Alan Greenspan has a piece in the Wall Street Journal today which essentially casts him as the Pontius Pilate of the financial crisis. Or, to sum it up rather sucinctly, “it wasn’t my fault”. You’re welcome to read through it and agree or disagree. However, the imporant point I think that should be taken from the Greenspan piece are the last two paragraphs:
Any new regulations should improve the ability of financial institutions to effectively direct a nation’s savings into the most productive capital investments. Much regulation fails that test, and is often costly and counterproductive. Adequate capital and collateral requirements can address the weaknesses that the crisis has unearthed. Such requirements will not be overly intrusive, and thus will not interfere unduly in private-sector business decisions.
If we are to retain a dynamic world economy capable of producing prosperity and future sustainable growth, we cannot rely on governments to intermediate saving and investment flows. Our challenge in the months ahead will be to install a regulatory regime that will ensure responsible risk management on the part of financial institutions, while encouraging them to continue taking the risks necessary and inherent in any successful market economy.
Those words reminded me of the quote I saw in business columnist Tom Oliver’s piece today in the Atlanta Journal Constitution:
“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” — F.A. Hayek
Any columnist who starts with a Hayek quote is guaranteed to get my attention. And I’ve come to enjoy Oliver’s columns. However, reviewing Greenspan’s advice and admonitions in those two paragraphs, juxtaposed against the simple and elegant truth of Hayek’s statement you find yourself back in the outback watching that big red kangaroo headed for a collision with the car. It is inevitable, there’s nothing you can do about it, they can’t or won’t hear your warnings and all you can do is watch – and cringe.
Frankly, as we watch the machinations of government and listen to their declarations, we have begun to understand that for the most part, those in charge of all of this haven’t a clue. As Oliver states:
Far from demonstrating the demise of free enterprise, this long-running, deepening recession is revealing the limitations of government.
Government, in its various yet powerful incarnations, has been offering one fix after another since August 2007.
The more the Fed and Treasury have tried, the less sure they seem and the more nervous the money makers have become.
It’s understandable that folks would look to the new administration for new ideas. So it’s harder than usual to acknowledge that the ideas are in fact pretty old and, having been tried, found wanting.
Whatever one may think about the so-called stimulus, it’s too easily deconstructed as pork and policy initiatives.
And if it’s still debatable whether to nationalize the financial industry, the move to nationalize health care, education and energy can hardly be disguised as economic recovery programs.
It is understandable that those who derive their power from government would use this recession as an excuse to further government’s reach. But they act as if government has been absent — as if they’ve been absent — from the role of regulator and legislator.
He’s precisely right – it wasn’t a problem with lack of regulation or lack of legislation. It was a lack of proper regulatory oversight and a willful decision by legislators to ignore the building crisis coupled with government distorting the market and actually incentivizing risk taking far beyond that which is prudent that led us here. And now that they have us in this position, all of them, Greenspan included, are engaged in a flurry of finger-pointing and name calling at every one but the right ones. This wasn’t a crisis which happened in just the last 6 months or 8 years. This one has been building for a while.
“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” — F.A. Hayek
We had Democrats in charge and then we had Republicans. Again and again.
Both endorsed and encouraged the subprime sleight-of-hand. Both appointed heads of the regulatory agencies that could’ve stopped the poison seeping through our banks’ balance sheets. Both allowed gamblers to hedge and swap derivatives on top of derivatives that no one can explain and that are proving far more debilitating than the debacle they were insuring against.
Freddie Mac and Fannie Mae became toxic assets of the government while doing the bidding of congressmen who now act like the piano players in a brothel.
The Federal Reserve proved to be anything but reserved, instead stoking a fire that burned us all.
These were not the result of idle hands of government, but rather deliberate deeds that created false markets with inflated credit while turning a blind eye to those who finance election results.
Oliver’s characterizations are dead on – and he’s nailed both the fed and the Congress. The most irritating thing to me about this whole mess, other than the obvious huge loss of wealth, is the success those who were responsible for writing the rules, laying out the playing field and calling the game are escaping both blame and punishment for what they’ve brought about. That toad Barney Frank having the chutzpa to talk about prosecuting those who were guilty of getting us in this mess still astounds me. If anyone should be undergoing such prosecution right now, it is he and numerous other congressmen and women, both past and present.
