When it comes to military procurement, President Obama says:
“I reject the false choice between securing this nation and wasting billions of taxpayer dollars,” Obama said on a day when he signed a presidential memorandum reforming the contracting system across the entire government.
But when it comes to a spending bill with 9,000 earmarks?
Democratic Senator Evan Bayh calls it what it is – wasteful spending.
Where’s the presidential leadership on this? If there’s waste in the procurement system and that’s a target, why isn’t waste in the spending bill also a target?
Another day older and deeper in debt. Of course, that’s because you plan to spend $3.6 Trillion on budget over the next year.
WASHINGTON – President Obama laid out his first budget plan, a bold $3.6 trillion proposal that would transfer wealth from rich taxpayers to the middle class and the poor, and predicts a stunning federal deficit of $1.75 trillion this year – nearly four times last year’s record.
Obama blamed the expected federal deficit explosion on a “deep and destructive” recession and recent efforts to battle it, including the Wall Street bailout and the $787 billion stimulus plan.
Among the budget proposals, the plan would:
extend a $400 tax credit for most workers while letting expire former President George W. Bush’s tax cuts for couples making more than $250,000 a year. The budget contains almost $1 trillion in tax hikes over 10 years on individuals making more than $200,000 and couples earning more than $250,000;
close tax loopholes for the wealthy to raise $318 billion toward a down payment on Obama’s universal health care plan;
clamp down on the Pentagon budget, which would get a 4 percent boost next year, but would then get increases of 2 percent or less over the next several years;
make permanent the expanded $2,500 tax credit for college expenses;
spend more than $6 billion on cancer research at the National Institutes of Health next year, a 15 percent hike;
spend $3.9 billion to improve the nation’s sewage treatment plants and drinking water systems; and
raise $15 billion a year, beginning in 2012, from auctioning off carbon pollution permits to help develop clean-energy and renewable-energy technologies. The administration “will work expeditiously” to get Congress to approve an 83 percent reduction in global warming emissions by mid-century. There’s also more money at NASA for space-based monitoring of greenhouse gases.
After reviewing some of the comments from those intended to be taxed, as well as some of the criticisms of those taxpayers’ intelligence [as an aside, I think the liberals denouncing both the story and the interviewees are playing a little fast and loose with the assumptions, since the taxpayers displayed no misunderstanding of marginal rates, and voiced concerns solely based on principles], I got to thinking about how much money will this proposed tax hike really raise. This seems important, not only because of the size of proposed budget, but also since a common refrain from those in favor of letting the top rate snap back to 39.6% (from the current 35%) is that it will only cost those taxpayers 5 cents on the marginal dollar, which is very little to worry about much less enough to change behavior, or so the argument goes.
Before looking at the actual numbers, let’s get something straight first. While it is accurate to say that raising the top rate only costs these taxpayers a nickel per extra dollar earned, that is not all that is being proposed. These taxpayers will also be losing deductions and credits that they would otherwise have, as well as paying extra taxes on anything subject to cap-and-trade taxes, should that lovely piece of legislation be passed. Moreover, if you truly believe Obama when he says that those with incomes less than $250,000 per year will receive a tax cut, then it seems ludicrous to pretend that at least some, if not virtually all, of those taxpayers near the margin will change their working behavior so as to be in the benefit group rather than the extra-taxed one.
Nevertheless, for purposes of calculating the expected tax revenues generated under this plan, I’m going to assume that nobody changes their behavior in the slightest (i.e. everyone earns as much taxable income as possible), and that the number of taxpayers and the amount of taxes paid largely mirrors the 2006 numbers (which is the most recent data available).
According to IRS figures [xls], about 50% of all taxable income came from the $200,000 and above earners in 2006. By my calculations that came to $2.056 Trillion dollars in taxable income from 3,847,241 taxpayers (about 9% of all returns). This cohort paid approximately $522 Billion in taxes, or about 62.4% of the total $837 Billion in tax receipts. These are the people upon whom the new burden will be placed according to President Obama.
In order to figure out how much taxable income is above $200K (there is no breakout for $250K and above), I took all of the taxpayers in the $200K to infinity range (3,847,241) and multiplied it by 200,000 (= 769,448,200,000).
