It may be time to dust off George Orwell’s satire, Animal Farm (1945), and to heed again its lesson on abuse of power.  Though he was sympathetic to socialism, Orwell was reacting to the extremes of Stalin’s oppressive hand.  The egalitarian society where "all animals are equal, but some animals are more equal than others" reminds us of the turpitude that drove “health care reform” against the will of the people.  Washington knows better than the individual what is good for him.  

Four years later, in Nineteen Eighty-Four,Orwell defined a framework on the nature of collectivist dystopia: doublethink (contemporary example: the health care bill will reduce the deficit, even as Democrats make expensive side deals); big brother (force insurance coverage by auditing business and individual); memory hole (forget that candidate Obama promised to cut wasteful spending from the budget line by line, the national debt doesn’t matter to President Obama).

Last Saturday before the fateful health care vote, The Wall Street Journal published a 1996 article by Milton Friedman in which he quotes an Alexander Solzhenitsyn novel describing the perils of state-run health care: from treatment quotas to contentious relationships between doctors and patients.¹  Friedman traced the origins of the actual U.S. versions of these problems directly to government meddling with market mechanisms: the medical insurance tax exemption given to the corporations rather than to the individual, the expansion of Medicare and Medicaid that results in de facto price controls and rationing, and the institution of “managed” care.  Intermediaries separate the consumer from the supplier and the market cannot work freely.

The present administration’s and Congress’ aversion to market solutions to health care and other challenges is entirely consistent with a stunning avoidance of sound economics.  Obama’s immediate circle of advisors is forced into contradictions between liberal ideology and properly conducted study or foundational principles.  For example, advisor Larry Summers describes his intellectual admiration of Austrian free market economist Fredrick Hayek thusly, “What I tried to leave my students with is the view that the invisible hand is more powerful than the [un]hidden hand.  Things will happen in well-organized efforts without direction, controls, plans.  That's the consensus among economists.  That's the Hayek legacy.”²  And Council of Economic Advisors chair, Christina Romer, wrote in 2007 “tax increases are highly contractionary.”³  Both supported a deficit-busting “stimulus” with meager tax cuts and heavy government interference.

Remarkably, Obama’s programs do nothing to increase supply of products and services, almost as if Washington assumes supply is infinite and can only be regulated or taxed, rather than created and allocated by market prices and demand.  In health care reform, demand is increased but supply of insurance and treatment is managed and prices controlled.  In Orwellian newspeak, a government “insurance exchange” replaces “free market”, and interstate commerce is expressly shunned.  Capital will be taxed at a higher rate without considering the inevitability of its eventual flight to safer havens outside our country.  As our trade deficit deepens and jobs move from our shores, labor is made more costly by increased payroll taxes and regulation while Germany demonstrates that worldwide competitiveness is a function of lower labor costs and increased productivity.⁴   

All of this is ominous: as the neo-Keynesians scamper around to provide theoretical underpinnings for Obama, the Financial Times reports,⁵ “Credit Suisse produced a provocative research report pointing out that the country whose debt profile most resembles that of Greece is - hold your breath - the U.S.” 

Before we meet the fate of Greece, then, Obama’s advisors might do well to revisit Hayek, author of the classic repudiation of a command economy, The Road to Serfdom, with whichKeynes enthusiastically concurred.  In his Nobel Prize lecture⁶, Hayek concluded,

“The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men's fatal striving to control society - a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.”

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[1] “A Way Out of Soviet-Style Health Care, Solzhenitsyn's prophetic warning about the depersonalization of medicine.”   The Wall Street Journal, 20 March 2010, http://online.wsj.com/article/SB10001424052748704784904575111273624979544.html?KEYWORDS=milton+friedman

[2] Lawrence Summers, quoted by Yergin, Daniel. & Stanislaw. Joseph.   The Commanding Heights: The Battle Between Government and the Marketplace that Is Remaking the Modern World. New York: Simon & Schuster. 1998

[3] Romer, Christina D., Romer, David H. “The Macroeconomic Effects Of Tax Changes: Estimates Based On A New Measure Of Fiscal Shocks”, March 2007 http://www.econ.berkeley.edu/~cromer/RomerDraft307.pdf

[4] “Europe's Stragglers Find Villain: Germany's Competitiveness.” The Wall Street Journal, 22 March 2010, http://online.wsj.com/article/SB10001424052748704534904575131980473107158.html?KEYWORDS=Europe%27s+Stragglers+Find+Villain%3A+Germany%27s+Competitiveness

[5 “Is the dollar rally about to come to a nasty end?” Financial Times, 20 March 2010, http://www.ft.com/cms/s/0/0608c18c-33c1-11df-8b99-00144feabdc0.html

[6] Hayek, Friedrich August von. “The Pretence of Knowledge.” Nobel Prize lecture, 11 December 1974, http://nobelprize.org/nobel_prizes/economics/laureates/1974/hayek-lecture.html

China wagged a stentorian finger at the U.S. this week.  The People’s Republic is angered by our sale of arms to the Republic of China (Taiwan), by our interlocution with the Dalai Lama, but largely because they feel increasing pressure to float their currency, the renminbi.¹  As our largest creditor—China holds almost $1 trillion of U.S. Treasuries², nearly 12% of our public debt—this last vestige of communism believes they may lecture the last bastion of capitalism in defending a protectionist exchange policy.  They may have a point.

By borrowing heavily from China, have we left ourselves vulnerable to economic scolding?  Partly because of low labor rates and partly because the Chinese “peg” the renminbi to the dollar to artificially depress the apparent prices of their products, they run large trade surpluses.  In 2009, we exported $69 billion to China, but imported $296 billion—a deficit of $227 billion.³  In comparison, our trade with the European Union is balanced as the Euro floats freely against the dollar: $221 billion in imports, $281 billion in exports, for a deficit of $60 billion.⁴  The Chinese government absorbs the excess supply of foreign currency received by their exporters, and has accumulated a stash of $2.4 trillion in foreign reserves.⁵  Some of the influx is foreign direct investment—capital that is attracted by China’s high growth and a corporate tax rate of 25% compared to 35% in the U.S.

This purposeful combination of capitalism and central control contrasts with our confounding admixture of capitalist rhetoric belying government control or influence on much of our industry and the loss of focus of government’s role in a free economy.  At least the Chinese do socialism with no pretense.

The law provides that, semi-annually, the Treasury Department must identify any country that manipulates its currency "for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade."⁶  The next report is due on April 15, and 130 member of Congress have already written to Secretary Geithner advocating for the declaration.⁷  What happens next is unclear.  The law calls for the Treasury Secretary to negotiate with the offending country, but "shall not be required to initiate negotiations in cases where such negotiations would have a serious detrimental impact on vital national economic and security interests."  Ay, there's the rub: Geithner needs Chinese credit to fund his boss’s deficits.  Imposing punitive tariffs, as we have done selectively last year, may set off a trade war and aggravate the recession.

One may wonder why we would object to a country selling us products at artificially depressed prices.  Such an arrangement enriches our consumers.  Under normal conditions price dislocations correct themselves and excess reserves in the exporting country find their way back to the importing country by the way of investments, trade, or exchange of currency that results in price balancing.  These market mechanisms are averted in the current environment because the Treasury competes with private entities for those surpluses.  China’s unpegging the currency will be healthy in the long term, because it will allow markets to determine capital and trade flows.  In the transient period, unpegging will increase prices of Chinese products or substitutes for those products, and may raise interest rates as the Treasury begins to lose a source of cheap money.  Neither is politically desirable, yet pressure will grow for free floating currency from industries and labor unions who feel they are being disadvantaged.  Not all industries will benefit equally from an exchange readjustment because China will still have comparative cost advantage in many labor intensive sectors; but market-determined exchange rates are always better for free global trade.

As long as we are dependent on debt financing of public programs that seems deceptively painless and low cost, and on elevated consumption of cheap products to the detriment of saving and investment, and as long as China is willing to hold huge dollar reserves and buy Treasury securities, a tense economic and financial arrangement with China will exist.

Free trade should be fair trade, but confrontational dialog and retributive reactions (raising tariffs) hide weak domestic policy.  Pressure on China to float the renminbi should be accompanied by a more competitive business tax regime—to attract capital to our shores, and by a commitment to smaller, less intrusive government—to reduce our dependence on debt.  Putting America on sounder capitalist footing will immunize us against protectionism. 

