Banks, Keynes, Subprime Mortgage Crisis and Great Recession

Posted by PITHOCRATES - September 17th, 2013

History 101

(Originally published June 11th, 2013)

Bringing Borrowers and Lenders Together is a very Important Function of our Banks

Borrowers like low interest rates.  Savers (i.e., lenders) like high interest rates.  People who put money into the bank want to earn a high interest rate.  People who want to buy a house want a low interest rate.  As the interest rate will determine the price of the house they can buy.  Borrowers and lenders meet at banks.  Bankers offer a high enough interest rate to attract lenders (i.e., depositors).  But not too high to discourage borrowers.

This is the essence of the banking system.  And capital formation.  Alexander Hamilton said that money in people’s pockets was just money.  But when the people came together and deposited their money into a bank that money became capital.  Large sums of money a business could borrow to build a factory.  Which creates economic activity.  And jobs.  The United States became the world’s number one economic power with the capital formation of its banking system.  For a sound banking system is required for any advanced economy.  As it allows the rise of a middle class.  By providing investment capital for entrepreneurs.  And middle class jobs in the businesses they build.

So bringing borrowers and lenders together is a very important function of our banks.  And bankers have the heavy burden of determining saving rates.  And lending rates.  As well as determining the credit risk of potential borrowers.  Savers deposit their money to earn one rate.  So the bank can loan it out at another rate.  A rate that will pay depositors interest.  As well as cover the few loans that borrowers can’t pay back.  Which is why bankers have to be very careful to who they loan money to.

Keynesians make Recessions worse by Keeping Interest Rates low, Preventing a Correction from Happening

John Maynard Keynes changed this system of banking that made the United States the world’s number one economic power.  We call his economic theories Keynesian economics.  One of the changes from the classical school of economics we used to make the United States the world’s number one economic power was the manipulation of interest rates.  Instead of leaving this to free market forces in the banking system Keynesians said government should have that power.  And they took it.  Printing money to make more available to lend.  Thus bringing down interest rates.

And why did they want to bring down interest rates?  To stimulate economic activity.  At least, that was their goal.  To stimulate economic activity to pull us out of a recession.  To even eliminate recessions all together.  To eliminate the normal expansion and contraction of the economy.  By manipulating interest rates to continually expand the economy.  To accept a small amount of permanent inflation.  In exchange for a constantly expanding economy.  And permanent job creation.  That was the Keynesian intention.  But did it work?

No.  Since the Keynesians took over the economy we’ve had the Great Depression, the stagflation and misery of the Seventies, the savings and loans crisis of the Eighties, the irrational exuberance and the dot-com bubble crash of the Nineties, the subprime mortgage crisis and the Great Recession.  All of these were caused by the Keynesian manipulation of interest rates.  And the resulting recessions were made worse by trying to keep interest rates low to pull the economy out of recession.  Preventing the correction from happening.  Allowing these artificially low interest rates to cause even more damage.

The Government’s manipulation of Interest Rates gave us the Subprime Mortgage Crisis and the Great Recession

My friend’s father complained about the low interest rates during the Clinton administration.  For the savings rate offered by banks was next to nothing.  With the Federal Reserve printing so much money the banks didn’t need to attract depositors with high savings rates.  Worse for these savers was the inflation caused by printing all of this money eroded the purchasing power of their savings.  So they couldn’t earn anything on their savings.  And what savings they had bought less and less over time.  But mortgages were cheap.  And people were rushing to the banks to get a mortgage before those rates started rising again.

This was an interruption of normal market forces.  It changed people’s behavior.  People who were not even planning to buy a house were moved by those low interest rates to enter the housing market.  Then President Clinton pushed other people into the housing market with his Policy Statement on Discrimination in Lending.  Getting people who were not even planning to buy a house AND who could not even afford to buy a house to enter the housing market.  Those artificially low interest rates pulled so many people into the housing market that this increased demand for houses started raising house prices.  A lot.  But it didn’t matter.  Not with those low interest rates.  Subprime lending.  Pressure by the Clinton administration to qualify the unqualified for mortgages.  And Fannie May and Freddie Mac buying those risky subprime mortgages from the banks, freeing them up to make more risky mortgages.  This scorching demand pushed housing prices into the stratosphere.

