
But none of that matters to Obama:
Mr. Obama said the cap strikes the right “balance” between fair compensation and proper stewardship of taxpayer funds. “This is America. We don’t disparage wealth. We don’t begrudge anybody for achieving success. And we believe that success should be rewarded. But what gets people upset –and rightfully so–are executives being rewarded for failure, especially when those rewards are subsidized by U. S. taxpayers.
“For top executives to award themselves these kinds of compensation packages in the midst of this economic crisis is not only in bad taste, it’s a bad strategy — and I will not tolerate it as President.”
Again, it’s hard to generate much sympathy for executives who’ve come begging to Washington. But at the same time, what point is there to heavy handed measures that don’t do anything more than satisfy some people’s jealousy and outrage? Shouldn’t these proposals be designed to put people back to work?