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The Lesson of Warren Harding Revisited

February 10, 2010 Leave a comment

Though I have written extensively about the Recession of 1920, it is worth revisiting it per Glenn Beck’s show last night.  Beck rightly pointed out that the policies of decreased taxes and decreased government spending implemented by both Harding and Coolidge paved the way for the dramatic economic growth of the roaring 20s. What Beck didn’t mention was that prior to this period of unprecedented economic expansion, President Warren Harding had inherited one of the worst recessions in American history.   This Recession of 1920-21 is another one of the dirty secrets glossed over in the Progressive history books.

By late 1919, America was facing inflation in prices as measured by CPI of 20%.  Between 1920 and 1921, unemployment doubled from 5.2 to 11.7%.  During this same period, from their peak in June of 1920, prices declined by 15.8% on a year-over-year basis, a 50% greater deflation in prices than during ANY 12-month period during the Great Depression.  So what was Harding’s proposal to deal with this mess? To understand how to get out of recession, Harding looked towards how we got into it in the first place.

For America was coming out of World War I.  Government was controlling huge swaths of the economy, as it had mobilized land, labor and capital towards war production and away from normal commerce as dictated by consumer demand.  In addition to the mass of resources that needed to be reallocated according to market forces, the economy had been further distorted due to the policies of the Federal Reserve which had inflated the money supply by 71% from 1913-1919 (while the physical volume of business had only increased by 9.6%), and whose policies had led to an increase in prices of a staggering 234% between 1914 and 1920.  Prices needed to readjust according to the reallocation of resources.  In addition, not surprisingly, due to the costs of war, the federal budget had grown to $18.5bn.

One will note the parallels to our economic situation today.  Just as war led resources to be allocated away from where an unfettered economy would have directed them, so too did the artificial boom fueled by the Federal Reserve and various government policies lead resources to be misallocated towards assets such as houses and stocks during our most recent boom and bust cycle.  While unsustainable businesses and concomitant rises in prices developed in the private sector, the government too drastically increased.

Harding understood the root cause of recession.  As he noted in his inaugural address:

The economic mechanism is intricate and its parts interdependent, and has suffered the shocks and jars incident to abnormal demands, credit inflations, and price upheavals. The normal balances have been impaired, the channels of distribution have been clogged, the relations of labor and management have been strained. We must seek the readjustment with care and courage…All the penalties will not be light, nor evenly distributed. There is no way of making them so. There is no instant step from disorder to order. We must face a condition of grim reality, charge off our losses and start afresh. It is the oldest lesson of civilization.

And so what was his big Keynesian stimulus plan to bring the economy back from the abyss?  He argued during his Republican nomination speech:

Gross expansion of currency and credit have depreciated the dollar just as expansion and inflation have discredited the coins of the world. We inflated in haste, we must deflate in deliberation. We debased the dollar in reckless finance, we must restore in honesty. Deflation on the one hand and restoration of the 100-cent dollar on the other ought to have begun on the day after the armistice, but plans were lacking or courage failed. The unpreparedness for peace was little less costly than unpreparedness for war. We can promise no one remedy which will cure an ill of such wide proportions, but we do pledge that earnest and consistent attack which the party platform covenants. We will attempt intelligent and courageous deflation, and strike at government borrowing which enlarges the evil, and we will attack high cost of government with every energy and facility which attend Republican capacity. We promise that relief which will attend the halting of waste and extravagance, and the renewal of the practice of public economy, not alone because it will relieve tax burdens, but because it will be an example to stimulate thrift and economy in private life.

And so, shockingly Harding practiced what he preached.  Regarding deflation, the Federal Reserve jacked up interest rates from 4.75% in January 1920 to 7% in June 1920, and held this rate through the aforementioned major drop in prices through May of 1921.  Harding slashed the federal budget from $18.5bn in 1919 to $6.4bn in 1920 all the way down to $5.1bn in 1921.  Meanwhile, the government actually ran surpluses during these years, allowing them to pay down the debt by $300mm from 1920-21.  The Chief Economist of Chase National Bank of the era, Benjamin Anderson summed Harding’s philosophy and his attack on the recession as follows:

The idea that a balanced budget with vast pump-priming government expenditure is a necessary means of getting out of a depression received no consideration at all. It was not regarded as the function of the government to provide money to make business activity. It was rather the business of the US Treasury to look after the solvency of the government, and the most important relief that the government felt that it could afford to business was to reduce as much as possible the amount of government expenditure, which had risen to great heights during the war; to reduce taxes—but not much; and to reduce public debt.