A correction was long overdue.  But the Federal Reserve kept pushing that correction off by keeping interest rates artificially low.  But eventually inflation started to appear from all that money creation.  And the Federal Reserve had no choice but to raise interest rates to tamp out that inflation.  But when they did it caused a big problem for those with subprime mortgages.  Those who had adjustable rate mortgages (ARMs).  For when interest rates went up so did their mortgage payments.  Beyond their ability to pay them.  So they defaulted on their mortgages.  A lot of them.  Which caused an even bigger problem.  All those mortgages Fannie Mae and Freddie Mac bought?  They sold them to Wall Street.  Who chopped them up into collateralized debt obligations.  Financial instruments backed by historically the safest of all investments.  The home mortgage.  Only these weren’t your father’s mortgage.  These were risky subprime mortgages.  But they sold them to unsuspecting investors as high yield and low-risk investments.  And when people started defaulting on their mortgages these investments became worthless.  Which spread the financial crisis around the world.  On top of all of this the housing bubble burst.  And those house prices fell back down from the stratosphere.  Leaving many homeowners with mortgages greater than the corrected value of their house.

It was the government’s manipulation of interest rates that gave us the subprime mortgage crisis.  The Great Recession.  And the worst recovery since that following the Great Depression.  All the result of Keynesian economics.  And the foolhardy belief that you can make recessions a thing of the past.

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Banks, Keynes, Subprime Mortgage Crisis and Great Recession

Posted by PITHOCRATES - June 11th, 2013

History 101

Bringing Borrowers and Lenders Together is a very Important Function of our Banks

Borrowers like low interest rates.  Savers (i.e., lenders) like high interest rates.  People who put money into the bank want to earn a high interest rate.  People who want to buy a house want a low interest rate.  As the interest rate will determine the price of the house they can buy.  Borrowers and lenders meet at banks.  Bankers offer a high enough interest rate to attract lenders (i.e., depositors).  But not too high to discourage borrowers.

This is the essence of the banking system.  And capital formation.  Alexander Hamilton said that money in people’s pockets was just money.  But when the people came together and deposited their money into a bank that money became capital.  Large sums of money a business could borrow to build a factory.  Which creates economic activity.  And jobs.  The United States became the world’s number one economic power with the capital formation of its banking system.  For a sound banking system is required for any advanced economy.  As it allows the rise of a middle class.  By providing investment capital for entrepreneurs.  And middle class jobs in the businesses they build.

So bringing borrowers and lenders together is a very important function of our banks.  And bankers have the heavy burden of determining saving rates.  And lending rates.  As well as determining the credit risk of potential borrowers.  Savers deposit their money to earn one rate.  So the bank can loan it out at another rate.  A rate that will pay depositors interest.  As well as cover the few loans that borrowers can’t pay back.  Which is why bankers have to be very careful to who they loan money to.

Keynesians make Recessions worse by Keeping Interest Rates low, Preventing a Correction from Happening

John Maynard Keynes changed this system of banking that made the United States the world’s number one economic power.  We call his economic theories Keynesian economics.  One of the changes from the classical school of economics we used to make the United States the world’s number one economic power was the manipulation of interest rates.  Instead of leaving this to free market forces in the banking system Keynesians said government should have that power.  And they took it.  Printing money to make more available to lend.  Thus bringing down interest rates.

And why did they want to bring down interest rates?  To stimulate economic activity.  At least, that was their goal.  To stimulate economic activity to pull us out of a recession.  To even eliminate recessions all together.  To eliminate the normal expansion and contraction of the economy.  By manipulating interest rates to continually expand the economy.  To accept a small amount of permanent inflation.  In exchange for a constantly expanding economy.  And permanent job creation.  That was the Keynesian intention.  But did it work?

