Economics

With the deficit ballooning and Democrats committed to expanding the size of government further, the search goes on for ways to tax the middle class, especially that part defined as the “rich.” President Obama has tried to deflect political responsibility for such decisions by appointing a “deficit commission” whose report is due, quite conveniently, shortly after the mid-term election. Since it is stacked with people such as the former head of the S.E.I.U., one can guess at the outcome. It will be one-third proposed spending cuts, which, based on every time such proposals have been made, will never materialize or will really just be cuts in the rate of growth. Two-thirds will be tax increases, which the Democrats will happily embrace, but which will not produce the revenue expected because people change their behavior.

One tempting target is the mortgage interest deduction, a solidly middle-class tax benefit. In true Obama fashion, he will probably limit the deduction only for the afore-mentioned “rich,” i.e., those couples making more than $250,000 per year. In California that probably means two retired school teachers collecting their pensions. But I digress.

Economists see the whole deduction as a subsidy to homeowners and, therefore, as an undesirable distortion of the market. There have been many proposals from such economic purists to eliminate the deduction, usually accompanied by a call for reduced tax rates. The Democrats like the first half of the argument, but not the second. Any elimination or reduction of the deduction will therefore create a significant tax increase that will make homes less affordable, especially for those of us who are being taxed under the alternative minimum tax and for whom the mortgage deduction is one of the very few itemized deductions that still have meaning. An elimination or sudden reduction in the deduction will have a depressing effect on housing prices, creating further problems for people whose house equity is scant or even “under water” due to the housing market deflation. Needless to say, the broader economic effects will be to create further recessionary pressures and to make more people dependent on government welfare programs.

It would be much more sensible to phase in such a reduction or elimination of the mortgage interest deduction over time, perhaps thirty years, to allow a more gradual adjustment in home prices. In any event, if the mortgage interest deduction is viewed as an inappropriate subsidy to home owners (though home ownership may be worth such a subsidy as a social good on its own terms) and therefore should be eliminated, it is only appropriate that other tax subsidies be similarly eliminated. For example, the property tax deduction should be eliminated, especially since those who are subject to the alternative minimum tax do not get to use it. Moreover, any tax benefits for rental property should be struck. Interest deductions, repairs, amortization, property tax deductions, capital improvements, insurance expenses, and others should receive no consideration under the tax code. Since the tax benefits to landlords are reflected in the price charged to renters, it is only reasonable that renters not be subsidized by home owners. That goes, as well, for the renter’s tax credit in California. If there is to be envy-based tax law revision, one can just as readily say that it is time for the renters and the poor to pay their fair share of income taxes.

Once that is done, the standard deduction should be reduced because it is calculated roughly on the value to lower earners of itemized deductions, were they to take them at an amount suited to their standard of living, the main components of which are the deductibility of state taxes and mortgage payments. One can probably continue to find tax benefits that become “unfair” as others are eliminated. After all, the definition of a tax “loophole” is a tax benefit for which you qualify but I do not. For example, why have those who take care of themselves or buy insurance subsidize those who have high medical costs? Why subsidize those who live in high income tax or sales tax states if we eliminate the deductibility of property taxes on which other states rely, instead.

At the conclusion of this process, the fair tax is one that takes an equal percentage of each person’s total earnings or, better yet, a tax on consumption, rather than the current system. But that is unlikely to happen under a Republican administration, much less a Democratic one. Until that happens, though, please spare us the argument that the mortgage interest deduction is an “unfair” subsidy.

President Luiz Ignacio Lula da Silva (nicknamed “Lula”) of Brazil is a socialist. As such, his urge is to redistribute income, to “spread the wealth,” as then-candidate Barack Obama put it to Joe, the Plumber, in 2008. But as Lula so classically phrased it in an interview with a Spanish newspaper recently, “Before being a socialist, you have to be a capitalist.” The quote is so pregnant with meaning, I have used it as my quote for the week.

The full quote is, ”The country had no credit, had no working capital or financing or income distribution. What kind of capitalism was that? A capitalism without capital. I decided then that it was necessary to first build capitalism, then make socialism, we must have something to distribute before doing so.“ Consider what Lula is saying. Most obvious, there is the recognition that only capitalism creates wealth. Socialism does not.

Then, there has to be income distribution. While I suspect that he meant this only in terms of getting business working, so it can distribute income, I read that as meaning that income has to be earned in different amounts by different people. If income is relatively equally distributed, there isn’t much to give the poor. Not coincidentally, capitalism rewards initiative and ability (socialism doesn’t). That, quite naturally, results in income inequality. Such inequality, it has been determined, is enhanced the more advanced the economy. That makes sense, given the importance of knowledge and specialized talent, in advanced modern economies. Communities that are agricultural or artisan economies are more likely to have relative wealth equality.

Then, there is the admission that socialism takes from those who produce and gives to those who don’t. Therefore, socialism discourages incentive, productivity and, hence, wealth. The productive subsidize the lifestyle choices of the unproductive, thereby increasing unproductivity. Socialism is against the most basic demands of liberty. Obviously, such an approach also cannot continue indefinitely, as, sooner or later, socialism runs out of other people’s wealth. Socialism is an inevitable path to poverty, and no socialist society can grow itself out of that state. The only wealth creation is in the coffers of the rent-seeking political class. But even that can only last a while. Plato described well the inevitable redistributionist tendencies of uncontrolled democracies, tendencies that eventually produce tyranny, as there are no more Peters to rob so as to pay the Pauls.

Lula understands this. The best and the brightest currently running this country seem to have moved directly from economic downturn to socialist redistribution. One interpretation might be that this just shows that Obama is not a socialist. He doesn’t even understand what a good experienced socialist knows. But another explanation could be that he is the academic version of the socialist, whose programs are determined by the wishful thinking of the faculty lounge.

One of the allegations indicting King George III for tyranny in the Declaration of Independence is that, “He has erected a multitude of New Offices, and sent hither swarms of Officers to harass our people, and eat out their substance.” That sounds very much like the condition taxpayers are in as a result of the growth of government bureaucrats and the explosion in the cost of salaries and pensions to the point where these placeholders are compensated far better than comparable workers in the private sector.

In one sense we are, of course, in a formally different position than the colonists. We (in the collective sense, since I usually vote against government programs and for representatives who are against most programs) vote for politicians who then, in the figurative darkness of the cloakroom or alcove make deals that end up supporting their campaign contributors and associated interest groups. Public choice theory tells us that these motivated minority factions will work much harder, and thus be far more effective, at promoting their agendas than will be the diffuse public trying to meet their private obligations and life’s challenges. The politicians naturally will go with the vocal and intense minority, rather than the silent and disorganized majority. This well-trod public policy path produces greater and greater expansion of government, as these groups’ desire for money and power meshes well with the politicians’ desire for money and power—money that comes from taxpayers and power that ebbs from the individual and flows to the government and the rent-seeking courtiers.

Government regulations increase. More bureaucrats are hired. Staff increases. More funding is needed, funding that is never enough and outpaces the growth of population and the influence of inflation. More taxes are needed. As 17th century English Whigs opposing the Stuart monarchs and 18th century Americans opposing the British well understood, taxes were a direct threat to freedom. The more of one’s productivity the government appropriated, the less autonomy one had and the more dependent on the state one was. We have become much more pliant in our acceptance of state control over our pocketbooks and our persons. The private interests that develop around these programs help deliver votes from the beneficiaries of the programs to keep the politicians in office. Once again, their intensity of commitment and focus on self-interest outcompetes the more complex voting decisions—and the decision whether to vote at all—made by the general public.

Full-time legislatures, interventionist judges who see their roles as policy-makers, expanding bureaucracies, public employee unions exacerbate the problem. A critical mass is reached that effectively prevents a relatively painless retrenchment or dismantling of the bureaucratic state. There now exists not only the corporatist state of big government, big labor, and big business (the operative feature of fascism) opposing taxpayers and initiative-driven productive entrepreneurs. The same system is replicated within government, with legislators and administrative agency heads the role of government, government bureaucrats and workers the role of big labor, and the ideological interest groups the role of big business. All of them, as well, oppose taxpayers and initiative-driven productive entrepreneurs.

Once a critical mass is reached the system, lacking effective controls, enters the stage of run-away chain reaction. But eventually it runs out of fuel, that is, money extracted from increasingly unwilling taxpayers. At first, those in control will demonize the rich for not “paying their fair share,” even though they are paying most of the taxes. When the rich leave or change their activities, the rest have to pay. Eventually those funds run out or the taxpayers become increasingly hostile to further taxes. At that point, those in charge have several choices. The most likely is to run a deficit and to borrow against the future. That can work for a time, but since the borrowing is not for productive innovation, it does not create the economic means to repay the loans. Therefore, eventually the borrowing eats further into the people’s wealth, requiring more taxes or more borrowing in an accelerating cycle.

At some point borrowing becomes infeasible. At that point, if taxes are no longer a practical option under existing democratic processes, the government has several choices. It can undergo the evolution from democracy to tyranny to exact the taxes and force people into poverty. That was Plato’s prediction in The Republic. It is the typical reaction. Or, it can repudiate the debts, thereby forcing people into poverty and pitting the rent-seeking classes against the producers in a political struggle likely to end in social turmoil—and, quite possibly, autocracy. That is the stage Greece is approaching.

The way out is to cut the size of government in all phases except to insure common defense and domestic tranquility, in the language of the Constitution’s preamble. The sooner that is done, the sooner less treasure is taken from the productive classes and given to the political drones. More important, the fewer government restrictions, the more people’s productive spirits are released and more wealth created for everyone who wants to participate. Unfortunately, the messages from Sacramento and Washington D.C. show that the old order has not been shaken enough for a fundamental change in approach. Rather, more regulations, more taxes, more borrowing, more give-aways to politically connected rent-seekers, and more growth of the inefficient crony capitalism of the corporatist state. And, therefore, less productivity, less wealth, less freedom, less personal autonomy, and a lower standard of living.

Here is some evidence of the problem: One-third of San Francisco’s city workers earned more than $100,000 last year (in a recession). That includes clerks and custodians, not just department heads. It gets better, or worse. The amount doesn’t include benefits, which are particularly generous for government workers.
California public pensions are driving the state into insolvency. These pensions are “defined benefit” plans, which private businesses have mostly abandoned in favor of “defined contribution” systems. The auto companies’ financial problems are significantly due to their obligations under old pension plans.
Fred Barnes of the Weekly Standard lays out some gruesome facts. Talking just about California: “In California, 9,111 retired government workers have pensions of more than $100,000. One retiree draws an annual pension of $509,664. Among retired teachers, 3,065 receive more than $100,000. One gets $285,460. Pensions for retired state workers and teachers will rise 2 percent this year, though Social Security recipients aren’t getting any cost-of-living increase. The hike in California isn’t tied to inflation.”

An inevitable result of any action is the potential activation of the “law of unintended consequences.” The more complex the action, the more likely, far-reaching, and unpredictable those unintended consequences. Hence, the oft-cited lesson about the fog of war that quickly lays waste even the best plans. On the political scene, this is often manifested in tax schemes that produce undesirable changes in behavior completely unexpected by the politicians. Recently, there has been reporting about emerging unplanned ramifications from the Obama/Reid/PelosiCare law.

Next on the administration’s smorgasbord of bad ideas is “financial industry reform.” This is basically a classic pseudo-populist retread from the Democrats’ class-warfare playbook intended to melt the political iceberg towards which they are headed, rather than change course. Unfortunately for them, due to an aroused electorate and decentralized system of information distribution, it is too late and their efforts will be unavailing. Still, the law will have many consequences, many of them bad. Under the control of Christopher Dodd, Chuck Schumer, and Barney Frank, it is unlikely that this law will do much other than further entrench favored large financial institutions of the type that have been so adept at financing the afore-mentioned politicos. Them and, to the tune of nearly $1 million, Barack Obama. Consistent with the corporatist Democratic economic program, one can look forward to further cartelization in the European manner.

As still-fresh experience with the 2002 Sarbanes-Oxley Act tells anyone willing to look, the political classes react, and overreact, to real or imagined business crises. Many times the problem is simply a failure to enforce existing laws. Other times the problem is that existing regulations are so destructive that, like water blocked in its natural flow by some obstacle that eventually finds a new course, entrepreneurs find new—and sometimes more complex and opaque—ways to meet their business and financing needs. New regulations just add further layers of expense and administrative hurdles that foster institutional sclerosis while often adding little in the way of benefit. Instead, they stymie innovation and risk-taking. Add to that natural propensity of politicians the fact that trillions of dollars are involved in the industry, and the urge to interfere (with suitable benefits to one’s cronies) becomes overwhelming.

That experience is repeating itself. As this very enlightening article explains, the financial reform bill—like much of the Obama administration agenda—threatens entrepreneurship. That entrepreneurship is the principal job engine for the American economy and depends for its own vitality on flexible and decentralized financing options. By requiring enhanced (and expensive) registration procedures and making it more difficult to attract private financing (not through the big funds and banks), the article estimates a potential impact of 500,000 jobs. Per year.

As this legislative monstrosity comes closer into view, it will be easier to see some of its more glaring defects, though the eventual effects will not be immediately apparent, any more than the decision of some companies to list on foreign exchanges rather than U.S. exchanges after Sarbanes-Oxley’s draconian changes was immediately apparent. The bill may well contain a few common sense regulatory adjustments. It’s hard to say. But it is likely to be regulatory overkill, especially when, once again, the bill will have over a thousand pages. Many of the harmful parts may be hidden and will, like landmines, explode unexpectedly. For example, in targeting the perceived evil of “derivatives,” one can confidently expect that the law will go beyond resolving basic bureaucratic turf disputes among the SEC, the CFTC, and the FDIC, and undermine the very valuable functions of providing a rapid flow of information and of risk-hedging that these instruments perform. Moreover, it is also quite possible that the rules will cause investors who have need for such instruments to move to other markets or to try to find (more opaque) ways to get around those new restrictions. After all, some say that the need of business for such functions and the current regulatory hurdles for traditional ways to meet that need (e.g., short sales, basic options, insider trading, insurance contracts) was what at least in part caused resort to these much more complex and multi-layered securitized debt obligations and derivatives based on debt obligations.

For my SCALE Business Organization students, the link, above, provides great reading of securities law issues we discussed. H/T Overlawyered.

With the U.S. insisting on further dismantling the free enterprise system and locking the economy increasingly into a fascistic model of corporatism, we are set for the inevitable descent into crony capitalism with its attendant loss of productivity and innovation. We have seen that with the government move into the automobile industry that has benefitted unions and politically-connected financial interests, the take-over of health care through the incipient cartelization of the health insurance industry, and the pending attempts to do the same for the banking business. Combine that with huge expansion of the money supply, unsustainable deficits, more heavy-duty micro-regulation of everything from energy producers and consumers to the food industry, and an attempt to avert disaster by raising income taxes on the most successful and consumption taxes (the VAT) on everyone, and we are in for a world of hurt. There will be years of stagflation reminiscent of the economy of the 1970s. And, given the aforementioned automobile and energy industry regulations, cars with that 70s style and quality. I hope that we are spared a revival of 70s clothes and music, at least.

That’s the optimistic scenario. If things don’t go so well even after we do what every European welfare state does to sustain its social addiction, namely, cannibalize our military defense, we could become Argentina. “A century ago, if you had told typical citizens of Argentina (which at that time was enjoying the fourth-highest per capita income in the world) that it would decline to become just the 76th richest nation on a per capita basis in 2010, they probably would not have found it believable.” That was before they made all those terrible economic decisions the article summarizes at the end, and which we are well on the way to emulating.

I have heard many times that there is hyperinflation in our future because the Fed will keep interest rates too low too long and also prove unable to withdraw the oceans of dollars lapping around, and eventually over, the economy. Usually these alarmists are bloggers or commenters on blogs. I rarely read similar concerns coming from economic experts. That doesn’t mean the experts are right, and the bloggers are wrong. I, too, share doubts that the Fed’s timing on such matters will have the finesse to thread the needle between inflation and double-dip recession as it seeks to extract huge amounts of dollars. All easy joking aside, unless the government purposely tries to monetize the debt through inflation, I don’t see Zimbabwe in our future, though.

However, as I have written before, I see a decent likelihood of a repeat of the 1970s era of stagflation. Moderately significant inflation combined with low economic growth and stagnating standards of living. The Obama brand of moderate socialism impedes risk-taking and depresses investment for two reasons. One is the uncertainty of what tax and regulatory burdens the administration will impose next. After health care, cap-and-tax is on the list along with increased rigidification and bureaucratic oversight of financial institutions. But the contours of regulation and taxation have not been drawn. Nor is it clear that there will not be further socialist projects coming down the road, as long as this furthest-left ideological faction controls the national government and becomes increasingly unmoored from traditional process to get its program adopted. Uncertainty reigns.

The only thing as bad as the uncertainty of what lies ahead with Obama, Pelosi, Reid, and their shock troops is the substance of what they have produced. As the lines on legal and open risk-taking and personal initiative are drawn tighter and the entitlement mentality clasps people more forcefully, success becomes defined more through political maneuvering and less through economic creativity. In effect, there is a whole new class of unproductive drones whose whims must be satisfied through allocations of time and money. That, in turn, increases the cost of innovation, and riskier projects and potential innovations will be delayed until they become less risky through incremental intermediate advances or never undertaken at all. It is possible that innovations will be made “under the table” or through a black market, but the lack of transparency of those transactions impairs their economic efficiency. That will increase their expense and, once again, stultify innovation.

So, stagflation, not hyperinflation. Twentieth-century (and current) Argentina, not 1920s Germany. Venezuela, not Zimbabwe. This article on Obama and America’s coming two-decade economic hibernation makes much the same point, with Obama cast in the role of Jimmy Carter. In Carter’s defense, once he saw the problems his regulatory and tax policies were causing, he was able to pivot towards capitalism and deregulation enough to begin to nudge the economic ship out of the doldrums. Though he also kept nagging Americans in his annoying fashion. I am not at all persuaded that Obama has even the political flexibility and pro-capitalism sentiments that Carter displayed.

What lies ahead? “The U.S. standard of living, says superstar Northwestern University economist Robert Gordon in a new paper, is about to experience its slowest growth ‘over any two-decade interval recorded since the inauguration of George Washington.’ That’s right, get ready for twenty years of major-league economic suckage. It is an event that would change America’s material expectations, self-identity and political landscape.  Change in the worst way.”

What can be done? “Since the 2008 election, American economic policy has been about wealth preservation (keeping the economy from sliding into a depression) and wealth redistribution (healthcare reform.) Wealth creation? Not so much.  That needs to change….Preserve wealth, redistribute wealth or create wealth.  Hopefully, President Barack Obama will choose door #3. Investing more in basic research (not just healthcare) would be a start, as would slashing the corporate tax rate. A new consumption tax would be better for growth, but only if it replaced the current wage and investment income taxes.” Quite so.

There has been a lot of amazement at the apparent ability of the Chinese economy to avoid most effects of the current global recession. New York Times columnist Thomas Friedman and others see this as a sign of the superiority of an authoritarian government and “Confucius capitalism.” Others are less sure that the Chinese miracle is anything other than a mirage. The Chinese economy is highly leveraged and has gone on a building and manufacturing boom for that has left huge inventories and empty skyscrapers. Those skeptics say that the laws of economics have not been repealed for China, and that the economic bubble eventually will burst. Unfortunately for everyone else, when it does burst, it will cause an economic mess globally, resulting in a devaluation of the dollar (and most other currencies) against the yuan, de-leveraging and domestic political tension in China, and higher interest rates for Americans.

Mark Steyn, on our “Greek” future: A growing and unsustainable welfare state, with the predictable results. Actually, Steyn is not entirely correct in his analogy, as the U.S. is not suffering from the demographic collapse of the Greeks that inverts the entitlement pyramid even more. With, again, the exception of population growth, Greece is less like the U.S. than is Europe as a whole. Greece is more like California, as Steyn correctly notes:

“Think of Greece as California: Every year an irresponsible and corrupt bureaucracy awards itself higher pay and better benefits paid for by an ever-shrinking wealth-generating class. And think of Germany as one of the less-profligate, still-just-about-functioning corners of America such as my own state of New Hampshire: Responsibility doesn’t pay. You’ll wind up bailing out, anyway. The problem is there are never enough of ‘the rich’ to fund the entitlement state, because in the end it disincentivizes everything from wealth creation to self-reliance to the basic survival instinct, as represented by the fertility rate. In Greece, they’ve run out Greeks, so they’ll stick it to the Germans, like French farmers do. In Germany, the Germans have only been able to afford to subsidize French farming because they stick Americans with their defense tab. And, in America, Obama, Pelosi and Reid are saying we need to paddle faster to catch up with the Greeks and Germans. What could go wrong?

An earlier Greek had an insightful discussion of the weakness of democracy, a weakness that inevitably leads into collapse and tyranny. I am speaking of Plato and his work The Republic. This is a good summary of his Book 8:

“Now they begin speaking about how democracy leads to tyranny: the insatiable good that democracy defines as freedom. However, should the city fall into misfortune, the people will blame the rulers and call them oligarchs. Should anyone then obey the rulers, they will be denounced as voluntary slaves; they honor rulers who act like subjects and subjects who act like rulers. This extends to homes, so that parents must act like children and children like parents. Similarly, teachers are terrified of pupils, and children fight with adults about everything. There is also complete freedom and equal rights between the sexes, and slaves are as free as their owners. This makes the citizen’s soul too sensitive to endure any slavery, and eventually they will disregard the laws, as they must have no master over them. In democracy, there are three classes: the drones [politicians and rent-seeking members of various elites that are part of the political class], who speak and transact; the rich, from whom the drones can get money; and the people, the peaceful, self-employed, workers and farmers who form the largest class. The revolution starts because the majority sees what the rich have and believe that they are oligarchs. The drones incite this even further, and there is a main advocate for the people [a demagogic leader]. Inevitably, the advocate becomes the tyrant and fights in a civil war against the property-holders. When they get this far, they are often scared that the rich will try to kill them, and so ask for bodyguards to defend the ‘defender of democracy.’ The people provide this because they trust the tyrant.

In the beginning, when a tyrant walks around he will greet everyone, deny being a tyrant, and make promises to individuals and the state. He will also cancel debts, distribute land to the people, and pretend to be kind and gracious to everyone. [I.e., he promotes a welfare state.] However, after exiling his enemies, and befriending the others, there will be no need for him as a leader, and therefore he will keep starting new wars so that the people keep thinking that they need him. He will also need to raise war taxes and the like, and people will begin to hate him, even the people who put him there in the first place will start to speak against him. Therefore, if he wants to survive as a tyrant, he must eliminate everything until he is left without a single friend or enemy, and he must always beware of everyone around him. Ultimately, he is either to live with worthless people, or die.”

In the book itself, Plato is even blunter, at times. He describes how the people will not support the politician unless “they get a little honey” from the politicians. Plato describes the polity as analogous to a beehive. He also describes how the “orderly class,” the productive wealthy will be squeezed by the political class, the “drones.” The incipient tyrant props himself up as the “protector of the people,” only to turn on them and upon any in the political class who dare to oppose him. “And therefore he must look about him and see who is valiant, who is high-minded, who is wise, who is wealthy…he is the enemy of them all,….”

As the furor around the President’s nigh-on $4 trillion FY 2011 federal budget with its $1.5+ trillion deficit continues, it is important to keep in mind what is Mr. Obama’s fault and what is not. It is not Mr. Obama’s fault that the country is in a recession. Nor is it Mr. Obama’s fault that unemployment has gone up, or even that it has reached 10%, according to one measure (17%, according to another), different numbers according to yet others. Nor is it Mr. Obama’s fault that there is a broad asset devaluation that is eliminating froth, a devaluation that has both a short-term and a long-term component. Nor is this year’s (FY 2010) or next year’s (FY 2011) deficit entirely, or even mainly, the fault of Mr. Obama. Nor was last year’s (FY 2009).

With the disclaimers in favor of the President out of the way, let me be clear (to borrow a phrase from the press-anointed great orator) that I am not joining him in saying that those conditions therefore are the fault of his predecessor. Indeed, one aspect of Mr. Obama’s responsibility for the degree of current economic problems is his habit of blaming his predecessor rather than getting on with it. More about that later.