I then subtracted that number from the (rounded) total of taxable income for the same range (@ $2.056 Trillion), and got $1,286,551,800,000. If I thought about it correctly, then that should be the amount of taxable income above $200K.
I then took my above-$200K number and multiplied it by 5 cents, figuring that the increase in marginal rate of 4.6% would lead to about a nickel per taxable dollar earned in new revenues, if everything were to remain static.
From all of that I figured that approximately $64.3 Billion in new taxes would be raised by the new tax hike … to cover a $3.6 Trillion budget.
I sent my calculations to Dale, who became so engrossed in the matter that he put together an entire spreadsheet figuring the numbers in not one, not two, not three, but in six different ways. I realized later that asking Dale to check out my math was rather like standing on one foot and excitedly calling attention to my “skill” while in the midst of an acrobat convention.
After Dale played with the numbers [xls] for awhile, he arrived generally at the conclusion that the absolute most that could be raised was in the neighborhood of $85 Billion, and at worst around $55 Billion. On average, Dale calculated that approximately $65 Billion was the likely amount of new tax revenue that could be expected if all payers in the 2006 cohort behave exactly as they did then. Sticking with the metaphor, “Yes, Michael, that’s a decent one-legged stand you have there.”
In short, a complete klutz has a better chance of joining the Flying Wallendas than the bottom 95% of taxpayers do of getting a tax cut. Instead, they will all see a significant tax hike, whether in their marginal rates, in excise taxes, corporate taxes, fuel taxes, or other forms of indirect taxation. And as those taxes begin to mount up, and the national debt does it’s best imitation of the Challenger, people will work and produce less and less, and tax revenues will dry up.
That is the plan for our recovery. Read it and weep.
It is certainly worse abroad than here. As Dale pointed out, if this is a failure of the “free market” why is Europe, which is very tightly regulated, having a worse time than we are? Ambrose Evans-Pritchard has a blog post outlining the woes of Europe. First, the real possibility of repudiation of debt:
Ex-Bundesbank chief Karl Otto Pohl has just said that Ireland and Greece are in danger of defaulting on their sovereign debts and/or may be forced out of the Euro, for those who may not be aware of his Sky interview by my colleague Jeff Randall.
“I think there are countries considering the possibility. It would be very expensive,” he said. “The exchange rate would go down, 50 or 60% and then interest rates would go sky high because the markets would lose all confidence.”
Then we have the possible abandonment of the Euro in order to “re-establish economic competitiveness quickly”:
Laurence Chieze-Devivier from AXA Investment Managers — in “Leaving the Euro?” — says that the rocketing debt costs of Ireland, Greece, Spain, and Italy are taking on a life of their own. (Italy has just revised is public debt forecast from 2010 from 101pc to 111pc. That is a frightening jump. While the CDS default swaps on Irish debt is are at 376 basis pouints. Austria is at 240. This is getting serious).
It is far for clear whether all these countries will accept the sort of drastic retrenchment required to stay in EMU. “By leaving the euro, internal adjustments would become less `painful’. An independent currency would re-establish economic competitiveness quickly, not achieved by a sharp drop in employment or wage cuts”.
The possible death of the “European nation”:
Carsten Brzeski for ING in Brussels said the eurozone laggards were more likely to default than pay the punishing costs of leaving EMU.
“It is difficult to believe that Portugal, Italy, Ireland, Greece, and Spain, would be better off outside the eurozone. While a government could possibly get away with a redenomination of its debt, the private sector would still have to service its foreign debt. We believe any attempts to leave monetary union would lead to the mother of all crises, and total isolation in any future European integration”
Mr Brzeski said the bigger danger is that countries will face a buyers’ strike for their debt as a flood of bond issues across the world saturates the markets.
“A further worsening of the crisis could lead to (partial) sovereign defaults in one or several countries.”
How is that likely to happen?
The country’s parliament could pass a law redenominating debt into the new Lira, Drachma, or whatever. But there would be a pre-emptive run on bank deposits long before then. “Anyone not desirous of losing money would presumably see the writing on the wall and transfer any funds beyond the reach of the state. In other words, close down that account with Monte dei Paschi di Siena and open a new one with Commerzbank in Germany”.