Nor did the government increase public employment with a view to taking up idle labor. There was a reduction in the army and navy in the course of these years, and there was a steady decline in the number of civilian employees of the federal government. This policy on the part of the government generated, of course, a great confidence in the credit of the government, and the strength of the gold dollar was taken for granted. The credit of the government and confidence in the currency are basic foundations for general business confidence. The relief to business through reduced taxes was extremely helpful.

According to Anderson, how did the recession end?

…we took our losses, we readjusted our financial structure, we endured our depression and in August 1921 we started up again. The rally in business production and employment that started in August 1921 was soundly based on a drastic cleaning up of credit weakness, a drastic reduction in the costs of production, and on the free play of private enterprise. It was not based on governmental policy designed to make business good.  (See Benjamin Anderson’s Economics and the Public Welfare or his gratisThe Return to Normal“)

Now we can debate fiscal and economic policy all day, but across the spectrum, it should be clear to all that a government that intervened and created the conditions for economic crisis will not be able to solve it.  If government’s can create prosperity when the private sector is imperiled, then why would Americans be against government central planning when all is rosy?  Do the rules of economics not apply during downturns?

If we can agree that recessions are the result of resources being improperly allocated, then we can also agree that the only way to return to economic health is to allow for their reallocation according to the market.  This involves allowing nonproductive business ventures to go belly-up, prices to naturally fall where they have unjustifiably risen and reduction in the size of government allowing resources to be released to entrepreneurs to reverse the ills of the artificial boom and spur growth.  All measures that impede the natural cleansing of an economy will only ensure pain and suffering like that witnessed over the last few decades in Japan.  Harding had things right and it would do our lawmakers good to follow his lesson: central planning and government control creates problems; innovative Americans are the only ones who can solve them.

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Timothy Geithner’s Famous Last Words?

February 7, 2010 Leave a comment
(thanks to Big Hollywood for this)

From Bloomberg:

Treasury Secretary Timothy F. Geithner said the U.S. is in no danger of losing its Aaa debt rating even though the Obama administration has predicted a $1.6 trillion budget deficit in 2010.

“Absolutely not,” Geithner said, when asked in an ABC News interview broadcast today whether a downgrade is a concern. “That will never happen to this country.”

The U.S. plans to rein in the deficit once the labor market recovers, Geithner said. In the short run, that means focusing on ways to “make sure that this economy is growing again,” he said. The administration says the deficit will shrink over the next four years as more Americans find jobs and the economy accelerates.

“This is within our capacity to do,” Geithner said.

Where to begin?  First off, I have long believed that Tim Geithner is in fact the fall guy for the economy in the Obama administration.  He has been involved with the bailouts from day one including perhaps a criminal one with AIG, come off as smarmy and weaselly in testimony and been perceived as less competent and well-liked than Bernanke in the court of public opinion.  If I had to guess, when it becomes clear that we are stuck in the economic doldrums (probably closer to the 2010 elections), Barack Obama will fire Geithner and trudge out a man with more panache and credibility, likely Paul Volcker.

On the substance of Geithner’s comments, that anyone in this administration can actually believe that the economy is going to accelerate and the deficit will shrink over the next four years is laughable.  Even if you had breakneck economic growth, and there are absolutely no signs of that on the horizon, the deficit is still growing at an exponential rate, and Congress has shown no signs that it is going to take the steps to deal with the most bloated line items — namely entitlements.  The most expensive parts of our budget are considered sacred, and for a politician to touch them would be considered a sin.

How could Geithner be right that we will never lose our rating?  Well, the ratings agencies are US companies, granted an oligopoly by the state, so it is possible that government could threaten them were they to consider downgrading us.  In this scenario we could have a de facto downgrade however if yields spike up in the bond markets on US debt with Treasuries trading effectively as if we have been downgraded.  Another scenario is that the government builds false demand (or an artificial “bid” in trader lingo) to keep the yields on our debt low by either pressuring the primary dealers to continue to gobble up our bonds (and then at times selling them back to the Fed shortly thereafter), threatening foreign nations to prop us up or creating some kind of incentive to get Americans to invest in Treasuries.  Otherwise, I don’t see how America can be considered fiscally Aaa, but then again the ratings agencies rate a lot of junk Aaa.  They can in fact put lipstick on a pig.