Still, Mr. Bush is to blame for some of the current misery. The increased federal funding for education and the drug prescription programs, along with other non-defense and non-national security items, enlarged the size of the federal budget significantly during his tenure. The tax cuts were not the problem, as they, predictably, increased federal revenue. Federal revenue, adjusted for inflation, did not go down; federal expenditures went up. Even the wars were essentially funded, with the FY 2007 deficit (pre-recession) dropping to around $160 billion. Many of us on the Right opposed Bush’s spending programs (even though the prescription plan ended up costing less than we had feared). As an aside, it is entirely unconvincing for Mr. Obama to rail about the fiscal irresponsibility of Bush’s prescription drug benefit when his own proposal is to expand it and to pay for that expansion in some undisclosed fashion. Adding to the budgetary strain of Bush’s compassionate conservatism was Congress’s profligate spending, including during 6 years of Republican hands on the spigot. Bush’s unwillingness, as a bargain for Congress’s support of his foreign and national security policies, to exercise his veto until the Democrats took over Congress in 2006 exacerbated the fiscal irresponsibility.

With the recession swinging into full force in 2008, deficits went up towards the end of FY 2008. Revenues dropped due to the slow down in economic activity and the financial panic, while federal spending increased, including the first portion of TARP loans to the banks. Still, the deficit at the end of FY 2008 was under $500 billion. With the economic inertia moving in the direction of recession, those deficits clearly would have increased, no matter whether Bush or McCain had been President in 2009, rather than Obama.

Looking at the recession itself, rather than the deficit, to the extent we are seeing the result of an unsustainable asset bubble, Bush is also partly to blame. So are Greenspan, Clinton, both Congressional delegations, and various bureaucracies, such as the SEC. On the deficit front once more, Bush, to his credit, tried to reform Social Security to bring its future costs under control, only to be demagogued by the Democrats and the media to the point where these people plus enough politically spineless Republicans (who typically lost their seats in 2006 and 2008 anyway—Chris Shays, are you listening?) derailed his proposals.

On the asset front, Bush and members of his administration many times warned about the problem of sub-prime loans, especially those under laws to pressure banks into lending to increase home ownership among poor and certain racial minority home buyers to purchase houses. His administration also warned about murky derivatives and the banks’ purchases of such investments. His proposal to curb these practices did not make it out of committee in the Senate due to loud wailing by Congressman Barney Frank (who, contrary to more recent posturing, was oblivious at the time to the dangers of over-leveraging) and officers of Fannie Mae and Freddie Mac (including well-paid Democrats). Then there was the filibuster threat from the Democrats (who controlled well more than 40 votes) against legislation to curb these practices that Frank and others described as “not broken.” Perhaps Bush should have used more political capital to push this matter along, but his eyes were on national security and the obstructions and attacks from the Democrats and the media on that front. Still, he does bear some responsibility for the failure to address these excesses more resolutely and successfully.

Greenspan’s role in artificially keeping interest rates too low, opening the spigots, cheapening the dollar, and driving investors to more and more speculative risk-taking (fueled by government participation through programs that reduced the risk of failure) is well-known. Plentiful dollars were looking for safety in commodities, starting with real estate, including investments in riskier and riskier loans. The bundling and securitization of these loans, together with the opacity of these bundles that might contain mixes of solid and risky loans in unknown ratios, contributed to the uncertainty about bank holdings that helped trigger and sustain the panic of 2007-2009. Eventually the limits of plausible real estate investments were passed and capital looked for other commodity havens, from gold to oil to rice. Commodity prices soared, with speculation in oil contracts fueling a huge spike in energy costs. That asset bubble, too, contributed both to the dollar inflation and the self-reinforcing cycle of commodity fever, and eventually helped cause the economic bust as many of those speculative positions had to be liquidated and the froth wrung out.

These economic trends are well beyond the power of any President to control and direct. To blame Bush or Obama is ridiculous. If any single institution were blameworthy, it would be the Congress, which, after all, is constitutionally and politically responsible for taxing and spending decisions. But even Congress by itself did not cause these conditions. Nor can Congress control them.

However, the President and the Congress can mitigate or exacerbate these conditions. For that, Mr. Obama and the current Congress bear much blame. Although I was inclined against the TARP law, I could see the argument for it. Obama likes to portray the cost of TARP as a Bush-caused deficit issue. But, first, the TARP was a loan program, much of which has been repaid during Obama’s administration. So, this should help his current deficit numbers. The problem is that Obama wants to spend these funds on other programs, so they contribute to the deficit once more. Second, Bush only signed off on the first half of the authorized TARP funds; Obama signed off on the second half. He did not have to do this. That decision is his responsibility and, to the extent that he argues the entire FY 2009 deficit should be assigned to Bush, this is deceptive.

Moreover, the “stimulus” that supposedly has saved and created so many jobs (but in fact has done so mainly for government jobs) was an Obama decision. As were the 2009 bail-outs of automakers. These aspects of the deficit clearly belong to Obama. Since the government no longer tries to figure out the impossible task of computing the number of jobs saved/created by the stimulus, but says that any jobs for which such money went automatically were saved/created, it is difficult to say what real impact the stimulus had on joblessness. The broader consensus outside the White House is that it has had little or no impact. As well, there is a negative effect of the stimulus on jobs. The need to borrow the funds for the stimulus crowds out private access to credit that might have saved those jobs. If the government is simply monetizing these costs, the bill will come due through inflation or taxes, the latter of which especially are job killers.

That brings me to the crux of the blame Obama must take. His radical programs reduce incentive for private capital to come in and take risks for job-creating expansion rather than sit on the sideline and invest in safety (gold prices have shot up) or by bidding up stocks to dubious price-earnings levels. His class-warfare tax rhetoric, the massive and radical collection of entitlement spending proposals (health care, student loans), the looming cap-and-tax regulations, the radical bureaucrats he has appointed (such the head of the off-the-rails EPA), the take-over of—and meddling in—car companies, the faux-populist attacks on banks and Wall Street, all spook investors and discourage risk-taking.

If I am a truly wealthy person, and I am threatened with higher taxes, I park my wealth in low- or no-tax investments (e.g., municipal bonds) or figure out tax avoidance devices. If I have to work because I own a business, I will squeeze my employees for at least some of the additional cost, by lowering their compensation/benefits, by firing some and having the others work more, or by moving more of my business out of the U.S. If the workers don’t like it, they can quit, and I will replace them with unemployed workers at the lower price. None of these things will increase jobs or, in the aggregate, help the economy. People are not passive, and history shows this to be the expected reaction. It happened in the late-1930s in response to FDR’s class warfare rhetoric and his tax and regulatory policies. Unemployment actually increased and did not come down significantly until the labor shortages created by WW II took care of it.

With lower economic activity induced by Mr. Obama’s rhetoric and proposals, and with the cost of these programs, no wonder that the deficits stretch out as far as projections are made. His spending proposals, unlike the temporary expenditures on the wars in Afghanistan and Iraq that Mr. Obama likes to blame, create structural deficits. They impose continuing and increasing costs. Worse, those expenditures, and his regulatory proposals, suppress economic growth, the very thing that might allow him to finance at least some of the anticipated growth in the cost of existing programs, such as Medicare. They do that by requiring government either to raise taxes, thereby reducing investment, if taxes are targeted at the rich, or depressing consumption, if taxes are targeted at the middle class. Alternatively, the government can borrow, thereby raising the cost of credit for private institutions competing with the government for loans and again reducing investment. Finally, the government can print money and create inflation, thereby creating great uncertainty about the value and stability of investments made now and also raising the cost of credit.

So, while Mr. Obama cannot be blamed for the recession and for all of the deficit, he (and the equally radical leadership in Congress) can be held accountable for the lingering joblessness and for increasing proportions of the deficits. Those are, even now, exacerbated by the economic fear and uncertainty created by his own radical agenda and his destructive and partisan class warfare rhetoric and tax proposals. It is ridiculous to blame his predecessor when his own projected deficits, in its best years, exceed his predecessor’s deficits in his worst year. With each passing month, his excuses become more laughable. Voters are getting that message better than, apparently, he is. His whining and attempts to deflect from his responsibility arising from his own proposals are backfiring.

Mr. Obama did inherit a recession; he did inherit a deficit, just as Mr. Bush inherited the collapsing NASDAQ and, to a lesser extent, Dow Jones, with the economic slow-down of 2001. Obama’s advisers and supporters are right in saying that the deficits and the recession would have been here no matter who was President. But they are wrong in not accepting that it is Mr. Obama who is prolonging and exacerbating the condition.

From Investor’s Business Daily comes Michael Ramirez’s impression of Mr. Obama:

For those of you who want a quick run-down of Keynesianism and Austrian School economics, this is an entertaining and very clever presentation. It’s probably not a total surprise that I am rooting for the nerdy guy, I mean Hayek. Go ahead and enjoy. Release that inner economics nerd.

For those whose inner nerdiness extends to singing karaoke, here is a link to the words.
HT: Ali Vazin

A few years ago, the city of New London, Connecticut, sought to seize the land of Suzette Kelo and others in her neighborhood (with compensation), to clear it, and then to open it to development by other private entities to obtain more tax revenues. The houses to be destroyed were habitable, and the area was not blighted. Kelo and some of the others had lived in those houses for years, sometimes for a couple of generations.

The residents challenged what they saw as an abuse of the city’s eminent domain power, as the properties were not condemned for a traditional “public use,” such as a highway or a school. Instead, the properties were given to others for what the city claimed was a “public purpose,” a higher tax base. The challengers deemed this a violation of the Constitution’s takings clause, but the Supreme Court eventually held against them.

One of the beneficiaries of the city’s actions was Pfizer Corp., which was building a facility there and wanted to have better and more upscale surroundings, including commercial and residential development. Ten years after the initial condemnation move, the homes have been razed, but the property is still undeveloped. Worse, Pfizer has withdrawn, closing its research facility and moving those jobs to a city across the river from New London. Cosmic justice for the foolish government of New London. As Ed Morrissey opines,

“The Kelo decision — which was not a radical departure by any means, but the nadir of a slow trend of hostility towards private property — assumed that the decision about the best use of private property by private entities was better off being made by the government.  That insulted the entire notion of private property and put individual liberty in jeopardy….Instead of having homeowners on that property, paying taxes and providing stability, the city now has an empty lot and a ton of political baggage.  The biggest lesson is that private owners should have the benefit of deciding for themselves the best private use of their land — primarily to bolster the rule of law and the concept of private property that lies at the heart of our personal liberty, but also because government is a lot more likely to muck it up.”

This is an eery and depressing glimpse into the future of government control over health insurance/care.

With the report that the unemployment rate has risen past the symbolically significant 10% rate to 10.2% comes the furious spin. Republicans spin this as an indictment of the President’s policies, though surely even the, well, stupid “stimulus” boondoggle and the wasteful quasi-socialist industrial policy of the car company bail-outs cannot realistically be said to have contributed to it. They are too small and too recent to have such an effect. The White House advisers are, correctly in my mind, reminding people that the unemployment rate is a lagging indicator that will rebound only after economic growth itself is well on its way. A rise in the figures for temporary hires suggests that is, in fact, happening, as employers wait to commit themselves to hiring full-time employees until they see that growth has picked up sufficiently strongly and durably to justify the investment.

At least for a brief moment we are not hearing, mercifully, the constant bleating about how the stimulus “created or saved” such and so many jobs that, even if taken at face value, still amount to only a small fraction of jobs lost. And the “if” is a big one. “Jobs saved” is a completely imaginary figure based on so many imponderables that it rivals in reliability the enemy body counts estimated by the military after skirmishes in the jungles of Vietnam. “Jobs created” is only marginally better and, if one excludes jobs that went to teachers and other members of public employees’ unions, laughably small. One estimate has it that, under more credible figures, each of these jobs cost nearly a quarter million dollars. Cheaper just to hand each recipient $100,000.

As of this writing, our President himself has been silent, but one awaits his usual explanation: “It’s George W. Bush’s fault. We are just cleaning up the mess we inherited.” This is of a kind with all his explanations for sundry hesitations, missteps, and failures and will remain so for as long as he can delude himself and a sufficient portion of the American public into thinking such mush. The recent elections are the morning alarm going off the first time. He can hit the snooze button, but the next election’s results will sound much more insistent.

I actually agree with him up to a point. He did inherit a messy economic situation that resulted from an asset bubble that set off a classic financial panic. To that extent he cannot legitimately be faulted for the current unemployment rate. As these matters proceed in a cycle that needs to work itself through until the economic underbrush has burned and new sprouts of prosperity can reappear, it is not Mr. Obama’s doing that the rate has gone up well beyond what he and Joe Biden promised when the stimulus bill was foisted on the American people.

But by the same token, it is very little the fault of the Bush administration that this recession occurred. The asset bubble was primarily the result of the Fed’s easy credit policies maintained too long and of Congressional laws from a prior era that pushed for home ownership by unqualified buyers in the guise of eradicating some imaginary racism in lending. In classic post hoc, ergo propter hoc fallacy, the only evidence for this racism was the disparity in home ownership between Asians and non-Hispanic Whites on the one hand, and Blacks and Hispanics on the other.

To the extent Bush can be faulted, it is the deficit spending aggravated in part by a large expansion of government social spending through the Medicare drug benefit expansion and the “No Child Left Behind” program. The deficit spending, tax cuts, and low interest rates expanded the debt and helped drive down the value of the dollar, while artificially stimulating the economy. While the first and (more convincingly) the third might have made sense to help ease the recession Bush inherited after the 2000 bursting of the tech bubble and the economic hit of 9/11, only the second of these made sense over the full length of Bush’s term.

But to the extent the Bush deficits helped bring about or worsen the current recession, the incumbent in the White House is not in a position to chide Bush. With the massive current deficit and with the huge structural deficits planned for the future, Mr. Obama appears intent on showing up Mr. Bush as an amateur in profligacy. And therein lies the problem for me. The President is not at fault for causing the recession. Nor is he at fault for not bringing down this unemployment rate sooner. Sure, either he revealed utter economic incompetence or he simply lied when he predicted that the stimulus would keep unemployment from rising above 8%, a figure that, based on leading indicators and the steep growth of the unemployment numbers for the prior months, was obviously fantastical. But these panic-induced economic jolts occur too suddenly for government policy to have much effect, with the possible exception (and I want to emphasize “possible”) of steps to assure liquidity in the banking system.

The problems I see with this President and with the Fed are the reckless abandon with which government seeks to take over the economy and the huge amounts of money that continue to slosh around like so many mines ready to explode as economic activity increases the velocity of money. If the economy is showing underlying signs of growth, as the White House insists, the Fed’s continuing near-zero interest tolerance must raise eyebrows. High government spending, inevitable tax increases, and low (or even negative) interest rates to me sound like the perfect opposite of sound economic policy. It erodes the currency, reduces private productivity, and maximizes economic inefficiency.

While the President is not to blame for the current surge to 10.2%, he is increasingly responsible for a failure of the rate to decrease significantly. More clearly, there will be no hiding if his (and his Congress’s and party’s) fraudulent economic policies cause a double-dip recession, high inflation, or, as may be most likely, a long malaise of stagflation. Even if it might have been credible once, “It’s Bush’s fault” is increasingly irrelevant and, to the American people, incredible.

The much ballyhooed 3.5% growth of GDP in the third quarter is a mirage, as the increased spending is not due to any change in fundamentals but to policies with the solidity of quicksand. The temporary cash-for-clunkers program and other tax and stimulus gimmicks are set to expire. That will drag down the next quarter. Then the Treasury needs to start winding down its exposure of trillions of dollars sloshing around. Either tighten and risk a double-dip recession or wait and risk higher inflation. The longer the fed waits once the economy begins to pull forward (as it may start doing soon, though not at 3.5%), the higher the risk of inflation.

This Bloomberg article has some quick and sobering analysis that sounds right to me. I agree with the conclusion that there may well be growth, but that it will be in the anemic 2% range. Moreover, I think it will be accompanied by inflationary pressures due to the irresistible impulse of Democrats to increase spending that will have to be financed through a monetized deficit, as I don’t see China and others continuing to buy Treasury offerings to support structural deficits that will get worse for a long time. But, then, a devalued dollar may be, as I’ve said before, the weapon of choice nominally to rebalance financial institutions’ balance sheets and to revive manufacturing by making American exports cheaper in a manner of economic warfare. That strategy only works, however, if we don’t have to keep paying more in inflated greenbacks for energy imports, and our unwillingness to expand domestic production makes that unlikely.

My colleague Byron Stier has asked whether there should be a return to the gold standard to impose some discipline on the dollar. On the level of the individual, I certainly believe in the value of investing a part of one’s assets in gold as a hedge against upward price volatility due to inflation. Gold is a “pessimistic” investment, and, for reasons I’ve mentioned, prefer the more optimistic investment in stocks. But it is prudent to hold some gold without becoming a “gold bug.”

On a macro level, fiscal discipline is a matter of political will only, though that political will may be harnessed more readily depending on the economic conditions of the moment. Crisis conditions focus the mind wonderfully, including the minds of politicians. Similarly, monetary policy ultimately comes down to self-discipline (as well as some structural independence from the political organs of government). Tying a currency to gold (or any other standard) is merely an attempt to formalize a political will of the moment and to hem in by this external formal restraint the discretion of policy-makers that otherwise will succumb too quickly to the path of least political resistance if economic conditions get tough in the future. But those policy-makers, and their legislative cohorts, at any time can suspend or revoke the link between the currency and some “objective” outside standard of value. There is nothing ultimately sacred or binding about a gold, or any other, standard for the dollar.

At the same time, the absence of a formal link does not mean there is no link. A unit of currency is still just a piece of paper that represents a willingness on the part of the recipient to accept it as a medium of exchange. That willingness reflects what that unit of currency can be expected to buy of a vast array of goods and services. If there is not enough economic discipline, and there are too many units of currency chasing too few goods and services, the currency will cheapen nominally. Though such price inflation can cause economic dislocation and turmoil, as a certain expectation settles among the public, it just becomes a matter of how many zeros the basic unit of currency will have. Technically that can be altered by moving the decimal point to change, for example, $1000 to $10.00. More difficult than such a cosmetic maneuver is an adjustment in the political and economic expectations that caused the inflation in the first instance.

So, it all seems a rather futile exercise to tie the currency to an outside standard. But the reality is not so clear. The standard may be a symbol, but it also serves as an anchor. Because of its visibility, and the benefit it may bring to commercial sectors of society, any attempt to discard it will cause a political reaction and exact a political (and economic) price. It therefore acts as a brake on the political institutions that must contemplate whether conditions warrant such a step. To the extent that a state of economic normalcy does not include a high rate of inflation, such a standard can moderate tendencies towards politically cheap, but economically expensive, policies.

The question, then, becomes what should be that outside standard to which the currency is pegged. Historically, that has been gold. Given the relative stability of supply over a long time, and gold’s traditional use as adornment, it served as a very compact and useful medium of exchange, similar to the way that specific seashells did among some American Indian and insular cultures.

Today, however, some alternatives make more sense. Gold’s use as an industrial metal has increased, and supply is comparatively restricted, so that, by itself, a gold standard may be too drastic a limitation on the need for monetary growth as economies expand. A too-restrictive standard is more likely to be abandoned more quickly. Therefore, gold might best be combined with other commodities (silver, platinum, titanium, copper) and/or baskets of currencies to moderate fluctuations in value, as well as provide both an effective standard and one that does not become an straightjacket on growth. This is similar to the combinations proposed by some as a backing for the system of IMF Special Drawing Rights that they want to turn into a full-fledged international unit to replace dollar as a world-wide reserve currency. I am not in favor of adopting a one-world currency, but I think the model can be useful for a revitalized dollar.

This is an interesting column by Republican Whip Eric Cantor on the pending regulation of derivatives. Derivatives have been around for a long time and include such hoary examples as stock options. But many, especially in government, blame the financial panic of 2008 on the heavy use of murky derivatives to “speculate” in markets such as of mortgage-backed securities and various insurance-related products. Cantor is concerned about the inevitable government overregulation that will impeded innovation and investment, frustrate appropriate risk hedging, and increase consumer prices.

Cantor knows a lot more about this than I do. I thought that one of the areas of potentially fruitful regulation might be to bring such derivatives more squarely within the regulatory power of the SEC and to encourage exchange-traded derivatives or other clearing-house mechanisms to provide stability and a certain transparency to the market. There is always a tension between the need to raise capital as efficiently as possible and to provide efficient, market-based means to control risk. To the extent that government regulation burdens these goals, businesses and corporate finance advisers will find a way around or between these regulations. That is in part why the market in these previously thinly-regulated derivatives exploded. So there is a danger that the institutionalization of derivatives marketing or, worse, ham-fisted government regulation, will cause business to look for ever-more exotic and obscure methods of financing and hedging. But a broader regulatory authority should allow the SEC or other responsible agency some ability to deal with these innovations. But that, too, Cantor believes, will create inefficiencies as specific companies cannot adequately tailor derivatives to their business needs.

I don’t know that the situation is as bad as Cantor believes. True, SEC registration slows down the issuance of securities and creates expenses. But over the last three decades, the SEC has become more conscious of the need to accommodate businesses’ needs to raise capital efficiently, though it is entirely possible that the current regulatory ethos and anti-capitalist mindset of the President and Congress can alter the outlook of the bureaucrats, as well. One would think that the appropriate regulatory agency can develop the proper regulatory and exemptive framework that would allow sufficient flexibility for the individuation of derivatives suitable to companies’ needs. As well, regulation (preferably market-focused) of derivatives trading can foster stability and confidence, while not sacrificing efficiency. That is, unless government misjudges the markets and imposes the same kind of politics-driven, economically foolish regulations as it did during the last outrage over capitalist “failings.” That event, the Enron deceptions, brought us the regulatory monstrosity known as the Sarbanes-Oxley Acxt.

An ominous sign of future developments, the decline of the dollar. As foreign buyers buy fewer and fewer dollars and more and more euros and yen, the excess of dollars will put further pressure on the currency and on interest rates. If this continues, and there is not reason to believe it will change, the Fed Chairman will be put in an increasingly tenuous position. He will have to take the higher interest route to bring back the dollar and throttle the economy. Or, he will have to print money and risk inflation that will cause tremendous economic dislocation and eventually lead to raised interest rates that will throttle the economy.

This is the more optimistic forecast, one that merely predicts a long, slow downward drift for the dollar. This is the intermediate view about the fate of the dollar. With very few reservations, the vote is in favor of a weakened dollar caused by deficit spending and leading to an economic decline for the U.S. The Bush administration did not do enough to maintain a strong dollar, as shown by the rise of gold and other currencies in relation to the dollar. But, just as with deficit spending, they were pikers. This is far worse. For someone like me who believes in King Dollar through careful control over the money supply, government spending restraint, and low taxes, the Obama administration is an unbridled disaster.

The Dow-Jones average of 30 industrials closed above 10,000 for the first time in about a year. While still off by 4,000 from its all-time high just two years ago, it is up about 3500 from its low this past March. The Dow is at the same level it was about 10 years ago, shortly before the tech bubble burst. I wonder, though, whether this rally is either real or meaningful. My concern about the “reality” of the rally is based on reports I have seen that the average NYSE price/earnings ratios (Mr. President, please take note of this term for the next time you want to talk about P/E ratios) have gone above what many economists see as justified. The question is whether there is froth building once more, given the tepid outlook for the economy for the next year. A 2.5% growth rate is not exactly a juggernaut. And that assumes that the dollar won’t cause enough problems to require a serious interest rate hike that likely will be coming within a year after that, anyway.