Oliver concludes as follows and I can’t help but say a hearty “amen” to what he has to say:
We periodically recoil in horror at government’s failure to protect foster children or care for veterans or the mentally ill. But then we turn around and assume government will perform better in areas more complicated.
Why does the failure of government so often lead so many to believe we need more government?
Like the hair of the dog for the alcoholic, it may calm the trembling hands for a moment but it inevitably leads to another spree and another hangover.
We’re headed into a “or worse” moment. No one in government is going to listen to Alan Greenspan’s admonitions or believe Tom Oliver’s brief accounting of the history of this crisis. Instead we’re going to see precisely the opposite happen – more regulation, more strings, more intrusion, more control. And, as Hayek said, we’ll again see “how little [men] really know about what they imagine they can design.”
David Brooks had started down the road to Damascus when he was called back into the fold by Dear Leader. His Op-Ed in today’s NYT is the result.
Most of Brooks’ offering is a rather transparent attempt to shame congressional Republicans into supporting Pres. Obama’s agenda:
The Democratic response to the economic crisis has its problems, but let’s face it, the current Republican response is totally misguided. The House minority leader, John Boehner, has called for a federal spending freeze for the rest of the year. In other words, after a decade of profligacy, the Republicans have decided to demand a rigid fiscal straitjacket at the one moment in the past 70 years when it is completely inappropriate.
The G.O.P. leaders have adopted a posture that allows the Democrats to make all the proposals while all the Republicans can say is “no.” They’ve apparently decided that it’s easier to repeat the familiar talking points than actually think through a response to the extraordinary crisis at hand.
There are myriad problems with Brooks’ line of reasoning, including many in just to two foregoing paragraphs (e.g. How much input did Republicans have into the recent legislation? By “adopted a posture” is he referring to “not having control of either the House or the Senate”?), but I wanted to focus in on a couple of points in particular.
After some platitudinous admonitions, Brooks launches into his prescription for Republicans to save capitalism:
Third, Republicans could offer the public a realistic appraisal of the health of capitalism. Global capitalism is an innovative force, they could argue, but we have been reminded of its shortcomings. When exogenous forces like the rise of China and a flood of easy money hit the global marketplace, they can throw the entire system of out of whack, leading to a cascade of imbalances: higher debt, a grossly enlarged financial sector and unsustainable bubbles.
I really don’t know what point Brooks thought he was making, but he failed miserably on any score. First of all, “exogenous forces” cannot be “weaknesses” and/or “shortcomings” with capitalism since, by definition, they come from outside that system. At best, examining such forces can be used to understand better ways of protecting capitalism from them. In the context of the entire Op-Ed piece, however, it appears that Brooks is pitching the tired line that capitalism must be reigned in so that people don’t get hurt. That’s like diagnosing the problem with house, finding termites, and then thinking of ways to protect the termites from the house.
Furthermore, Brooks cites a “flood of easy money” (which, of course, is caused by government) as an example of an exogenous force, and then lists the following “shortcomings” of capitalism: “higher debt, a grossly enlarged financial sector and unsustainable bubbles.” What do any of those things have to do with capitalism? If anything, these are once again a failure of government skewing incentives.
In fact, when the government does its darnedest to make the cost of borrowing money historically low, people would be really stupid not to take advantage of that. We all know that rates fluctuate, and that the cost of money will be more expensive when they go back up. Logically therefore, it only makes sense to borrow when the Fed turns the money spigot on and then to find some sort of an asset to grow that money in. That, of course, is what leads to bubbles as everyone has barrels of money but not as many clear ideas of what makes a good investment. Instead of taking the time to really investigate what opportunities are available, and which ones fit a particular person’s portfolio, the herd mentality takes over and we all tend to keep up with the Jones and Smiths whether that means buying tulip bulbs or a run-down house we intend to flip.
The bottom line, however, is that these sorts of scenarios start with government intervention into the market place. In addition to turning on the money spigot, the federal government was also encouraging lenders to make high-risk loans, and for the Freddie Mac and Fannie Mae to buy them up, securitize them and sell them into the derivatives market. Again, that’s all fine and dandy (until it it all goes to hell), but it has nothing to do with “weaknesses” and “shortcomings” of capitalism, and everything to do with government sticking its big fat honker where it doesn’t belong.