10 Points Americans Must Understand About the Economy

January 15, 2010 5 comments

1. The interest rate is a price – the price of credit like the price of any good.  In a free market the price would be set like the price of any good at the intersection of the supply of funds (our savings), and demand for funds (businesses’ and individuals’ investing wants).  Instead, we have an interest rate that is arbitrarily picked by a handful of economists from the Federal Reserve Banks.  To repeat, one committee centrally plans the cost of credit, of which interest rates on all debt are directly or indirectly based.

2. The Federal Reserve has the monopoly power to print or inflate the money supply, thus artificially lowering the cost of money (the aforementioned interest rate).  This means that they can (and always do) devalue the money in your pocket as every dollar printed decreases the value of all dollars to come before them.  Inflating the money supply may not lead to an increase in prices if an equal or greater amount of goods is produced, but the purchasing power of the dollar will still be reduced because without printing money, your dollars would have been able to buy more goods.  Alternatively, if more dollars are printed than goods are produced, prices will increase though not necessarily uniformly across all goods.  Inflation may not manifest itself in explicitly higher prices but merely impede prices from falling for certain goods as they would were the money supply to remain constant.

3. When you deposit money in a regular checking account, the bank doesn’t hold onto this money.  Banks only keep a small percentage of the money you deposit on hand in their reserves, lending the majority of the money you (or the Fed for that matter) deposit to others who lend it to still others and so on, in the process substantially increasing the money supply.  This is known as fractional reserve banking.  If everyone in America or even a decent percentage of Americans tried to take their money out of the bank on a given day, millions would be unable to access their cash.  Effectively, even with FDIC Insurance, all of the banks are insolvent as they do not hold anywhere near 100% of the money you deposit in their vaults, nor does the FDIC have the funds to cover all deposits.  The hypothetical that the Fed could potentially print up money for the FDIC to distribute is beyond the scope of this post.

4. The government’s debt is merely an insidious tax like inflation.  Government debt can only be paid down by taxing the people.  This tax can occur through direct confiscation by government, or indirectly when holders of our government’s debt demand a higher rate of interest, which in turn signals to markets that our economy is not generating sufficient revenues to pay down the debt, which leads to a perception of economic weakness and thus an increased cost of borrowing for everyone in the economy.  If the government prints money to pay down debt (which in and of itself should cause our debt holders to flood the markets with our debt and thus raise interest rates on everyone), this will represent a tax on the people as well.

5. Deflation, or a decrease in the money supply is the only antidote to inflation.  If the money supply is decreased, each dollar in your pocket becomes worth more.  The concomitant fall in prices will correct the artificial initial rise in prices from government printing of money.  In the process, since decreasing the money supply increases the cost of money, unsustainable enterprises with heavy debt loads will be put out of business, cleansing the economy by freeing up unproductive resources.  Where debtors benefit from an increase in the money supply because they can pay down their borrowings with cheaper dollars, creditors will benefit from a decrease in the money supply because they are paid back with more valuable dollars, which is one of the reasons why government prefers to inflate as it can lessen its own debt load and that of many of its constituents.

6. Deflation in prices while a symptom of deflation of the money supply is also the natural result of increases in productivity, as goods produced more cheaply in greater quantities (in the absence of money printing) will lead to falling prices which benefits consumers.  The so-called “paradox of thrift” that the MSM uses to vilify deflation in prices is wrongheaded, as people will spend on all sorts of products knowing that over time they will fall in price, as we have witnessed with numerous electronics over the years.  Even during a depression, when asset prices fall to certain levels there will always be buyers.  And if people are paying off their debt and/or saving in a time of falling prices in lieu of spending, this will be good for the economy because increasing the pool of real savings lowers the interest rate and allows businesses and individuals to borrow funds for investment at lower cost, legitimately stimulating the economy.

7. Despite the wishes of President Obama, all taxes are passed on to consumers as companies raise their prices to compensate for the increased cost of doing business.

8. Government cannot create wealth.  All it can do is take money from some people and redistribute it to others.  Every dollar the government uses must be taken from the private economy. Printing money to pay for things as we noted merely devalues your dollars, effectively taxing you.  Government financing through debt represents a claim on your wealth, a tax which as noted may be paid directly or indirectly.  Thus, while federal, state and local taxes may appear on a historical basis relatively low, the tax rate is deceptively masked by excluding government bilking through inflation and debt.  Government is a wealth killer, not a wealth creator.