Such a wholesale shift would lead to a collapse in the money supply, perhaps equal to the 38pc contraction in M3 from October 1929 to April 1933 in the US — but concentrated in a much shorter period. “Banks would be forced to call in outstanding loans, bring about a collapse in the country’s business.”
Certainly a bit of a doomsday scenario, but, unfortunately, not at all outside the realm of possibility. In fact, as they are, some are arguing it will happen in the near future. Almost every bit of it the result of market distortions implemented or enabled by government.
In this podcast, Bruce, Bryan, and Dale talk about the president’s new budget, and the end of the Post-WWII global financial system.
The direct link to the podcast can be found here.
The intro and outro music is Vena Cava by 50 Foot Wave, and is available for free download here.
As a reminder, if you are an iTunes user, don’t forget to subscribe to the QandO podcast, Observations, through iTunes. For those of you who don’t have iTunes, you can subscribe at Podcast Alley. And, of course, for you newsreader subscriber types, our podcast RSS Feed is here. For podcasts from 2005 to 2007, they can be accessed through the RSS Archive Feed.
A lot of high-fives on the left concerning a portion of the budget dealing with energy. The Center For American Progress, in a post entitled “Energy Budget Is Sunlight After Eight Years of Darkness” says:
The most significant energy proposal in this budget is the inclusion of revenue in 2012 from the auction of all greenhouse gas emission allowances to major polluters under a cap-and-trade system. The budget assumes that this program will raise $646 billion between 2012 and 2019. Some of these funds would create jobs via a $120 billion investment in clean energy technologies over the same period. The auction revenue would pay for a “global warming tax cut” for working families with $526 billion. It would fund Making Work Pay, which provides a refundable income-tax credit for low-income working families. Any remaining funds would go to other families and businesses to offset higher energy prices.
In other words, CAP believes that adding huge additional costs onto the already high cost of producing goods, services and energy will “create jobs” to offset those lost apparently. And the money collected will be redistributed to make things fair.
As so-called members of the “reality based community”, you have to wonder if they’ve ever bothered taking off the rose colored glasses and glanced around the real world.
Alan Wood in Australia asks:
CAN the Senate save Kevin Rudd and Penny Wong from their global warming folly? It can, and it might, if it rejects the Government’s attempts to prematurely lock Australia into a flawed carbon trading scheme. Ask yourself, do you believe that the worst global recession since the Depression, with job losses accelerating, is the time for Australia to introduce a carbon trading scheme that will squeeze growth, jobs and investment? Business certainly doesn’t.
Is there anyone in the Congress who can do the same for Barack Obama? Probably not. Do they understand that the carbon trading schemes in place around the world are literally melting down? Again, probably not.
And jobs? Well right here at home we can learn from the impact of the draconian regulations and resultant costs imposed on industry by such schemes and what that means. California, as usual, provides the case study:
California regulators Thursday adopted the world’s first mandatory measures to control highly potent greenhouse gases emitted by the computer manufacturing industry. “The financial impact is going to be severe,” Gus Ballis, a spokesman for chip maker NEC Electronics America Inc., a subsidiary of NEC Electronics Corp. in Japan, told the board. Ballis warned, “We’re potentially on the chopping block — whether they are going to keep us or pull our production back to Japan.”
The painful loss of 1850 jobs at Pacific Brands in NSW, Victoria and Queensland is more than a byproduct of the global recession. The main reason for shifting to China, chief executive Sue Morphet said on Wednesday, is that manufacturing in Australia “is no longer a competitive advantage” to the company. The Prime Minister owes it to businesses large and small, as well as to Labor’s core constituency, workers, to re-evaluate the impact on employment of his emissions trading scheme, especially in mining, where Australia has such a strong comparative advantage.
The German biofuels industry is facing bankruptcy according to their industry association, despite millions of state-sponsored subsidies in recent years. “It is five to twelve, but few politicians understand,” said the chairman of the Association of German Biofuel Industry (VDB), Kurt Stoffel. “The biodiesel market for trucks has come to a complete halt,” said Stoffel.