My concern about the “meaningfulness” of the 10,000 mark is that this reflects to some extent the decline of the dollar’s value. The 10,000 today is not the same as the 10,000 ten years ago. The dollar has lost considerable ground against gold and other commodities, as well as against other currencies. Just since March, as the financial panic eased abroad, investors fled the dollar. The Fed’s dangerous monetary policy and an administration that appears hell-bent on creating a huge structural deficit are not exactly producing medium and long-term confidence in the dollar. The dollar has lost so much in value against gold and other currencies that it has been calculated that, just in March, 2009, dollars, the value of the Dow right now would be at 8600. That is still a significant jump since the March low, but only about 60% of the increase in nominal dollars. At least that 8600 number gives a better sense of how much of the price appears to be due to predictions about real future economic performance, though I am still skeptical that it will materialize.

I have lots of unease about the value of the dollar. Not to sound conspiratorial, but it would not surprise me if the Obama administration had a very conscious plan to devalue the dollar significantly to try to float away the debt. Deficits-induced inflation will, in a very rough and undesirable way, reduce purchasing power and the standard of living. But, hey, those houses currently “under water” in relation to their mortgages will surface again, even if only nominally. Obviously, that will eventually result in higher interest rates, which will depress house values, but perhaps not as low (nominally) as they were before.

With my concern about inflation, then, isn’t the stock market the way to go? I think that some investors are drawing just that conclusion, getting out of cash holdings and bonds as they see the financial panic easing. That, too, is helping propel stock prices, resulting in those questionable price-earnings ratios. I am currently putting most of my retirement plan contributions in a combination U.S./foreign stocks fund allocation, with the rest in money-market funds. I like stocks; I think of stocks as an optimistic investment, showing faith in the economy and the future. So, I am drawn to them. But, at the same time, had I more money, I’d buy some gold as a pessimistic hedge. (Had I even more money, I’d buy real estate now.) Gold seems high to me, but not any more ridiculously so than Dow 10,000.

There are increasing international calls for the replacement of the dollar as the international reserve currency. Those calls so far have come to naught, as there is no single currency strong enough to replace the dollar right now. The Chinese yuan, if it ever gets there, still has a couple of decades or more to go. But there are calls to use a basket of currencies plus gold as an alternative. And soon. That, too, has problems, but it poses enough danger to the dollar that even the talk about such things puts downward pressure on our currency, increasing the price of imports, especially oil. It is not too surprising that the oil producers are leading the charge, though our Chinese enablers have been increasingly vocal, as well. The combination of the proposed use of gold as part of this basket and the devaluation of the dollar (as well as Chinese and private fund buying) has created a quasi-gold standard and pushed gold prices to record highs.

Sarah Palin puts her finger on part of the problem, the U.S.’s obstinate refusal to promote domestic energy production. Environmental nihilism translates into Democratic Party fecklessness in that regard. While the dollar self-destructs due to the trillion dollar deficits, the administration wants to pile on additional burdens through de facto nationalizations (financial entities, manufacturing), social programs (health care), and environmental strangulation (cap-and-tax).

I have read that there are several trillion dollars floating around because the dollar is the reserve currency. That excess money will have to be absorbed. Right now, the money is repatriated through purchases of American products or securities, which thereby have an advantage over those of other countries. That competitive advantage will disappear, hurting Americans in the end. Higher interest rates or inflationary pressures. Pick your poison. And economic poison it will be.

All American government spending, taxes on capital and earnings, and the myriad of efficiency-inhibiting policies from environmental laws to welfare laws to labor laws to affirmative action and similar political distortions will only worsen the coming stagflation. It may sound good to some that there should be government-financed health care so that no person goes bankrupt because of hospital bills. Good slogan; but if such events really are an endemic problem of the current system, the proposed alternative threatens to bankrupt the whole country because of hospital bills paid by the government. The modern Euro-style welfare state is unsustainable for the Europeans. Americans are not insulated from that economic fact of life, either.

Perhaps this is unduly pessimistic. Perhaps the old order will continue as the U.S. slowly digs out from under the rubble. But creative destruction of this type often leads to a new ordering, and those who are best poised to take advantage will be the winners. Those who pursue political and economic fantasies will lose. One must always remember, the facts of life are conservative.

Economist Peter Schiff deplores the pretense at the recent G20 meeting in Pittsburgh. The President wants the Chinese to do more to stimulate their economy and Americans save more and to curtail spending. Unfortunately, that is the opposite of what is happening. Americans actually have saved more and paid down debt. But the various stimulus programs the administration puts in place overwhelm that effort by encouraging Americans to commit to purchases they otherwise might not make and well may not be able to afford. These stimulus packages are not much better than the “teaser” mortgage rates about which the administration complained when done by private lenders, and the use of which by unqualified borrowers was the likely catalyst for the housing market collapse. Nor are the looming tax hikes and the attempts by the administration to slow down American economic growth and lower American standards of living by taking over health care and imposing anti-growth energy policies helpful. They hurt, not help, long-term American savings and domestic capital formation.

For the Chinese, any stimulus to the economy (which, by the way, the Chinese have done) is going to take money that otherwise would be parked in U.S. debt. I disagree with the author that the Chinese government will just stop buying U.S. debt and allow the Chinese people “the full fruits of their labor.” While that indeed would force the U.S. to cut back government spending significantly or to raise taxes drastically, either such option would strangle the economy in the short term. Or the U.S. can print money, which would seriously weaken the dollar. Were that to happen, however, the Chinese would effectively see their holdings wiped out. And they cannot shift to domestic demand so quickly as to make up for that loss and for the loss of the U.S. markets that would entail. So I don’t see sudden and massive shifts in Chinese investment policy. We are so in debt to them, we, in effect, “own the [Chinese] bank.”

But I agree that the Chinese are moving away from financing the U.S. debt, and will do so more emphatically once the rest of the world’s economies rebound. They are buying gold, a part of the reason gold prices are high. They are seeking, along with others, to move away from a single reserve currency in the dollar. It is likely that they will seek to spur demand for goods among their own people, who cannot yet afford most consumer goods they produce. And, with their one-child policy, there is a limit to how many cheap toys can be sold in China. Moreover, China, with its aging population, will soon need to provide for all those oldsters that the one child per family cannot support out of his or her own earnings without seriously depressing their own standards of living and impeding their own ability to form families.

But these are slow and longer-term processes. As they proceed over the next decade or two, they will contribute to the U.S. sinking into a lower-growth, lower-productivity, higher-tax, higher-unemployment, higher-inflation, weaker-dollar period of stagflation. Government bail-outs, industry take-overs, and increased socialization and environmentalist domination will only exacerbate that economic malaise.

A linchpin in the environmentalists’ push to constrain economic growth and to restrict energy usage is that we are running out of oil. For a while, during 2007/2008’s speculative run-up of oil prices, we were regaled with frequent tales about “peak oil,” that oil production was on a shorter or longer fade-out to oblivion. Therefore, we needed to curtail consumption to make oil supplies last a few years longer. But, of course, just in case oil and similar energy resource production wasn’t going the way of a dying star, we had to curtail consumption anyway to keep the sea levels from rising to the point that in 500 years, certain island atolls would be under the sea.

Even in California, there is still oil to be found, much to the chagrin, no doubt, of “Call me Senator” Barbara Boxer and John Kerry. And that is on dry land, thanks, apparently, to the the state’s maze of earthquake faults. Much more is available and even more likely to be discovered, offshore. But in California the secular priesthood of environmentalism (one can picture them in their caftans and sandals driving their Priuses) insists on putting such offshore drilling off-limits. Meanwhile the state’s finances crumble along with its job prospects. Oh, and with its water resources.

Incidentally, in the link to the Boxer-Kerry cap-and-tax bill, which Kerry with a straight face called an anti-pollution bill, because he had no idea what cap-and-trade was, there is a wonderful “defense” of the bill by the Democrats. “Wonderful” in the sense of its cluelessness. The bill is supposed to cut emissions by 2020 to 20% below what they were in 2005, and 83% below that 2005 figure by 2050. The Democrats claim that should be easy to achieve, because emissions have dropped since the House enacted its version and are now already 6% below 2005 levels. Leaving aside the question why we need such a bill if a 6% cut has already been achieved without it, one needs to look at the reason for the cut. It is due to the recession. So, 10% unemployment produces a 6% cut, what will be the slowdown in economic growth and rise in unemployment necessary for a 20% cut in emissions? Assuming that we have a linear progression (a big assumption), why, 33% unemployment should do it. And that won’t even do it globally. The Chinese and Indians (or the Africans and South Americans) won’t be so economically stupid and civilizationally suicidal as to go along with this nonsense, assuming this is more than just political posturing and an attempt to benefit a few politically well-connected actors such as GE and Al Gore’s carbon-trading enterprise.

I remember how, during the election of 1996, the media the happy state of the economy, with the likely success that would bring to Bill Clinton in his bid for re-election. The unemployment rate that prosperous November, 1996, was 5.4%. During the 2004 election, as during much of the rest of George W. Bush’s term, that same media delivered story after story about the dismal state of the economy. The unemployment rate that dismal November, 2004, was 5.4%. Indeed, over two terms each years, the employment figures for the Clinton and Bush administrations were quite similar, with average unemployment at 5.2% for Clinton and 5.3% for Bush. Range was 3.8% to 7.1% for Clinton and 4.4% to 7.6% for Bush. Lest anyone mention the real estate bubble during the Bush years, we had the dot-com bubble and the effects of the end-of-the-cold-war dividend during the Clinton years.

The point is not the slight differences and general similarities of the statistics. I don’t even think that, in general, Presidential policies much affect the general cycles of the economy. However, administration policies can distort things in the short run and, typically, exacerbate economic swings. What is more significant for me is the usual media double standard that applies. This year during the Age of Obama, The New York Times (and other publications) has been extolling the virtues of “staycations” and “funemployment.” It does so once more here. It may be true that unemployment gives people a chance to refocus and even to rediscover a more balanced lifestyle. At least for some who are not starving, and up to a point. With a 9.7% national unemployment rate, that point is fast arriving. In California, the unemployment rate is 12.2% (though one wouldn’t know it from the post-Labor Day traffic on the freeways), and it’s only the fourth-worst in the nation. That’s got to make even funemployment more stressful.

But, as Ed Morrissey at Hot Air points out, there were no similar articles during the Bush years. Instead, it was doom and gloom, at 5.4% unemployment. Articles derided the “jobless recovery” and bemoaned the emptiness of “McJobs” and the diminishing prospects for a fulfilled life for every demographic but “The Rich.”

These analyses bear as much relation to reality as the old Vietnam War-era enemy body counts or as the Obama administration’s fantasy world numbers about jobs “saved” or “created” by the “Porkulus” spending programs.

We shall see how things go if Obama succeeds with the nationalization of American banking and industry. A lot of people may be longing for that 5.3% average unemployment of the Bush years, once the “fun” of funemployment wears out along with the welcome that the funsters had when they moved into their parents’ homes. Those McJobs may begin to look good.

Historians have often pointed to American protectionism in the 1930s, such as the Smoot-Hawley Tariff Act, and European trade retaliation as exacerbating the economic downturn that became the Great Depression. Economists have been warning some time now that the U.S. should reject any similar moves, as they likely would trigger trade retaliation that would threaten economic recovery. There has been considerable concern that President Obama would resort to protectionist actions, as he and his advisers had often expressed hostility to free trade while he was a Senator and during the presidential campaign.

However, he also let it be known, to the Canadians, for example, that he did not really mean his protectionist rhetoric and, instead, was a closet free trader. Once elected President, the Europeans and the Chinese warned Obama against protectionist actions. Obama kept a low profile and stayed away from protectionist moves, except to the extent that driving down the dollar and making American exports cheaper overseas might be seen as economic warfare. No more. The President has slapped duties on cheap Chinese tires.

The result of this will be several-fold. First, these tires (which are preferred by lower-income buyers) will cost consumers more. American sellers purchase these tires for resale. Domestic manufacturers opposed the duties, as they cannot manufacture such tires profitably due to higher labor costs. Moreover, American manufacturers are not equipped to pick up the slack, even if they wanted to, because of the different processes involved. That’s why those domestic producers purchased those tires from China and rebranded them.

The real supporters of this action were the manufacturers of other goods who want the President to impose similar tariffs to protect their industries and, of course, the United Steelworkers Union, whose bidding Obama is doing. Big Business, Big Labor, and Big Government is a combination sure to bode ill for the American consumer. This protectionism, extended to other industries, too, will raise prices and throttle competition, as was shown by the experience of the American car industry when they received protection from competition from Japanese car makers years ago. American cars were of poor quality and comparatively expensive, a reputation from which the car industry still has not fully recovered.

Then there is the inevitable Chinese retaliation against American producers. Predictably, the Chinese launched investigations into charges of “dumping” by the U.S. of chicken and automobile products. If the Chinese penalize those American products, it would roughly equal the amount the Americans are imposing on Chinese tires. Purely by coincidence, I’m sure. Predictably also, the Obama administration is loudly proclaiming the unfairness of the Chinese protectionism, while confidently defending their own. Agricultural producers had asked the administration not to apply the tariffs because they feared the likely Chinese reaction against such important American exports.

There is real danger from such protectionist tit-for-tat. A trade war would be very harmful to economic recovery, especially as the U.S. needs exports (which were a true jobs stimulus over the past year) to fuel employment. However, most experts believe that, after this initial spitting contest, China and the U.S. will work to keep the trade friction within manageable bounds.

The Tax Foundation analyzes IRS data to show that the top 1% of households pay more federal income taxes (40.4%)  than the bottom 95% combined (39.4%). Better yet, their percentage of the total income taxes increased under both Presidents Clinton and Bush and even since 2004. That does match, however, an increased share of income, as well. The wealthy pay about twice the share of income taxes than their share of income (22.8%). The bottom 95% earn 62.6% of income. As I’ve posted previously, the U.S. has the most progressive income tax system in the world, more so than either Sweden or France. So, when the debate turns to whether or not the “rich” are paying their “fair share” of taxes, it may be a suitable subject for debate. But the falsely righteous certitude of the Left that the rich are not doing so is a red herring.

This is a more thorough collection and explanation of the data.

Another dog-bites-man story. As economic models and past experience predict, the raising of the minimum wage has its worst effect on the young. So it has come to pass that the unemployment rate for young people is higher than for anyone else, and higher than it would have been. Especially at a time of scarce capital when they can hardly afford the lost leader of training costs, business is not going to hire those whose skill and productivity are the lowest, and whose services have been priced out of the market by a politically-oriented and ill-timed increase in the minimum wage. But, hey, it is the young who overwhelmingly supported Obama, so there is a bit of cosmic justice. The problem is that this also hurts the one-third of young voters who voted against Obamanomics. And this won’t end there. Long after older people are gone, the young will be paying for a discredited economic program that believes in putting the economy under the administrative capabilities of the DMV, growing the economy by raising taxes on productive vigor, eliminating debt and protecting the currency by creating long-term structural deficits, and assuring growth and jobs through a series of proposals to cut energy production and refining.

Herewith a collection of recent articles I have found enlightening about health care proposals.

The Weekly Standard provides insight into the Dutch effort since the 1980s to move away from nationalized health insurance, first to a kind of public option/non-profit cooperatives/private mix and when that didn’t alleviate the problems sufficiently, to a more openly private insurance system. This is noteworthy for several reasons. The Dutch economy is among the most heavily socialized. The Dutch system, like other European systems began from the position that health care was a right for everyone. The country experienced the predictable inefficiencies of the system with its lack of incentives through competition.

Contrary to the desires of American liberals, the watchword has become to overcome managed competition. People now have to buy private insurance that the top one-third of the population already bought to escape the public system.

The article also reviews the many ways that government systems fail and how they try to control the inevitable costs. Government health care may not deny you the care altogether. But, “[one] way for a government to ration care is to simply delay it. You probably will get the care eventually but a long wait time means that there are fewer resources, facilities, and equipment needed in a health care system.” Or, “[another] approach to rationing is to limit availability of technology.” Examples would be the few MRI machines available in Canada, so that people have to go to the U.S. or, once again, wait. Or, “[rationing] may also take the form of limits on payments for medications.” That results in underfunded budgets for medications, which cannot be exceeded on pain of fines. Thus, needed drugs are underprescribed.

The solution in countries that ration health care? “For those who want to avoid these waits, supplemental private insurance and access to a discrete private system is one solution. While some countries have expanded access in the public system because wait times became intolerable, this has led to costs rising at rates that have themselves become a major issue.” An example of that is the German system, with which my family has some familiarity. The French system is often lauded as being a particularly responsive public system. France is one of the countries that has consciously expanded access to health care to reduce wait times. But France, combining expansive care with bureaucratic inefficiency, now has a budgetary albatross whose costs have so spiralled out of control that they threaten the government’s fiscal stability. This has become a major political and economic problem.

Economist Robert Samuelson discusses the inevitable cost explosion that will come under any government health insurance coverage. Extending Medicare to all will suffer from the defects of the current version of the program, but on a grander scale. Samuelson does not believe that rationing will be the result. Instead, as all the liberal talk of health care as a “right” shows, and as has already occurred with mandates imposed on private insurance coverage, Congress will expand the program but only talk about constraining costs. The best that can be expected from Congress is to try to squeeze doctors, hospitals, and drug companies. The rest will be increased taxes and/or deficits. And the President? “He simply claims that his plan will do things it won’t. What he’s offering is an enlarged version of the status quo that, as he says, is already unsustainable.”

Public systems are clearly prone to odd examples of expansion of “necessary” health care.

Once more about those uninsured: General estimates place the number of uninsured Americans who make less than $50,000 (roughly the median earnings of a family of four) and who don’t qualify for government programs at 8 to 14 million. The lower figure are the chronically uninsured, the higher figure those who are temporarily uninsured at some point when the survey is taken. Not 46 to 50 million, a figure thrown around that has been debunked for a long time. Even in that category, a lot are young single people in excellent health who probably could afford to pay relatively cheap premiums if they were not subsidizing costly insurance mandates, but opt not to do so. The Census date used there are from 2007, but there has been little change in the percentages of uninsured over many years.

Then there is the usual collection of stories of Canadians being sent to, or escaping, the wonderful Canadian health care system that liberals seek to emulate. There is the agreement between Ontario and the city of Detroit and other municipalities to provide services to Canadians they cannot get there as readily. Detroit!?! Even defenders of the arrangement agree that such safety valves allow Canada to have a smaller health care budget. That should answer the argument why Canadians pay less for health care. As with so much of their national existence, they depend on the U.S. On whom will they be able to free-ride if the U.S. follows their lead?

Another, though older, example of that vaunted Canadian care. Via Mark Steyn at The Corner, some incidents from EuroCare, including the sad tale of Irish mothers who have to wait months before getting a first obstetrician appointment. Again, via Mark Steyn, the tale of 4000 mothers who had to give birth in unusual circumstances due to a lack of maternity beds in Britain. Also note the links in the middle of the Daily Mail article for further examples.

A zestier discussion, courtesy of Ann Coulter, who argues (correctly, in my mind) for more competition among insurance companies and fewer government mandates.

We are beginning to hear that the economy is improving, and that we have avoided a repeat of the Great Depression. I am not sure about the correctness of the former, as there are a lot of respectable economists and various famous types (Warren Buffett and George Soros) who have warned about a looming double-dip recession or a long period of stagflation. As to the latter, the Obama defense brigades from The One himself, to the Vice-President, to New York Times columnist Paul Krugman have begun to sing the praises of the “stimulus package” as the reason for whatever recovery there is. It is interesting to point out, however, that those same folks also trumpet the need for a “second stimulus” under the apparent prescription of faux-Keynesian economic medicine that, if a dose is good, a much more massive dose is better.

As an aside, I have become convinced by arguments that, to whatever extent government action helped avert economic melt-down, it was due to the Fed flooding the banking system with money. I think that action was inefficient in that, for balance sheet reasons, the flow of credit didn’t improve quickly, and that it even now hasn’t fully filtered down to consumers. I also think that the bill for that action and other fast and loose games with the dollar still has to come due and will be a shock. But the small size and the delays and inefficiencies of the “stimulus” mean that any recovery is not due to those causes. That is not even considering the economic costs imposed immediately on the private credit markets by the government’s deficit spending for the stimulus. In fact, if the economy is recovering, further stimulus (and most of the stimulus money that was budgeted is allocated to the next two fiscal years) will soon create additional inflationary pressures.

Economist Alan Reynolds of the Cato Institute gives a historical perspective that shows that Big Government has not shortened economic downturns. Instead, and contrary to Paul Krugman, government intervention and increased control over the economy has exacerbated those downturns compared to the period before the New Deal. Moreover, in this recession, the countries with the highest government share of GDP have suffered the greatest contractions. As a side point, it is embarrassing that in Communist China, all levels of government control 30% of the economy, while in the “capitalist” U.S., they control nearly 37%. (I have seen figures that suggest U.S. government spending at all levels is closer to 40%.) The U.S. percentage is projected to grow an additional 5-8% share over the next two decades if Obamacare is adopted.

Mark Steyn points out other problems with Porkulus as an economic recovery stimulus:

“In the second quarter this year, both the French and German economies grew by 0.3 percent, while the U.S. economy shrank by 1 percent. How can that be? Unlike America, France and Germany had no government stimulus worth speaking of, the Germans declining to go the Obama route on the quaint grounds that they couldn’t afford it. They did not invest in the critical signage-in-front-of-holes-in-the-road sector. And yet their recession has gone away. Of the world’s biggest economies, only the U.S., Britain and Italy are still contracting. All three are big stimulators, though Gordon Brown and Silvio Berlusconi can’t compete with Obama’s $800 billion porkapalooza. The president has borrowed more money to spend to less effect than anybody on the planet.

“Actually, when I say ‘to less effect,’ that’s not strictly true: Due to Obama, one of the least-indebted developed nations is now one of the most indebted – and getting ever more so. We’ve become the third most debt-ridden country, after Japan and Italy. According to last month’s IMF report, general government debt as a percentage of GDP will rise from 63 percent in 2007 to 88.8 percent this year and to 99.8 percent of GDP next year.”

Ouch. Middle class tax increases, anyone? I trust Mr. Krugman knows what happens to economic growth when taxes are increased.

Leaving aside how exactly one determines the mythical figure of jobs saved about which the administration likes to crow, Mark Steyn has also found one area where the stimulus has worked, per the President’s definitions: Government jobs. California’s experience is similar. Despite recent cutbacks, California state and local government has added 110,000 jobs since the recession began. The rest of the state is reeling from record unemployment. One suspects a connection.

Obviously, Big Government spending cannot produce wealth in the way that private enterprise can. There are quite a number of reasons, from lack of information to lack of incentives and competition to political rather than economic decisions-making (and an attendant corruption of efficiency through graft). Otherwise, why not make like the facetious response to the claim that minimum wage laws increase wealth. If so, why stop at $7 or $10? Why not make it $100 or $500 per hour, and get more wealth. Why not have Big Government take over the means of production (Soviet Union) or at least have everything run through a cartel of industries in a Big Business/Big Labor/Big Government alliance (the New Deal)?

I have had people ask me what I would propose regarding health care. I suppose that it is easy to be critical of things but more difficult to provide alternatives. Ultimately, people get tired of mere carping and nay-saying.

My first instinct is to say, “Nothing. Things are imperfect, as with all human endeavors. But they’re tolerably well, and as good as, or better than, any demonstrated alternative.” But maybe there is some room for improvement, in the details, though not the foundation. The problem is that I am not a health care expert, so my criticisms and proposals are based on things I have read, my own life experiences, and a basic ideological orientation that asserts that, in the absence of strong countervailing community interests (including fundamental moral positions), decisions that affect oneself are best left to one’s own choice. I believe that on both ethical and utilitarian grounds. I say”ethical,” in that, as autonomous, equal, rational, and rights-bearing creatures, we are, in the first instance, entitled to make decisions without control by others in matters that affect us. The more those matters affect us and the less they affect others in degree and numbers, the greater our claim to autonomy. Unless someone is a child, an incompetent adult, or a person who has opted to transgress against fundamental moral norms of the community embodied in certain criminal laws, I as an individual, or we as a community, have no inherently greater claim to the right to decide matters of personal autonomy than the individual himself. None of us is more of an autonomous, rational, and rights-bearing individual than others. Thus, decisions made by individuals are more likely to be “just” in promoting a life of fulfillment for each of us and in achieving a harmonious balance among members of the community by emphasizing voluntary agreement, not coercion.