9. The real estate problem in our economy centers on the fact that people owe more money on their mortgages than they are able to pay down.  The only fix to this problem is for people to either generate more income to service their mortgages, or default.  Any intervention to keep people in homes they can’t afford will merely perpetuate market imbalances, propping up the value of real estate and preventing qualified buyers from purchasing homes at fair prices.  There will be no true recovery in the mortgage-backed securities  market until the forces of supply and demand sort out this mess.

10. Our economic crisis at the most basic level occurred because too much money and credit were pumped into the economy, given that again the interest rate was set artificially low not by supply and demand in the market but by government fiat.  The recession signals that we must fix the distortions and malinvestments resulting from the centrally planned interest rate. The healthy path to recovery is to allow prices to fall (aided by debt repayment), liquidate failed enterprises (encouraging reallocation of land, labor and capital to more productive and profitable lines of business) and encourage saving to increase the pool of loanable funds for economic expansion. Any actions to the contrary (i.e. more or less all government policies being implemented or bandied about) will merely prolong the pain.

Note that this is by no means a comprehensive study of the above subjects, but rather a cursory look at essentials that the American public must grasp before we can ever expect to return to prosperity.

The Recession of 1920 – Causes, Responses and Insights

January 11, 2010 Leave a comment

In my study of political economy, one of the most overlooked yet fascinating historical episodes I have come across is the Recession of 1920-21. A handful of free-market economists have tackled this crisis, and I decided to throw in my lot with them and pursue the subject further myself.

Below is the abstract for my critique of the acutely sharp downturn (so you know what you’re getting into) and the embedded paper in Scribd format. Scribd however is a bit screwy in its formatting of the paper, failing to capture various diagrams for example, so I strongly suggest instead reading the Word doc downloadable HERE.

Enjoy!

Abstract: Many attribute our current recession to the evils of unbridled capitalism. In response, our leaders have embarked on the typical Keynesian recession prescriptions in order to stimulate the economy and lead the nation out of the economic doldrums. Unbeknownst to most Americans however, prior to the Great Depression, policymakers used different tools to help guide the country out of recessions. Herein we examine the causes, responses and insights gleaned from the Recession of 1920-21, the last downturn in which leaders relied on the age-old policy of laissez-faire, combined with massive reduction in government and encouragement of deflation.

Daily Quips

November 19, 2009 1 comment


Given the massive volume of ridiculous news stories revealing the travesties occurring in this country on a daily basis, I have decided to start regularly posting my thoughts on selected pieces each day. I will continue of course to produce lengthier more substantive pieces as well.

Without further ado, I present today’s Daily Quips:

As Pamela over at Atlas Shrugs highlights, AG Eric Holder gave his opinion on bringing KSM to justice in Manhattan, the site of his heinous crimes. Holder boldly asserted, “we need not cower in the face of this enemy. Our institutions are strong, our infrastructure is sturdy, our resolve is firm, and our people are ready.” In light of the remarks of government officials such as Henry Paulson:It’s a safe banking system, a sound banking system. Our regulators are on top of it,” Barney Frank (on Fannie and Freddie): “I think we see entities that are fundamentally sound financially” and Barack Obama: “But I do have an unyielding belief that all people yearn for certain things: the ability to speak your mind and have a say in how you are governed, confidence in the rule of law and the equal administration of justice, government that is transparent and doesn’t steal from the people, the freedom to live as you choose. These are not just American ideas. They are human rights. And that is why we will support them everywhere,” all signs indicate that we should be running scared. If a bigwig politician tells you things are safe and sound, things naturally must be in awfully bad shape.

Obama saidif we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the U.S. economy in a way that could actually lead to a double-dip recession.” Thank you captain obvious for the biggest understatement I have ever seen. First off, people are losing confidence in the USD and our economy as reflected in the rallies in foreign currencies and equity markets. Most importantly, the price of gold has been making new nominal highs on a daily basis. You think there might be consequences to quadrupling our deficit in less than a year of being President? You think there might be consequences to the fact that we have unfunded liabilities of over $100 trillion? The One may be the most enlightened President since George W. Bush.

The Press is doing everything they can to bring down Sarah Palin. Regardless of how you feel about her, and honestly I am not close to having fully formed a judgment about the woman, the hypocrisy of the media here is sickening. The double standard that the media employs when it comes to how they treat liberals versus conservatives, and in-particular wholesome middle-American female conservatives is abominable. The MSM has not fact-checked one thing about President Obama, yet they have repeatedly beaten Sarah Palin to death. I don’t care what your political leanings, the behavior of the media towards the former governor has been and continues to be beyond disgraceful.