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[1] “China Talks Tough to U.S.; Premier Blames American 'Trade Protectionism' for Tensions Over Currency.” The Wall Street Journal, 15 March 2010, http://online.wsj.com/article/SB10001424052748703457104575121213043099350.html?mod=WSJ_hpp_MIDDLENexttoWhatsNewsSecond&mg=com-wsj

[2] U.S. Treasury, http://www.ustreas.gov/tic/mfh.txt

[3] Trade in Goods (Imports, Exports and Trade Balance) with China, Foreign Trade Statistics, U.S. Census Bureau, http://www.census.gov/foreign-trade/balance/c5700.html#2010

[4] Trade in Goods (Imports, Exports and Trade Balance) with European Union, Foreign Trade Statistics, U.S. Census Bureau, http://www.census.gov/foreign-trade/balance/c0003.html

[5] “China's Reserves Expand.” The Wall Street Journal, 18 January 2010, http://online.wsj.com/article/SB10001424052748703657604575004501953577566.html

[6] “What US law on currency manipulation says.” Reuters, 12 March 2010, http://www.reuters.com/article/idUSN1218046820100312?type=usDollarRpt

[7] “U.S., China Up The Ante In Currency Policy Game.” The Wall Street Journal, 15 March 2010,  http://online.wsj.com/article/SB10001424052748703909804575124020434903644.html?mod=googlenews_wsj

In the debate on health care both sides quote Congressional Budget Office (CBO) estimates to support their positions.  Proponents position CBO as a “neutral referee”, while detractors question the assumptions CBO uses to score the proposals.  It would be a mistake to confuse “neutral” with “accurate”, but too convenient to dismiss projections without understanding the tolerances that bound the estimates.

The current health care bill that is positioned for a vote in the House of Representatives, the Patient Protection and Affordable Care Act, H.R. 3590 (PPACA), passed by the Senate 60-39 on Christmas Eve, was “scored” by CBO¹ to “yield a net reduction in federal deficits of $130 billion over the 2010-2019 period”.  This is a niggardly, insignificant 1.3% of the total deficits projected for President Obama’s budgets over the same year period, $10 trillion. 

Looking deeper into the CBO analysis, we find:

1) CBO estimates deficits will increase under PPACA after the sixth year, thus claims of favorable effects on the deficit are temporary.

2) 76% of the increased revenue contributing to the reduction in deficits comes from taxes, fees, and penalties that are ultimately paid by the consumer, thus supporting the contention that this is partly a tax bill in disguise.

3) Gross incremental costs are projected at almost $1 trillion.  Costs can usually be estimated with greater precision than can offsetting revenues and cost savings, as the CBO admits: “The range of uncertainty surrounding that assessment [of the net effect] is quite wide …” 

4)  The much touted savings in Medicare comprises reduction in payment for most services and hospitalization, and “setting payment rates in the Medicare Advantage program [private Medicare plans]”.  These speculative “savings” require more government activity in the market to reap a fuzzy $438 billion over ten years.  As William F. Buckley, Jr. said, “When you raise taxes, you raise taxes.  When you forecast spending decreases, you are engaged in necromancy.”

5) Member of Congress apparently insisted the CBO project beyond 10 years, over the CBO’s resistance.  Hedging their estimates, the CBO “expects” there might a small reduction in the deficit after 2019, but “The imprecision of that calculation reflects the even greater degree of uncertainty that attends to it,” and “These longer-term calculations assume that the provisions are enacted and remain unchanged throughout the next two decades, which is often not the case for major legislation.”

What is not uncertain is that we won’t hear anyone from Congress or The White House quoting that line.

When asked to forecast the quantitative effects of economic policy, the best answer is to cite one’s right to remain silent.  Not afforded protection under the Fifth Amendment, CBO is required by law to evaluate every bill, while obliged by the principles of science to inform their readers of uncertainties in their work.  In a 2007 study², they analyzed sources of deviation and error in their budget projections and demonstrated that total surplus or deficit might, with a probability of 90%, deviate by -4% to +4 % of gross domestic product four years after the budget year for which the initial estimate is made.  For our current GDP of $14.4 trillion, this is a range of ± $580 billion.  And CBO puts this disclaimer in the 2008-2018 Budget and Economic Outlook³: “Actual budgetary outcomes are almost certain to differ from CBO’s baseline projections because of future legislative actions, unanticipated changes in conditions affecting the economy, and many other factors that affect federal spending and revenues.”  Uncertainty grows proportionally with time, so any projection beyond five years—upon which politicians are prone to rely—must be tempered with skepticism.  

With such uncertainty in mind, it is still instructive to uncover the bottom line of these analyses.  In a letter to Senator Jeff Sessions in January⁴, CBO concludes “… enacting PPACA … would … increase gross federal debt”, which now stands at $12.5 trillion—a full 87% of GDP.  That is the kind of number that would make Greece envious.

www.americancivility.us

www.twitter.com/freecapitalism

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[1] Letter to Senator Harry Reid, Congressional Budget Office, 19 December 2009, http://www.cbo.gov/ftpdocs/108xx/doc10868/12-19-Reid_Letter_Managers_Correction_Noted.pdf

[2] “The Uncertainty of Budget Projections: A Discussion of Data and Methods.” Congressional Budget Office, April 2003, http://www.cbo.gov/ftpdocs/78xx/doc7837/03-05-Uncertain.pdf

[3] The Budget and Economic Outlook: Fiscal Years 2008 to 2018, Congressional Budget Office, January 2008, http://www.cbo.gov/ftpdocs/89xx/doc8917/01-23-2008_BudgetOutlook.pdf

[4] Letter to Senator Jeff Sessions, Congressional Budget Office, 22 January 2010,  http://www.cbo.gov/ftpdocs/110xx/doc11005/01-22-HI_Fund.pdf

Buried on page 8 of the President’s 11 page health care reform proposal¹, is the key to resolving the protracted debate: “insurers have little incentive to lower their premiums”. 

Positioned as a middle ground between the House and Senate bills, the White House proposal nevertheless does nothing economically to provide incentives.  The very next sentence in that section is: “The Senate bill includes a tax on high-cost health insurance plans.”  The President’s proposal endorses this tax (although it postpones the year of inception from 2013 to 2018 and raises amount of premiums exempt from the tax).  This, then, is what our elected officials in the Senate and the White House consider “incentive”—the equivalent of trying to lower the average price of cars by taxing luxury vehicles.

It is an axiom of economics that taxing something results in less of it.  Some insured who need the high-cost health plans for severely ill or difficult cases in their families will no doubt continue to buy them out of necessity.  They will be forced to pay the tax, which will leave them with less to buy products and services, say for college education, or to invest in a business that creates jobs.  Others may drop their high cost plans because of the tax.  In that case the insurance companies will try to raise their premiums toward, in the extreme, $1 less than the government exemption to make up for their lost revenue without triggering the tax.  All other things being equal, taxing part of the stream of insurers’ incomes will thus raise rates, not lower them.

The President’s plan endorses a $67 billion “assessment” (read: tax) on insurers because they “stand to gain as more Americans get coverage”.  A second axiom of economics is: corporations do not pay taxes; individuals pay taxes.  There is a proposed excise tax of $20 billion on medical devices and a $23 billion “revenue increase” (notice in how many ways government can say “tax”?) from the pharmaceutical industry.  Taxes will do absolutely nothing to give “incentive” to produce more medical devices and drugs.  There is also a new “fairness tax” (an oxymoron if there ever was one) for Medicare Hospital Insurance on income from “passive income”—dividends, annuities, royalties, and rent—the very types of income upon which seniors rely to supplement Social Security income.  Health care reform has thus become instead a complex tax bill.

The words “oversight”, “mandate”, “require”, “review” appear 15 times in the plan, as in oversight by the Department of Health and Human Services (HHS) of State insurance authorities, or oversight of insurance premium increases: a geometrically disproportionate shift of power to Washington.  As The Wall Street Journal reported², Massachusetts, which passed the precursor to ObamaCare under then-governor Mitt Romney, has started down the treacherous path of price controls, oversight presumably having failed.  This should be sufficient evidence to disqualify Romney from his Party’s presidential nomination, as the GOP struggle now to illume the same inevitable result at the national level.  Price controls constrict supply, as the energy price controls of the 1970s proved, precisely the antithetical effect to the objective of increasing access to and consumer choice of products and services.

The un-Constitutional mandate to force the uninsured to buy insurance or to force the recalcitrant to “make a payment to offset the cost of care they will inevitably need” is an amusing exercise in government's attempt to over-engineer an industry.  The minimum penalty tax in 2015 is proposed as $325 or 1% of income whichever is greater.  This means that an individual earning $40,000 in adjusted gross income may pay only $400 a year and be covered by government insurance.  And if he can prove “hardship”, he is exempt from paying even that.  Why would anyone buy private insurance under such a scheme?