No.  Since the Keynesians took over the economy we’ve had the Great Depression, the stagflation and misery of the Seventies, the savings and loans crisis of the Eighties, the irrational exuberance and the dot-com bubble crash of the Nineties, the subprime mortgage crisis and the Great Recession.  All of these were caused by the Keynesian manipulation of interest rates.  And the resulting recessions were made worse by trying to keep interest rates low to pull the economy out of recession.  Preventing the correction from happening.  Allowing these artificially low interest rates to cause even more damage.

The Government’s manipulation of Interest Rates gave us the Subprime Mortgage Crisis and the Great Recession

My friend’s father complained about the low interest rates during the Clinton administration.  For the savings rate offered by banks was next to nothing.  With the Federal Reserve printing so much money the banks didn’t need to attract depositors with high savings rates.  Worse for these savers was the inflation caused by printing all of this money eroded the purchasing power of their savings.  So they couldn’t earn anything on their savings.  And what savings they had bought less and less over time.  But mortgages were cheap.  And people were rushing to the banks to get a mortgage before those rates started rising again.

This was an interruption of normal market forces.  It changed people’s behavior.  People who were not even planning to buy a house were moved by those low interest rates to enter the housing market.  Then President Clinton pushed other people into the housing market with his Policy Statement on Discrimination in Lending.  Getting people who were not even planning to buy a house AND who could not even afford to buy a house to enter the housing market.  Those artificially low interest rates pulled so many people into the housing market that this increased demand for houses started raising house prices.  A lot.  But it didn’t matter.  Not with those low interest rates.  Subprime lending.  Pressure by the Clinton administration to qualify the unqualified for mortgages.  And Fannie May and Freddie Mac buying those risky subprime mortgages from the banks, freeing them up to make more risky mortgages.  This scorching demand pushed housing prices into the stratosphere.

A correction was long overdue.  But the Federal Reserve kept pushing that correction off by keeping interest rates artificially low.  But eventually inflation started to appear from all that money creation.  And the Federal Reserve had no choice but to raise interest rates to tamp out that inflation.  But when they did it caused a big problem for those with subprime mortgages.  Those who had adjustable rate mortgages (ARMs).  For when interest rates went up so did their mortgage payments.  Beyond their ability to pay them.  So they defaulted on their mortgages.  A lot of them.  Which caused an even bigger problem.  All those mortgages Fannie Mae and Freddie Mac bought?  They sold them to Wall Street.  Who chopped them up into collateralized debt obligations.  Financial instruments backed by historically the safest of all investments.  The home mortgage.  Only these weren’t your father’s mortgage.  These were risky subprime mortgages.  But they sold them to unsuspecting investors as high yield and low-risk investments.  And when people started defaulting on their mortgages these investments became worthless.  Which spread the financial crisis around the world.  On top of all of this the housing bubble burst.  And those house prices fell back down from the stratosphere.  Leaving many homeowners with mortgages greater than the corrected value of their house.

It was the government’s manipulation of interest rates that gave us the subprime mortgage crisis.  The Great Recession.  And the worst recovery since that following the Great Depression.  All the result of Keynesian economics.  And the foolhardy belief that you can make recessions a thing of the past.

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FT164: “If the poor ever stopped being poor the Democrats would have trouble winning elections.” —Old Pithy

Posted by PITHOCRATES - April 5th, 2013

Fundamental Truth

There is no Greater Killer of Poverty than a Job-Creating Free Market Economy

A lot of people vote Democrat because of the perception that the Democrats are for the little guy.  The working man.  The poor.  The disenfranchised.  The sick.  The maimed.  Children.  Women.  Minorities.  Gays.  Lesbians.  Etc.  While Republicans are for rich white men, bankers, corporate executives, Wall Street investors, etc.  Democrats care about people.  While Republicans care about profits.  Democrats good.  Republicans bad.  At least, that’s the common perception in much of America.

The working man.  That’s who the Democrats are for.  The working man.  And what exactly does ‘the working man’ mean?  It means men who are working.  Obviously.  (We’re using the term ‘working man’ because it’s long been part of the lexicon of the Democrat Party.  But we include both men and women when using the expression ‘the working man’.)  The Democrats champion unions to protect the working man.  And to show their gratitude the unions put all their financial support behind Democrat candidates.  So putting people into good jobs is a very important mission for the Democrat Party.  At least that is the perception.