POTUS Obama is “furious” about the leaks coming from the Afghanistan deliberations. I agree with him, these leaks are harmful to our troops. Almost as harmful as the fact that it is taking him MONTHS of playing with our soldiers’ lives to make a decision! Maybe if he had a firm grasp of the situation and acted accordingly there wouldn’t be time for all of these leaks. I am all for taking the time to make a prudent decision but something tells me Afghanistan is more about politics than national defense for this administration.

Barry Ritholtz over at the Big Picture illustrates why we are doomed for a long and painful Depression. The more you see the policies being enacted by this administration, and compare them to those of Hoover and FDR, the more you get the sense that this isn’t Barack Obama merely being naive, but actually intentionally trying to plunge us into the economic abyss.

Kalamitous Krugman

August 29, 2009 3 comments


In a recent New York Times Op-Ed entitled “Till Debt Does Its Part,” Nobel Prize-winning economist Paul Krugman rebuffs those few reactionary souls who argue that all this debt we are incurring is a bad thing. He assures us,

…don’t fret about this year’s deficit; we actually need to run up federal debt right now and need to keep doing it until the economy is on a solid path to recovery. And the extra debt should be manageable. If we face a potential problem, it’s not because the economy can’t handle the extra debt. Instead, it’s the politics, stupid.

Sometimes you really have to wonder what the standards are for winning a Nobel Prize. We have an economy built on consumer debt which relative to disposable income increased from a low in 1945 to its peak in 2007. As the Daily Reckoning further notes, we have $20 trillion in excess debt to work through over the coming years. Yet while on the private side, we need to pay for our sins, liquidate our debts, allow malinvestments to go belly up and start over on more solid fiscal ground, apparently the public sector can just keep on trucking.

As the sage Mr. Krugman notes,

Right now deficits are actually helping the economy. In fact, deficits here and in other major economies saved the world from a much deeper slump. The longer-term outlook is worrying, but it’s not catastrophic. The only real reason for concern is political. The United States can deal with its debts if politicians of both parties are, in the end, willing to show at least a bit of maturity. Need I say more?

Explain this to me exactly. When are deficits a help to an economy in distress? If the whole reason we are in economic distress is because of a glut of debt, then why is the answer to pour more gasoline on the fire? Any company that still functions in any semblance of a free market knows that if it can’t service its debt, it will be forced to make difficult decisions, potentially opting for bankruptcy. It cannot continually slop at the trough of the debt market.

But Krugman seems to think that the government can have its cake and eat it too. Where a sober person might argue that in hard times, a government must tighten its belt, like a business or a man, Krugman seems to think that incurring more and more debt, in essence stretching out the inevitable painful liquidation whilst creating another debt/currency crisis down the road is better. Why have one financial crisis when you can have two or three stretched out over a longer period of time? You get the sense that Krugman’s agenda is more political than economic sometimes.

Which brings me to my next point. Krugman believes the only reason for concern over the debt is “political.” Proud of this claim, Krugman states, “Need I say more?” Well yes, I think you need do so. Our currency, and the debts run up by our government denominated in our currency are backed by the full faith and credit of the United States government; which is to say our money and debt are backed by our economy, our people. If we are in for a prolonged period of negative private sector growth, high unemployment and increased intervention in all aspects of life, especially our economy, how can Krugman make the assumption that the ability to continue adding to our debt solely rests on the “maturity” of the politicians? Can Barney Frank snap his fingers and suddenly make the world buy our paper?

If the politicians wish to be “mature” they can remove themselves from the private sector, slash spending and taxes, let whole swaths of industry go belly up and allow people to foreclose on their homes and pay off their debts. Alternatively, if the politicians wish to be immature, they can do so through intervention and coercion.

Krugman as one might expect opts for the latter, immature route. Mind-numbingly, he proclaims:

If governments had raised taxes or slashed spending in the face of the slump, if they had refused to rescue distressed financial institutions, we could all too easily have seen a full replay of the Great Depression.

As I said, deficits saved the world.

In fact, we would be better off if governments were willing to run even larger deficits over the next year or two. The official White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years. If that’s at all correct — and I fear that it will be — we should be doing more, not less, to support the economy.

Krugman, going along with his Keynesian (read socialists) brethren, forgets about the failures of all of the interventionism even before his idol FDR ever got into power during the Depression, in addition to the disastrous results of similar policies (which he of course advocated) over the last two decades in Japan. These frauds continue to peddle the same illogical government gobbledygook that prolonged the Depression, all the way to “cash for clunkers”, the modern day equivalent of FDR’s forced killing of crops and slaughtering of pigs.