There is more.  Under the Democrat’s proposal, the government will pay insurers directly between 70% (for a maximum income $88,000) to 94% (for a minimum income of $29,000) of a family’s "total health care costs"; i.e., 85% of all American families will receive some sort of subsidy—making this plan a massive entitlement program under the rubric “cost sharing”.

The underlying assumptions about insurance and medical care in this proposal are: government can 1) increase supply; 2) reduce prices; and 3) eliminate waste, fraud, and abuse in programs like Medicare and Medicaid.  If (1) and (2) were true, (3) would be unnecessary, as otherwise government would have been proven competent to run an industry.  The good bulk of the President’s plan addresses (3), however, because they concede, “Medicare currently overpays private plans by 14% … and has also done little to reward quality”.  Hence, government cannot increase supply, or they cannot reduce prices, or both.  Which is why polls show³ between 52% and 58% of Americans are opposed to the President's plan.

Twitter.com/freecapitalism

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[1] http://www.whitehouse.gov/sites/default/files/summary-presidents-proposal.pdf

[2] “Back to the ObamaCare Future”, The Wall Street Journal, 2 March 2010, http://online.wsj.com/article/SB10001424052748703444804575071294139286892.html

[3] “Health Care Reform.” Rasmussen Reports, 1 March 2010, http://www.rasmussenreports.com/public_content/politics/current_events/healthcare/september_2009/health_care_reform

In a recent Gallup poll a surprising result emerged.  Asked about their feelings toward divers economic systems, a stunning 53% of Democrats and 61% of liberals indicated a favorable view of socialism.¹  That explains much about the intentions behind the programs the administration and Congress have been trying to foist on the American people.  Fortunately, the same poll confirmed 58% of all Americans have a negative view of socialism, which undergirds the sudden and visceral rise in populist resistance to those very programs.

Do they teach socialism in school anymore?  It was only 20 years ago that the Soviet Union and communism, an extreme form of socialism, collapsed.  If we take for granted that during that time educators assumed socialism was dead forever, today’s young voters could not have lived through its abject failure, even vicariously, and the most susceptible among them might be subject to seduction by its false promise.  There is scant debate today on the causes of the collapse of the auto or mortgage industries, for example, as a function of the industries' deviation from pure capitalism in contrast to an analysis built on the unproven assumption that capitalism failed.  Is it un-American to conclude that GM just wasn’t making products that the market valued, or that government interference in mortgages, through Fannie and Freddie, skewed prudent management of financial risk?

No one likes to speak of communism today, and in polite society accusing democratically elected representatives of being sympathetic to socialist policies is repulsive even to the accuser.  Yet, when the majority of a major political Party favors socialism, we must take notice and be alarmed.

A common definition of socialism is “central planning by government of economic activity”.  Communism adds state ownership of economic activity.  The United States government now owns all or part of companies in varied industries: automobile manufacturing, insurance, mortgages, banking, student loans, railroads, broadcasting, property management, energy production, and legal services.  The government extends its reach over our private economic lives in many other ways.  The Federal Register “the official daily publication for rules, proposed rules, and notices of Federal agencies and organizations, as well as executive orders and other presidential documents” contains close to 80,000 pages.²  And when a President, Republican or Democrat, claims we should be getting more energy from fuel cells or switchgrass, we should be shouting from the highest hills, “Leave the science projects to venture capital!” for otherwise these are the ultimate manifestations of central planning.

Cataclysmic change in our economic system to pure socialism or even communism is practically not likely today, but we must be vigilant against the insidious creeping transformation that is largely irreversible and that brings us closer to economic darkness.

First, because Marx’ description of socialism, “from each according to his ability to each according to his means” is egalitarian in aspiration but economically impractical in implementation.  It assumes that those who are able will continue producing wealth, knowing it will be perennially confiscated; and it assumes that those who receive from the fruits of labor of others will eventually become producers.  With neither reward for labor nor profit for invested capital why would the first group continue their behavior or the second give theirs up?  The Soviet system collapsed because of that very absence of incentives and sanctions implicit in the Marxist doctrine.

Second, we should be vigilant because the flawed theory of socialism presupposes an omnibenevolent, omnipotent government: the entity that does the from-to distribution of goods and services in the Marx definition.  To make socialism work, we must exchange indiviudal choice for state authority with faith in the state's noble and moral intentions.  The price of this exchange is freedom; the cost is the inevitable inefficiency and errors that transpire from a government staffed not by gods but by humans susceptible to everyone else’s foibles and temptations.

Third, as a derivative of the first and second reasons, socialism cannot be moral; or, more precisely, it does not permit individuals to choose moral acts, the complete expression of which requires man’s free will.  Communism, because it is total and complete, is clearly akin to enslavement and clearly immoral.  By comparison, socialism’s throttle on freedom is commensurate to the proportional size of government relative to the economy.  Because the government cannot produce a single product or a solitary service without taking resources from the free economy, it should be apparent that the size of government and an individual’s access to freedom are in inverse relationship.  Socialism is concentrated in small, illusively benign degrees, and its affect on moral action is anesthetic by slowly growing levels.

It is not enough, therefore, to oppose formal establishment of socialism to protect our freedom.  It is not even enough to simply stop the growth of government.  It is necessary only to make government smaller. 

John Maynard Keynes, no pure proponent of free markets, observed, “Marxian Socialism must always remain a portent to the historians of Opinion — how a doctrine so illogical and so dull can have exercised so powerful and enduring an influence over the minds of men, and, through them, the events of history.”

[1] http://www.gallup.com/poll/125645/Socialism-Viewed-Positively-Americans.aspx

[2] http://www.gpoaccess.gov/fr/

This weekend we celebrate Ronald Reagan’s 99^th birthday.  The 40^th President of the United States would no doubt be aghast at the gymnastics in Washington: Democrats stepping over each other to make government bigger. Twenty years after Reagan left office, America has seen diametric reversal of the philosophy he held dear, that smaller government is better government.

Here, then, is an imaginary conversation with the last conservative President, revered by many as the last great American leader.  Actual quotations by Reagan (RR) are in italics.

Question: Mr. President, please give us your feeling about the situation in our country today.

RR: Well… (as he typically starts his responses with homegrown American humility) … I’m convinced that today the majority of Americans want what those first Americans wanted: A better life for themselves and their children; a minimum of government authority. Very simply, they want to be left alone in peace and safety to take care of the family by earning an honest dollar and putting away some savings. This may not sound too exciting, but there is something magnificent about it.¹

Q: What effect does the size of government have on individual freedom and economic growth?

RR: Today’s Democrats, like Carter had run for the presidency on a platform calling for …  what the Democrats called “national economic planning.” I’m sure they meant well - liberals usually do - but our economy was one of the great wonders of the world. It didn’t need master planners. It worked because it operated on principles of freedom, millions of people going about their daily business and making free decisions how they wanted to work and live, how they wanted to spend their money, while reaping the rewards of their individual labor.²

Q: Give us an example of national economic planning that would concern you today.

RR: One of the traditional methods of imposing statism or socialism on a people has been by way of medicine. It’s very easy to disguise a medical program as a humanitarian project. Now, the American people, if you put it to them about socialized medicine and gave them a chance to choose, would unhesitatingly vote against it. We have an example of this. Under the Truman administration it was proposed that we have a compulsory health insurance program for all people in the United States, and, of course, the American people unhesitatingly rejected this.³

Q: President Obama has just released the largest proposed budget in the history of the United States, $3.8 trillion dollars.

RR: The ten most dangerous words in the English language are “Hi, I’m from the government, and I’m here to help.”⁴  It occurs to me that what I said about John Kennedy applies to Obama: Unfortunately, he is a powerful speaker with an appeal to the emotions. He leaves little doubt that his idea of the ‘challenging new world’ is one in which the Federal Government will grow bigger and do more and of course spend more.⁵  But I would remind you, The size of the Federal budget is not an appropriate barometer of social conscience or charitable concern.⁶

Q: Does the national debt—the amount of money we are borrowing from our children—worry you?

RR:  I was 21 and looking for work in 1932, one of the worst years of the Great Depression. … To be young in my generation was to feel that your future had been mortgaged out from under you, and that’s a tragic mistake we must never allow our leaders to make again.⁷

Q: Why do you feel government has gotten so big?

RR: Government is like a baby.  An alimentary canal with a big appetite at one end and no responsibility at the other.⁸

Q: What about the effect of the size of government on taxes?

RR: Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.⁹  And I have to point out that government doesn’t tax to get the money it needs, government always needs the money it gets.¹⁰

Q: So raising taxes is no way to cut the deficit?

RR: Governments don’t reduce deficits by raising taxes on the people. Governments reduce deficits by controlling spending and stimulating new wealth, wealth from investments of brave people with hope for the future, trust in their fellow man, and faith in God.¹¹

Q: Any final words, Mr. President?