Jobs.  They are important.  For there is no greater killer of poverty than a job.  Countries that have advanced free market economies have plenty of good-paying jobs.  Where much of the populace lives well above poverty.  Like in Chile.  After Milton Friedman and the Chilean economists known as the ‘Chicago Boys’ ignited free market principles in Chile starting in 1973.  Countries that don’t have advanced free market economies have few good-paying jobs.  Where much of their populace lives in abject poverty.  Such as in Haiti.  And these prosperity/poverty levels impact more than just day-to-day life.

The United States has a High Standard of Living because of a Business-Friendly Environment

Chile suffered a magnitude 8.8 earthquake in 2011.  One of the largest earthquakes ever to be recorded in history.  It claimed approximately 525 lives.  Haiti suffered a magnitude 7.0 earthquake in 2010.  Less powerful than the Chilean earthquake.  Yet the Haitian earthquake claimed approximately 220,000 lives.  The difference between these two death tolls?  More people have good-paying jobs in Chile than they do in Haiti.  Giving Chile a more advanced free market economy.  And better building codes and standards.  Allowing them to survive a stronger earthquake with less loss of life.

This is what jobs give you.  Working people have money to spend.  And working people have money to pay taxes.  Which can lift people out of poverty.  And lift nations out of poverty.  Which is why the United States has such a high standard of living.  Their economy became the number one economy in the world because they had so many jobs.  Thanks to a very business-friendly environment.  The Americans encouraged entrepreneurship.  And supported it with a sound banking system that encouraged capital formation.  Thanks to all those workers saving some of their earnings for the future.  Savings that provided the capital that built America.

So jobs are good.  And providing jobs for the working man is even better.  Because that’s what a working man wants.  A job.  So the Democrats, then, should be all about job creation.  If they are for the working man.  As is the perception.  But is this perception correct?  Well, if you determine that by the number of jobs they’ve created, no.

The Obama Policies are Business Unfriendly to Keep People Poor so the Democrats have Someone to Champion

Before George W. Bush became president in 2001 there were 210,743,000 in the civilian non-institutional population (see Employment Situation Archived News Releases).  Basically those who could have a job.  Of those who could have a job there were 141,489,000 in the civilian labor force.  By the time Bush left office there were 154,587,000 in the civilian labor force.  An increase of 13,098,000 to the civilian labor force.  Which is an increase of 1,637,240 annually.  Or 136,438 monthly.  So this is what a Republican did for the working man.  Now let’s see what a Democrat did.

Before Barack Obama became president in 2009 there were 154,687,000 in the civilian labor force.  At the end of March 2013 there were 155,028,000 in the civilian labor force.  An increase of 441,000.  Which is an increase of 103,765 annually.  Or 8,647 monthly.  The Bush economy created more jobs in a month that the Obama economy created in a year.  In fact, for every job the Obama economy created the Bush economy created 15.8 jobs.  So if you determine who is for the working many by who gives the working man more of what he wants, jobs, it is clear that the Republican is for the working man.  Not the Democrat.

No, President Obama’s economic policies are not business-friendly.  They are decidedly unfriendly to business.  Even punitive.  Which is why there has been no real job creation with the Obama economic policies.  Wall Street may be doing well.  The stock market may be doing well.  But the working man sure isn’t.  In fact, those who are doing well in the Obama economy are rich white men, bankers, corporate executives, Wall Street investors, etc.  So if the Democrats are not for the working man who are they for?  Poor people.  In fact, they love poor people so much that they work hard at keeping them poor.  Giving them a meager government handout instead of a job.  Which is how they win elections.  By giving poor people free stuff.  And if the poor ever stopped being poor the Democrats would have trouble winning elections.  Which is why the Obama economic policies are so business unfriendly.  So there are always poor and impoverished people they can champion.