Mr. Krugman seems to think that interventionism is what saves economies. Might I ask then, why not intervene from the start? If the state is so good at managing crises, why not let it manage all industry in good times as well? Is the free market only sufficient when the Dow is rising? And if deficits are the cure-all, then why do nations ever default on their debt? Why is Zimbabwe the way Zimbabwe is? Could it be that perhaps the central planners are not so divine after all?

To be fair, Krugman, digressing notes:

But what about all that debt we’re incurring? That’s a bad thing, but it’s important to have some perspective. Economists normally assess the sustainability of debt by looking at the ratio of debt to G.D.P. And while $9 trillion is a huge sum, we also have a huge economy, which means that things aren’t as scary as you might thinkHere’s one way to look at it: We’re looking at a rise in the debt/G.D.P. ratio of about 40 percentage points. The real interest on that additional debt (you want to subtract off inflation) will probably be around 1 percent of G.D.P., or 5 percent of federal revenue. That doesn’t sound like an overwhelming burden.

Even though all this debt we’re adding on might not actually be so great, we have a huge economy. Ah, the panacea of the huge (albeit shrinking) economy – an economy based on consumption, services and debt, the hallmarks of any economic powerhouse. He also argues that a rise in debt/GDP of 40% is OK, since this debt will only be 5% of federal revenue, which doesn’t sound so overwhelming. So essentially, because it’s only 5% of a massively-sized federal government which will have ever-decreasing tax revenues necessitating continued debt financing (to pay for more boondoggles), we should be OK to pay off our debt (with devalued dollars I suppose?).

What might our lenders think about that? Krugman has an answer for this too.

Now, this assumes that the U.S. government’s credit will remain good so that it’s able to borrow at relatively low interest rates. So far, that’s still true. Despite the prospect of big deficits, the government is able to borrow money long term at an interest rate of less than 3.5 percent, which is low by historical standards. People making bets with real money don’t seem to be worried about U.S. solvency.

I would challenge the assumption that the US government’s credit will remain good. As Krugman notes, our debt/GDP is going to rise significantly, “The official White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years,” and as I mentioned government is intervening in the economy on an unprecedented scale, but relax, our friends in the Far East will continue to bankroll us. Krugman should take a page from Milton Friedman’s playbook (along with those of Hayek, von Mises and Bastiat) and remember that there is no such thing as a free lunch. All government can do for “revenue,” is directly tax, or indirectly tax through issuing debt (taxing future generations and/or devaluing the currency) or printing money.

While Krugman argues that the people “making bets” don’t seem worried about our solvency, as numerous publications have noted, the Chinese are buying less treasuries and stockpiling commodities (however short-lived the Times may think it will be), indicating that they are diversifying out of dollar-denominated assets. Meanwhile, the government has had to take the drastic measure of purchasing its own Treasuries, with the Fed committing to buy $300bn in notes (i.e. printing $300bn) and also monetizing the debt more discretely. In other words, the government has had to keep its own borrowing costs down artificially, making up for the lack of demand of its primary dealers by bidding for its own debt. But look at the YTD yield curve for the 10-Year Treasury, and tell me that the markets aren’t reacting at all to our fiscal recklessness:


Moreover, just because rates haven’t spiked by 500bps in the last year, does that mean that market participants really aren’t scared about our solvency? Markets can stay irrational for long periods of time, just look at the housing bubble or any of the other bubbles which after the fact have seemed so obvious. Further, I would argue that creditors like China are being perfectly rational. The Chinese are trying to shift their money towards assets with real tangible value like commodities, while doing as little as possible to spook the government debt markets, because doing so would hurt the value of their own paper. If they flooded the markets with Treasuries, all of their dollar-denominated assets would plummet in price. It’s not in their interest for there to be a run on the US government yet. But that doesn’t mean that they won’t slowly but surely make their exit from US paper assets, leading to higher borrowing costs for our government and less confidence in our dollar. As I mentioned, there is no free lunch.

Krugman notes that other governments that have practiced similar profligacy like Belgium and Italy never faced financial crises in the early 1990s, but there are obvious notable differences. We are the biggest economy in the world. We were the most prosperous one. We have the world’s reserve currency. We are not accustomed to the kind of fiscal stagnancy faced in Europe. I just do not see that Krugman’s comparisons hold water. A more apt comparison in my eyes would be the US versus the British Empire circa its collapse.