I say “utilitarian,” in that decisions made by individuals are more likely to reflect the greatest good for the greatest number, as well as the best weighing of offsetting “pains” and “pleasures” by and for each individual. As has been shown in theory and practice, on matters of such individuation involving great numbers of persons and situations, the information necessary and the precision of communication required to have an outside planner make these decisions far outstrips our ability to gather and evaluate. Again, there may be issues where the effect on others is so widespread and so direct and palpable that outsiders are as able (and perhaps better able) to gather and evaluate that information than any particular individual with his or her closer horizon of experience. But health care is not such an issue.

On to the details. I’d like to see more of a return to consumer purchases of medical services and competition for consumer dollars. The elephants in the doctor’s waiting room are the insurance companies.

There is certainly a case to be made, though not overwhelming, of excessive insurance company power. Talk of some quasi-oligopolistic market structure and resultant social damage is overdone, however. Most people surveyed by far are happy with their own insurance coverage, with a significant plurality describing themselves as very happy. Their concerns about the delivery of health care are rooted in the scare tactics employed by self-serving politicians, power-seeking bureaucrats, ideological Leftists, and sensationalistic media outlets regarding the fates suffered by often carefully-culled and manipulated “victims.” Moreover, American medicine produces far more innovation in technology and pharmaceuticals than the rest of the world combined. That world, by the way, typically “free rides” significantly on American skill and ingenuity, thereby lowering their own medical care cost. American medical services avoid the indirect economic and social costs from which socialized systems inevitably suffer, economic costs imposed by scarcity in the form of long lines and lost wages, and social costs from the pain and disability that results from delayed treatment. I have previously posted about personal experience my family and I have had in such matters. Efficient delivery of service, happy clients, and product innovation are not the things economists associate with monopolistic or even highly oligopolistic market structures. If one wants to see the evils of monopoly in action, one is better served to go to government enterprises, such as the government school systems, for example, or Medicare.

But let’s assume that there is a problem of insurance companies inappropriately interfering in medical decisions between doctors and patients, a problem my family and I have never experienced, and one that I believe is far less significant than with the ’90s-era HMOs that were the least great answer to rising health care costs (and the worst characteristics of which would be undertaken under Obamacare, but in the hands of government bureaucrats). First, break down state interference with insurance company competition. I have read in several places that there are many hundreds, perhaps a couple of thousand, insurance plans available. If interstate competition were opened up, it is likely that more would be formed. Congress could do that with legislation.

Second, get rid of the preferential tax treatment of employer insurance plans. That was a development of World War II when government (here we go again) distorted the labor compensation market by imposing wage controls. Employers could compete with each other for skilled labor not through wage rates, but through benefits. Labor unions liked this, as did insurance companies. So (here we go again), big business and big labor approached big government for help. And, of course, got it.

That change in tax treatment itself might induce competition. But, if tax policy is to be employed, I would have large health savings accounts (without the ridiculous forfeitures imposed under current law). People could buy whatever insurance plans they want. If that is too much individual freedom for liberals, the government could limit such tax-advantaged plans to high-deductible catastrophic medical plans. Also, limit medical insurance to just that, medical treatments, to reduce the cost of coverage, just as car insurance covers catastrophic events, not ordinary oil changes and battery purchases. No acupuncture, massage, herbal treatments, homeopathy, chiropractic, psychotherapy and counseling, medicine men, midwives, new age healers, etc., many of which now must be covered by insurance carriers as different interest groups lobby for their piece of the pie. If someone wants those treatments, they are free to get them, perhaps through their health savings accounts. Otherwise through their regular funds.

Third, and related to what was described in the preceding paragraph, eliminate government mandates on insurance plans that increase the cost by requiring coverage for exotic services. Moreover, many of the mandates include coverage that younger, healthier people will not use but that they have to pay for, thus subsidizing the older subscribers. Allowing more insurance plan discrimination, that is, individual choice and tailoring of the policy to one’s needs, will reallocate costs of coverage to the true beneficiaries. Those market-distorting mandates also cause more younger people to forgo insurance altogether to avoid paying these subsidies.

Fourth, tort reform. Limit pain and suffering and other damage awards for medical malpractice that are not directly tied to hard economic evidence. Same for product liability actions against drug makers. Limit or eliminate punitive damage claims in such suits. Limit lawyer recovery in such suits, especially if brought on a contingency basis. While student loans are high for law school graduates, there is no need for lawyers to recover large percentages of dubious multi-million or even billion dollar judgments. Institute a “loser pays” system, with liability under more circumstances than today for lawyers who bring frivolous suits. Perhaps have arbitration of such lawyer liability before panels of doctors and lawyers?

Fifth, for those who cannot afford such plans, various options are available. The most obvious are vouchers. Medicare and Medicaid programs are in trouble, and without effective subsidies from a private sector released from regulatory shackles, would be even more so. I don’t know what the answer is. Perhaps it is higher reimbursement rates and a structure based not on fee-for-service. Obviously, that runs the risk of higher costs. Perhaps some rationing is the answer, where the types of services covered are more restricted, especially under Medicare. For those who can afford it, private supplemental insurance works. Medicare/Medicaid already is a socialized system with a shortage of doctors, hidden costs like waiting times, fraud, and bureaucratization. One can try to make it somewhat more efficient, but those efforts are constrained by the structural limitations of such a system. That certainly does not justify efforts to expand it to embrace everyone equally within its misery. Not that equality really exists in any socialized system. There are always those who cut to the front of the line, and graft is assured. Poverty, as a relative concept, will always be with us, and its existence for some is no reason to threaten us all.

I actually agree with those who say that health care is a right, but likely not in the way the supporters of Obamacare see it. Health care is a right in the sense that you have the right to decide your health care to preserve your life and well-being as you deem appropriate. Therefore, any interference by government with your autonomy and choices (such as the de jure or de facto imposition of single-payer health insurance) is an interference with that right and a threat to your life, health, and liberty. But you have no “right” against your fellow citizens for subsidies (indirectly by favorable tax treatment or directly by a “public option”). Of course, your fellow citizen may (and should) help you if you cannot afford essential health care, by providing free services or making charitable contributions that make services financially possible. But, as I said, if we want to continue Medicare/Medicaid, I have no fundamental objection, except to their expansion. However, limitation of their scope is urgently needed.

Health care costs are going higher, inevitably, as the population ages. It is that fact, not greedy doctors or drug or insurance companies that is the cause for the projections in the growth of health care costs. An additional factor is, ironically, technological and pharmacological innovation that causes everyone to want the most advanced treatment, before it has become more routine and less expensive.

As an aside, if we are really interested mainly in cost containment, focusing on more preventive care, ironically, seems not to be the solution to lower the cost of health care. I have read about studies that show that, on a macro level, population-wide preventive care is more expensive than actually treating an ailment once it appears in the relative few it will affect. Moreover, the increased rate of death for those for whom the ailment is not caught will decrease, however slightly, the cost of providing health care for the aged. On the other hand, at an individual level, those additional deaths may well be a collection of personal tragedies that impose an indirect cost we are unwilling to bear, yet.

There are probably many other private choice-oriented changes that can be made to improve competition and efficiency, while promoting the ability of the patient and the doctor to choose the most appropriate treatment. But the answer is not to replace the relatively well-functioning current system with a universal version of the one part of the current structure that indubitably is failing, Medicare.

Some foolishly argue that we spend a higher percentage of our GDP on health care than does, say Canada, yet we have an average life expectancy that is a few months less. Let’s leave aside the fact that Canada is much more racially homogeneous and has a far smaller population than the U.S. Let’s leave aside the ubiquity of Canadian license plates on vehicles in the parking lots of U.S. hospitals. Let’s leave aside the Canadian Supreme Court’s decision that the interminable waiting times for procedures under the Canadian system made the effective ban on private insurance for treatment in Canada unconstitutional. Let’s leave aside the by-now commonplace stories of a lack of facilities in Canadian hospitals that requires patients to be flown to the U.S. for treatment. Let’s leave aside the indirect costs on the economy from productive hours lost sitting in waiting rooms. Let’s leave aside the shortage of doctors, especially specialists. Doubtless, such costs contribute to the traditionally higher structural unemployment and lower standard of living in Canada (and Europe).

Let’s simply ask such doubters of the private health care system what they make of the fact that the American system of government schools spends more per pupil than any other Western country but one, yet gets far worse educational results. Or that private schools in the U.S. spend far less per pupil than government schools, yet get far better educational results. Would such an aficionado of government control agree that, therefore the American system with its powerful teachers’ unions is irretrievably broken? Or would he come up with a myriad of excuses?

What about the fact that we spend more on our military than does Canada? Are we safer than they, who hide behind our military shield that subsidizes their security in much the same way the availability of the vibrant American health care system hides the failures of the Canadian? If not, should we spend as little as they do?

Then there are those who rant against the fact that insurance companies, drug companies, and doctors (remember Obama’s press conference where he talked about the doctors running around doing unnecessary tonsillectomies, presumably seizing unsuspecting unfortunates off the street?) make a profit, and who want to provide everyone with equal care as a matter of “right.” They praise the government plan because it would have lower costs in that there wouldn’t be those nasty profits. Let’s leave aside how those folks feel about cutting their “excess” wages, which are, after all, profits from their labor, at least after an allowance for basic food, clothing, shelter, and medical care. Let’s leave aside the inevitable costs of government programs through bureaucratic inefficiencies, graft, and expansion of coverage. I would say that food and shelter are even more basic “rights” of the sort those liberals mean by the term than is health care. Do they propose that we eliminate the private, profit-driven production and distribution of food? Or of shelter? I believe that was tried in a massive social experiment. It was called the Soviet Union. There are still smaller versions of that experiment. They are called North Korea and Cuba (though the latter is making noises of privatizing aspects of food production for greater efficiency and productivity). If such an approach is laughable in the providing of food and shelter, why would it work any better in the providing of health care? Or anything else?

Nothing says gov’t control better than our new good friend, the Castro regime. And—they’re running out of toilet paper. The good news? They hope to have ”a shipment” by the end of the year. That’s even worse than Sheryl Crow’s “I use just one sheet per bathroom visit” from 2007. Charmin’. If you’re a fan of Cuban cigars, you better hope they don’t run out of the gloves they wear when making them. Otherwise, who knows what kind of, ahh, stuff you’re smoking. If Obama meets the Castros, will he shake their hands?

So, in typical Democratic socialist economics/politics, despite shortages, prices get lowered. That should take care of the problem. But, wait. What products are getting lower prices to help the masses? Why, it’s canned squid and mayonnaise. Those must be sought-after dietary staples in planned economies.

Say, who runs the retail stores? The military. Nothing fascist about that. Just because that also happens in the People’s Republic of China and in Venezuela doesn’t suggest a pattern. Does it?

One more gem: “Castro, who replaced his ailing older brother Fidel Castro as president last year, also has complained that Cuba’s productivity is too low. He has taken various steps to boost output, including putting more state-owned land in private hands and pushing for salaries to be based on productivity.”

Productivity in a state-run prison economy is too low? Who’d have thought that! What’s the remedy? Why, it’s to privatize. Maybe then an agricultural country can finally import less than 60% of its food. Note that the remedy is not to expand the “government option.”

The administration touts the unexpected (and almost guaranteed to be temporary) 0.1% drop in the unemployment rate. The decline is due to the drop in discouraged workers opting to stop looking for work. When workers have stopped looking for work for a month, they are deemed to be out of the labor force. The unemployment measure looks at workers seeking work but unable to get it. Thus, it doesn’t look at those who are collecting unemployment and waiting for conditions to improve before they look for a job, those who have become self-employed, or those who are working reduced hours. Unemployment figures, then, are just that: Figures. They are considered a lagging indicator of economic health. Employment may continue high even after the economy has begun to contract, while unemployment may continue high even after the economy has begun to recover.

New York Magazine has come up with more interesting, and probably no less reliable, ways to measure economic health. There are the Overeducated Cabbie Index, the Squeegee Man Apparition Index, and the Speed at Which Contractors Return Calls Index. But the most intriguing is the Hot Waitress Index, which predicts that, the hotter the waitresses, the cooler the economy. Unlike general employment, this is a leading indicator for economic recovery, as better-paying enterprises will quickly look for the, looks-wise, genetically more blessed individuals when the economy improves, thus causing them to leave their waitress jobs. So, be sure (in the interest of research and economic speculation only, of course) to check out the waitresses. And hope that the food is hot, but the waitresses are not.

My son Christopher and I went to several car dealers this past weekend to buy a car for him to drive to school. Everywhere there were signs hyping the “cash-for-clunkers” program. Since we donated our gas-guzzling SUV clunker to charity last year, we are not able to participate in this latest mind-boggling taxpayer-funded government give-away to big business and big labor. Instead, we settled for buying a nice low-mileage used Jeep at a very favorable price.

But the occasion got me to thinking about this program. In modified Keynesian theory it makes some superficial sense. Use government funds to stimulate a demand for a product in the hope that this will spur production and reduce unemployment. That, in turn, will jump-start the economy. The funds used for this plan have to be borrowed, but the rising economy will allow taxes to be raised to pay back the borrowed funds. As a side product, the more fuel-efficient cars acquired will reduce aggregate demand for petroleum products, thereby spurring the economy.

Predictably, theory and reality don’t match. Let us leave aside the indefensible subsidy of those who happen to have an old beater sitting in the driveway and would like a new car by those who have budgeted carefully and responsibly and who, by the bad luck of timing, are past the opportunity to take advantage of this. Someone has to pay for this boondoggle, since government does not produce the money needed for the program. Let us leave aside the fact that this is little more than the result of political pressure by Government Motors (though other companies also benefit), owned by the administration, and the UAW to subsidize their operations.

More generally, the problem is the one so elegantly summarized in the 19th century French economist Frederic Bastiat’s “broken window fallacy.” Bastiat showed how going around breaking windows to stimulate the business of the glaziers does not advance the economy, as the funds used to pay for those windows otherwise would have been spent more efficiently on a multiplicity of things that now have to be foregone to pay for the high demand for windows. Otherwise, wars and natural disasters would be calculated as economic boons, not overall catastrophes.

First, some of those clunkers likely were cars that their owners did not regularly use. Instead, they were probably using other, more fuel-efficient cars for regular transportation, so the overall petroleum savings are likely to be far less than anticipated by the pencil-pushers. Second, the government program has been administered in typical government fashion. It was funded to provide a steady boost to sales over months. It ran out of money in a week, because the government bureaucrats failed to consider the extent to which people, as rational actors, change their positions in response to economic stimuli. There really are very few laws of macroeconomic policy that one needs to know. One of those is that, given the legal opportunity, Paul will gladly use Peter’s money to buy himself something. But one can count on those who would take over and regulate one-seventh of the economy through health care “reform” not to understand that.

Third, the program has diminished effectiveness on its own terms, as many of those same clunker owners would have bought new cars within the next couple of years anyway. So the program just moves demand forward in time at the cost of future production. With the effects of the first dip of the recession on production and employment likely to last well into next year, and with a second dip a distinct possibility within two to three years, the net stimulus is likely to be little or nothing.

Fourth, it has already been shown that the government program, which requires these clunkers to be destroyed, hurts used car dealers and private sellers, as well as the poor. One way is by subsidizing new car purchases, which depresses prices for used cars that those in the market to buy a car might otherwise purchase. Another is by reducing the number of clunkers that such dealers might purchase from their owners, it reduces future inventory. A collateral effect of this is that poorer buyers who cannot afford new cars might be able to pay for a functioning clunker that he or she can use to get to a job.

Fifth, at least some buyers of such new cars, attracted by the artificially low price of the new car, will not be able to afford the payments and higher insurance costs. Look for increased repossession of such vehicles in the future, leaving the owner without any vehicle and the bank with a bad loan. Has this happened before? Government interfering in the normal operation of the markets and producing an excess of bad loans? The one note of optimism that this might not happen is that credit right now is difficult to get, as lenders have overtightened standards. The concern about underqualified buyers might turn out to be unwarranted.

That brings up the problem with excessive credit tightening. My son, as a law student and first-time buyer, had no credit, effectively. The car dealer told us what I had already heard and experienced, namely, that credit costs more for most people, and it is more difficult to qualify. The government programs to lower the cost of credit by lowering interest rates to banks and pursuing an essentially zero cost of credit to banks have not benefited consumers. Rather, banks use the spread to increase their profitability, as reflected in high earnings recently. Moreover, burned by the recent frenzy of accusation that they have “taken advantage” of unqualified borrowers and by the push for mortgage recalculation that has spooked the markets, lenders have tightened requirements that, as predicted, make it more difficult for many to qualify and at higher rates for those who do. As massive government spending programs create structural deficits that have to be financed in significant part by borrowing, government credit needs will continue to crowd out private borrowers and overall increase the cost of borrowing. We can look forward to these conditions that will reduce our living standards and economic growth, and increase unemployment, for the indefinite future. With Obama’s massive dislocation of the economy, European-style sluggishness is the new reality. Welcome to it.

UPDATE: Jonah Goldberg at National Review Online makes many of the same points I raise here. Rich Lowry piles on. I like the program he suggests for jeans and lingerie. Turn in those old clunkers and get some new ones. Fresh cotton, with fabric that does not reveal the individual threads. Or silk (for the ladies, mainly). With the holidays just a few months away, such a program makes great economic (and romantic) sense.

Even as we hear about the recession showing signs of ending because the freefall rate is slowing or the stock market is up somewhat or the trillion dollar stimulus is starting to kick in (unless it isn’t and won’t until, well, maybe nextyear and is insufficient anyway so we need a second stimulus), there are those of us (George Soros and I, for example, unlikely ideological bedfellows we are) who see the danger of no real recovery and stagflation or at least double-dip recession. The recent retreat of energy prices is not a vote in favor of recovery. The problem with the media’s desperate attempts to make any swallow a spring for Obamanomics is that the fundamentals haven’t significantly changed. Lack of credit growth is still a problem due to overleveraged assets. All those ads and programs for generous government-subsidized (or Fed-subsidized) refinancing opportunities, but most can’t take advantage of them because of lack of equity. People are paying down debts instead of saving. Credit card companies are demanding higher payments, which will, in turn, make people fall behind, worsening the credit and solvency crunch.

This article concisely analyzes the problem of a credit recession (a classic “panic” when a financial bubble bursts, contrasted with the more common and more easily-solved inventory recession). That problem cannot be solved by any amount of demand-side government stimulus deficit-spending or tax rebates, and will be made worse by inflationary monetization of government-acquired and guaranteed debt, recovery-stifling tax increases, or credit-suffocating massive government borrowing. It requires a realignment of assets and liabilities through the good old bankruptcy processes of shedding debt and getting a true value for assets that currently lack transparent valuation. Banks and other creditors have to suffer the results of their credit follies (even though some of those may be the result of government pressure for politicized lending practices). While that is strong medicine, the alternative isn’t working and, according to this article, cannot work. Only then can real credit growth resume.

The alternative is a replay of the lost decades of Japanese economic stagnation, but on a more massive scale.

Not depressed enough? Consider this article about the true state of the unemployment figures. Such figures are, of course, subject to much manipulation. On the one hand, their definitions and measurements have been changed over the years. They do not reflect people who have stopped looking for work, which is a particular problem for accuracy during a period when jobs are relatively unavailable. They do not count people working on government make-work projects as unemployed. They do not accurately value the effect of reductions in hours for those who are employed. On the other hand, they do not count as a positive when a person who is fired starts his own business (”household employment”). The author expects unemployment, traditionally a lagging indicator, anyway, to hit 11% nationally (some would suggest that it is over 10% already) by next year and not to decline until 2011. Worse, the author considers a double-dip recession a distinct possibility.

Still not depressed enough? Here’s what Obamanomics is doing for the U.S. in terms of competitiveness and tax burdens compared to Europe and China. We are getting more socialist than Europe, taxwise? Than China, in terms of business taxes and growth?

During the campaign, Barack Obama promised hope and change. Regarding the economy, he, his minions, and the media trumpeted that he would reinstill faith and cure the economy of its depression. His promises of economic recovery have turned out to be true for at least one industry. I just have to wonder why. Saved by the gun clingers?

This article provides an overview of President Obama’s proposed revisions and overhaul of the financial industry and its regulatory scheme. One of the “changes” will be the establishment of an agency that will be charged with insuring that lenders make loans under the Community Reinvestment Act (one of ACORN’s favorite means to pressure lenders into making risky loans to lower-income people). The article also goes into detail about the danger to the economic system from such loans. It is generally agreed that aggressive pushing of such loans exacerbated the systemic risk from the recent mortgage lending bubble. The author explains the history of such loans and the prevalence of the political and legal pressure brought on lenders to lend to unqualified borrowers. One example:

“Lenders also face the risk of being sued for discrimination if they fail to make loans to people with bad credit, which often has a racially-disparate impact (proving that such impact is unintentional is costly and difficult, and not always sufficient to avoid liability under antidiscrimination laws). They also risk possible sanctions under the Community Reinvestment Act.

“Banks get sued for discrimination no matter what they do. If they don’t make enough loans in low-income, predominantly minority neighborhoods, they get accused of ‘redlining,’ and are subject to sanctions under politically-correct laws like the Community Reinvestment Act, which contributed to the financial crisis by pressuring lenders to make risky mortgage loans.

“But if they do make such loans, they get accused of ‘reverse redlining,’ and get sued by the liberal special-interest groups and municipalities that encouraged them to make such loans during the mortgage bubble. Baltimore and various borrowers have also brought ‘reverse redlining’ lawsuits against banks.

“The Washington Post reported that bond-rating agencies like Moody’s and Fitch are now getting sued, too, for ‘reverse redlining,’ under the theory that they encouraged risky loans to low-income minorities (who subsequently regretted taking out those loans) by giving respectable ratings to the mortgage-backed securities produced by packaging those mortgage loans. The plaintiffs include the National Community Reinvestment Coalition, which has been pressuring lenders to make risky loans to low-income minorities for years. They blame the ratings-agencies for allowing lenders to make loans to minorities with ‘insufficient borrower income levels.’”

Get ready for more of the same.

One of my students, Matthew McConnell, sent me this anecdote about the failings of socialism:

“An economics professor at a local college made a statement that he had never failed a single student before but had once failed an entire class.

“That class had insisted that socialism worked and that no one would be poor and no one would be rich, a great equalizer.

“The professor then said, ‘OK, we will have an experiment in this class on socialism. All grades will be averaged and everyone will receive the same grade so no one will fail and no one will receive an A.’

“After the first test, the grades were averaged and everyone got a B. The students who studied hard were upset and the students who studied little were happy.

“As the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride, too, so they studied little. The second test average was a D! No one was happy.

“When the 3rd test rolled around, the average was an F.

“The scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else. All failed, to their great surprise, and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great but when government takes all the reward away, no one will try or want to succeed.

“Could not be any simpler than that.”

My friend Butler Shaffer ran a similar experiment, as did I with some of my classes.

I told the students that I would offer two alternative methods of grading. I would first grade all papers and assign raw point scores. I would then grade the papers in the usual manner. I would then enter those grades if students had sent me a note that they wanted to be graded under Option 1, the traditional grading. If students had sent me a note that they wanted to be graded under Option 2, I then removed those papers from the pile and gave each of those students the average of all the grades in that pile.

This was explained to the students very clearly. I then told the students that I was considering this dual approach and asked them to vote in class whether they wanted to be graded under Option 1 or Option 2 to gauge their interest in the proposed system. The several times I tried this, never more than about 10 to 15% of the students voted for Option 2.

I then asked the students why they voted for Option 2. Typically, the answers were that they were afraid of doing poorly and this would allow them some sort of safety and protection. The takers for Option 2 also were disproportionately female (though certainly not all).

The students who opted for Option 1 typically did so because they did not want their reward to depend on the performance of others whose study and work habits they could not control. They also reasoned that those who chose Option 2 were likely to be the weaker students, which would drop the average. These students did not want to be encumbered by those weaker performers and felt quite confident of their own abilities.