RR: Freedom is never more than one generation away from extinction. We didn’t pass it on to our children in the bloodstream. It must be fought for, protected, and handed on for them to do the same, or one day we will spend our sunset years telling our children and our children’s children what it was once like in the United States where men were free.¹²

Thank you Mr. President. May God bless you.

____________

[1] Nationally televised address, 6 July 1976

[2] Reagan on the 1980 primaries, http://www.ronaldreagan.com/primaries.html

[3] Ronald Reagan Speaks Out Against Socialized Medicine, 1961

[4] Remarks to Future Farmers of America 28 July 1988

[5] Letter from RR to Richard Nixon about John F. Kennedy, 1960

[6] Remarks at the Annual Meeting of the National Alliance of Business, 5 October 1981

[7] Address to the nation on the economy, 13 October 1982

[8] The New York Times Magazine (14 November 1965), p. 174

[9] Remarks to the White House Conference on Small Business, 15 August 1986

[10] Bush-Reagan Debate 1980 on Taxes at League of Women Voters, 24 April 1980

[11] Radio Address to the Nation on Small Business, May 14, 1983

[12] Address to the annual meeting of the Phoenix Chamber of Commerce, 30 March 1961

The President’s State of the Union (SoU) address last week had a little something for everyone, contradictory policies, and not enough in any single area to make a difference in the economy.

First, there was something for everyone.  Bank bailouts are suddenly distasteful and the taxpayers need recompense for saving them; the Recovery Act (a.k.a. stimulus) “worked” and yielded two million jobs—although the official government web site still counts a mere 640,329, itself a dubious number with unemployment still over 10%; and the administration generally saved the country from the brink of disaster.  Democrats heard health care, climate legislation, restrictions on campaign funding by corporations; and Republicans heard capital gains cuts, nuclear power, and off-shore drilling.

Conspicuously absent from the self-congratulatory words was the role the Fed played in averting a depression by flooding the market with more money than that which is necessary for inflation-free growth.  Was it because the Administration did not wish to shine the spotlight on the Fed to assure Ben Bernanke’s reconfirmation last week?  The more probable answer is that, with the exception of Paul Volcker and Larry Summers, few in the administration, and most notably the President himself, understand the role of monetary policy and how the rate of growth in money supply can either catalyze or neutralize the effect of fiscal actions.

As long as the government continues to spend more than it receives and as long as the Treasury can sell U.S. debt and the Fed can print money to pay for the debt, it feels like the government is “stimulating” the economy.  But when the costs start to accumulate beyond reasonable manageability—in the form of higher taxes on future generations, a weak currency, and inflation, all three being correlated—the country may face periods of low growth or retraction or even default or a devalued dollar in the extreme.

Second, Obama proposed contradictory policies.  New fees on banks to purportedly make TARP whole attacks bank capital, hence lending, and do nothing to discourage risky behavior that originally spawned the program.  Shifting rescue funds to community banks signals to the market that only Washington will pick winners and that it will continue to bail banks out from imprudent lending.  Hoping for a “doubling of exports within five years” but neglecting to set a Kennedy style “moon-shot” objective for energy independence—say, by the end of this new decade—merely protracts an untenable reliance on imported oil.  Although Obama mentioned nuclear energy and off-shore drilling he did not acknowledge the plan to achieve energy independence that his National Security Advisor, General Jones, published during the transition.¹

Finally, the President’s proposals are riddled with half measures.  No one knows yet what he meant by proposing to eliminate the capital gains tax on small business, for example.  Most small businesses are partnerships or S-corporations whose earnings are taxed at the owners’ levels, and most small businesses need cash flow above all.  Therefore, it would have made more sense to propose lowering the marginal tax rate on income instead.  For larger corporations—those entities who have the privilege of paying tax twice on their income, once at the corporate level and once more at the shareholder level, and who, with Japan, pay the highest corporate taxes among the OECD countries, Obama might have proposed lowering the corporate tax to make the U.S. more competitive or even ending double taxation as his one time advisor, Robert Reich, proposes.

Markets need certainty of stability and businesses need hope for a more competitive cost structure.  Said in equivalent terms, both need government to reduce their respective financial burdens and move out of the way.  Obama offered neither, because he offers too much to too many.  And so we end up with a proposed budget as staggering as $3.8 trillion, 30% of the GDP, and a record deficit of $1.6 trillion.

Also on the Examiner.

__________

[1] A Transition Plan for Securing America’s Energy Future, Presented to President–elect Barack Obama and the 111th U.S. Congress, http://www.energyxxi.org/reports/Transition_Plan.pdf

Pity Ben Bernanke.  The Fed Chairman has his detractors in the Senate, although minority leader Mitch McConnell believes the confirmation is not in danger.  It seems more Senators each day join the anti-Bernanke movement, including Sen. John McCain.

Bernanke lost the people’s confidence because of his role in the bank bailout with then Secretary of the Treasury, Hank Paulson, in the final days of the Bush administration.   The two were the primary proponents of the $800 billion controversial Troubled Asset Relief Program (TARP).   According to some, Bernanke took an activist role when he twisted Bank of America’s arm into absorbing Merrill Lynch.  Bernanke threatened the entire Board and the Chairman of B of A, Ken Lewis, with dismissal when Lewis wanted to back out of the deal as he discovered that Merrill’s actual losses significantly exceeded what Merrill disclosed and would cause a “Materially Adverse Change” to the deal structure.¹  Together with the other interventions transpiring at the time, this over-extension of the Fed Chairman’s duties fueled the sense of unease about government’s role in the economy, particularly because the Fed’s role and functions are generally obscure. 

There is no doubt, also, that the public feels hoodwinked into swallowing  a TARP program that never accomplished the objectives for which it was intended.  Excluding the inexplicable use of TARP funds to bail out automotive companies under pressure from one of President Obama’s core constituents, the United Auto Workers, TARP was used to provide capital directly to banks rather than to purchase their “toxic assets” (exotic securities with no liquid market) as the law was written.  Since TARP increased the deficit, and the deficit is financed by the Fed, the Fed could have worked with the banks directly under its charter to shore up bank capital and prevent failures.  TARP became symbolic of distorted government programs that no one understood but everyone instinctively disliked, and Bernanke remains a symbol of TARP.

Reading Bernanke pre-crisis, however, leaves a different impression about his core beliefs.  In a 2002 speech honoring Milton Friedman’s 90^th birthday, Bernanke paid homage to the legendary monetarist by an insightful analysis of his and co-author Anna Schwartz’ seminal work A Monetary History of the United States.²  Bernanke agreed with the historical and empirical evidence Friedman & Schwartz adduced and concluded “… the economic collapse of 1929-33 was the product of the nation's monetary mechanism gone wrong”  caused by the Fed over-contracting the money supply.  Bernanke’s own research, quoted in his speech, “argued that the effective closing down of the banking system might have had an adverse impact by creating impediments to the normal intermediation of credit”; in other words, banks choke off lending if there are widespread bank failures—precisely the situation we now face.  At the end of his speech, Bernanke, as representative of the Fed, famously confessed, “I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.”

We see in these statements Bernanke’s fear of risking another depression in 2007-2008 that explains his reaction extending beyond the bounds of the Fed’s primary purpose to manage the money supply and fight inflation.  Had he stayed with that mission, he might not be suffering the animadversion of today’s politician-turned-economist.

Many are concerned about the affect the extraordinary Congressional dissent is exerting on the independence of the Fed.  This putative "independence" is questioned by economists such as Loyola University professor Thomas DiLorenzo.³  Still others, including Rep. Ron Paul (R. TX.), believe that the Fed should not be independent and should answer to the people through elected representatives, hence his call for an annual audit of Fed operations.  Then there is the White House.  Bernanke’s job is made all the more difficult by the inevitability of tighter money supply in the future that will cause higher interest rates.  Without real economic growth, however, it is difficult to tighten money; yet the perils of another bubble loom if interest rates are held at zero or if more money is poured into the system.  Unbeknownst to themselves, the administration’s actions and words seem to be dispositive to the growing unrest surrounding the Fed, which has little choice but to print the money to finance their runaway spending, cool the uncertainty of speeches that are more populist than substantive, and finance the heavy risk and leverage assumed by Freddie and Fannie.

Bernanke can do himself and the country a great service by recalling the words spoken ten years before his speech by his intellectual mentor.  When asked in an interview, “what would you say are the unsolved economic problems of the day?”⁴, Friedman replied with characteristic trenchancy: “One unsolved economic problem of the day is how to get rid of the Federal Reserve.  The most unresolved problem of the day is precisely the problem that concerned the founders of this nation: how to limit the scope and power of government.  Tyranny, restrictions on human freedom, come primarily from governmental institutions that we ourselves set up.”