Regardless, I want to return to the fundamental point that going into more debt to solve a problem caused by too much debt makes no sense. One might argue that sometimes debt can be beneficial and not cause long term harm. One might cry that parents are right to take out a mortgage on a house to raise their children. If the family can reasonably expect to generate the cash flows to retire this debt over time, then this will certainly be fine. But the US is like one giant family of drug-addled deadbeats looking to buy a mansion in the Hamptons, having already foreclosed on its subprime mortgage, maxed out all of its credit cards and traded in its Rolexes to the local pawn shop. And its only cash flows are those it can obtain by plundering its citizenry.

Debt is OK if you can reasonably expect to pay it off. To incur even greater debt in the face of debt that you will already be unable to service is downright immoral and will lead to severe consequences for the people.

These deficits in and of themselves are also not productive. They represent a stealing of wealth from future generations. As I mentioned, the only way to pay down the debt will be to tax future Americans, either directly or indirectly through inflating the money supply and thus devaluing the currency. Further, regarding what the debts are actually being used to finance, as I have argued in accordance with sound Austrian economics, the deficit spending for bailing out failing ventures stops the market from naturally adjusting, and leads to less productive if not downright destructive “jobs,” and labor being diverted from the private sector.

So in some respects again, Krugman is right that our politicians need to be mature. But the people get the government they deserve, and as of yet though there have been some bright signs, the majority of people don’t seem to want to deal with the pain that mature servants would bring them today for a brighter tomorrow.

It is worth noting that in Krugman’s delusion, he actually makes a redeeming comment:

Over the really long term, however, the U.S. government will have big problems unless it makes some major changes. In particular, it has to rein in the growth of Medicare and Medicaid spending.

He actually has me for a second, until the subsequent stanzas:

That shouldn’t be hard in the context of overall health care reform. After all, America spends far more on health care than other advanced countries, without better results, so we should be able to make our system more cost-efficient.

But that won’t happen, of course, if even the most modest attempts to improve the system are successfully demagogued — by conservatives! — as efforts to “pull the plug on grandma.”

Keep it classy, Paul.

The Emperor Has No Clothes

March 19, 2009 1 comment


What we are seeing right now are the kinds of last ditch efforts that reveal how truly inept and desperate our leaders are. First there is the AIG bonus fiasco, a case study in the bumbling incompetence of the representatives in charge of containing the financial fallout (ironically the very people that preempted it). Then there is the move to quantitative easing — a seemingly sophisticated way of getting around the fact that the state is effectively socializing the government debt market and literally printing a trillion dollars out of thin air (as is the government’s wont). The implications of these two bamboozles are very telling.

In the case of AIG, first let me go on record as saying that AIG was a poorly run company that strayed from its business of insuring, and became a large hedge fund. When times were good, the illusory value created for shareholders in churning out CDS contracts and getting involved with all sorts of other derivatives made it seem as if this company was rock solid. But once the laws of economics came into play as we have seen time and time again, the straw men were revealed; malinvestments were proved to be malinvestments.

As such, the fact that anybody in this company who was responsible for running it into the ground should receive any bonus money is appalling. Adding insult to injury however, once they made the deal with the devil and accepted a government bailout (really a bailout of their counterparties who would have been decimated were AIG to have gone under as they should have), the situation has turned into a political and ethical hellstorm for the American public. Taxpayers paying bonuses for employees that destroyed the company the taxpayers are backstopping; politicians who conveniently forgot that their bailout legislation insured that these bonuses would be paid, only to turn around now and work to pass bills to tax bonuses at 90%.

First, contracts should be honored, and if a company wants to pay inane amounts for failure, then so be it; BUT that company should be allowed to fail for its disastrous business practices. Further, on principle, I am against this knee-jerk reaction to kill the greedy businessmen. On the other hand, the fact that we are all paying for private incompetence is an outrage. Again, we wouldn’t be talking about this if we had allowed the company to go belly up. Be outraged at the government for bailing AIG out, not AIG for being a garbage company.

Just think about the little game the politicians are playing — nationalize a failed company with taxpayer money, then tax bonuses to get taxpayers’ money back. Seems a bit screwy doesn’t it? Our dollars are sloshing around in all different directions. As you can see from this mess, the government isn’t exactly the most competent or honest steward. They are also capitalizing on the populist backlash against “corporate greed” to cover their own blunders for a measly $165 million, chump change compared to all the cash they have thrown around. Even if you hate Wall Street, when it comes to Barney Frank and Chris Dodd versus guys like Martin Sullivan and Angelo Mozilo (call him a derivative of his Wall Street brethren), it seems like a push to me. Then again, Mozilo was gracious enough to help Dodd get a good mortgage. Advantage incompetent/corrupt businessmen.