Britain said on Thursday it backed the building of new coal plants and would make a decision soon on whether these must have expensive, climate-friendly technologies fitted called carbon capture and storage (CCS). “We will need new fossil fuel plants including coal if we are going to maintain diversity in energy mix and energy security….”,
Yet here we are getting ready to implement a scheme that is already seen to be worsening the economic conditions around the world (and being abandoned by those realing the losses). Unsurprisingly our implementation would most likely occur just as we are beginning to see an end to the recession.
The administration certainly seems to be aware of the cost of such legislation but still plans on pursuing it:
Steven Chu, President Barack Obama’s new Secretary of Energy, told The New York Times earlier this month that reaching agreement on emissions trading legislation would be difficult in the present recession because any scheme to regulate greenhouse gas emissions would probably cause energy prices to rise and drive manufacturing jobs to countries where energy was cheaper.
Yet, with blinders fully in place, and giddy at the prospect of sticking it to evil corporations while redistributing their ill-gotten gains, the left applauds a plan which will cripple our economy for decades to come.
If ever there were budget proposals poised to send us into darkness, it is this plan put forward by the Obama administration.
Barack Obama is about to submit his first budget to Congress.
Finally, because we’re also suffering from a deficit of trust, I am committed to restoring a sense of honesty and accountability to our budget. – President Barack Obama to a joint session of Congress, Feb 24, 2009
That’s the promise. The reality, as the Washington Post observes, isn’t quite in keeping with the promise:
President Obama’s spending plan is built on the assumption that lawmakers can resolve some hugely contentious issues — and it relies on a few well-worn budget tricks.
The tricks? The usual stuff – calling something what it isn’t and inflating future spending numbers to make the future real numbers appear to be “savings”. For instance:
And though Obama told Congress on Tuesday that his budget team has “already identified $2 trillion in savings” to help tame record budget deficits, about half of those “savings” are actually tax increases, administration officials said. A big chunk of the rest of the savings comes from measuring Obama’s plans against an unrealistic scenario in which the Iraq war continues to suck up $170 billion a year forever.
The tax increases, of course, include an increase in taxes on the top 2%. And further savings are based on pretending that the Bush administration planned on spending $170 billion (seems like a small number when compared to the numbers being thrown around these days, doesn’t it?) beyond 2011 when it planned on pulling the bulk of the troops out of the country.
“It’s a hollow number,” said Sen. Judd Gregg (R-N.H.), the senior Republican on the Senate Budget Committee, who recently withdrew as Obama’s nominee to head the Commerce Department. “You’re not getting savings if you’re assuming spending that isn’t actually going to occur.”
What accounts for the other major source of income?
But to pay for it, the president counts on a big infusion of cash from a politically controversial cap-and-trade system, which would force companies to buy allowances to exceed pollution limits.
The promise that energy costs are going to skyrocket seems one promise he’s bent on keeping. That of course will require more spending to offset the consequences (but don’t figure on being in on the subsidy, you probably won’t qualify). And then there’s the redistributionist “spread the wealth” bonus to be realized from cap-and-trade:
Obama also wants to use the money to cover the cost of extending his signature Making Work Pay tax credit, worth up to $800 a year for working families. That credit, which will cost $66 billion next year, was enacted in the stimulus package, but is set to expire at the end of 2010.
Cover the cost is a way of saying, making the program permanent.
Then there’s the deficit promise. Obama has set a goal of cutting the deficit in half by the end of his first term. As observers say, there’s absolutely nothing difficult about reaching that goal:
This year’s budget deficit is bloated by spending on the stimulus package and various financial-sector bailouts, expenses unlikely to be repeated in future years. The nonpartisan Congressional Budget Office recently predicted that the deficit could be halved by 2013 merely by winding down the war in Iraq and allowing some of the tax cuts enacted during the Bush administration to expire in 2011, as Obama has proposed. That alone would cut the deficit to $715 billion, according to the CBO.
Notice that final number, folks. That’s “half” of the deficit. In other words he’s going to be running a deficit north of $700 billion dollars and trying to convince you how well he’s done. In fact, all he’ll have done is add several trillions to the debt with several trillions more to come if reelected.