If the free market party doesn’t offer the public an honest appraisal of capitalism’s weaknesses, the public will never trust it to address them.
The “free market party”? Who does he think he’s kidding here? The Republicans haven’t acted like a free market party since … well … it’s been so long I can’t remember.
Moreover, I simply can’t fathom how Brooks thinks a “free market party” would ever be able to reconcile itself to joining hands with Obama on his completely anti-capitalist agenda.
Power will inevitably slide over to those who believe this crisis is a repudiation of global capitalism as a whole.
Earth to Brooks: that’s already happened. Look who the president is for crying out loud, or take the time to read your own newspaper. Each and every day we hear about how the excesses of capitalism caused this crisis, and how the “libertarian” policies of Bush (HA!) have landed us in this awful spot. Capitalism didn’t get a trial, Mr. Brooks, it was rounded up, convicted and summarily shot as soon as the latest grand experiment in government do-goodism failed (again).
Honduras is going through a rather large spike in kidnappings. From 5 in 2005 to 121 in 2008. In an attempt to understand this rise in kidnappings, The Overseas Security Advisory Council (OSAC), part of the Bureau of Diplomatic Security of the U.S. Department of State, was sure that economic conditions had most likely driven the spike. But what specifically was likely to have caused it? Apparently an increase in the minimum wage:
In January, Honduran President Manuel Zelaya increased the minimum wage 60 percent, raising monthly wages from US$ 181 to $289. As a result, an estimated 15,000 people have been laid off in urban areas. This number is expected to steadily increase as businesses cannot afford the new mandatory wages. Remittances from Hondurans in the U.S. have also decreased throughout 2008.
Some analysts predict increased crime in Honduras due to citizens unable to find legitimate sources of income. Many unemployed Hondurans could look to kidnapping for ransom in order to obtain large sums of money for a small amount of planning and effort. As the disparity between economic classes continues, wealthy Hondurans or foreigners of affluent appearance conducting business in Honduras could continue to be targeted at a higher rate.
Of course everytime increases are argued against here, those in favor of them tend to wave off the point that raising the wage will cause unemployment among those who can least afford it. Obviously I’m not contending that if we do so here, those laid off will take up kidnapping, but to pretend such rises in minimum wage don’t have any detrimental effect is simply not true – and Honduras provides the case study.
Warren Buffet on the economy and the effort of the government to “stimulate” it:
While praising efforts by Federal Reserve Chairman Ben Bernanke and others to stimulate the economy, he said the economy “can’t turn around on a dime” and that their efforts could trigger higher inflation once demand rebounds.
“We are certainly doing things that could lead to a lot of inflation,” he said. “In economics there is no free lunch.”
Funny how, when someone like Warren Buffet – who has been a supporter of Obama – says things like ‘trigger inflation’ and ‘no free lunch’, people who were previously playing the denial game (massive spending is necessary and good) suddenly figure there may be a problem. Meanwhile the laws of economics have continued to function despite the denial.
For the most part the press has ignored Buffet’s words and they’ve been downplayed by the administration. But perhaps if those who’ve been in denial are willing to consider Buffet’s warnings, they’ll be open to listening to others. Such as warnings about the double talk that’s been coming out of the Obama administration the past few weeks. For instance:
Confidence (too little) and uncertainty (too much) define this crisis. Obama’s double talk reduces the first and raises the second. He says he’s focused on reviving the economy, but he’s also using the crisis to advance an ambitious long-term agenda. The two sometimes collide. The $787 billion “stimulus” is weaker than necessary, because almost $200 billion for extended projects (high-speed rail, computerized medical records) take effect after 2010. When Congress debates Obama’s sweeping health care and energy proposals, industries, regions and governmental philosophies will clash. Will this improve confidence? Reduce uncertainty?
A prudent president would have made a “tough choice” — concentrated on the economy; deferred his more contentious agenda.