As I mentioned, the reason we keep dropping truckloads of money into AIG is because of AIG’s counterparties. This is the real game being played. For all of the populist backlash against the banks by politicians, Wall Street has been a part of Washington since the days of Alexander Hamilton. The whole financial system has been socialized since 1913. The Federal Reserve is the government’s bank that controls the fate of all of the other banks on the street. I don’t even know if I would really call its conduits private institutions because their policies are to a large extent determined by their lender, the Fed. But of course, the Fed is a private bank based on its charter too.

All in all through my incoherent rambling, what I am trying to get across is that we are witnessing the crack-up of this system, and the quantitative easing measures to buy a trillion dollars in treasuries and mortgage-backed securities to bring down yields on all sorts of debt (and also to effectively screw my double-inverse short position in long treasuries temporarily, boy that’s a mouthful) reflect the utter panic at the prospect of the socialized financial system going under.

Basically, the government needs to keep yields low to service its own debt and to bail out other debtors, such as for example most Americans. Foreign countries no longer want to purchase more treasuries given the massive supply and the lack of yield (due to the previous flight to the “safety” of our nation’s debt). So after the Treasury creates all this debt to finance the deficits that we’ll never be able to pay back, the Federal Reserve comes in and buys the treasuries, effectively pumping in a trillion bones or clams or whatever you call them to the market. It is the highest stakes shell game ever played. And also the most dangerous.

Since all the government can do at this point besides letting the chips fall and the system collapse (which will happen anyway in this author’s humble opinion) is to inflate (in fact that’s all the Fed does anyway), they are inflating like crazy. They have never lost the battle to falling prices before, and I don’t see them losing the battle this time given the pertinacity of the Depression scholar, the eminent Mr. Bernanke. He will probably get his rising prices sooner or later. Markets certainly think so given the massive run-up in gold, oil and decline in the dollar relative to other currencies. And of course when inflation does hit, the yields on government debt will have to rise anyway. I wonder if Bernanke and Co. thought that through?


But more fundamental than all of this is just the sheer desperation that these actions show: government officials going in ad hoc to side-step contracts by taxing at 90% those receiving TARP money over 250K…or something like that, the minutiae pales in comparison to the principle; government officials going into the debt market and buying treasuries it creates with another one of its entities (flooding the world with dollars) since nobody else wants to hold our junk bonds as we are totally insolvent as a nation to begin with. And then just look at the simply embarrassing, amateur actions of the Obama administration: going after Rush Limbaugh and Jim Cramer (a pretty socialistic guy himself)…giving Gordon Brown a set of DVDs during his visit to the US…attacking the very businessmen who are the only ones that are going to be able to help our economy rebuild…focusing on NCAA picks, Twittering, Facebooking and Lenoing instead of doing his job. What exactly is President Obama thinking?

Americans really need to understand the dire nature of the situation. These guys (and gals) in power on the whole are simply second-rate actors. They are in Washington for self-interested reasons, not with the longterm well-being of their constituents at heart. Companies lobby (basically bribing) politicians to get ahead through patents, monopolies, regulations and other ways to insure that they can win because of a playing field that is not level. The politicians are more than happy to oblige because they will be rewarded upon leaving office with lavish jobs or other support from their business friends. So long as the nation doesn’t implode in their faces, or if it does, so long as they can deflect their failures on others and act sympathetic, they can stay in power forever (see Barney Frank). It is all one big joke. The sooner we accept that these people are not to be taken seriously — that they are a bunch of crooks and frauds who work in the public sector to gain advantages because they couldn’t make it in private life, the sooner we can get the government off our back and out of our lives.

When I imagine the founding father’s thinking about who they wanted to represent the people, I see a group of largely retired folk who had been fairly successful in life and thus had no reason to govern to benefit themselves; they were to serve as competent and honest stewards and largely maintain the status quo (i.e. the Constitution) because they felt it was their duty and valued the sacrifices made to build a country guided by the rule of law and the belief in preserving the life, liberty and property of the people. The government was never intended to be the intrusive, insolvent ignoramous of an institution that it is today. America, wake up and take this country back from these pathetic excuses for representatives!