I then told the students that they had just demonstrated why socialism can never work as a voluntary arrangement in a large group. Socialism must always be maintained as a monopoly in which everyone must participate. Something to ponder as the administration talks about a “public option” with continued private choice for health insurance. That public option must eventually be rigged to destroy the private system, so that everyone is forced into the public system. That is also one of the reasons the public school bureaucracy is so opposed to vouchers, as those would allow private schools to present a true alternative to the public school system.

California’s unemployment rate is at a record 11.5%. This rate is almost certain to rises, especially as unemployment is a lagging economic indicator. So even once some green shoots of economic recovery and growth appear, the employment picture will continue to darken for about six months. If the recent stock market rally is sound, and stocks are leading indicators that reflect investors’ expectations of future performance, the unemployment figures should begin to show improvement early next year. However, there are quite a few analysts who consider this just a “bear rally,” a temporary phase of optimistic risk taking reacting to psychological motivations not founded on economic fundamentals. If that is the case, the signs of recovery are a false spring, and economic winter is not yet past. Then, a jobs recovery is at some undetermined time in the future.

Meanwhile, California continues to scare away business with ridiculous environmental “progressivism,” a dysfunctional tax system heavily reliant on business taxes and personal income taxes on the “rich” (really the upper middle class), and a business-unfriendly regulatory system. The state is turning into a third world polity, with a thin crust of very wealthy (who often don’t pay taxes here due to second homes in low-tax states), a large undercaste of poor (many of them multi-generational welfare recipients or illegal residents), and a middle and upper middle class increasingly squeezed by the inane policies of the state government over the past years.

On the other hand, how bad can things be, when sales of the latest electronic gadgets are booming, and when there is still a market for “vitamin water”?

The Wall Street Journal takes on the fable of Obama’s “wealthy” as those making $250,000 per year. Although my wife and I are not in that league, as long-time dual income earners at good jobs in Los Angeles, we also have a six-figure income. But, taxes and the cost of living in L.A. being what they are, having small children as well as college students, and supporting a parent, our income hardly allows for a grand lifestyle. Our cars have an average of 110,000 miles and seven years on them. We have made our house suit our taste, but it probably would not qualify even as a guest house for John Edwards and Al Gore. And Tony Rezko didn’t give us a deal. So I well understand the sentiments of some of those interviewed.

If there is any consolation for those hit by the coming Obama tax increases, it is that the need to bring down the deficit means that they will soon be joined by the rest of the half of Americans who still pay income taxes.

This article explores the negative international trade implications of the GM bail-out. While the administration is willing to accept these negative consequences, the reasons it does are for domestic political gain. But such gain can come only when political considerations such as support from organized labor and environmental groups trumps economic common sense. The result is a distortion of the market that makes the resulting product less desirable to consumers due to lack of efficiency, inferior quality, and higher price.

For months, the media have been filled with stories of horror at the prospect of a GM bankruptcy. It was the industry equivalent of the comet strike that is said to have extinguished the real dinosaurs 65 million years ago and devastated life on Earth. It was part of the drumbeat of propaganda to subsidize the auto industry at the end of the Bush administration and with even greater volume with Obama.

I always thought that this spectacle was overblown. Any shocks from a bankruptcy would be manageable, and it was better to get the process started than waste money and have to do it later, anyway. Most likely, such bankruptcy would result in a restructuring and reemergence of a new company, with no government involvement. GM has plenty of worthwhile assets in certain of its brands and in its dealer network. Some investors or competitors were bound to snatch those assets at bankruptcy prices if the worst, an outright liquidation, were to happen. The most vulnerable part of the auto industry, the suppliers (who themselves have been shedding jobs) could have been protected under the process. Indeed, carrying forward the analogy to the real dinosaur extinction, that creative destruction launched the age of mammals and the evolution of human beings, an advance in the forms of life. Similarly, after a period of adjustment, the destruction of GM likely would lead to innovation, creativity, and long-term advance for the industry.

So, now the bankruptcy has occurred, except that the government is deeply involved. Despite its denials, the government is bound to make decisions based on a political calculus, rather than business considerations. The administration already engineered the removal of GM’s CEO and the installation of its own candidate. It will control the majority of the shares, with another hefty portion owned by its political ally, the UAW, whose bloated contracts materially contributed to GM’s decline. The government will control a majority of the directors. The government has already said that it will subsidize the company, but only to build its favored “environmentally-appropriate” small cars, another decision based on political and ideological environmentalism rather than consumer wishes and choice. To complete the picture, expect the government to begin putting foreign car companies at an economic disadvantage, even for vehicles manufactured in the U.S.

Now that the government has completed its takeover of the American car companies, the bankruptcy has still occurred. Miraculously, it’s no longer a big deal for the economy. Who would have predicted this sudden happy turn-around?

The government has placed functional control of its car company policies in the hands of a 31-year-old recent graduate student who is also on leave from getting a law degree, but who has no business school background, no practical business background, and never been in an automobile plant before. What could possibly go wrong here?

Maybe the answer to the riddle is a speculation that I have read, namely, that the administration realizes that GM is likely to fade away but that Obama wants to buy time to reduce the impact on the economy (and the retirement plans of the autoworkers) from a GM collapse. Apparently, even the Obama plan requires the company to drop another 20,000 jobs. While that speculation seems far-fetched at first blush, the administration’s “business plan” and its “management team” do not instill much faith that the plan will succeed. And the history of government-controlled car companies (1970s British car industry comes to mind) and union-dominated airlines (pre-bankruptcy United Airlines do not give cause for optimism that there will be a happy economic end. So perhaps Obama is seeking to delay the inevitable, at least until he is out of office.

This is a lesson for Arnold and the California Democrats. It is also a lesson, though not as powerful, for the Obama administration. Money is mobile, and the more money you have, the more mobile you typically are. If a state creates a hostile tax climate, the truly rich will simply leave. Many have second homes and establish residency in low-tax states, as Maryland has found out. That, of course, leaves the middle and upper-middle class to pick up the tab.

While such mobility is less practical to avoid the federal government’s tax policies, the very wealthy still have tactics that allow them to protect their incomes and assets, including physically moving to another country, or at least moving wealth to minimize taxes. At the very least, though, the article reinforces that people change their behavior in response to tax policies, and that tax increases never produce the touted increases in revenue. Inevitably, to raise funds falls on others than the wealthy and retards economic growth.

On a related topic, the IRS reports that tax revenues have dropped. As a result, the projected deficits may be even larger than previously announced. While this loss of revenue is to be expected in a recession, this time even the eventual economic recovery may not produce significant enough tax revenues to reduce huge deficits. And those projections don’t even include the shock the economy will receive if the Obama administration lets the Bush-era tax cuts expire for the upper income levels.

Arnold Schwarzenegger and the politicians in control of the California legislature are a disgrace. After they didn’t get voter approval on May 19 for more money to enable their spending addiction, they chose to “play rough.” They’re going to shut down health programs for the poor, endanger public safety by releasing prisoners, close almost all state parks, and various other cuts to essential programs. As should be clear, even Californians are opposed to higher taxes and also believe that government spends too much rather than too little. In that, they reflect public sentiment among Americans generally.

Instead of cutting these areas in the ways proposed, how about some alternatives? How about allowing off-shore oil drilling to bring in revenue (and clean up the seepage of oil on the sea bottom off Santa Barbara)? I realize that might spoil the views for some of Arnold’s wealthy entertainment industry friends, but why shouldn’t wealthy liberals make some sacrifice? Or, how about getting rid of the loony environmental fees and cost increases from “greenhouse gas” emissions restrictions that scare jobs out of the state? While we’re at it, how about reduction of other environmental and labor regulations that make California uncompetitive? There are other reductions that can be made: Public employees, through their unions, are bleeding the state and holding its finances hostage. Get rid of the outrageous compensation packages for prison guards, not of the prisoners. Ditto for public safety personnel:

“Michael Haley of the Napa Valley Taxpayers Alliance points out that the funds required for the expanded pension and compensation of government employees that began in 2000 ‘are more than we can ever hope to collect in taxes, even with large tax increases, and it centers around the state’s main expense, employee compensation’. Haley also notes that during the Gray Davis tenure, pension promises were unsustainable: ‘Safety personnel can now retire with 90 percent or more of their highest salaries at age 50, and other employees can retire with 75 percent or more at age 55.’”

Cut school funding to administrators and sundry frivolous government school mandates and programs. Heck, bring in vouchers to introduce competition to the public schools. Any temporary cost will more than make itself paid over a very few years as government school monopolies are forced to do whenever choice exists: Compete by raising quality and lowering cost. What a concept.

The non-partisan Legislative Analyst’s Office has some interesting and worthwhile proposals to cut revenue. Unlike the politicians, the LAO sees what everyone else does, namely, that California has severe structural deficit problems that will last even after there is an economic recovery in a year or two.

Or, if that is all just too terrifying, how about adopting the budget going all the way back to, gasp, 2005-2006. Compare the 2009-2010 budget projections with the earlier ones. Revenues for 2009-2010 are projected at $86 Billion. According to this chart, expenditures in 2005-2006 were $91 Billion for a manageable $5 Billion deficit. Or, if we want to be really responsible, we go back one more year, to 2004-2005. Then, expenditures were $79 Billion, so we would have a $7 Billion surplus. Or, we could take that 2004-2005 budget, increase it by almost 10% (not far off the rate of inflation since then) and be in balance. The problem is not income. That has risen from $76 Billion to $86 Billion for the general fund, about 13%, better than the rate of inflation. At the same time, in four years, general fund expenditures went from $78 Billion to $103 Billion, about 32%, far beyond the rate of inflation. The culprit is not the generosity of California taxpayers feeding the government maw, but the insatiable appetite of politicians for money to increase their power by paying off their constituencies with public programs.

One of Obama’s judges-with-empathy selling points has been the case of Lilly Ledbetter, the Alabama woman who sued her employer for sex discrimination but whose suit was dismissed by the federal courts as barred by the short statute of limitations under the federal statute. Her case became notorious through distorted media reports, and she was invited by the Democrats to give a speech at their convention in 2008. One of the first laws passed by the new Congress eliminated the statute of limitations, thereby exposing employers to suits for events that are claimed to have happened decades earlier when records have been discarded and witnesses for the company have died. Moreover, Congress increased the potential damage awards.

Stuart Taylor at National Journal peels away the layers of her story and unveils what really happened:

“First, Ledbetter waited more than five years after learning that she was paid substantially less than most male co-workers to file her Title VII claim for back pay, compensatory, and punitive damages. Second, by that time a key supervisor — whom she belatedly accused of holding down her pay raises after she rejected his sexual advances — had died. Third, Ledbetter chose not to pursue a claim under the Equal Pay Act of 1963, which has a much longer time limit (three years) than Title VII but does not (yet) provide for big-bucks damage awards.

“Fourth, her years of poor performance evaluations, plus repeated layoffs that affected her eligibility for raises, convinced a federal magistrate judge (although not the jury) that her relatively low pay did not prove sex discrimination. Maybe Ledbetter was a victim of discrimination, as the jury found. Maybe not. The evidence is too stale to allow for a confident conclusion — which is one reason the justices ruled against her.”

The overwrought and unfair legislation produced by Congress to “remedy” the statute of limitations by abolishing it may well be augmented by additional unwise and radical labor legislation described in the article. On this front, as well as on the regulatory and taxation front, the Obama administration is working overtime to turn the U.S. economy into California’s version. As the cost of goods and services rises, as our standard of living erodes in accordance with Obama’s campaign admonition that Americans must learn to make do with less, and as unemployment persists, our competitive economic position in the world will continue to decline. The metamorphosis of the once-vibrant and innovative American economy into European-style dirigisme continues apace.

While such laws are a boon for lawyers, one wonders when business will react simply by declining to hire members of the groups most likely to sue. Although such calculations are speculative, surely employers must consider the cost of such potentially extortionate lawsuits.

Author John Steele Gordon points out the obvious, the reasons why government cannot run a business. But it’s not obvious to most politicians, professors, and media types. The pithy explanation: Politicians need headlines; executives need profits. Courts understand that they are not in the position to second-guess business decisions, which is why there exists the business judgment rule in suits over alleged corporate mismanagement. Government bureaucrats and members of Congress are hardly better at running a business. If they were, they’d be—running their own business.

He lists several salient reasons for government’s incompetence here. To take one that sounds familiar to Californians from the run-up to the recent special election:

“Cost cutting is alien to the culture of all bureaucracies. Indeed, when cost cutting is inescapable, bureaucracies often make cuts that will produce maximum public inconvenience, generating political pressure to reverse the cuts.”

Now, how do businesses deal with economic fluctuations? Especially when they are not tied to the government’s purse strings and don’t have crippling obligations to pampered unions? They compete, especially through pricing. What a concept!

I have had supporters of the Obama socialization of health insurance tell me that having the “public option” as an alternative to private insurance companies will still preserve consumer choice. As the first article makes clear, if the market is not rigged, government cannot compete with private business. Which is why the administration will rig the market and eliminate private plans for all but the wealthy (such as Obama and his advisers, Senators, etc.).

Regarding the second article, this shows that even large “middle-men” between the food producers and the consumers listen to, and react to, the market. I have seen defenses of the (real, single-payer) Obama health plan based on the argument that it will lower costs by eliminating the profits of the middle-men that “control” the allocation of health care. Leave aside from the fraud and incompetency problems with government health insurance (see the first article). If this argument is correct, why not eliminate the private food distributors and replace them with government grocery stores and warehouses? Indeed, why not eliminate the private food “refiners” and have government buy farmers’ crops and produce the baked and canned goods that would then be sold in the government stores. Food is at least as important as health care, and lower food prices will be better achieved through government control, just as lower health care costs will be, if Obama’s supporters are to be believed.

Wasn’t there a country that had such a socialized system of food refining and distribution? Oh yes, I remember now. It was a place called the Soviet Union. And they had a system of government health care, too! I wonder what ever happened to them.

One of the quotes on my blog wall is from Margaret Thatcher, “The facts of life are conservative.” The California state government and the particularly loathsome villains from the public employees’ unions, who have been pursuing pie-in-the sky liberal fantasy economics for years, are about to run into this reality. Liberals like to refer to themselves as the “reality-based” community, in distinction, of course, to those hopelessly-befuddled clingers to guns and religion, the conservatives. The conceit therein is glaringly self-evident.

If California politicians were interested in capping spending, they could easily do so. As the article points out, such an effective cap once existed, until the public employee unions that have a grip on the legislature far more sinister and destructive than Huntington’s old Southern Pacific Railroad had on the 19th century counterpart got a hold of it. They persuaded voters to weaken the spending cap. Just go back to that cap and restrict spending to a baseline plus inflation and population growth. Allow additional spending on projects through bond measures or specially-voted appropriations approved by a supermajority of voters. If additional revenues are needed, how about, for starters, dropping uncompromising opposition to oil drilling off the coast?

The current measures are just not serious and deserve to be defeated.

This article by Art Laffer and Stephen Moore explains the well-understood, but constantly-disregarded, economic lessons derived from human nature, that high taxes and spending, combined with regulation, stymie job creation and economic growth:

“Here’s the problem for states that want to pry more money out of the wallets of rich people. It never works because people, investment capital and businesses are mobile: They can leave tax-unfriendly states and move to tax-friendly states….

“Updating some research from Richard Vedder of Ohio University, we found that from 1998 to 2007, more than 1,100 people every day including Sundays and holidays moved from the nine highest income-tax states such as California, New Jersey, New York and Ohio and relocated mostly to the nine tax-haven states with no income tax, including Florida, Nevada, New Hampshire and Texas. We also found that over these same years the no-income tax states created 89% more jobs and had 32% faster personal income growth than their high-tax counterparts.

“Did the greater prosperity in low-tax states happen by chance? Is it coincidence that the two highest tax-rate states in the nation, California and New York, have the biggest fiscal holes to repair? No. Dozens of academic studies — old and new — have found clear and irrefutable statistical evidence that high state and local taxes repel jobs and businesses.”

The way out of this mess for California is clear. Cut state spending, taxes, and regulations. But that is politically unfeasible in a state that is taking on the characteristics of Rust Belt states of a generation ago. The Democrats in control of the legislature, the nominal Republican in the state house who seems to be getting scared of the pact he made with the political devil, and the powerful public employee unions will make sure that this will not happen.

This was totally predictable. California’s tax hikes are not bringing in the expected hoped-for dough. Part of the shortfall is due to the economy. But both economics and history would have told anyone who wanted to know, that this would happen. If taxes are raised, people adjust their behavior by earning less, hiding income, relocating, etc. Some of those haven’t happened yet, though that will become more of a problem as time passes. The sales tax loss, though, can happen more quickly as people move up purchases pre-tax hike or, afterwards, postpone or cancel them. As the article points out, “It’s no secret that the recession is taking a toll on the state’s thinning coffers, but more troubling is that revenue is coming in slower than pessimistic forecasts.”

From a historical perspective, the same thing happened with the “budget balancing” by Republican governor Pete Wilson and the Democratic legislature in the 1990s. If I remember correctly, the budget deal was to raise taxes by $7 billion, cut expenses by $8 billion, and have accounting gimmicks of $1 billion. When it came time for appropriations, the cuts weren’t made. The tax hikes only raised $1.5 billion. The accounting gimmicks “worked,” but it took the economic revival to alleviate California’s budget woes, at least for a while. A case of history repeating itself.

At the weekly class, as he was discussing gambling among various topics of morality, Father Dave Heney opined that putting money into the stock market was much like betting on horse racing or playing blackjack and asked what difference there was between them. (He said this with a broad smile as he advertised the church’s upcoming Casino Night.) Yours truly quickly rejoined that there were differences of consequence and suggested a couple. As this question is one that some students have raised in my Securities Regulation/Mergers and Acquisitions class, it is a serious point and deserves a more considered response than I gave too spontaneously in the class.

Whether putting money in the stock market is the same as putting money on Sea Biscuit in the third race depends on establishing some reference points. Father Dave’s reference presumably was the lack of control that the individual participant in the stock market has over the stock’s performance. He puts his money down and then waits for the corporation’s components (employees, officers, directors, capital, machines, etc.) to produce profit. Moreover, he has no control over the general direction of the economy or industry innovation that might make the corporation’s products obsolete. In that sense, he has no more control over the outcome than does the bettor has over the performance of the horse and jockey or over the performance of the other horses that day.

So, “control” over outcome is one factor in determining whether something is gambling. At one extreme would be playing the California lottery, where success depends on a random appearance of numbers. At the opposite extreme would be whether I choose Corn Flakes or Cheerios from my cupboard for breakfast. Horse racing and stock market investing are both somewhere between the two.

But there is a difference. In horse racing and Black Jack we are dealing with “closed systems.” The race involves a limited number of horses on which to place a bet. I can choose not to bet, but once I am in, my success is determined by others at a time set by events, not by my choosing. I cannot say at the half-way mark, “O.K., my horse is ahead. I’m out. Pay me.” Same thing after one card is dealt in Black Jack. The rules tell me otherwise.

But I can sell and leave the system of stock investment any time (in the normal case). I can choose from a myriad of stocks that are suited to my needs for security, my interests (such as “social responsibility”), and my expertise (oil stocks for petroleum geologists, say). I can opt not to enter, but even if I do, I can leave at a time I choose to be of most advantage to me. Even if that turns out to be wrong, my free will is less restrained and my control greater to maximize my profit in the stock market than in the other cases. The ability to leave a job or any other relationship when I see fit is a treasured aspect of personal freedom for many. It is certainly a greater freedom than what exists when by contract (indenture) or law (serfdom or slavery) I must stay in the employment for a certain time or until released by my employer at his option.

The control difference applies most to purchases of stock for long-term investment. It applies less to short-sale hedging, because of the short window to “cover” the short sale. And it applies far less to option and futures contracts. In particular, buying stock index futures comes quite close to a coin-flip. It may be useful as a hedging device, but I really have no control over the outcome once I jump in.

A related, but somewhat different, factor is “knowledge.” How much do I know about the choice before I make it? For example, if I count cards in Black Jack, and I do quick calculations about probabilities, I can shape my decision based on that knowledge, though, unless I play the W.C. Fields way, I cannot control the identity of the next card drawn. Similarly, I may know that the horse has won in certain races and does best under certain track conditions. I may know the overall record of the horse. I may know similar information about the other horses. The more I know, the less “random” my choice is. Again, this is quite different from picking “red” when playing roulette, where my knowledge of the wheel’s previous results and my knowledge of probability don’t do much good.

I may know quite a bit about the company whose stock I purchase. I know the price, a short-hand way of concisely communicating information about the company in relation to the other companies, akin to the horse’s win-loss record. I may buy or research diligently quite a bit of information, which reduces the randomness of my choice. Though the amount of information about the company that I can acquire may be greater than about Black Jack cards or even horses, the difference is quantitative and a matter of degree. This doesn’t make the stock market qualitatively different from the horse race.

Another factor to consider whether something is gambling is the impact of my success (or lack thereof) on others and vice versa. Specifically, I mean by that whether my win will necessarily come at another’s expense. If I win at Black Jack, others (such as the house) must lose. Same for the horse bet. Only one horse can win, so that those who bet on other horses in that race must lose for me to win.

That is not the case in stock investing. As said before, unlike the horse race or the Black Jack bet, the stock market is not a “closed system.” Someone need not lose for me to win in the stock market. It is not necessarily the case that, just because I want to buy Acme stock because I think it is a good investment for me, that someone must be selling to me because he thinks it’s going to go down. First, in initial sales by issuers, the expectation of the issuer as well as the buyer is that the stock will go up. Even in secondary market transactions, when I buy a stock, the seller may be selling because he has to pay taxes, he is retiring and wants to buy a less-risky annuity, he wants to go to law school or on a vacation, he wants to make a down payment on a house, and so on for a myriad of other reasons. The seller doesn’t have to “lose” for me to “win.” As noted earlier, that is less the case with short sales or with option and futures sales, especially stock index futures. But even there, the value of such tools as a hedge may avoid these transactions necessarily being zero-sum deals.

In slightly different vein, the stock market is not a closed system in that there is no finite value overall. Over time, all the participants in the horse race bets cannot win. There is no wealth change overall because we are still dealing with the same static components, that is, horses, riders, bettors, and the rules of the game that define it. In the stock market, human ingenuity and effort can change the value of what the stock market represents. Everyone can win over time as the overall size pf the pie is increased faster than the number of people eating it. There are no similar rules that restrict the capacity of the human mind for adaptation and innovation.

Rather than see stock market investment as the same as horse race betting, and both as gambling, I would suggest that there is a continuum. On one end would be the random picking of a number, such as a lottery. I have no control other than the picking of the number; I have no useful knowledge; and for me to win, others must lose. On the other end would be choosing my breakfast cereal. I have the best knowledge I can as a human about what is in the boxes and I control fully what happens. Any loss to the shareholders of Kellogg’s because I chose to enjoy a General Mills cereal that morning is extremely indirect. In an investment sense, I might choose a gold coin that I have tested. Once more, I have the best knowledge I can about the investment, I have considerable control over what happens to my specific investment (though I do not control the world price of gold), and no one necessarily loses by my decision to buy, hold, or sell.

Horse racing and Black Jack are between these two. That is why there is such a controversy in the law in distinguishing “games of chance” (gambling) from “games of skill” (not gambling). Some of the distinctions among different kinds of poker are puzzling. That said, horse racing and Black Jack have elements of skill that makes them less obvious cases of gambling than lotteries, and moves them on the continuum.

Participating in the stock market also is further on that continuum away from gambling and games of chance. The closest to that end probably are various derivatives, such as stock index futures and certain options. A little farther away from that end would be short sales and then commodity futures. Run-of-the-mill “long” purchases of stocks and bonds would be farther away from gambling still. Indeed, I would conclude that the differences between horse racing or Black Jack and stock market investing is not merely a difference in degree, but one of kind, in the control and freedom I have in making decisions over the investment.

So, Father Dave, I will say that your question was very incisive, and my quick response too reactive. But I think my response was correct, though it needed a more reasoned and nuanced approach.

Economist Robert Samuelson examines the design of Obamanomics and finds it sorely lacking.