The era of big deficit financed government isn’t just back, it’s back on steroids sitting in a rocket sled pointed at economic hell.
The Washington Post tells us:
President Obama is proposing to begin a vast expansion of the U.S. health-care system by creating a $634 billion reserve fund over the next decade, launching an overhaul that most experts project will ultimately cost at least $1 trillion.
I put those words in bold so you would understand that even the WaPo considers his plan to be “a vast expansion”.
Now, a question for you – when is the last time you remember “experts” who projected anything to do with the cost of a government program coming anywhere close to the ultimate cost? Or overestimating the cost?
So what can we really expect the true “ultimate” cost to be? Well if history is any guide somewhere around 2 to 3 times what they’re “projecting.”
And how will he pay for this? Why the same way Medicare has – by shifting costs to patients with private insurance and letting them pick up the slack:
Obama aims to make a “very substantial down payment” toward universal coverage by trimming tax breaks for the wealthy[tax increases - ed.] and squeezing payments to insurers, hospitals, doctors and drug manufacturers, a senior administration official said yesterday.
Of course, understand that when the cost of your private health insurance benefit goes up because of all the “squeezing” (i.e. cost shifting) going on, your company will either cut benefits, raise your insurance premium or both. And you shouldn’t at all be surprised that if given the option of dropping health care insurance for a government run system or continuing to pay through the nose for a private one, your company takes the first option. That is also part of this plan, although unstated.
Let me clarify something in the previous post. Some commenters are saying that they don’t understand how government will allow private money to be created, and relinquish the death hold they want to keep on the economy. The short answer is, I don’t think they’ll have a choice. We’ll concentrate on the US here, but keep in mind that the rest of the developed nations are in even worse shape than we are.
What allows the government–any government, but democratic ones in particular–to operate as they do is the consent of the people. Even totalitarian governments have to worry about that, ultimately, although they can keep the lid on for a time, even for a couple of generations. But even totalitarian regimes often run into explosions which topple them, eventually.
But the loss of faith in a liberal, democratic government is the kiss of death for that government. It doesn’t take a full scale revolution. it just takes people to stop cooperating. India was liberated through non-violent action. So was South Africa. nce the people say, “You’re done.” the government is done.
Right now our economic system is built on nothing more than the “full faith and credit” of the US Government. And that will last only as long as we, the people, have faith in it.
Now this particular recession may not be the one that kills that faith. It may be just one of the warning signs of a coming collapse. But a crash is coming, and, I think sooner, rather than later. We cannot continue indefinitely to fund the spending of the richest country on earth with the savings of one of the poorest.
The total debt and future obligation of the US government now exceeds, by a substantial percentage, the total with of the country’s assets. We have a mountain of debt and payment obligations that exceeds our ability to meet, even if we were able to liquidate the entire country.
If we wish to retire those obligations we have essentially two alternatives: We can repudiate them, or we can pay them off through hyperinflation, which, as a practical matter, amounts to the same thing.
For instance, let’s take social security and medicare. We simply don’t have enough money to pay those obligations. We can slash benefits, or eliminate cost of living increases, which is nothing more than repudiating the debt. We can raise the payroll tax to 30% or more, but that will slow economic growth so much that the increase in revenue will be more than offset by the increased unemployment and slower GDP growth that would result, which would make it even more difficult to pay off other obligations, such as Treasury Bonds. Or we can simply print the money, and pay off the paper obligation with money that has signifigantly less purchasing power than the face value of the obligation.
However we go about it, it amounts to a repudiation of all or part of our obliations, and reveals that the government is both faithless and, as investors take note of the repudiation and decide not to buy government paper any more, creditless as well. What paper they have, they will attempt to unload on any idiot stupid enough to take them.
The dollar will collapse to the point that imported goods, even cheap, shoddily made Chinese ones, might as well be made of unobtainium.
The life savings of million upon millions of Americans will evaporate overnight.
There will be serious hardship, and massive unemployment.
That’s the kind of hardship I’m talking about.