Instead he’s decided he’s not going to let a “good crisis” go to waste and pursue his very expensive agenda which has nothing to do with the economic crisis (or alleviating it). All the while he preaches about crisis, catastrophe, sacrifice, tightening belts and doing with less even as he plans to expand government beyond anything we’ve ever seen.
It is an amazing performance.
It is time to get real about what the promised cap-and-trade tax means to the average American.
Politicians love cap and trade because they can claim to be taxing “polluters,” not workers. Hardly. Once the government creates a scarce new commodity — in this case the right to emit carbon — and then mandates that businesses buy it, the costs would inevitably be passed on to all consumers in the form of higher prices. Stating the obvious, Peter Orszag — now Mr. Obama’s budget director — told Congress last year that “Those price increases are essential to the success of a cap-and-trade program.”
Essentially Congress will be creating a new commodity literally out of thin air. It will only create a certain amount of that commodity and so create instant scarcity. As we all know, scarcity drives up prices. The next year, the plan is to remove a portion of the created commodity from the market creating even more scarcity and driving prices for the commodity even higher.
Imagine steel as the commodity. Imagine steel prices going through the roof. Do you suppose they might effect the price of, say, automobiles? Metal buildings? The price of building a bridge or sky scraper?
So who, in the final analysis, is going to end up paying for this increase in steel prices? Why the final consumer, of course. Naturally, with steel, in some cases you can choose to consume (buy a new car, rent an office or approve the bridge) or not consume. However, with the CO2 tax on all industry, to include manufacturing, service, transportation and energy, you have little choice in the matter of consumption. You will be picking up the tab for this.
That brings us full circle to the promised tax cut for 95% of America and my promise that what government gives with one hand it takes with another, making the tax cut illusory at best:
Hit hardest would be the “95% of working families” Mr. Obama keeps mentioning, usually omitting that his no-new-taxes pledge comes with the caveat “unless you use energy.” Putting a price on carbon is regressive by definition because poor and middle-income households spend more of their paychecks on things like gas to drive to work, groceries or home heating.
After all the caterwalling the left does about “progressive taxation” they are about to implement the most regressive tax I can imagine. And as I’ve pointed out, the tax is pervasive, touching just about all aspects of life. Food prices will rise. Energy prices will go through the roof.
The Congressional Budget Office — Mr. Orszag’s former roost — estimates that the price hikes from a 15% cut in emissions would cost the average household in the bottom-income quintile about 3.3% of its after-tax income every year. That’s about $680, not including the costs of reduced employment and output. The three middle quintiles would see their paychecks cut between $880 and $1,500, or 2.9% to 2.7% of income. The rich would pay 1.7%. Cap and trade is the ideal policy for every Beltway analyst who thinks the tax code is too progressive (all five of them).
Of course there is talk of subsidizing those at the lower end of the economic ladder so the impact of rising prices is lessened. Naturally that also negates the impact of the cap-and-trade system. In the end, your tax dollars subsidze the system while increased prices are passed along by so-called polluters. As the price of permits rise over the years, permit holders pay the increasing cost, pass it along and you again subsidize it. The rich can afford it, the poor will be subsidized, so who will get squeezed? Why that middle class that Obama and Biden are so concerned with.
Economically, estimates are that we’re going to have a miserable year in ’09 and possibly ’10. But we may begin to see a recovery really start to take hold in ’11, just in time for the 2012 presidential election. The smart politicians in Washington plan to delay cap-and-trade implementation until 2012. The reason should be obvious. If cap-and-trade has the expected impact on the economy, we could very well see the recovery stall and head back into recession. But politically the timing would be perfect. The mirage of recovery would be just enough to keep the current administration in power for another 4 years, before the economy wrecker of cap-and-trade begins to do its work.
David Brooks, 3 days after a semi-courageous, “what-the-heck-is-going-on” column, received calls from the senior staff at the White House and quietly got back in line:
In the first place, they do not see themselves as a group of liberal crusaders. They see themselves as pragmatists who inherited a government and an economy that have been thrown out of whack. They’re not engaged in an ideological project to overturn the Reagan Revolution, a fight that was over long ago. They’re trying to restore balance: nurture an economy so that productivity gains are shared by the middle class and correct the irresponsible habits that developed during the Bush era.