Dr. Bernanke might assure his confirmation if he makes his second penance to Dr. Friedman: You're right, we did it.  We're very sorry.  But thanks to you, we won't do it again.

________________

[1] Letter to Congress by Andrew Cuomo, State Of New York, Office of the Attorney General, 23 April 2009, http://www.oag.state.ny.us/media_center/2009/apr/pdfs/BofAmergLetter.pdf

[2] “Remarks by Governor Ben S. Bernanke at the Conference to Honor Milton Friedman, University of Chicago, Chicago, Illinois, November 8, 2002, on Milton Friedman's Ninetieth Birthday”, The Federal Reserve Board, http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021108/default.htm

[3] DiLorenzo, Thomas, J. Dr. “The Myth of the Independent Fed.” The Freeman, April 1997, http://www.thefreemanonline.org/featured/the-myth-of-the-independent-fed/

[4] Interview with Milton Friedman, June 1992, David Levy - Vice President, The Federal Reserve Bank of Minneapolis, http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=3748

Washington was in a flurry last week about causes of the banking crisis of 2007-2008.  Unfortunately, politicians are too eager to propose solutions without fully understanding all the dimensions of the problem.  The process has just begun, a bit late some might say, and already the inquiry is infused with proposals that are designed to make people feel good rather than protecting them from future crises.

A commission headed by Phil Angelides, former treasurer of California, aims to write the definitive history and analysis of the financial crisis, much as the 9/11 Commission has done.¹  As a first step, they deposed CEOs of four top banks in an exchange that was at times contentious: "people were throwing themselves out of windows on Wall Street [during the Depression, but now] they're lining up for bonuses" observed Angelides.  When Lloyd “we-do-God’s-work” Blankfein, Chairman of Goldman Sachs, described the practice of selling mortgage backed securities to clients while contemporaneously betting against those securities, Angelides thought it looked more like the work of the devil: "It sounds to me a little bit like selling a car with faulty brakes, and then buying an insurance policy on the buyer of those cars."²  These types of financial institutions are expected to hedge bets for their clients, albeit an ethical dilemma is created when they bet against their clients, or when they move markets artificially to create paper profits.  An example of the latter case is the practice of buying insurance against corporate default (credit default swap) while selling the company's stock short to drive up the price of that insurance: another way to buy insurance and kill the insured for profit.

As the commission was just beginning its work, the President felt obliged to proffer punitive solutions: “We want our money back and we’re going to get it,” he chanted, perhaps in anticipation of the decision of the Massachusetts voters to turn Ted Kennedy’s seat back to the people.  All Obama needed was a hand sign as the populist-in-chief floated the notion of a "Financial Crisis Responsibility Fee" presumably to “recover” funds given banks under TARP.  But … wasn’t TARP supposed to include its own mechanism for taxpayer funds to be paid back?  What is pernicious about this new tax is that it will be assessed not on profits but on uninsured liabilities—in effect on deposits and loans to the bank.  It should be obvious that these fees will land on depositors’ statements.  On the one hand the administration wants banks to lend more, while on the other they seek to tax their sources of capital.  

It is a “teachable moment”—to use one of the President’s preferred ways of benefitting from aberrations in human interaction—to examine why the “responsibility” fee passes over the most irresponsible of corporations that contributed to the crisis: General Motors and Chrysler, which also received government aid, and the two most sanguinary companies responsible for the mortgage market failure, Freddie and Fannie.  This kind of selective punishment and reward is simply favoritism characteristic of centralized industrial management, the supporting postulate of which is “government knows best”.

Paul Volcker, former Fed chairman and current advisor to the President, provides a more sober approach.³  He argues against “unmanageable conflicts” within banks between consumer lending and high-risk trading and believes the functions should be separate, much as they were when the Glass-Steagall of 1933 was enacted to separate commercial and investment banking.  There may be merit to the idea of ending the admixture of bank businesses with dissonant objectives and interests, but reversing deregulation sets precedence for government management in other industries and may introduce higher transaction costs for consumers.  Improved regulation that fosters efficiency in capital markets while imposing the necessary consumer and investor protections is better than striking grand new economic policy or imposing obligatory corporate structures.  Good banking helps businesses manage risk, not take unnecessary risk solely for trading gains.

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[1] Inquiry Panel's Head Is Known as a Scrapper.” The Wall Street Journal, 14 Jan. 2010, http://online.wsj.com/article/SB10001424052748704675104575001324187741494.html

[2] “Panel Rips Wall Street Titans.” The Wall Street Journal, 14 Jan. 2010, http://online.wsj.com/article/SB10001424052748704362004575000752756113586.html

[3] “Volcker Voices His Views in a Vacuum.” The Wall Street Journal, 15 Jan. 2010, http://online.wsj.com/article/SB10001424052748704363504575003510035624020.html

[4] “Bernanke's Puzzling Bubble Logic.” The Wall Street Journal, 14 Jan. 2010, http://online.wsj.com/article/SB10001424052748704675104575000862637148440.html

[5] “Once again, cheap money is driving up asset prices.” The Economist, 7 Jan. 2010, http://www.economist.com/businessfinance/displaystory.cfm?story_id=15211520

It is becoming sadly accepted that if something isn’t broken, give it to Congress and they will break it; and if something is broken, Congress will return it unfixable.  It doesn’t seem to matter which of the two parties is in power, which is why we are witnessing the rise of populist movements like tea parties.  Anger reminiscent of original Tea Party that provoked the colonies against the monarchy erupts when citizens feel, a) their interests are not being represented, b) they have lost faith in the political process.  Thus, voters today implicitly equate a tyrannical King George with an unapproachable and unrepresentative present day legislature.

The process by which the health care reform is being proposed has become the central object of disdain.  While both sides of the issue have valid objectives and ideas for reform, both have allowed objectivity and the benefit of the country to be obscured by ideological obstinacy that borders on idolatry.

Democrats start by outlawing denial of health insurance on the basis of preexisting conditions—a desirable outcome—but unless market forces are set free to dilute the added risk that insurance companies would bear, the concomitant costs will be passed to lower risk customers, thus raising premiums for all.

Each side wishes to make health insurance accessible to more Americans, although Democrats seek to mandate its purchase, even under the threat of penalty.  The power to oblige a citizen to buy a product as a condition of citizenship is nowhere permitted the Congress in the Constitution.  The English King did not have to worry about violating a Constitution, and neither, it seems, does Congress concern itself with such annoyances.

As an economic solution, a free market in health insurance would allow better management of risk by private companies and make insurance more accessible to individuals.  In such a market, individuals, not their employers, would be free to purchase a policy of their choice from any insurance company anywhere in the country; i.e., a free market driven by consumer demand.  For reasons that might befuddle an introductory high school economics class, Democrats will have none of such a plan, and for reasons that would confound those students’ civics class, Republicans prefer to highlight the political foibles of Harry Reid rather than extolling the virtues of this diametrically clear alternative to constricting our freedoms with mandates.

Changing the ownership of health insurance from employer to employee would require a parallel change in the tax deduction from corporation to individual.  Such an innovation would end as well the tax code's discrimination against independent workers and small businesses.  By opposing such a shift, Democrats confirm for themselves the accusation they hurl at their opponents, that they are beholden to insurance companies and corporations, and in their unique case—unions, and act not as elected officials but as paid lobbyist.  In the resulting detritus of how-a-bill-becomes-a-law, individuals will have lost an opportunity for personal management of their health.  Yet, no other single action will expand coverage and put downward price pressure on premiums than liberating the market.

There are many things right with the American health care system.  The World Health Organization (WHO) recently ranked the U.S. first among 191 countries for "responsiveness to the needs and choices of the individual patient." ¹  However there is a “dearth of doctors” in certain specialties.²  Taxing medical devices and otherwise raising taxes on small businesses—which includes most medical practices—would decrease supply further and raise prices.  Prospective medical students are discouraged by the high cost of the education and of operating their businesses, which costs are largely driven by defensive medicine to avoid lawsuits that could, in the extreme, destroy their practice.  Why not then—dare we use the word?—stimulate the supply side of that industry by allowing a complete amortization of a doctor’s education over, say, a ten year period, and by limiting tort actions for all but the most egregious cases.  Most doctors don’t leave scalpels in their patient’s body or induce drug overdose in rock stars.

The unethical Senate deals exemplified by the Louisiana Purchase, Cornhusker Kickback, and Florida Flim-Flam, the necessity of which reinforce the public's perception that the less meritorious a bill the higher the minimum bid in the vote auction, leave one with the depressing observation that insurance companies, corporations, drug companies, and trial lawyers are favored over individuals—the patient and his doctor.