So, how much trust will there be in a government who, after all that, comes back and says, “We’ve learned our lesson. Trust us now. It’ll all be different this time.” among a people who’ve watched the government repudiate all of the promises made over the last 70 years?
And how much more will this be true if there is a feasible, private alternative, consisting of hundreds, perhaps thousands of independent sources of money, and credit? One whose reliability can be publicly judged every minute of every day, and which has no coercive power?
It wouldn’t take a revolution to force the government out of the money and economics business. Or the retirement or health care business. All it will take is a lack of trust. Who will want to do business with an entity that has utterly failed to deserve any trust?
The collapse itself will be the revolution.
UPDATE: By the way, the government’s repudiation of its obligations has already begun, in regards to Social Security. If you are in my age cohort or younger, you are not allowed to retire at age 65. Your retirement age is now 72. The government changed the deal. For us, we have to wait an additional 7 years to begin collecting our benefits. Those of us who do not die before age 72, that is.
That wasn’t the deal we had when we started our working lives. The government unilaterally changed the terms of our Social Security compact. They didn’t call it “repudiation” but, that’s certainly what it was.
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.
Perhaps you’ve heard about Joe Biden’s latest gaffe regarding his task of overseeing the Recovery Act:
How can the public know that the money is allocated correctly? That’s the question CBS’s Maggie Rodriguez asked.
“We’re going to put every bit of this transparently up on a website. You’re gonna know. You’ll be able to go on a website. Every single bit of this will be on a website,” he explained.
“You know, I’m embarrassed. Do you know the website number?” he asked looking offstage. “I should have it in front of me and I don’t. I’m actually embarrassed.”
He was able to get the website “number” from someone off camera.
“Recovery.gov. It’s Recovery.gov. It’s up and running,” he said with newfound confidence.
If that doesn’t inspire confidence, then maybe you should just go visit the “number” VP Joe suggested. Before you do, however, keep in mind that, from far to wide and low to high, the Obama administration has been touting not just the need for transparency,
Orzag said the two goals are to spend stimulus money “quickly” and “wisely,” adding, “We have to go beyond normal procedures to a higher level of transparency.”
But also on the determination and ability of the administration to deliver it:
“I [Pres. Obama] am also proud to announce the appointment of Earl Devaney as Chair of the Recovery Act Transparency and Accountability Board. For nearly a decade as Inspector General at the Interior Department, Earl has doggedly pursued waste, fraud and mismanagement, and Joe and I can’t think of a more tenacious and efficient guardian of the hard-earned tax dollars the American people have entrusted us to wisely invest.”
Apparently, the whole point of Recovery.gov is to show where your tax dollars are going, and what they are being spent on. So let’s have a gander.
On the front page, my eyes were immediately drawn to the large graph dominating the left side of the page:
Wow! According to that chart, the largest expenditure by far ($288 Billion) is going to tax relief. Heck it’s twice as much as the next category of State and Local Fiscal Relief which is only get a paltry $144 Billion. That’s fantastic news. I feel so bad now for thinking that the bill was nothing more than a huge wealth transfer and goodies giveaway. Tax relief is always a good idea when it comes to pulling ourselves out of a recession.
But wait? What’s that asterisk? I click on the chart and am taken to a lovely bubble graph that displays the same information. But with more bubbles, which are always nice. And bubble are transparent too, right?
Yep. There it is again, that $288 Billion in tax relief, dwarfing all the puny spending bubbles. Of course, being an intelligent person, I know that you have to add all of the spending bubbles together to see how they compare to the tax relief, but it’s strangely comforting to see that giant, transparent bubble named Tax Relief making all the other bubbles seem, somehow, insignificant.
Unfortunately, that asterisk is still there as well. I follow it down to the bottom of the page where, in tiny print, I see these words:
* Tax Relief – includes $15 B for Infrastructure and Science, $61 B for Protecting the Vulnerable, $25 B for Education and Training and $22 B for Energy, so total funds are $126 B for Infrastructure and Science, $142 B for Protecting the Vulnerable, $78 B for Education and Training, and $65 B for Energy.
I think my bubble has burst. But that’s how government works now I guess: making bubbles bigger than they ought to be.