The budget, they continue, isn’t some grand transformation of America. It raises taxes on energy and offsets them with tax cuts for the middle class. It raises taxes on the rich to a level slightly above where they were in the Clinton years and then uses the money as a down payment on health care reform. That’s what the budget does. It’s not the Russian Revolution.
How moderately wonderful, right? They’ve now dazzled Brooks again. They’re not “liberal crusaders”, they’re moderate pragmatists who want to lend stability to the economy.
Brooks then goes through a litany of things “Republicans should like”. He finishes up by claiming he still thinks they’re trying to do too much too fast, and that may lead to problems “down the road”, but all in all, he’s impressed by their sincerity, commitment to what is best for America and the fact that all of this is not going to cost anywhere near what all the critics claim.
On their face, the arguments are nonsense. This is the biggest planned expansion of government in a century. Estimates are the federal government will be hiring between 100,000 and 250,000 new employees to oversee its new programs and spend the trillions of dollars being borrowed through debt instruments right now.
Unlike the rather facile and easy to impress Brooks, Charles Krauthammer takes a look at the spin and deconstructs it rather handily.
At the very center of our economic near-depression is a credit bubble, a housing collapse and a systemic failure of the entire banking system. One can come up with a host of causes: Fannie Mae and Freddie Mac pushed by Washington (and greed) into improvident loans, corrupted bond-ratings agencies, insufficient regulation of new and exotic debt instruments, the easy money policy of Alan Greenspan’s Fed, irresponsible bankers pushing (and then unloading in packaged loan instruments) highly dubious mortgages, greedy house-flippers, deceitful homebuyers.
The list is long. But the list of causes of the collapse of the financial system does not include the absence of universal health care, let alone of computerized medical records. Nor the absence of an industry-killing cap-and-trade carbon levy. Nor the lack of college graduates. Indeed, one could perversely make the case that, if anything, the proliferation of overeducated, Gucci-wearing, smart-ass MBAs inventing ever more sophisticated and opaque mathematical models and debt instruments helped get us into this credit catastrophe in the first place.
And yet with our financial house on fire, Obama makes clear both in his speech and his budget that the essence of his presidency will be the transformation of health care, education and energy. Four months after winning the election, six weeks after his swearing in, Obama has yet to unveil a plan to deal with the banking crisis.
As Krauthammer points out, none of the costly things that Obama pledged to focus on have anything to do with the down economy. They all do, however, include the the probability of causing even more damage if enacted.
And since they’ve been in office, Obama or his surrogates (mostly in the guise of Timothy “tax cheat” Geithner”) have talked down the stock market, the auto industry, the oil and gas industry, the health care industry, energy, banks, financial and the defense industry. They still don’t seem to realize what impact their words have on markets, or if they do, then one has to assume they’re doing this on purpose. I tend toward the side of ignorance, but at some point, after it has been pointed out to them over and over again, you have to abandon that belief and head toward the other conclusion. Their words, quite literally, are wrecking the economy.
Markets can’t stand instability and insecurity. When leaders talk about what’s wrong with this industry or that industry and what they intend on doing to punish or change how that industry does business, investors get very nervous. As you might imagine, they’re extremely nervous right now, as reflected by the Dow. They know that there is a government assault coming, in some form or fashion, on the industries I’ve mentioned. So they’re going to get out of the position they now hold in them and they’re going to refrain from investing in them until they’re clear what that assault will entail. And I don’t use the word “assault” lightly.
Health care, defense, oil and gas, pharma, auto, energy, housing, banking, finance etc. are all under a form of assault by the new administration. Health care will change and expand dramatically under government auspices, oil and gas will lose tax breaks, cap-and-trade will bury the auto industry and shoot energy prices through the roof – affecting transportion and manufacturing. Cram-downs affect the housing, banking and financial sectors. Who wants to invest in any of that when a judge can reward irresponsible home owners with a write down of their principle? Meanwhile responsible home seekers will see the interest rate go up by about 2 points to cover the losses. That’ll spur homebuying, won’t it?
Like Dale pointed out about the Red Kangaroo, you can see this coming from a mile off. And “useful idiots” like David Brooks climb back on the bandwagon and resume cheering the parade to economic ruin.
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.
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.
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.