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Thomas Jefferson, Alexander Hamilton, Agrarian Past, Industrial Revolution, Federalists, Republicans, Reynolds Affair and Philip Freneau

Posted by PITHOCRATES - September 20th, 2012

Politics 101

Jefferson could not Turn a Profit on his Plantation and was Forever in Debt Leading to a Lifelong Disdain for Merchants and Bankers

At the time of the Founding America was (and would be for a long time) an agrarian nation.  A country of farmers.  Big and small.  Rich plantations.  And lots of hard-working family farms that were far from being rich.  Yeomen famers.  Who, to borrow a phrase from Oliver Wendell Douglas, “got their hands dirty!”  For those of you too young to recognize this line it’s from the 1960s classic sitcom Green Acres.  Where Douglas was a rich New York City (NYC) attorney who moved out of NYC to Hooterville to be a farmer.  Who he called the backbone of America.  Much like Thomas Jefferson.

Douglas and Jefferson shared a lot in common.  Both were lawyers.  Both were part of high society.  And both could make a good speech (or put something great in writing).  Douglas lived on Park Avenue in NYC.  And he and his wife travelled in the top social circles.  Just like Jefferson.  They both enjoyed the best of the best.  But neither were very good farmers.  The Douglas farm was a disaster despite his best efforts.  While Jefferson could not turn a profit on his plantation.  And was forever in debt.  Leading to a lifelong disdain for merchants and bankers.  Especially merchant bankers.

Alexander Hamilton was born on the British Isle of Nevis.  And raised in St. Croix.  Hamilton was a bastard child.  Illegitimate.  A stigma that spurred him to do everything aggressively in his life to show he was not a second-class person.  He worked at an early age.  In commerce.  And he was very good.  A natural.  Very smart.  And brave.  A veteran of two American wars.  He loved America.  But having been born and raised outside of the country he had no allegiance to any state.  Put it all together and it made Hamilton a nationalist.

Jefferson wanted to hold on to the Agrarian Past while Hamilton wanted to bring on the Industrial Revolution

Hamilton was just as much a Patriot as the other Founding Fathers.  Perhaps more so as he actually served in the Continental Army.  And while serving he saw how poor military power and poor financial power made a country dangerously weak.  The Americans almost lost their Revolution because of a weak nation that could not provide for her army.  So he wanted to make America strong.  And united.  The key in Hamilton’s eyes to making America a powerful nation (like Great Britain) that could stand up against any enemy was a strong union.  And in the Washington administration he advanced policies towards that end.  Ironically, policies that would do more to drive the nation apart.

So Hamilton (Secretary of Treasury) and Jefferson (Secretary of State) could not be more different.  And as they started to push their agendas in the Washington administration they grew to hate each other.  For their visions for America couldn’t be more different.  Despite both being ardent Patriots.  Jefferson wanted to hold on to the agrarian past.  While Hamilton wanted to bring on the Industrial Revolution.  Jefferson believed in the landed aristocracy built upon virtue and talent.  Not the aristocracy money could buy you.  Or birth or a title like in a monarchy.  Which Jefferson believed Hamilton was trying to turn America into.  As did all the farmers throughout the South and in the West.  Who all hated bankers and merchants.  Those people who made money off of other people’s labors.  Investors and speculators.  While speculation in land, on the other hand, was perfectly acceptable as it was what the southern gentry did to acquire their wealth.

And so began the political parties.  The Federalists were for a strong national government that Hamilton tried to make as strong as possible.  And the anti-Federalists.  Who already felt that the national government had grown too strong.  Or as they would become under Jefferson’s leadership, the Republicans (which were NOT the forbears of the current Republican Party).  In general, southern planters.  While Hamilton led the Federalists.  In general, northern businessmen.  The game of politics was born.  And it got dirty pretty quickly.  Thanks to each party’s friends in the media.  The newspapers of the day.  Which were pretty much political arms of these parties.