When the foundational principles of personal freedom and of economic liberty are compromised in a bill, even worse when they are prostituted, there is only one salutary fate: defeat.

Also on the Examiner

[1]  “Where U.S. Health Care Ranks Number One.” The Wall Street Journal, 7 January 2010 http://online.wsj.com/article/SB10001424052748704130904574644230678102274.html

Nationalization is a contagion that just won’t go away.  Just when we thought our children were safe from central planners, Secretary of Education Arne Duncan proposes taking over all college loans from the private sector in an article¹, “Banks Don't Belong in the Student Loan Business”, to which the instinctive response is: why not?  Aren’t banks for lending?  The argument proffered by the Secretary is in the subtitle to the article: “They [banks] get billions in federal subsides that can provide financial aid to needy students.”  Duncan’s “… real aim is to simply stop using banks as the middle man for student loans.”  One doesn’t know which is more startling—the conclusion that middle men who provide service for a fee should be wiped out by a government intent on communizing every facet of economic activity or the admission by a department secretary that government should not provide subsidies.

What Duncan and most government officials fail to see is that Washington is the real middle man: a dollar taken from a taxpayer in California becomes less than a dollar when paid to a taxpayer in Arkansas by the amount of the Federal government’s “processing fee”—its expenditure and borrowing costs.  In the case of the Department of Education (ED) this is $70 billion plus interest plus annual escalation.  Add to this the estimated $87 billion in the student loan subsidy ED will distribute over the next ten years and soon it adds up to real money.

All of which raises the rebuttal that ought to be put to Duncan: Government does not belong in education business.  Since ED was first established under President Carter, the United States has made no progress vis-à-vis other advanced societies.  A 2004 OECD study² showed we outspend all countries except Austria, and yet our literacy performance for that age is still below 12 industrialized countries.

Nor is the problem all in Washington.  The current system of funding education with property tax funds shows no objective merit.  I compared total state spending on education with SAT scores and participation rates, ranging from 90% in Maine to 3% in South Dakota.  Correlations are negative between the combined SAT score and per capita state education spending or per capita property taxes and mildly positive between participation and spending or taxes³.  In other words the high tax, high spending states can lead the student to the test, but they cannot assure good scores.  One may argue it is good more students are applying to college in those profligate states.  But scores over a ten year period have dropped nationally four points in critical reading while rising only four points in math, with the poorest results in high cost states; the worst being Maine which dropped 39 points in reading and 36 points in math in that ten year period.

The No Child Left Behind Act of 2001 apparently left some children behind.  A study by the National Bureau for Economic Research⁴ showed that whereas math scores improved in the 4^th and 8^th grades after the Act, reading scores did not. 

Private schools, however, consistently show better results.  ED’s own National Center for Education Statistics concluded, “In grades 4 and 8 for both reading and mathematics, students in private schools achieved at higher levels than students in public schools.” ⁵  So why are we still clinging to the public school?

A precondition to achieving the best education necessary to preserve and promote our precious liberties and economic growth is a challenge to basic assumptions:

1. Embedded and automatic increases in elementary and secondary school budgets resulting from rising property assessments diminish accountability and hinder improvements in student performance.  Parents ought to be allowed the freedom to pay directly for the school of their choice without being penalized by paying a tax and a tuition.
2. If we subsidize economic activity, it becomes more expensive.  Therefore, to arrest the increase in college education costs, we should stop subsidizing it.
3. If we expect less from our children, we will get less.  Government’s sole role ought to be to set standards for excellence, and this should be and can be achieved by volunteers at no cost to taxpayers.

The average per pupil cost for students K-12 nationally is almost $9000 yearly⁶, while the average private education costs $8400.  Making education private, closing ED, and ending the property tax financing of public education, makes both economic and educational sense.

Also appears on Examiner.

Twitter.com/FreeCapitalism

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[1] Duncan, Arne. “Banks Don't Belong in the Student Loan Business.”  The Wall Street Journal, 17 Dec. 2009, http://online.wsj.com/article/SB10001424052748703514404574588751838773352.html

[2] Raising the quality of educational performance at school.” Organisation for Economic Co-operation and Development, 2004, http://www.oecd.org/dataoecd/17/8/29472036.pdf

[3] -0.39 between combined reading, math, and writing SAT scores and per capita state education spending and -0.27 between the combined score and per capita property taxes; 0.60 between participation in the SAT tests and per capita spending and 0.50 between participation and per capita property taxes.  Statistical correlations range from -1 (perfect negative correlation) to +1 (perfect positive correlation) with 0 signifying no correlation.

[4] Dee, Thomas., Jacob, Brian. “The Impact of No Child Left Behind on Student Achievement.” The National Bureau of Economic Research, November 2009, http://www.nber.org/papers/w15531

[5] Braun, Henry., Jenkins, Frank., Grigg, Wendy. “Comparing Private Schools and Public Schools Using Hierarchical Linear Modeling.” July 2006 National Center for Education Statistics, http://nces.ed.gov/nationsreportcard/pubs/studies/2006461.asp

[6] U.S. Department of Education, http://www.ed.gov/about/offices/list/oii/nonpublic/statistics.html and http://www.ed.gov/about/overview/fed/10facts/edlite-chart.html#2

Other sources:

”Mean SAT Critical Reading, Mathematics and Writing Scores by State, with Changes for Selected Years.” The College Board, http://professionals.collegeboard.com/profdownload/cbs-2009-Table-3_Mean-SAT-CR-MATH-and-Writing-Scores-by-State.pdf

“Median Household Income (In 2008 Inflation-Adjusted Dollars)
Universe: Households.” US Census Bureau, http://factfinder.census.gov/servlet/GRTTable?_bm=y&-_box_head_nbr=R1901&-ds_name=ACS_2008_1YR_G00_&-_lang=en&-format=US-30&-CONTEXT=grt

“2006 Public Elementary-Secondary Education Finance Data.” U.S. Census Bureau, http://www.census.gov/govs/www/school06.html

“State and Local Property Tax Collections Per Capita by State, Fiscal Year 2007.” Tax Foundation, October 2009, http://www.taxfoundation.org/taxdata/show/251.html

During an interview on 60 Minutes on Sunday, President Obama called bankers who were bailed out by the United States “fat cats” who “don’t get it” ¹.  Why ought we to be surprised that bankers would behave in a way to maximize their income, when risks are assumed by the government?  Some predicted a bailout of certain banks through the Troubled Asset Relief Program (TARP) would fail to restore the financial system to health, primarily because it makes financial decisions political by vesting in the Executive branch discretionary authority to save favored institutions.²

The theory behind TARP was: by buying “toxic” assets—specialized securities that had no market, the descending prices of which destroyed bank value—banks would be restored to health and normal operations would resume.  TARP did not purchase a single toxic asset.  Instead, taxpayer funds were exchanged for shares or warrants (options on shares) in banks, credit card companies, including American Express and Discover, an insurance company, AIG, and two car companies, GM and Chrysler.  Chrysler was owned by a private equity firm, Cerberus, in which former Vice President Dan Quayle is a partner.  TARP funds were also given to auto parts suppliers and investment funds including the highly successful BlackRock.³  Taxpayer funds were thus dispatched to rescue any institution approved by the Treasury Department and wealthy private investors.

Central bankers and economists speak of the “moral hazard”, defined as “the inducement to engage in riskier behavior when safeguards such as insurance are in place.” ⁴  This is precisely the hazard in which we have fallen by not allowing inefficient banks and companies to fail and by preventing the market from reallocating their capital and labor.

We now learn that two beneficiaries of TARP funds, Goldman Sachs (GS) and AIG, were involved in an internecine relationship between 2004 and 2006 in which GS insured the toxic securities of other banks and reinsured those securities with AIG, thus lading it with heavy risk.⁵  When the market sank in 2007 and 2008, TARP funds saved GS’ losses on $22 billion of such trades.  It ought to be evident that if such trades have a high profit potential, largely because of their obscurity and complexity, and no downside because the taxpayer insures against “too big to fail”, the moral hazard is elevated.

Not all the bankers believe in “too big to fail”.  The head of JPMorgan, Jaime Dimon, writing in the Washington Post said, “Creating the structures to allow for the orderly failure of a large financial institution starts with giving regulators the authority to facilitate failures when they occur.  Under such a system, a failed bank's shareholders should lose their value; unsecured creditors should be at risk and, if necessary, wiped out.” ⁶  This is putting risk where risk belongs, directly on the owners of the business, the shareholders, and not the public at large.  We need reforms that would encourage the market, not the government, to allocate capital to businesses better able to manage risk and return for their shareholders, provided the requisite accounting transparency exposes irregular or exotic transactions.