“What Obama proposes is a ‘post-material economy.’ He would de-emphasize the production of ever-more private goods and services, harnessing the economy to achieve broad social goals. In the process, he sets aside the standard logic of economic progress.

“Since the dawn of the Industrial Age, this has been simple: produce more with less. (’Productivity,’ in economic jargon.) Mass markets developed for clothes, cars, computers and much more because declining costs expanded production. Living standards rose. By contrast, the logic of the ‘post-material economy’ is just the opposite: Spend more and get less. ”

That’s not an engine for growth. Get ready for stagnation.

As Daniel Henninger argues in this piece in the Wall Street Journal, the bursting of the asset bubble has given the political class a grand opportunity to reset time to the New Deal and the heavy duty dose of regulation and public control over private resources. This is not about financial liquidity, but about government control. There is nothing new about “Obamanomics,” a topic about which candidate Obama never claimed expertise or new ideas.

Note also the Henninger’s argument that this is a typical correction after a consumer credit bubble has burst (this time in real estate). This article makes a similar argument. That is, after all, why bursting economic bubbles traditionally were called “panics.”

Yesterday, I posted about Timmy Geithner’s stupid comment about the Chinese proposal to create a super-sovereign reserve currency based on the IMF’s special drawing rights. The dollar plunged until there could be a hasty retraction and damage control. I discussed the value to Americans of having the dollar as the major reserve currency, and the danger of overinflating the dollar. I mentioned the responsibility that comes with being the reserve currency and how the U.S. cannot afford to engage in actions (or talk) that makes the Chinese and other creditors fearful for their investment. This was a self-inflicted wound by Geithner and gave credibility to a proposal made by the Chinese, the Russians, the Iranians, and others on various occasions, and that members of the administration (including Geithner) had only just attempted to bury when questioned in Congress.

This Wall Street Journal article raises many of the same points I made:

“The dollar’s status as a reserve currency gives the U.S. enormous advantages, and it should be protected ferociously by our public officials. It means we don’t have to repay our debts in foreign currency and that our borrowing costs are cheaper. To the extent that the rest of the world follows a dollar standard, it also gives us far greater global sway.” 

This is a very insightful article on the folly of stimulus. The current situation is an asset bubble (primarily real estate) that, when it popped, resulted in a flight to other assets (such as oil and other commodities, driving up prices and creating yet more short-term bubbles), constricted credit, and induced economic fear. That is fairly typical of such cycles, which is why they were called “panics” in the 19th century. They often come on very quickly with sharp drops in the price of the assets as well as other economic indicators. Unemployment, being a lagging indicator, does not decline at first, and certainly not as quickly.

Left to themselves, such panics find a bottom, as lenders drop the price of money to lend once the demand for business and personal loans dries up. Moreover, people tend to save their excess money, rather than spend it as freely. While this exacerbates the unemployment situation over time, it also adds still further to the available capital. Sooner or later, depending on the size of the asset revaluation, the psychology of fear-driven risk avoidance changes, pent-up demand makes itself felt, and the low cost of capital leads to investment and risk-taking. The panic ends, sometimes quite quickly and usually quite dramatically, after having caused economic destruction. But that destruction is of Schumpeterian nature, a “creative force” that will lead to economic innovation and efficiency. It is not the artificial destruction of value by war, or Frederic Bastiat’s example of the purposive breaking of windows to provide jobs for glaziers. In the latter two examples, the money spent fixing these items might have been better invested in other items of value and thereby expand economic growth. In the economic destruction caused by the panic, it is a culling of the inefficient members of the herd.

Now, enter the government into all this. By taxing, spending, regulating, talking, acting, or pretending to act, government likely exacerbates the problem. To deepen (or even trigger) the panic, just keep talking down the economy as the Democrats have done for eight years of the Bush administration and as Obama did until about three weeks ago.

Acting or appearing to act frantically enhances the feeling of fear. When Ben Bernanke (until a week or so ago), Hank Paulson, and Tim Geithner keep changing their plans, it looks like desperation time among the clueless. That is not something likely to quiet panic among the population or to settle investors. The latter, especially, like calm and orderliness so they can go ahead with their speculative, risk-taking, economy-growing actions.

Then keep talking about raising taxes, especially on those with capital, so that those who would make productive use of capital are more reluctant to take those risks and factor into their decision the cost of those higher taxes. Also, it transfers capital from private hands oriented toward economic gains, to public hands oriented toward political gain. That, again, will delay recovery.

In addition, regulate the labor markets and the cost of doing business by making production more expensive through, say, environmental laws that raise energy costs or minimum wage laws that are above the market rate. Restrict competition for labor by making it easier to form anti-competitive organizations like unions. That makes investment in labor more expensive and prolongs the downturn in employment.

Enact restrictions on free trade such as “Buy American” requirements to produce trade retaliation and hurt export oriented manufacture.

Then enact massive spending programs that create a huge structural deficit for many years to come and result in an increasing share of government control over the economy. That deficit can only be eliminated by future tax increases that will make the cost of capital more expensive and lead to economic retrenchment, or by printing money, which will lead to inflationary pressures that erode the living standards of the middle classes and inevitably cause economic retrenchment. Call those programs “stimulus” even though they won’t come on line until the panic by normal development likely will have ended by then.

For good measure, inject unprecedented amounts of money unbacked by assets, productivity, or anything but government fiat. Hope that as the economy picks up steam you can recover all that money circulating out there quickly and accurately enough that there won’t be an inflationary expectation taking hold and requiring a hard correction and causing economic retrenchment.

Do any of those steps sound like items from the recent news? Many of those steps, or similar but less extreme ones, were taken by the Hoover and Roosevelt administrations. The result was an extended double-dip contraction. Let us hope that the inevitable beneficial effect of the lower cost of credit from reduced interest rates outpaces the economic drag from most of the rest of the government’s actions.

Would someone please muzzle this guy? I’m sure he’s a heck of a lot smarter than I am, but even I would know not to make such a stupid remark. Once he seemed to agree with the Chinese Central Bank’s commissar that the world should dump the dollar as its long-established “reserve currency” and substitute some “super-sovereign reserve currency,” the dollar immediately took a hit. Part of the dollar’s strength comes from its role as the dominant reserve currency, and Geithner’s remarks were (correctly) interpreted as a sign that the administration did not care about a strong dollar. Needless to say, investors who hold dollar instruments were unhappy, as the markets priced a weaker dollar.

Timmeh quickly rolled out the firehoses, but either the administration really wants a weaker dollar (and its inflationary fiscal policies certainly suggest that), or he stuck his foot in his mouth. The former would be an ominous development and hurt the economy in many ways, as cheapening the currency is never sound long-term strategy for a country. For one thing, a country whose worsening budget deficit addiction depends on the willingness of Chinese suppliers to keep investing in dollar-denominated bonds and accepting dollars for the goods they sell us, encouraging the Chinese to look for alternatives to the dollar seems a tad unwise. The latter, sticking his foot in his mouth, is evidence of incompetence. More and more, Geithner comes across as if he is the only guy wandering the halls at Treasury, trying to hold the place together and being completely out of his league and overwhelmed.

It is hardly coincidence that the countries who have made the most noise about replacing the dollar as the main reserve currency have been Russia, China, and Iran, not known to be America’s closest allies. On another point, consider the move towards a super-sovereign world reserve currency as the first step towards monetary unification, and that as the first step towards a political union. Using the history of the Euro as a guide, that is becoming an increasingly undesirable result from the standpoint of the EU’s more productive members. And a similar fate regarding the dollar would be undesirable for the U.S.

Mark Steyn has more reaction to Timmeh’s response. His linked articles express concerns similar to mine.

When governments come up with too much regulation that distorts the market, people find ways around the restrictions. So it is with municipalities who are not able to use their share of federal “stimulus” funds because of tight restrictions or unrealistic timetables. These are funds in search of projects. So these cities develop a market to trade these entitlements for cash or other government funds. This is analogous to the developing cap-and-trade system. But if the article is to be believed, what might be the wrench in the works? Another governmental entity, this time the Metropolitan Transit Authority, that seeks to undermine market efficiency. Undermine market efficiency? The MTA? No!!!

China has warned the Obama administration not to mess up the economy and inflate the dollar. The resulting interest rate hikes would greatly devalue the $1 trillion that China holds in U.S. treasuries. And the U.S. desperately needs China to continue to buy those treasuries to help finance the borrowing for its “economic recovery” program. It’s an interesting spectacle. The two are intertwined and neither can succeed without the other. On the financial issue, for China, the U.S. is too big to fail, not only to preserve the value of the assets it currently holds, but also to park its excess dollars from future exports. The U.S. needs China like an addict needs the dealer. On the economic side, the U.S. needs China to supply all those cheap consumer goods. China needs the U.S. to provide jobs for its people to manufacture all those consumer goods that its own people still cannot afford to buy.

So it may not be the impotent Republicans, nor the inchoate sense of unease among the diffuse American people, but the Chinese creditors, that put the brakes on Obamanomics. Delicious irony, that. We have a Communist Party-run regime warning the American government about the dangers of too much socialism. Obama is too far to the left for the taste of the heirs of Mao Zedong.

I have a suspicion that it is the Chinese warning that explains the stock market’s recent rally. Obama’s previous talk about massive government programs talked down the markets. Now that an unlikely cavalry in the form of the Chinese government is coming to the markets’ rescue, investors may be breathing a sigh of relief that Obama will be forced to curtail some of the excesses previously expected. Conservative facts of life again trump liberal ideology.

On the other hand, the Chinese influence may be limited by the fact that the U.S. is so much in the hole. As the old saying (updated to current numbers) holds, “If you owe the bank a million dollars, the bank owns you; if you owe the bank a trillion dollars, you own the bank.” Either way, I suspect that over the coming years, the Chinese will be more reticent to finance American debt at low interest rates, an ominous prospect, given the deficits projected by the administration and based, frankly, on pie-in-the-sky assumptions.

It is not clear to me why Federal Reserve chairman Ben Bernanke came out with this optimistic, though hedged, statement that the recession likely will end later this year, with gradual recovery next year and picking up steam thereafter. Bernanke also allowed as how we have avoided the possibility of a depression. How would he know that, given that the sharp downturn is so recent? Likely because there never really was a chance, as long as they avoided the mistakes of the 1930s, that is, constricting the money supply, passing a protectionist tariff, and increasing taxes on capital formation. So far, the government has avoided the first, but is merrily going down the path of the second and third. When FDR later in the 1930s encouraged all three again in his own campaign against malefactors of great wealth, and also promoted labor policies that kept wages artificially high, there was a second major dip. The administration is well on the way to that policy debacle, the latest news being that the administration wants all bail-out “stimulus” projects to pay union wages, not prevailing wages. That will add between fifty and one hundred percent to the labor cost, insuring that fewer people will be hired.

Maybe Bernanke, Geithner, and Obama (and various government insiders and their tippees) have seen information that leads them to be optimistic. That would be an explanation for the stock market’s recent, though premature, upturn. On the other hand, this could all be smoke. With Obama doing a sudden about-face from his previous trash-talking about the economy, this could be a coordinated effort at “happy talk” to counter the psychological effects of the campaign’s and then the administration’s negativity. After all, Obama has already got a large piece of his program enacted, with follow-ups being openly discussed and on the table. He doesn’t need to scare people as much any more. Or, again, there could be true information on which everyone is basing the sudden turn to optimism.

If this is on the level, then the recession would turn out to be a rather ordinary affair from the vantage of history. It would fall within the pattern that most recessions end within a couple of years. It would also call into serious doubt the need for any “stimulus” package, since that effect wouldn’t be felt until the economy was bottoming out anyway. In fact, if the market wrings out the froth in asset valuation, providing a stimulus at that belated time is more likely to push towards inflation.

Economists apparently are no longer as enamored of President Obama and Treasury Secretary Geithner as before they took office.

The reason might be the economic disaster staring us in the face, as this brief post and graph from The Corner about the deficits over the next decade projected by the Obama administration make clear. One of my criticisms of the Bush administration was the massive expansion of federal domestic spending, such as for Medicare prescription drugs and education. This sort of spending, when financed by borrowing, adds to the structural deficit. Those kinds of government programs always metastasize and far exceed their cost projections. Almost before the ink was dry on Bush’s signature, the government tripled its earlier projected cost for the drug benefit.

Private deficit spending can be well defended when done for (true) investment purposes or when needed to pay for an emergency. For the government, a war might be such an emergency. There is even a plausible argument for a moderate and targeted deficit to help the financial markets. The plausible counterargument of course is that the markets can select between “good” and “bad” financial institutions and the needed corrective action better than government can. Due to a lack of information and the effect of the law of unintended consequences, government interference is likely to prolong the misery or even to worsen it. And government rarely has a ”too-good-to-pass-up” investment opportunity of such fleeting nature that it would call for deficit spending.

President Obama’s programs are creating structural deficits that go well beyond any perceived need to fight economic recession. Left alone, even the worst recessions historically end within four years, and most do so in less time. The administration expects the economy to rebound within a couple of years, with probably overly optimistic projections. So one is hard put to explain deficits that, even with the administration’s rosy scenario regarding reduction of war and defense spending, increased tax receipts and robust economic recovery, will produce annual deficits far higher than those produced during the Bush administration that was fighting two wars.

For those who like statistics, perusing the linked Treasury’s Monthly Statement puts some more detailed numbers behind the graph. Note that the numbers in the report are themselves millions of dollars. So when the deficit figure is 2,000,000, that’s times a million, or $2 trillion.

Alternatively, perhaps the economists reflect the investment-producing class’ alarm over Mr. Obama’s ideological war against the creators of wealth. But then, maybe they just mirror the American people’s lack of confidence in Obamanomics. Take your pick.

From the corner at National Review, a brief round-up of various stimulus and bail-out measures so far.

A common truth for many guilt-ridden, capitalism-blaming Americans and their foreign counterparts is that the U.S. is to blame for the current global financial and economic problems. When they are not warning against protectionism and socialism, people like Vladimir Putin blame capitalist excesses. Certain European adherents of fashionable “moderate” leftism proclaim the end of the Anglo-Saxon (really at this point the American) economic model.

Cato has done some research that demonstrates that the U.S. was a latecomer to the downturn in comparison to others and also has suffered less of a decline. The author points out that Japanese industrial production began to collapse two months before the U.S. decline began. Real GDP in Europe and other places began to fall in the 2nd quarter of 2008, months before the U.S.’s GDP did in the 4th quarter. The U.S. decline in real GDP has been a small fraction of what has hit our largest economic competitors. Moreover, the real culprit of the economic slowdown was the stress put on production by the catastrophic rise in oil prices. Nine out of the ten post-war recessions have followed oil price spikes.

As the paper points out, “After looking at which economies fell first and fastest, it might be more accurate to say that some foreign  illness has spread to the U.S. economy than to assert or assume the causality ran only in the opposite direction.”

UPDATE: The Japanese economy contracted at twice the U.S. rate in the fourth quarter.

Steve Forbes lambastes Barack Obama—and George W. Bush. I have pointed out various national security issues on which the two agree. But Forbes is directing his ire against particular aspects of the economic program. Worse, from Forbes’s perspective is that those aspects of the economic program overturn policies from the FDR administration—policies that were good!

Forbes takes aim specifically at two policies. The first is an accounting policy called mark-to-market, suspended by FDR in 1938 but revived in 2007 by the Financial Accounting Standards Board and supported by the Bush administration. The idea is that, as financial values change, banks and insurance companies (among others) should adjust the values of the assets on their books to reflect those changes. The proposition seems reasonable on its face. There is no problem with something like this if there is a liquid market for such assets, e.g., blue chip stocks. But if the market has dried up, forcing a revaluation to some ill-determined and ill-timed lower value just puts banks in a precarious financial condition. Why? Because banks have capital requirements. When they have to devalue certain assets, they have to raise new capital. That may be an expensive proposition when there is a cash crunch. It also exacerbates the crunch itself by forcing banks to hoard cash for legal reserve requirements rather than lend it. Such markdowns have to be taken even when the underlying assets, such as real property whose mortgages are being paid. Forbes advocates a longer-term concept of value that avoids volatility associated with raising such values when times are good and thereby creating excessively easy credit. and lowering such values and inducing a deflationary spiral when times are bad. I see the problem. I am not sure the rules should be changed regarding how the asset is carried on the books, but, perhaps there is some room to adjust these rules so that the full force of mark-to-market does not apply to bank reserves required under regulatory law. Instead, maybe some longer period rolling average value could be substituted. I think that Newt Gingrich has proposed something like that.

The other problem, according to Forbes, is short-selling, at least of the “naked” type, that is, without some kind of assurance (usually paid for) that you have already secured the shares (e.g., by option) needed to cover the short sale. Forbes wants that “borrowing” rule as well as the “uptick” rule reinstated. I have no problem with that, if, in the case of the latter, it really makes a difference in price volatility. An earlier SEC study concluded that it didn’t. As to the former, the “borrowing” rule, I have no problem with that if it can be shown that it still sufficiently performs the hedging and information functions of short sales without unnecessarily high transaction costs, such as options.

UPDATE: Fed chairman Ben Bernanke is on board.

UPDATE 2: But then there is the SEC on mark-to-market. On the other hand, they agree with Forbes about the “uptick” rule for short sales

While the immediate concern is the market correction to take the froth out of the economy and particular assets, as well as the continuing seize-up of the financial markets, the looming problem is inflation. The huge budgets, with matching deficits for years to come, and the influx of easy money make this a concrete possibility. Governments around the world are pursuing these inflationary policies in a (partially vain) effort to combat the immediate and short-term effects of the correction and to achieve maximum political benefit for themselves. The problem is that this likely will inflate all currencies and leave them relatively unaffected towards each other. But it will achieve a temporary massive wealth transfer from the upper middle and upper classes to the poor and middle classes. For those most debt-ridden, the inflation will reduce or even eliminate the real debt. At the same time, this will hurt creditors as well as those on fixed incomes or with significant cash holdings (the savers). Of course, thereafter, as creditors seek to shift from the low-inflation expectation of the past couple of decades to high-inflation expectations, the cost of credit will increase. Everyone will suffer from that, especially the poor and the middle class. It will also damage job creation, again hurting the poor and middle class the most. So, I think the posting is right about the immediate effect of inflation, but, in the long run the old truth that inflation most hurts the lower and middle classes will be borne out.

To get a sense of the amount of money injected by the Fed, in relation to previous financial squeezes, check here for a really stomach-turning graph. Notice that the graph that shows the impact of borrowing due to the savings and loan collapse of the 1980s has numerous peaks and valleys against a y-axis of $10 Billion. But when measured against a y-axis of $800 Billion, the 1980s peak disappears. Then check the impact of the 2008 numbers. Those numbers are not going away. Then consider that, as the article notes, these numbers do not reflect the government’s cash infusion in Fannie and Freddie. Add to that the growth of unfunded liabilities for social programs, and there is a gathering storm.

Some speculations by Mark Steyn and his commenters about how low the Dow-Jones average will go before bottoming out. I agree with the last two of his commenters. I think that the S&P 500 is a better barometer than the Dow about the fundamental health of business in the country. I would even follow the Russell 2000 in that regard. But, ultimately, they all have followed the same broad pattern—down. And I fully agree with the judgment that the more that government intervenes in the financial markets, the longer it takes and the more difficult it is to establish a floor for the value of these assets. The sooner the government stops interfering, the sooner the market can get back to the business of correcting the prior overvaluation of the assets that are at the core of some of those strange derivatives. Remember that the Dow is a leading indicator of the economy. Don’t expect a jobs recovery until months after the Dow begins to recover as a reflection of investor confidence.

Here, via National Review’s The Corner, comes an interesting speculation that the mess at AIG was caused by an unexpected side-effect of banking regulation. The law of unintended consequences at work. Banks bought credit default swaps from AIG to satisfy regulatory requirements of reserve ratios. AIG sold huge amounts of these “insurance policies” that the banks treated as “regulatory compliance” policies. No one ever expected to collect on them. I’ve posted this before, but the AIG problem is what happens when every individual decision, here, to buy insurance, makes sense, but when the unexpected widespread disaster, out of all proportion to normal risk events, happens. The insurer is overwhelmed and can’t pay. These banks never expected to see this once-in-a-generation or even once-in-a-century financial seize-up.

Another post at The Corner scrutinizes some of the numbers of Obama’s budget. Scary stuff. Remember the bad old days when George W. Bush was averaging an annual $300 Billion deficit, while fighting wars in Iraq and Afghanistan? Here is Michael Ramirez’s view of Obama’s economic program.

If reading numbers is not a clear enough demonstration of what the markets are saying, here are some graphs. Notice the connection between the fortunes of Obama beginning at the end of September and the performance of the stock markets. Clearly, Obama scares investors. The markets continue to place little faith in his administration’s fundamental grasp of the problem rather than just an opportunity to increase the role of the state and suppress private capital. [Note: One of the graphs is wrong. The first one should show a decrease of about 1200 points, not 700. Same point, though.]

With a $2 trillion deficit and a $4 trillion budget, the federal government is continuing its takeover of the economy and its destruction of American capitalism. The leftward tilt of the administration ought to be apparent to everyone by now. Previously, when people at school asked me what I thought of Obama, and whether I was pleased that he was so conservative, I took a “let’s wait and see” attitude. I thought that matters would become clearer once he was backed into a corner or members of his first tem left. I was wrong. No need to wait that long. The mask has dropped, and the ideological gloves are off.

This has nothing to do with an “economic emergency” that, while significant, is not even at the level of the late ’70s/early ’80s in economic misery, much less the late ’20s and ’30s. The recession is a once-in-a-generation event that the administration is using as a front to reshape American culture and economics in a permanent (and damaging) manner. We are embarking on European welfare state-stagnation, and can kiss our long reputation for innovation and economic pre-eminence good-bye. Unfortunately, Obama’s intentional destruction of the system that has brought the U.S. an unparalleled standard of living will become obvious only gradually, as there is an inertia built into a system that does not change immediately. So it is likely that Obama will be gone when these effects will onfold fully and be able to escape responsibility for them.

Europe was able to survive with its welfare state only because it operated within the Pax Americana, with its defense obligations essentially paid for by the American taxpayer. We have no such luxury, and if we expect to support our welfare state the same way, doubtless our enemies will notice and become emboldened. Obama’s pledge to cut defense programs and to court every dictator and thug around signals the weakness on which enemies thrive. The administration is courting disaster. We are dealing with a bunch whose ideology has failed again and again economically and which is clearly out of its league in military matters. No wonder Obama styled himself a citizen of the world more than an American in his European campaign trip.

The administration proposes tax cuts and tax increases. The tax cuts of $800 in social security taxes will give people about $15 more per week. In addition, more people will get various income tax benefits that will bring the non-income tax paying portion to about 50% of the population. The other 50% will pay more, and those at the top will pay an increasingly disproportionate share. This is politically very dangerous, as it creates even less of a culture of shared claims and responsibilities. Those who pay nothing will find it increasingly easy to vote themselves more things for which others must pay. Those others will increasingly resent paying for others’ life-style choices. The politics of envy are about as likely to produce a healthy body politic as huge deficit spending is to eliminate the problem of debt.

Moreover, that little tax savings is likely to be outweighed by increases in state taxes (as here in California) and the Obama plan’s increase in taxes on drug and oil companies, more villains in the liberal playbook that must be brought to heal. Unless the government plans to nationalize those companies (which can no longer be considered to be in the realm of fantasy), the companies are going to pass those costs along to the consumers. They will pay more in gas and drug prices. If the government nationalizes those companies or subsidizes their prices (such as drugs), the taxpayers will foot the bill. But the more money is taken from the wealthier portions of the community, the less disposable private income there will be for investment and job-production. Employment decreases qualitatively and quantitatively, hurting the middle class the most and forcing more to turn to government relief.

Consider, too, that the tax increases will not really affect the very wealthy. They will base their compensation as they always have, on after-tax calculations. It will, however, hit the upper layers of the middle class. Many of them are small business owners, whose first goal is going to have to be to keep their families at a level of wealth commensurate with the efforts they are expending. So, those people will find ways around the tax system which, as usual, causes the fiscal gains from tax hikes to be less than expected. Alternativelt, they are less likely to hire others or to hire them at prior wages. This, too, will hurt job-seekers. The administration and its supporters among the public seem to think that they are immune from the realities of human nature and from the forces of the market. To many, Mr. Obama is more admirable than Jesus Christ. They will learn.