At a recent forum sponsored by The Wall Street Journal, an advisor to President Obama, Paul Volcker, the former head of the Federal Reserve Board under Presidents Carter and Reagan, challenged his fellow bankers, “Wake up, gentlemen … your response is inadequate” ⁷ as he lambasted financial “innovation” that created the complex securities distorting the social and economic missions of banks to lend prudently.  Volcker amusingly remarked, the best example of financial innovation is the ATM machine.

He also deplored the exorbitant personal rewards that have become incentives for hyperkinetic trading and financial engineering.  While it is not wise for a pay czar, Congress, or regulators to determine or jawbone compensation, it is unfair to ask taxpayers to subsidize compensation for decisions that erode capitalism.  The answer is straightforward: end the business tax deduction for bonuses, options, and other executive perks, and place a limit on how much salary can be subsidized by the taxpayer as a normal business expense.  If the shareholders wish to pay their employees more than that salary, they have the liberty to do so from their company’s profits and it should not be the public’s business, nor come from other taxpayers’ pockets. 

Is the Fed unwittingly contributing to the moral hazard?  In a rush to institute stop-gap facilities after the Bear Stearns meltdown in 2008, the Fed established the Primary Dealer Credit Facility (PDCF).  Primary dealers are a select group of 22 domestic and international banks who have the privilege of trading directly with the Fed and borrowing from PDCF to finance their portfolio of securities.  The effect is to open another discount window (the Fed facility that lends directly to institutions) to only an exclusive set of banks: a nefarious misuse of public funds especially when funds are available at or near 0% interest.

Anna Schwartz, the venerable economist at the National Bureau for Economic Research, argued in 1992, “Discount window accommodation to insolvent institutions, whether banks or nonbanks, misallocates resources.  Political decisions substitute for market decisions.  Institutions that have failed the market test of viability should not be supported by the Fed’s money issues.” ⁸

She observed about the 2008 crisis, "They [the Fed and Treasury] should not be recapitalizing firms that should be shut down." ⁹  The risk of failure in the market, as all other businesses face, imposes prudence on financial decisions.

It is no wonder, then, that Congressman Ron Paul (R, TX) successfully amended the financial services overhaul bill to audit the Fed.  Restoring sound monetary policy by the central bank is the first step toward restoring prudence to all banks.

Also appears on the Examiner

______________

[1] “White House Lashes Out at Bankers.” The Wall Street Journal, 12 Dec. 2009, http://online.wsj.com/article/SB126073152465089651.html?mod=WSJ_hpp_LEFTWhatsNewsCollection

[2] Avari, Michael. “The Treasury's Hedge Fund?” American Civility, 7 Oct. 2008 http://americancivility.us/american-civility/2008/10/7/the-treasurys-hedge-fund.html

[3] Bailout Recipients.” ProPublica, http://bailout.propublica.org/main/list/index

[4] “The Federal Reserve’s Primary Dealer Credit Facility.” Current Issues, The Federal Reserve Bank of New York, Volume 15, Number 4, August 2009 http://www.newyorkfed.org/research/current_issues/ci15-4.pdf

[5] “Goldman Fueled AIG Gambles.” The Wall Street Journal, 12 Dec. 2009, http://online.wsj.com/article/SB10001424052748704201404574590453176996032.html?mod=WSJ_hp_mostpop_read

[6]  Dimon, Jamie. “No more ‘too big to fail'.” Washington Post, 13 Nov. 2009 http://www.washingtonpost.com/wp-dyn/content/article/2009/11/12/AR2009111209924.html

[7] “Paul Volcker: Think More Boldly.”  The Wall Street Journal, 14 Dec. 2009, http://online.wsj.com/article/SB10001424052748704825504574586330960597134.html

[8] Schwartz, Anna J.: “The Misuse of the Fed’s Discount Window.” The Federal Reserve Bank of St. Louis, Sep./Oct. 1992  http://research.stlouisfed.org/publications/review/92/09/Misuse_Sep_Oct1992.pdf

[9] “Bernanke Is Fighting the Last War.” The Wall Street Journal, 18 Oct. 2008 http://online.wsj.com/article/SB122428279231046053.html

Governments are ignominiously incompetent at framing problems before they propose solutions.  Put many governments, each with a different objective, together in a single conference with the implied pressure to agree on a world solution to an ill-defined problem, and you have a formula for doing more harm than good.  Thus describes the situation at the Copenhagen summit on climate change.

The meeting has as its premise the theory that economic development produces effluents that cause the earth’s atmosphere to trap a larger portion of the sun’s radiation, as a greenhouse does.  These greenhouse gases (GHG), the theory goes, must be reduced in order to prevent the earth from overheating, typically defined as an increase of two degrees Celsius.  The gases and their relatively contributions to the greenhouse effect are: carbon dioxide, CO₂ (85.4%), methane (8.2%), nitrous oxide (4.4%), and other gases that deplete ozone (2.1%).¹  The first three occur naturally in the atmosphere and can be absorbed by “sinks” such as forests and oceans.  Most of the focus on GHG reduction is obviously on CO₂; the atmospheric concentration of which increased 36% since the Industrial Revolution in 1750.  Therefore, the theory says, decreasing these “carbon emissions” will prevent global warming.

As last week’s revelation of attempts to squash the views of scientists who disagree with this theory showed, the science is far from perfect.  Perhaps the leading scientist who does not view carbon emissions as a problem is John Cristy of the University of Alabama in Huntsville. Early this year, he testified before Congress² that, “… the actions being considered to ‘stop global warming’ will have an imperceptible impact on whatever the climate will do, while making energy more expensive, and thus have a negative impact on the economy as a whole.  We have found that climate models and popular surface temperature data sets overstate the changes in the real atmosphere and that actual changes are not alarming.”  Cristy relies on satellite data to more accurately measure the earth’s temperature than the traditional ground based stations that are affected by urbanization and that are provenance of the data used by global warming proponents.

Even if, in spite of the contentious science, one concedes the postulate of climate change, the cost of reducing carbon emissions is high, estimated at $150 billion annually through 2020.³  The Heritage Foundation estimates that the annual burden on the economy of “cap and trade”—the proposed mechanism allowing an industrial plant violating an emission standard to buy credits from another entity that is below the limit, such that the net effect between the two companies matches the standard—will be between $400 and $700 billion⁴, between 3% and 5% of GDP.  Furthermore, the proposals floating around Copenhagen obligate developed countries to offer reparations to developing countries to help the latter with any remediation resulting from climate change—essentially a new global tax on all products and services.

The solution is simple and within our reach, but evidently beyond the vision of governments.  In his testimony, Cristy further stated, “And, if the Congress deems it necessary to reduce CO₂ emissions, the single most effective way to do so by a small, but at least detectable, amount is through the massive implementation of a nuclear power program.  Other currently available alternatives simply cannot produce enough energy to be significantly noticed at a price and geographic scale that is affordable.”

Nuclear power produces no CO₂.  Yet, the United States produces only 19% of its power from nuclear energy as compared to France producing 86%⁵.  By contrast, the U.S. generates 49% of its electricity from coal⁶—the worst offender of GHG, whereas France produces only 4.1%.  What did the French do right?  Steve Kidd, Director of Strategy & Research at the World Nuclear Association, answers that question succinctly with two things lacking in the U.S.: a unified national energy policy and a standard power plant design that increases safety while cutting costs.⁷  It takes years to license and commission a plant in the U.S., each one with a unique design.⁸  The last plant to be brought on line in 1996 took 24 years to build.⁹  One plant, in Shoreham, Long Island, was built but never commissioned for political reasons.  Standard plant designs and streamlined licensing would alleviate these problems.

Perhaps the main objection to nuclear power is the management of spent fuel.  The severity of this is dubious when one considers that, according to the Nuclear Energy Institute, “Over the past four decades, the entire industry has produced about 60,000 metric tons of used nuclear fuel.  If used fuel assemblies were stacked end-to-end and side-by-side, this would cover a football field about seven yards deep.” ¹⁰

Reaching the same percentage of electricity production as France would cut 2.4 billion tons of CO₂ from our emissions, 129% of entire amount emitted by all of transportation.  It would reduce total CO₂ emissions by nearly 40%, without burdening our economy with new costs and regulations.

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[1] 2009 U.S. Greenhouse Gas Inventory Report, Environmental Protection Agency http://www.epa.gov/climatechange/emissions/downloads09/GHG2007-ES-508.pdf

[2] Christy, John R., University of Alabama in Huntsville. Written Testimony, House Ways and Means Committee, 25 Feb. 2009 http://waysandmeans.house.gov/media/pdf/111/ctest.pdf

[3] “Big Costs Are Hurdle to Climate Pact.”  The Wall Street Journal, 4 Dec. 2009 http://online.wsj.com/article/SB125988268007875549.html?utm_source=Newsletter&utm_medium=Email&utm_campaign=Heritage%2BHotsheet&mod=WSJ_hpp_MIDDLTopStories

[4] “The Economic Consequences of Waxman-Markey: An Analysis of the American Clean Energy and Security Act of 2009.” The Heritage Foundation, 6 Aug. 2009 http://www.heritage.org/Research/EnergyandEnvironment/cda0904.cfm?utm_source=Newsletter&utm_medium=Email&utm_campaign=Morning%2BBell

[5] Électricité de France, http://energy.edf.com/edf-fr-accueil/edf-and-power-generation/nuclear-power-122172.html

[6] “Coal Statistics.” World Coal Institute http://www.worldcoal.org/resources/coal-statistics/

[7] Kidd, Steve. “Nuclear in France - what did they get right?” Nuclear Engineering International 22 Jun. 2009 http://www.neimagazine.com/story.asp?storyCode=2053355

[8] “Licensing New Nuclear Power Plants.” Nuclear Energy Institute http://www.nei.org/keyissues/newnuclearplants/factsheets/licensingnewnuclearpowerplantspage2/

[9] “Nuclear Power: 12 percent of America’s Generating Capacity, 20 percent of the Electricity.” U.S. Energy Information Administration http://www.eia.doe.gov/cneaf/nuclear/page/analysis/nuclearpower.html

[10] “Nuclear Waste: Amounts and On-Site Storage” Nuclear Energy Institute http://www.nei.org/resourcesandstats/nuclear_statistics/nuclearwasteamountsandonsitestorage/?

In early 1961, the first year of President Kennedy’s administration, Time magazine reported, “More alarming to builders, who are accustomed to a recession pickup as cheaper mortgage money becomes available to home buyers, housing has stayed down.” ¹  Then, as now, the country was in ten month recession characterized by a housing decline. ²  Unemployment was 7%and the Federal debt 50% of GDP. 

According to economist Herbert Stein, the stock market fell sharply the following year. ³  To grow the economy, Kennedy first proposed raising government expenditures, but was blocked by Congress.  Ah, the good ol’ days!

Analyzing his options to boost the economy, Kennedy observed at the Economic Club of New York, December 1962, “In the past, this could be done in part by the increased use of credit and monetary tools, but our balance of payments situation today places limits on our use of those tools for expansion.

“It could also be done by increasing federal expenditures more rapidly than necessary, but such a course would soon demoralize both the government and our economy.  If government is to retain the confidence of the people, it must not spend more than can be justified on grounds of national need or spent with maximum efficiency.

“The final and best means of strengthening demand among consumers and business is to reduce the burden on private income and the deterrents to private initiative which are imposed by our present tax system … it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now.”  ⁴

This powerful realization elucidated a fundamental truth of economics: give incentives to people and they work harder, save more, and invest wisely.  As a result, counter-intuitively, tax revenues increase.

The Kennedy tax cuts started with a reduction of business taxes and a relaxation of depreciation rules, because Kennedy recognized they “increase incentives and the availability of investment capital.”  The bulk of the cuts, passed in 1964 after his tragic death, were in personal rates.  Before the cuts, the marginal rate—the tax paid on the last dollar a person earns—could only be described as repressive.  The top rate was 91%.  The lowest rate, 20%, applied between $0 and only $2,000 (equivalent to $14,000 today).  The middle class paid between 30% and 60% of their income to Washington. ⁵

Kennedy reduced the top rate to 70% and all brackets received cuts between 16% and 43%.⁶  Although other factors contributed, GDP grew 4.8% per year on average from 1961 to 1970, up from an average 2.6% per year for the nine prior years 1952 - 1960.  What is more, the Federal debt dropped to 36% of GDP through 1970, even as we built up defenses for the Cold War and Vietnam, because, as Kennedy predicted, tax revenues paradoxically increased with lower marginal rates.

The recession that President Reagan inherited in 1981 was remarkably similar to that assumed by Kennedy: six months of recession in 1980 followed by 16 months when unemployment rose to 9.7% in 1982. ⁷  Reagan had the added problem of dealing with 13% inflation and an energy crisis.  While others before him were wearing sweaters, tuning down thermostats, and talking about rationing energy, Reagan, understanding the nature of free markets, simply lifted the 1973 price controls on oil within days of taking office, which had the propitious effect of increasing supply and ending the crisis.  With Reagan’s support, the Federal Reserve under Paul Volcker brought inflation to just 3% by 1982 by tightening the money supply.

The dramatic successful conclusions of these two crises allowed Reagan to turn his attention to growing the economy.  Like Kennedy, he cut the top marginal tax rate from 70% to 50% in 1981.  Unemployment dropped through 6% during the next four years and tax revenues doubled throughout the 1980’s ⁸ as did GDP. ⁹  In 1986, Reagan signed a tax simplification law that cut the top marginal rate again to 33% and created only four brackets, which continued the economic boom.

Analyzing the effects of the Reagan program 14 years later, the Joint Economic Committee (JEC) of Congress concluded, “High marginal tax rates discourage work effort, saving, and investment, and promote tax avoidance and tax evasion…. The economic benefits of ERTA [Economic Recovery Tax Act of 1981, the first round of Reagan tax cuts] were summarized by President Clinton's Council of Economic Advisers in 1994: ‘It is undeniable that the sharp reduction in taxes in the early 1980s was a strong impetus to economic growth.’ " ¹⁰

What about the objection that tax cuts benefit only the rich?  The JEC said, “The share of the income tax burden borne by the top 10 percent of taxpayers increased from 48.0 percent in 1981 to 57.2 percent in 1988.”

In our present recession, unemployment is ironically where it was in 1983.  Since the Reagan years, the marginal rates have crept up to just under 40% under President Clinton, as the chart below shows¹¹, and down slightly to 35% under President Bush—still higher than the Reagan years.

In contrast to Kennedy and Reagan, President Obama and Congress are considering raising marginal rates and capital gains taxes, while toying with tax surcharges and other ways of taxation.  Like a pilot who is taught to push a stalling aircraft’s stick down when instinct tells him to pull it up, they should put faith in the Kennedy paradox.  May they find succor to push on the stick in the words of Patrick Henry, "I have but one lamp by which my feet are guided, and that is the lamp of experience. I know no way of judging of the future but by the past."

Also appears on the Examiner

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[1] “Business: Housing Troubles?” Time, 24 Feb. 1961 http://www.time.com/time/magazine/article/0,9171,828814,00.html

[2] “Business Cycle Expansions and Contractions”, The National Bureau of Economic Research, http://www.nber.org/cycles.html

[3] Stein, Herbert. “Why JFK Cut Taxes” The Wall Street Journal, 30 May 1996 http://www.msjc.edu/econ/jfk022502.htm

[4] Kennedy, John F.  “Address to the Economic Club of New York.” 14 December 1962 http://www.americanrhetoric.com/speeches/jfkeconomicclubaddress.html

[5] “U.S. Federal Individual Income Tax Rates History, 1913-2009.” Tax Foundation, http://www.taxfoundation.org/publications/show/151.html

[6] Robbins, Gary & Aldona. “Tax Policy & the 1960s: Another Look At the Kennedy Tax Cuts.” Institute for Policy Innovation, http://www.ipi.org/IPI%5CIPIPublications.nsf/PublicationLookupFullTextPDF/D363A0E54E2E40AB862567ED00213FCA/$File/kennedy.pdf?OpenElement

[7] “Employment status of the civilian noninstitutional population, 1940 to date”, Bureau of Labor Statistics, ftp://ftp.bls.gov/pub/special.requests/lf/aat1.txt

[8] “Tax Revenues Nearly Doubled During 1980s.” The Heritage Foundation http://www.heritage.org/Research/Taxes/images/bg1086c10.gif

[9] “Real Gross Domestic Product, Chained Dollars”  Bureau of Economic Analysis http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=6&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear=1980&LastYear=1999&3Place=N&Update=Update&JavaBox=no#Mid

[10] “The Reagan Tax Cuts: Lessons for Tax Reform.” Joint Economic Committee, Congress of the United States, April 1996, http://www.house.gov/jec/fiscal/tx-grwth/reagtxct/reagtxct.htm

[11] “Maximum Income Tax Rates.” The Heritage Foundation http://www.heritage.org/Research/Taxes/images/bg1086c2.gif