Don’t believe the administration’s claims about halving the deficit even in five years. Given the magnitude of the government takeover of the economy, this would require a private economy performing at an unlikely level of productivity. But even if they did, it would still leave a yawning deficit that would exceed considerably the average of all deficits while George W. Bush was in office. And it would take an impressive amount of BDS (Bush Derangement Syndrome) for W to be blamed for the fiscal effect of Obama’s new policies five years after W left office.

A large chunk of the payment for his health plan would come from smaller federal government payments to insurance companies for Medicare. Does anyone think that this won’t influence service? Even if the companies continue in that market, they will pay less to health care providers, who, in turn, will either cut services or multiply treatments and lab tests to affiliated clinics in an effort to cover costs. The government’s announcement that they will lend directly to students not only puts the taxpayer on the bill and likely subsidizes unnecessary college attendance (and higher tuition), but it harms private lenders. Their stocks took a hit recently, as always happens when the government’s taxpayer subsidized unfair competition displaces private actors.

In a must-read article, the Wall Street Journal takes a hard look at the numbers of a budget that will increase the federal government’s share of the Gross Domestic Product to record peacetime levels. Even under the rosiest projections by the administration, the government’s new programs will crowd out private activity well beyond the Bush years and the post-WW II average. The record-breaking deficits run a parallel course. Something has to give, be it interest rates, inflation, growth.

The Wall Street Journal’sDaniel Henninger delivers a scathing analysis of the depth and breadth of the radical program by the current administration to alter the relationship between government and free individuals. We can look forward to higher taxes (that inevitably have to fall on all tax-paying Americans), more welfare to support the life-style choices of the unproductive, indolent, and irresponsible, and more regulations from energy to industrial policy to health care that will reduce private choice and increase costs. It’s the “citizen-of-the-world” European model of state dominance over private enterprise, and of the rent-seeking political class over productive and creative individuals. Better be prepared for Euro-style structural unemployment and underemployment figures, as well. How long is it before the intelligent and productive depart for greener pastures, and we begin to suffer the brain drain to other countries (China and India, anyone) that, do to our greater freedom and willingness to reward individual incentive) we have used to our advantage for decades.

What does it say about the administration’s economic policies when Vladimir Putin (!) warns Obama against moving towards socialism? The Russian ex-KGB chief, who understands how socialism works based on his practical experience with it, denounces the destructive effect of socialism and talks up the free market. Sounding quite different from the administration and Congress with their eagerness to protect the frivolous and feckless at the expense of the prudent and responsible, Putin declares, ”Nor should we turn a blind eye to the fact that the spirit of free enterprise, including the principle of personal responsibility of businesspeople, investors, and shareholders for their decisions, is being eroded in the last few months. There is no reason to believe that we can achieve better results by shifting responsibility onto the state.”

Not to be outdone in teaching the Obama administration about capitalism and free trade, Communist China has warned against trade protectionism like the “Buy American” provisions of the “stimulus” package signed by Obama.

In light of the President’s push for the economic “strangulus” bill, and his being likened to FDR, great interest has arisen in the New Deal. The contributors to National Review’s The Corner have been particularly active. Here is another posting about the problematic policies of the New Deal. Especially insightful is this observation:

“Keynesian and other supposedly scientific theories for a government-run economy crash because of politics. Even if the theory of government spending “stimulus” made sense (considering that it doesn’t create any new wealth), government spending would be skewed toward powerful pressure groups who are likely to be better off than the general population.”

Socrates in Plato’s Republic was resigned about the inevitable failure of this most rational of regimes, scientifically designed and controlled in great detail by the most intelligent of men and women to overcome the irrationalities of individual choices. Why would this best of all systems fail? Because ultimately the precise science needed (in The Republic, the “marriage number”) to make the system function would be overwhelmed by the natural drives and passions of humans (in The Republic that was “eros”). Substitute economic planning for the marriage number and politics for eros, and there is the connection.

One of my students, Ali Vazin, sent me a Washington Post opinion piece by a couple of economists about having the federal government nationalize the banks as Sweden did for a while in the 1990s. If one accepts the idea that government ought to step in at all under the theory that this is needed to get credit flowing, the nationalization proposal is just another way to try to separate the “toxic assets” from other aspects of the banks. Once the government does that, the banks eventually are sold to private owners. This is simply a more direct way of government assuming the obligations that are said to be weighing down the balance sheets. Other ways to do this would keep the banks in private hands: Have the government just buy the bad assets and form a “bad bank” to hold and gradually liquidate them. Or have the banks hold them, but have the government “guarantee” the bad loans. These are variations on a theme, though a direct government take-over would be more “socialist” in form and, perhaps, existing shareholders and even bondholders would be more thoroughly wiped out. It would also eliminate the difficult task of identifying and valuing the “toxic assets” quickly. After all, one thing government does well is move slowly (except when it sees a political benefit from hasty action, such as a trillion dollar government seizure of the economy). Other difficulties, such as selling those assets over time, would exist under any of those methods.

To me, the most questionable aspect of this proposal is that it will inevitably succumb to politics. Given the history of Senator Chris Dodd’s and Representative Barney Frank’s connections to the banking industry, not to mention then-Senator Barack Obama’s connections to Fannie Mae and Freddie Mac, it is pollyannaish to assume that they or various FOBs (”Friends of Barack”) and others will not get sweet deals out of this over the bodies of the prior private owners and the American taxpayers. Given the size of American banks, compared to Sweden’s, there is simply too much involved for there not to be massive corruption and influence-peddling. This problem is endemic to politics and government regulation, of course, but the sheer size of a government take-over of chunks of the American financial industry guarantees a huge political distortion. Moreover, the incentive to retain government control so that those placed in charge can continue to exert political influence is irresistible. Whatever sense a “temporary” nationalization of the banks may make from a scientific economic perspective, it is the inevitable political corruption of the process that is the problem.

In light of the massive amounts of government spending being pushed through the “strangulus” bill and various other government bail-outs, economists are debating whether the Keynesians or the supporters of the Austrian School (which I favor) have it right about the effectiveness of government spending in producing economic growth. Part of that debate is speculation about the proper size of government (federal, state, and local) as a percentage of Gross Domestic Product. This article from the libertarian Cato Institute takes a look at that question.

I remember that, during the early 1980s after the stagflation of the 1970s, total government spending approached 40% of GDP. The article has it at 36%, but I remember articles that had it in the upper 30s. No big difference ultimately. With the brisk expansion of the economy in the 1980s and, after a brief stall, in the 1990s, that percentage went down. Government spending was relatively constrained because of the “peace dividend” after the fall of the Soviet Union and the Gingrich welfare reforms signed by Clinton. Then came the expansion of government spending under the Bush administration because of response to the 9/11 attacks and the war against Saddam, as well as the massive expansion of domestic spending through “No Child Left Behind” and the expansion of the Medicare drug program for older persons. With the massive social programs and the higher budget baselines for future expenditures that are part of the economic “strangulus” bill, the forecast is for a significantly higher role for government for the foreseeable future. I have seen estimates that, even without the economic train wreck that is this bill, federal government expenditures alone would rise to at least 25% of GDP within about a decade due to rising Medicare and Social Security outlays. Add to that the 17% of state and local expenditures (an optimistic figure), and the total is 42%. Again, that does not consider the huge future expenditures built into the current bill and totally unrelated to any “stimulus.”

The article determines that studies have generally shown that optimum government size does not exceed 25% of GDP. That means government at all levels. A government share of GDP above that amount causes a drag on economic growth. When government share of GDP approaches double that amount, one can imagine the drag on economic growth and the resulting comparative poverty.

Though the stock market took a bath yesterday, it had risen substantially last week, even as the jobless rate increased by .4%. The stock market is a leading indicator. It goes down before there are significant job cutbacks. That was the process last year. Similarly, the stock market begins to rise before the job numbers improve. One can expect at least a six-month lag. The stock market reacts to perceived future developments. In a downturn, companies also eventually shed workers to bring employment in line with production. As demand for the product increases, with a reduced number of employees, there is an increase in employee productivity. That raises wages, as well as profitability. Eventually, increased production reaches the point that more employees have to be hired again. That reduces unemployment, and the jobs recovery is underway. At the bottom of the downturn, companies are also helped by a decrease in the cost of credit and raw materials. Both of those have happened recently (with the ominous exception of that inflation hedge, gold), especially regarding energy. Apparently, wages have increased for those who remain employed (a phenomenon similar to what happened in the Depression, though there it was done prematurely through government action that delayed the recovery), which is especially stimulative when considered in light of the near-zero inflation rate and the collapse of energy prices that effectively gives an additional wage hike to consumers. It’s like a tax cut, and much better than the ridiculous one-time rebates or credits, in that people expect the low inflation rate and the lower prices to continue for awhile and thus are more likely to adjust their longer-term spending decisions accordingly. With the one-shot rebates, there is no similar adjustment in behavior. After all, the only thing you can do with a lousy $600, according to Michelle Obama, is buy yourself one pair of nice earrings.

Larry Kudlow gives his evaluation of these developments. Especially in light of the market’s tanking yesterday, I don’t know that his optimism is well-founded, and that recovery is around the corner. But he is certainly correct to show that the government spending stimulus will, as usual, arrive late in the game and probably do harm rather than good. By the time all that government spending arrives in 2011, the concern likely will be inflation that will be exacerbated by that spending. Right now, the increase in the money supply is off-set by the decrease in velocity in the circulation of money due to the slow-down in economic activity. But once the pace of that activity rebounds along with an increase in the velocity of the circulation of money, the fed will have to reduce the money supply drastically. This has to be timed well to avoid inflation, but cannot decelerate so sharply as to crash the recovery. Adding a huge fiscal stimulus to the economy at that point cannot make that balancing act any easier. Good luck.

It may seem like piling on, but the issue is urgent. So, here is another article that explains lucidly how significant portions of the New Deal prolonged the Great Depression. Two points are particularly relevant to today. First, the concern about deflation is valid, but probably overblown. Another way to look at deflation is that it is a correction of the price bubble for various goods and services. Hence, news about a low annual  price rise over the short term is not a message of doom, but of hope for the future. Although he probably does not recognize this as a component of a larger mosaic of economic models, Governor Schwarzenegger’s effective ten percent pay cut for state workers through his involuntary furlough decree is a reduction of labor costs. The alternative is to lay people off. There are advantages to each. The former reduces per-unit labor costs, and avoids higher unemployment (though it increases underemployment, a concept not readily evident, given the normal work habits of state workers). But it increases the number of people who may be put in a precarious personal financial position. In that regard, firing a few may be less harmful than cutting the pay of many.

The second point is to avoid drastic interference by government in the economy through marketing arrangements, cartelization that eliminates competition for business or labor, propping up large industries, dictating prices, or interfering in conditions of employment with the result that labor costs are higher than economic conditions demand. As the article points out, the principal villain in that regard was the National Recovery Act, although the Agricultural Adjustment Act wreaked similar havoc for agricultural commodities. The former law was declared unconstitutional in the Schechter Poultry case, the latter in U.S. v. Butler. Both acts had successors that were marginally better than their unconstitutional predecessors, but the basic flaw of governmental distortion of the market remained and impeded the recovery.

My students are familiar with my characterization of Social Security as the ultimate Ponzi scheme, a historically-derived term for a pyramid scheme similar to the one peddled by Bernard Madoff. Professor Walter Williams describes why Social Security meets the definition of a Ponzi scheme.

When my children were learning arithmetic and getting acqauainted with that wonderful contribution of the (Asian) Indians to math, the value “0,” they were assisted in their comprehension by a character named “Zero, the Hero.” Stay with me here. I mention this because Zimbabwe has just revalued its currency. I am quite sure that this is sheer coincidence and has absolutely nothing to do with the economic “strangulus” bill in Congress, but Zimbabwe knocked 12 zeroes off its currency. The country had recently introduced a 100 trillion dollar note (which by the end of that day probably cost a 101 trillion dollars to print). After revaluation, that note would be 100 dollars. So I propose that Congress do the same thing. Knock 12 zeroes off their pork legislation. Right now, there is talk of $1.7 trillion in “stimulus” spending between the $750 billion passed last fall (of which Obama can still spend over $350 billion), plus the $50 billion to the automakers, plus the $900 billion the Senate is discussing. Of course, that doesn’t count the over $2 trillion the Fed has given to banks in direct cash infusions or loan/asset gurarantees. If we take away 12 zeroes, the $1.7 trillion becomes $1.70. Now that’s a government stimulus I can support. If we don’t reduce the government interference and distortion of the economy, we may follow the Zimbabwe dollar’s path in a few years. That’s only a slight chance, but, hey, that’s what they thought in Zimbabwe not too many years ago, too.

I nearly went into shock Sunday morning perusing the L.A. Times. There were actually three articles that overall were well-analyzed and made sense. One must give credit where it’s due. One of those articles was in the business section, and expanded on an issue in one of my previous posts, the dangerous rise of protectionism in the TARP bill of 2008 and the proposed trillion dollar bail-out:

“‘The single issue that unites all economists is that the freer the trade, the better,’ Rose said. Our friends abroad certainly think so as well. A spokesman for the European Commission said a ‘buy American’ provision ‘is not something we will stand idly by and ignore’ — meaning that they will be looking closely to see if it violates trade accords.

Similar concerns were voiced by Canada, Australia and others that look to the United States for free-market leadership.”

Of course, Obama has shown that classic style of leadership so admired by his disciples, the “let’s see which way the political winds are blowing” analysis followed by the “Present” vote: “The White House said Friday that President Obama hadn’t yet decided where he stood on the issue.” I’m waiting for the “I’ll go to Washington if they want me to come” and the “There is only one branch of government at a time” explanations.

A further glimmer of economic sanity is that the Senate seems increasingly disenchanted with the House’s Mother-of-all-pork Bill. The concern is about the massive spending, especially the fact that the majority of the proposals have nothing to do with “stimulus,” but just represent good old Democrat take-over of the economy as the funds are not to be spent until 2011 or later. Judging by history, the recession will have bottomed by then, if not turned around altogether. I am not opposed to certain infrastructure projects, but the timing of the sudden alarmist propaganda citing people whose pocketbook would benefit substantially from heavy government spending is suspicious, though predictable. Infrastructure rebuilding may well be needed, and an ambitious program justified (at least more so than takeover of the health care industry and various other welfare and social engineering programs). But those projects have to be evaluated on their own merits. Otherwise, if the justification for them is simply the “stimulus” that they cause to the economy, we might as well be building thousands of “bridges to nowhere” and then tearing them down and starting the projects anew. That’ll stimulate. If we’re trying to judge them on the merit, there is no way to get such projects off the ground soon enough for them to have any stimulative effect on the current downturn. Highways, bridges, harbors, water projects, airports, etc., don’t just get planned and built overnight, especially with the anti-progress environmentalist hardliners opposing modernity at every step of the way. When my classes discuss the Constitution’s “takings clause” as it applies to government condemnation of property, I tell the students tongue-in-cheek that the reason the Century Freeway (Interstate 105) in Los Angeles has that name is because that’s how long it took to get the road planned and built.

Mark Steyn warns about the protectionism built into the “stimulus” bill:

“Headline from the London Daily Telegraph:

“U.S.-EU Trade War Looms As Barack Obama Bill Urges ‘Buy American.’”

That would be the provision in the Senate bill prohibiting any foreign-made goods from being used in “stimulus” projects….The EU Trade Commissioner is outraged at the swaggering cowboy Obama shooting from the hip and unilaterally banning European goods from American soil. But so are American companies such as General Electric. Bill Lane, an executive honcho with Caterpillar (the 10th-biggest U.S. investor in the United Kingdom), says, “We are students of history. A major reason a very deep recession turned into the Great Depression was the fact that countries turned inward.” Ah, yes. The Buy American Act of 1933. How’d that work out?”

While this particular example comes from the U.S. “stimulus” bill, resurgent protectionism is a worrisome sign around the world.

One of the urban myths taken as unchallenged gospel truth in liberal circles is that women are earning 78 cents for each dollar earned by men. Even though study after study has dismantled this silly fiction, the media love to cite the number for maximum shock value. The truth is much less sensationalistic. When all is said and done, and the variables are held constant, the pay differential at most is 5%. Indeed, in many professions in various localities, women earn more than men with similar qualifications. Nationally, the unemployment rate for women seeking jobs is lower than that for men. So the recent Congressional posturing in adopting laws to advance “paycheck fairness” captures the leftist anti-business and anti-jobs ideology to be expected from the Democrats even while they protest that they want to promote job creation. The only jobs Democrats can be counted on to produce are those connected with public employee unions and plaintiffs’ trial lawyers.

If it is true that those who can, do; and those who cannot do, teach; then it is certain that those who cannot do or teach, administer; and those who cannot administer, work for the government.

Perusing the newspapers, one finds articles that bear witness to supposedly reckless lenders who lent funds to irresponsible borrowers living beyond their means. Then there are the stories of greedy speculators who produced a “bubble” in real estate through the creation of complicated derivatives that were disseminated to greedy and gullible investors (read, banks, insurance companies, mutual funds, pension funds) in a market that lacked transparency and accountability. Finally, there are the tales of various industries, notably the auto industry, whose lack of managerial foresight and technological adaptability has brought them to the brink of financial ruin.

Leave aside for now the role of government with its ill-conceived subsidies, myriad regulations, and ideologically-driven mandates. Let us also leave aside the hysterical reporting by the press and the political opportunism of Democratic partisans (and, it must be said, some like-minded or fearful Republicans) in creating a perception of apocalyptic disaster among the public that likely has contributed to the severity of current economic conditions. What is the “cure” for these evils that are said to have produced a credit crunch and a severe recession, if not a repeat of the Great Depression? The nearly universal response of the political class and their media and academic allies has been for the federal government to act. And to act boldly and quickly.

In real terms, that has meant a precipitous rush to entrenching a federal government that is living even further beyond its means than typical. It has produced a series of huge and complex maneuvers to deal with the credit crunch through transactions that, judging by what has happened so far, require no accountability and utterly lack transparency. Finally, there are increasingly bizarre calls for bail-outs of those same inefficient industries, plus numerous others, in an incipient industrial policy whose scope is exceeded only by its recklessness. In other words, the government proposes to do what it accuses private business of having done that has caused financial calamity. But the government promises to do it on a more massive scale.

All of this is premised on the supposition that the pain of what is essentially a process of asset revaluation can be avoided with just the right dose of the right fiscal medicine now that the supply of monetary medicine has been effectively exhausted. Then, as various fiscal medicines are tried and fail, there is a two-fold response. Let’s increase the dosage and let’s also administer different medicine. Little consideration is given to the notion that even medicine that might be beneficial at a certain dosage can become toxic at a higher level, and that medicine that is curative on its own can be neutralized or even become harmful in combination with others. Apparently, the mindset is to continue this process until the patient’s symptoms get better, whether that improvement is due to the medicine or occurs despite the medicine. That the treatment might kill the patient, and that alleviating the symptom does not necessarily mean curing the disease, is disregarded.

A fundamental problem here is the faith that, in this matter, macro-economic laws work mysteriously differently than micro-economic actions. Let’s think about an individual who is in debt and has a temporary liquidity problem. That person might take on a loan if he can be reasonably certain that his liquidity issues will be resolved shortly. Businesses with recurring financing needs may obtain “bridge loans” or, if they can, market short-term commercial paper to cover their needs. But, again, those actions are based on short-term considerations and on reasonable certainty, perhaps based on prior experience, that the specific need is temporary. If that individual or business cannot be sure the liquidity situation is temporary, a strategy to recovery based on borrowing himself out of illiquidity would be derided as folly. The borrower would quickly find lenders to be unwilling to lend and investors to invest. Instead, he would be advised to sell assets on the market, raise his income by getting another job or increasing sales, or, if necessary, proceed as swiftly as possible to bankruptcy court for an unwinding of his assets and liabilities. Those who had invested or lent to him previously would be forced to accept the hazards of lending and investing. And anyone lending to such individuals or investing in their effforts at that stage would be considered foolish.

Why would this be any different for a collection of large borrowers (banks) than for individuals and other businesses? And why would anyone think that the process of bringing the individual’s ability to own assets in line with his ability to pay for them would be anything but painful? If the individual has to sell the assets quickly, he may not get the same amount that he paid for them, or even what he owes on them. But the process allows the individual to bring himself into a position where he once again is able to act productively for himself and his community. The same goes for the banks.

Instead, the government is going to strew increasingly stratospheric amounts of cash around economic activity. At best, this would be limited to financial institutions either to get them to lend directly and thereby resolve the liquidity problems, or to straighten out their balance sheets and thereby to get them to lend to each other. At worst, this would be passed around to other firms as an industrial policy that has been tried so often and failed it is a wonder anyone still proposes it without triggering a storm of jeers.

The problem of course is that this strategy ultimately cannot avoid the underlying problem, namely, the need to revalue assets in real terms to what people can afford to pay, and thereby will pay, for them. The assumption is that this is all a temporary dislocation. If this proves false, and government intervention is likely to make it such by postponing the day of reckoning, the duration of the misery is extended unnecessarily.

Moreover, the government has to finance its efforts, just as an individual or business. What the government is betting is that the laws of micro-economic behavior don’t apply to it as a macro-economic actor. What false conceit. ”Government” is not productive. It takes wealth from those who are productive and gives it to others. Sometimes that is done to pay for the operations of government. This is especially important when government pays for the military in times of war. One problem with such wealth transfer is that, as government gets into areas best left to private enterprise, its activities produce less value in relation to what it takes from private persons than if the activity were left in the hands of private business.

Another and all too frequent problem is that government often takes from those who are productive and gives to those whose main goal is to gain a subsidy for activities that could not get financial support in open competition for resources. There are a very few debatable exceptions, such as protection for infant industries that might be considered somewhat analogous to patents and copyrights. But in most instances, whether through outright corruption or more ambiguous “influence,” this rent-seeking political class crowds out resources that would be put to more productive and beneficial use by private enterprise operating in the open market.

Finally, and most important, government must first have funds before it can spend. Again, government itself is not productive, so it must get the funds from (forced) investors through taxes, from lenders by borrowing, or by printing money. If government raises taxes, it prevents those taxpayers from using the money to buy things and spur economic activity through the efficient allocation by the market. It also prevents taxpayers from investing that money in private ventures to spur economic growth. Either one is especially bad when the business cycle is in a downturn and cash is comparatively valuable.

If government opts, instead of taxing, to borrow the funds, it necessarily competes with private borrowers and relies on the willingness of lenders to lend. This is especially troublesome in a downturn when cash is valuable and when assets are declining in relative value. With lenders reluctant to lend when balance sheets are uncertain, the cost of credit goes up. If demand for cash increases through government borrowing, interest rates go even higher. And that interest must be paid, beginning immediately, thereby requiring government to raise more taxes or to finance the cost of its borrowing with more borrowing. All of this stymies productive and innovative private economic activity that is most likely to reverse the economic slide quickly. While the U.S. government, with the dollar as the world reserve currency, is in a better position to borrow from the rest of the world than are other governments, the U.S., too, faces limits when the rest of the world is in a downturn and capital is increasingly scarce. After all, China is also experiencing massive economic problems as demand for its exports slows and the supply of dollars it needs to park in the U.S. dwindles. So, to avoid throttling the more productive private economy, government, like any private individual, must tighten its belt rather than get outside investment (tax revenue) or loans.

That leaves the printing of money, which appears to be the preferred method currently. But money is just paper whose value depends on the trust people place in it as a medium of exchange for other things. The more money floats around with productivity and wealth unchanged or, worse, declining, the less the value of money becomes. Each unit of money represents a smaller amount of things for which it can be exchanged. At some point, the whole psychology regarding the money changes and an “inverse bubble” develops in regard to the money. Anyone for buying Zimbabwe dollars?

Now, the U.S. in a deflationary cycle can afford to print money, and that is the Keynesian response. After all, money is expensive in regards to other assets. But if the government keeps printing money after that strategy or other events have reversed the downturn, inflation looms. At that point, if the government and the Federal Reserve time everything right, they have to pull the money out of circulation by raising interest rates and taxes, which, in turn, increases the possibility of causing the downturn that government had just tried to avoid.

That is if everything is timed right. If not, there is a danger of inflation taking off. And the likelihood of failure is greater, the more drastic the government’s injection of money was. Think of this as a sort of leveraging. The more paper the government creates in relation to the country’s true productivity and asset value, the more quickly and drastically the government must lower the money supply and the greater the damage from a misstep. It is said that we are in a deflationary cycle right now. Perhaps. But then why isn’t the price of gold falling drastically in relation to cash? Gold, after all, is essentially just another medium of exchange. It must be that many people are concerned that the government will not be successful in controlling the flow of cash, and that the dollar will become less valuable in the near to medium term.

With all of these uncertainties and risk, there seems to be little benefit from this massive government interference. A historical precedent illustrates the problem. Through missteps, such as restrictions on the money supply during the latter part of the Hoover administration and in 1937, tax increases on capital and the wealthy, and protectionism such as the Smoot-Hawley Tariff Act, Congress and the FDR administration worsened and prolonged the economic downturn. The administration’s tax policies reduced capital formation. Its protectionist policies and industrial policies in favor of large cartels and against price discounting kept business from lowering the costs of its products. The administration’s agricultural policies kept those products’ prices artificially high at a time that people were going hungry, thereby “necessitating” more government expenditures. Its pro-union and minimum wage policies kept wages artificially high, thereby preventing a revaluation of the asset of labor. Overall, these policies reduced the incentive for entrepreneurial risk-taking and for job creation. The labor force remained stagnant and unemployment remained high until the massive World War II military draft reduced unemployment at least nominally.

If the important first step right now is to resolve the liquidity problem, and get banks to lend to each other, policies that prevent a revaluation of assets will only drag out the inevitable. There are different ways to address the liquidity issue. The direct approach of having government inject funds into banks in exchange for preferred stock turned out not to work because, rather than lend to other institutions of unknown financial solidity, banks hoarded the funds (much as taxpayers did with the 2008 “stimulus” payments) to shore up their own balance sheets.

Alternatively, government can collect the “bad assets” from the banks (the original TARP plan) so that banks can be assured that the remaining assets are solid and provide a basis for renewed flow of inter-bank lending that will then also loosen credit for other borrowers. In the absence of a market, the problem is trying to value those “toxic” assets. Indeed, there is an initial problem of even identifying what they are. What level of, for example, mortgages are sufficiently “risky” to qualify? And what about student loans, credit cards, and commercial paper? If government offers the banks too little, why would the banks sell those assets? If government offers too much, the taxpayers’ exposure is increased. And there really is no valuation mechanism, because of the complexity and lack of transparency of many of the exotic assets derived from the original mortgages.

Congress could, of course, nationalize the banks or force them to surrender identified loans. Leave aside constitutional issues. Unless the government wants to undertake complete and long-term nationalization, the valuation problem remains. And a policy of total nationalization that would extend to that great majority of banks that are sound, with the destruction of shareholder value that entails, would make future investment and lending that much riskier and expensive. Venezuela, anyone?

The best valuation alternative, then, would be to have the private sector sort this out, with the assistance of the bankruptcy courts. With no government bail-out in the offing, companies would not be able to prolong the agony by hiding their difficulties and falsely boosting their balance sheets with taxpayer funds. There would be no wealth transfer from taxpayers to shareholders and creditors. Since matters would be resolved fairly quickly, the danger from an attack on a healthy institution by speculative short-sellers would be lessened. Banks would seek bankruptcy protection. Some would be reorganized. Some would be liquidated. The toxic assets would be auctioned off at a price at which someone is willing to take the risk. This would begin to set a floor for those assets. That would facilitate the process of economic recovery, even if, years down the road, it may be determined that the floor was unduly pessimistic out of an excess of caution. And the risk would be born by private investors, not taxpayers.

Despite my skepticism, I was initially supportive of an emergency injection of cash for the banks to lend. But as the price tag exploded and the time frame expanded; as the financial injection caused banks to protect their balance sheets rather than unfreeze credit; as the somewhat defensible assistance to the financial sector turned into an indefensible industrial policy; as a targeted program metastasised into a political pork barrel; as a plan said to rescue a pillar of capitalism became an obvious attempt to restructure the entire system in favor of failed doctrines of, at best, state-directed capitalism; and as those left with vast and arguably unconstitutional discretion to administer the plan acted in contradictory and confusing manner suggestive of panic and clueless experimentation, I became convinced that my initial skepticism was correct. The government needs to stay out and let the market set the asset values. Then, once the shake-out has occurred, and the government is not simply creating a new asset bubble, the usual monetary policy rules may again apply in a chastened lending environment.

In some future posts, I will link to articles by various economists that explore the points I have raised in this posting. As I am not a trained economist, I have been pleased to see professionals raise some of these same concerns.

In the latest saga of Citigroup, the enterprise plans to split into a more traditional banking operation and an operation to handle its assorted non-banking business. The latter will also be assigned the mortgage loans, including the potentially toxic sub-prime loans and derivative investments. Although this decision appears to be in its early stages of completion, it is hoped to be a step in the right direction. It may establish a value for the banking side and assist in the flow of credit. Shareholders ordinarily would still suffer a serious dilution of their value because the non-banking side will have little or no value. But they’ll be saved to some extent by the government coming in to guarantee their assets.

With the exception of that last sentence, this restructuring into “good-bank, bad-bank” entities may be a good idea, or at least a better one of the bad ideas. It is potentially analogous to separating the good banks at large from the bad banks. I still think that the market should do that, and that the government intervention aspect is a bad idea because it keeps us from “finding the bottom” for those assets. I’d prefer Citi be auctioned off in parts. But those who defend such intervention in the hope of promoting the flow of credit and thereby settle the real estate market and provide stability for mortgage-backed securities, argue that this approach was the idea behind the original TARP bail-out before the government started giving money to the banks directly. The banks, quite predictably, did not relend those funds but hoarded them to create better balance sheets and protect creditors’ and shareholders’ value by waiting for the value of their assets to recover. Also, some of the big European banks with similar toxic assets used this approach, down to the government intervention.

Meanwhile, here is an explanation of the latest government cash injection plus loan guarantee for Bank of America/Merrill Lynch. Other than the liquidity injection, the government is setting itself up for some future exposure but no actual cash expenditure. So, this last part is not much different from the benefits many students get from federally guaranteed loans. A difference is that the student loan default rates can be relatively well predicted, whereas the exposure for the B of A/Merrill assets is still unknown. It’s like trying to insure against a nearly unique and unknown risk. But from appearances, there seems to be a healthy portion of respectable assets in the package, and as this quarter unfolds, the information from year-end plus the first quarter will make the likely risk clearer. So the problem with B of A is not that they are likely to go under; in fact, within a couple or three years they may well make a killing. The more structural problem with them, as I see it, is that they are such a consumer-unfriendly institution. I opened my first bank account with them, and the local branch was a rather friendly, helpful, flexible, and laid-back bunch. By the time I left them in disgust fifteen years later, they were the antonyms of those adjectives. I haven’t returned. From what I hear from some acquaintances who are current customers, things haven’t changed.

As fallible humans, we lack the ability to foretell the future. Indeed, the great majority of us even lack the ability to look beyond the facts that confront us at the moment so as to draw lessons that might help us put such a narrow snapshot of experience into broader perspective. That is quite understandable. We organize our lives in a way that assumes that things will be tomorrow just as they are today. We are by nature traditionalists. Too much change and uncertainty creates stress. This works at the minute personal level as well as at the larger societal level. We eat certain foods for breakfast, go to a certain coffee place to order the same concoction, go to the gym at a certain time, sit in certain pews at church (unless, like my family, we’re chronically late) and otherwise “stay in a rut” to organize our existence with maximum efficiency.

From a societal standpoint, too, most of us like the status quo. As every political radical knows, “revolutionary fervor” soon flags, and people want to get on with the business of living. If events come together to cause significant change in our societal arrangements (and I’m not writing here about a mere change in political administrations from Republican to Democrat), that change is, to the immediate participants at least, almost inevitably bad.

So, conditioned as we are to like the comfort of the present, and given our fallible intellect, most of us are oblivious to the changes that might befall us shortly. We don’t hear the waterfall ahead as we float along living our lives, until we are inexorably in the grip of the current. Certainly Europe in 1913 was hardly cognizant of the apocalyptic cultural changes that were about to sweep away the political and social structures that seemed so strong in the wake of the European military, technological, and scientific triumph whose evidence was all around. In the same way, we don’t know today whether in ten years there will still be a United States, though this Russian “professor” seems to be quite certain about the matter. And his answer is a resounding “nyet.”

Just as many saw the expansion of the economy over the past quarter-century, and particularly during the last six years, as a never-ending joy ride, today many see gloom-and-doom as the way of the world for the next generation. Bearish hyperbole is becoming the order of the day, from the press to the politicians to hawkers of “recession-proof” investments. Greenspan’s ”irrational exuberance” of 1996 has become the “woe-is-us pessimism” of today.

That leads to this article about an interesting book that offers the opinion that we might be at the end of a historical cycle of inflation. Such a cyclical reversal will spawn considerable upheaval, with collapsing asset values. It will then usher in a long period of price stability. An example given is the fourteenth century, during which a European cycle of spending and wealth creation through trade ended with the Black Plague.

I think therein lies the key. The cycle didn’t just end because of some expected adjustment in the value of overrated assets that had formed a value “bubble.” It didn’t end because there had been too much money chasing too few good assets. It ended because of natural disasters, made worse by bad government policies. The Black Plague (which some scientists now believe to have been a hemorrhagic fever like Ebola) caused a huge loss in the population, usually said to be about half Europe’s population. Climatic changes in the form of global cooling after the Medieval Warm Period caused significant crop failures and had been striking the population of Europe with famine for several decades before the plague arrived. Even higher taxes were to blame, as rulers’ concern about reduced standards of living resulting from famine-related losses in population, caused them to raise taxes. That, in turn, impoverished the population more and made it more susceptible to malnutrition and disease. Plus, of course, there was the effect of world war in the form of Mongol attacks in the East and threats of continued invasion.

We don’t have those conditions—yet. And if they arose, they would be the cause of massive economic collapse, not the fact that greedy officials at Fannie Mae and Freddie Mac handed out billions in subprime loans under skewed government lending programs. Now, while it is true that Europe is well on the way to committing demographic suicide, it is still a gradual process unlike the sudden collapse of the productive generations in the fourteenth century. While such decline will depress economic growth and even produce stagnation, by itself it is not likely to cause massive collapse. Also, while Al Gore tells us that we have global warming that may raise the temperature by a couple of degrees over the next century, we don’t have the existential threat of sudden and famine-inducing global cooling, right? Finally, there is no world war. Of course, that, too, can change as new existential threats appear. Certainly there are some on the radar, from a resurgent Russia to a surging China, to the smaller but perhaps deadlier irrationalities of Iran and North Korea and their terrorist proxies. And the threat of some disastrous pandemic more virulent than Avian Flu can never be ignored, especially in light of modern population density and mobility.

But for now, the economic correction, severe as it is, is just that. I am not disputing the existence of economic cycles of varying lengths and magnitudes, though it is probably impossible to know at which stages of the cycles we are or exactly how they influence each other. Well, at least not until some point after they are past. In the short and medium term, of much more concern to me than some cataclysmic wrenching of global civilization is a point mentioned at the end of the article, that this is not the end of inflation and the advent of price stability. Rather, it may be the beginning of a devastating bout of inflation, as government turns to printing money in a doomed effort to spend itself out of the correction. Stay tuned for that rather mundane result of a bad economic policy reaction to a normal business cycle adjustment.

More confirmation that the economy is in trouble. Larry Flynt is on to something when he demands a bail-out. If public investors can’t be lured to funding Penthouse magazine-related investments because of a certain ill repute, how can Hustler raise funds? Of course, investors aren’t interested in funding less racy media fare, either. Can a government bail-out of the loyally pro-Obama L.A. Times be far behind?

I heard one wag say that if Obama wants to bring back the New Deal, it means nine years of double-digit unemployment, followed by a major war (where over 400,000 Americans will be killed) and ending with the nuking of Japan before things improve. When I told my wife, she suggested we skip the intervening bad years and just proceed directly to the nuking of the Japanese.

I find it amusing, in an eye-rolling way, that so many of the Obamaniacs in the elites compare their idol to Franklin Delano Roosevelt. The professor whose office is next door to mine has a post card with pictures of his two heroes, FDR and BHO, on his bulletin board outside the door. He teaches legal history, no less, and should really know better. But as a Democrat, he’s probably not as well versed in the political economy of the New Deal.

In my constitutional law class, we discuss some of the New Deal-era Supreme Court cases. As a part of the lesson, I discuss the politics and economics of the FDR approach reflected in the laws challenged in those cases. Most, if not all, of my students hear for the first time some criticism of that revered icon of American history, Franklin Delano Roosevelt. I describe his program of corporate-state capitalism as fascistic and analyze the attributes that make it such. But even my litany of New Deal government policy disasters pales in comparison to these listed by National Review’s Jim Powell, the author of FDR’s Folly. That list shows the disaster that government interference and involvement in the economy always brings. Government ends up being like the doctors of prior centuries who (at best) undermined and delayed their patients’ recovery by “bleeding them” to cure them of their ailments.

The New Deal should be a road map, alright. A road map of where not to go. I prefer the direct route of recovery, and it does not involve the government.

The next time some liberal complains about the “rich” not paying their fair share of taxes, show them this article that shows that the U.S. has the most “progressive” system of household taxes (income taxes and employee social security taxes) in the world:

“Even after accounting for the fact that the top 10 percent of households in the U.S. have one of the highest shares of market income among OECD nations, our tax system is second only to Ireland in terms of its progressivity for households.

The table also shows that the U.S. collects more household tax revenue from the top 10 percent of households than any other country and extracts the most from that income group relative to their share of the nation’s income.”

But you’d never know that from the rhetoric of the last eight years about “tax cuts for the rich.”  Also, note the location of “egalitarian” Sweden on the table.

One just knew that this had to happen. While the cheap jokes are so easy and plentiful, I will try to resist. The porn industry is shrinking. “Francis Koenig’s fund AdultVest, which invests in porn-related assets, was up 50% in 2008, according to Tom Johansmeyer’s article in next month’s Atlantic ….  But video sales are down.” Why didn’t I know about this type of fund? I should have invested my retirement plan assets in that fund, rather than the shriveled real estate mortgage fund; it would have held up better. This is like the car industry, though. More of this stuff is coming over the internet, and less through dinosaur technology like videos. And slightly softer titillation can come from YouTube videos. Larry Flynt will have to adopt an old product to a new technical reality. Let’s not get hustled into another bail-out, I say. If they can’t make money off sleazy sexual material, they deserve to fail. I’m sure someone will force himself to pick up the business.

Mark Steyn poses a reasonable question: Why isn’t the left happy about the economic slowdown? Why aren’t Obama and the Democrats rejecting economic stimulus (if they think that printing money will work)?

“After all, everyone knows Americans consume too much. What was it that then Sen. Obama said on the subject? “We can’t just keep driving our SUVs, eating whatever we want, keeping our homes at 72 degrees at all times regardless of whether we live in the tundra or the desert and keep consuming 25 percent of the world’s resources with just 4 percent of the world’s population, and expect the rest of the world to say, ‘You just go ahead, we’ll be fine.’”

And boy, we took the great man’s words to heart. SUV sales have nose-dived, and 72 is no longer your home’s thermostat setting but its current value expressed as a percentage of what you paid for it. If I understand then Sen. Obama’s logic, in a just world Americans would be 4 percent of the population and consume 4 percent of the world’s resources. And in these past few months we’ve made an excellent start toward that blessed utopia: Americans are driving smaller cars, buying smaller homes, giving smaller Christmas presents.

And yet, strangely, President-elect Barack Obama doesn’t seem terribly happy about the Obamafication of the U.S. economy. He’s proposing some 5.7 bazillion dollar “stimulus” package or whatever it is now to “stimulate” it back into its bad old ways.”

Even more deliciously, as Steyn points out is the response of those foreigners who don’t like us spending so much of the world’s resources:

“The message from the European political class couldn’t be more straightforward: If you crass, vulgar Americans don’t ramp up the demand, we’re kaput. Unless you get back to previous levels of planet-devastating consumption, the planet is screwed.

“Much of the load will fall on the U.S.,” wrote Martin Wolf in The Financial Times, “largely because the Europeans, Japanese and even the Chinese are too inert, too complacent, or too weak.” The European Union has 500 million people, compared with America’s 300 million. Britain, France, Germany, Italy and Spain are advanced economies whose combined population adds up to that of the United States. Many EU members have enjoyed for decades the enlightened progressive policies that Americans won’t be getting until Jan. 20. Why then are they so “inert” that their economic fortunes depend on the despised, moronic Yanks?”

Steyn provides the answer. So far, without Obamanomics, the U.S. has a dynamic economy, based on residual freedom and initiative. It also has a steady population that is replenishing itself in a way Europeans are not.

Wondering what tax policies would help Obama and the Congress boost the economy, though not their standing with their left-liberal base? This Investors Business Daily editorial provides an outline of policies that would promote capital formation, starting with across-the-board tax cuts for individuals and businesses. Though increasing taxes on those who make more than $250,000 gives visceral emotional satisfaction to liberals who don’t themselves engage in job creation, it also punishes those most likely actually to provide the capital and the initiative to create jobs for others. It will be interesting to see whether Obama can resist the urge for mindless redistribution that seems to be hard-wired into liberals. So far, his stated conviction that government will create or protect 3 million jobs demonstrates a lack of awareness about economic realities and who “creates” jobs that does not inspire confidence in his bona fides on economic matters.

How far the mighty have fallen. As oil settles around $36 per barrel for January delivery, producers are hard hit. OPEC agrees to production cuts that some members claim are too small. But production cuts are not the answer.

The problem today is the inverse of last spring. Then, a psychology of scarcity was distorting the market. There was a genuine demand issue at the core of the price rise. But oil rose far too fast and high for it to have been simply the result of increasing demand from China and India. That, after all, had been occurring for some years. Part of the problem was a falling dollar (which is occurring now, as well, but with little effect). OPEC ministers claimed to increase production and said that the price of oil was too high—at $80!  Most of the distortion occurred because the promised production wasn’t happening. Quite the contrary. Traders got into the habit of bidding up prices to get contracts for a diminishing, not increasing, supply. Producers were slowing sales, as they could keep the oil in the ground or decline to sell for future delivery as long as they expected the spiral to continue. They were acting just like the homeowner who expected his house to go up if he waited a while longer, and who expected buyers to bid against one another if he chose to auction the property by listing it with a broker.

Then the developing oil bubble burst. Just as with other bubbles, it comes unexpectedly, quickly, and, perhaps, even from an unnoticed minor development. Here, the increasingly bleak outlook of the world economy as the housing and financial markets worsened, provided the catalyst. Unexpectedly, there were delivery contracts to be dumped. Producers, faced with declining prices, suddenly had to sell more of their product. The spiral continues. By historical standards, this has happened after every oil boom. The market may even overshoot a longer-term stable price range to the low end.

But there is nothing that producers realistically can do. Many oil producing countries depend on that commodity for most of their earnings. They cannot afford to withhold production for long, or their economies will collapse. This is particularly true for Venzuela, Iran, Algeria, Russia, Nigeria. Even as OPEC struts around announcing production cuts, those won’t happen. Some OPEC nations or non-OPEC producers will cheat. Cartels are unstable, particularly during an economic downturn. So, even if the announced production cuts were more significant than they are, they would still likely be window-dressing. If they were successful in raising the price, they would simply prolong the world-wide economic downturn and delay the day when prices are likely to edge upward even with increased production. Oil prices will go up when the world (i.e., the U.S.) economy eventually recovers.

This was predictable. Subprime mortgage-backed bonds are again being recommended to investors. Now before anyone rushes off to buy them through E*Trade, this is not for the average American. At the same time, the resurgent enthusiasm for such investments is not surprising. These bonds and the funds that invest in them have been talked down so much, they may well be undervalued. It happens every time. A bubble develops in an overhyped asset. The market collapses. That type of asset is then tarred, regardless of the individual merit of particular assets of that type. Eventually the bad ones are culled, but the stain remains. What is left is undervalued compared to other investments. Savvy risk-takers begin to buy up those assets. Eventually, the market recovers and those buyers reap a handsome reward. That, in turn, makes those who didn’t invest envious and people are scandalized by the huge profits made by these rich “money changers.” The same thing happened with high risk/high return “junk bonds” after the Michael Milken/Drexel, Burnham imbroglio in the 1980s. Junk bonds were derided and undervalued. Since then, I have read, junk bonds have outperformed other bonds, as well as stocks. The only thing that gives me pause is that the resurgence has come so quickly. Is that turn-around premature, or has the beating these bonds have taken been so effective at depressing values that the timing for recovery is already right?

One bank has certainly bought into the notion that these bonds have value. They are paying their executive bonuses in such bonds. Some see that as a kind of morality play to pay back the people who “caused” the financial crisis. Banks and their executives are unlikely characters to engage voluntarily in morality plays. Well, at least my bank isn’t. I think they see an economic opportunity.

The more I hear about the bail-out of the “Big Three” (there’s an outdated name) automakers, the more the whole idea makes me gag. There is the embarrassing spectacle of executives prostrating themselves before Congress as if before some potentate, as they seek money, for what? To get an intravenous drip of taxpayer money so they can continue to finance union pensions for the next three decades? To manufacture automobiles that no one wants, because of CAFE rules voted by politicians in thrall to environmentalist Levellers? So Congress will tell the companies whom they can hire as executives (”The chairman of G.M. must go”), what kinds of cars the companies can make (”Let’s just tell them to make electric cars and decree a certain gas mileage requirement for other cars”), and put a government proconsul (”car czar”) in charge. Somewhere (probably a very hot place) Karl Marx and Vladimir Lenin are slapping each other on the backs in congratulations, while next to them Khrushchev, Brezhnev and their successors are bemoaning the fact that the U.S. did not have this industrial policy in their day. The U.S.S.R. might indeed have “buried” us, in the words of Khrushchev. And what is this car “czar” appellation? Isn’t there something fundamentally anti-democratic and dictatorial about a “czar”? I doubt that the framers of the Constitution envisioned any American politician to be referred to matter-of-factly as a “czar.”

Since he will be a creature of Congress, it is doubtful that this “czar” will be able to deal with the structural and policy problems that hold down the car companies. This article by Holman Jenkins, Jr., in The Wall Street Journal exposes those problems (CAFE standards, import restrictions through the “two fleets” rule). He might have added the wage and pension contracts and the outdated equipment that Honda and others have said they would not want to buy in the event of a liquidation. I disagree with Jenkins that the one bright spot in the bail-out is the naming of this car czar. He asks whether anyone would buy a car designed by Congress. The same might be asked about a car whose design is controlled by a “czar.” We know what a government-designed car is like. It’s called a “Yugo.” Why? If you have to get somewhere, you go, because it doesn’t go.

Let them go under. No industrial bail-out policy. Let the market work. Go after the politicians and enviros who are also significantly at fault because of their incessant non-reality-based meddling in the market.

Amity Shlaes writes in the Wall Street Journal about the dangers of a New Deal-style spending program that emphasizes temporary job creation and other exploding-deficit stimulus packages by the next administration. Shlaes has written a well-received scholarly book about the Great Depression and the New Deal, The Forgotten Man: A New History of the Great Depression. Artificially high wages and high taxes make for high unemployment, as the statistics from the 1930s show. While you may have a job, and a not badly-paying one at that, companies cannot afford to hire and may have to lay off workers. This keeps unemployment unnecessarily high. High taxes inhibit capital formation. Of course, if taxes aren’t raised, and the deficit is allowed to balloon, that raises its own serious dangers of dollar collapse and at least “real” inflation.