The Newspapers launched Vitriol at each Other including a Lot of Lies, Slander and Libel

The Treasury Department was the largest government department.  It was huge.  With a huge budget.  Whereas the State Department was basically Jefferson and a few clerks.  Hamilton no doubt felt he was the most important man in America next to the president.  And Jefferson was sure that Hamilton was using his position to steal money from the treasury.  So sure that Jefferson and his Republicans launched Congressional investigations that turned up nothing.  Convincing Jefferson that Hamilton was a better thief than even he had imagined.  Jefferson still pressed and had a colleague introduce multiple resolutions in Congress against Hamilton hoping to get Hamilton thrown from office on a House vote.  The House voted down all resolutions.

James Reynolds was a con man who made his money by defrauding veterans.  And other criminal pursuits.  Tired of the scale of these scores he came to Philadelphia to make some bigger money.  By using his wife, Maria, to seduce and have an affair with Alexander Hamilton.  So he could blackmail him.  Which she did.  Then he did.  When Reynolds’ criminal past caught up with him and sent him to jail he talked about the affair.  Which was more than just an affair.  He told some Republicans that he and Hamilton were using treasury funds to fund speculation for personal gain.  Jefferson and the Republicans were overjoyed.  Sure that they at last had a way to get rid of Hamilton. When confronted in his home to answer these charges he fessed up and told the truth.  Which included no speculation with treasury funds.  While all the money paid to Reynolds came from his own pocket.  All treasury funds were present and accounted for.  Politicians being the gentlemen they were then were satisfied and promised to never speak of Hamilton’s marital indiscretions.

So the political battle between Hamilton and Jefferson would carry on in the press.  Hamilton contributed most of his writings to the Gazette of the United States which wrote positively about Federalist policies.  And enjoyed a national circulation.  So Jefferson countered that by setting up a Republican national paper.  The National Gazette.  Who James Madison helped kick off by convincing Philip Freneau to come to Philadelphia to edit the paper.  Which he did.  And Jefferson helped him with his finances by hiring him into the State Department.  Putting him on the payroll to attack Washington’s treasury secretary while he was the sitting Secretary of State.  Trying to undermine the very administration he belonged to.  And the war between the two men escalated.  The papers launched vitriol at each other.  Including a lot of lies, slander and libel.  Enlisting other papers to join in the journalistic malfeasance.  People who talk about negative political campaigns today have no idea how ugly it was back then.  There was no interest in reaching across the aisle.  They just wanted to destroy the opposition so they could advance their policies.   Much like it is today.  Only without it being about principle.  But advancing the privileged government class.  That other aristocracy that Jefferson hated.

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Goldsmiths, Specie, Bank Notes, Bank Reserves, Spanish Dollar, Continentals, Bank of the United States and the Panic of 1819

Posted by PITHOCRATES - June 26th, 2012

History 101

When Spain came to the New World they Brought Home a lot of Gold and Silver and Turned it into Coin

Our first banks were goldsmiths’ vaults.  They locked up people’s gold or other valuable metals (i.e., specie) in their vaults and issued these ‘depositors’ receipts for their specie.  When a depositor presented their receipt to the goldsmith he redeemed it for the amount of specie noted on the receipt.  These notes were as good as specie.  And a lot easier to carry around.  So these depositors used these notes as currency.  People accepted them in payment.  Because they could take them to the goldsmith and redeem them for the amount of specie noted on the receipt.

The amount of specie these first bankers kept in their vaults equaled the value of these outstanding notes.  Meaning their bank reserves were 100%.   If every depositor redeemed their notes at the same time there was no problem.  Because all specie that was ever deposited was still in the vault.  So there was no danger of any ‘bank runs’ or liquidity crises.

When Spain came to the New World they brought home a lot of gold and silver.  And turned it into coin.  Or specie.  The Spanish dollar entered the American colonies from trade with the West Indies.  As the British didn’t allow their colonies to coin any money of their own the Spanish dollar became the dominate money in circulation in commerce and trade in the cities.  (Which is why the American currency unit is the dollar).  While being largely commodity money in the rural parts of the country.  Tobacco in Virginia, rice in the south, etc.  Paper money didn’t enter into the picture until Massachusetts funded some military expeditions to Quebec.  Normally the soldiers in this expedition took a portion of the spoils they brought back for payment.  But when the French repulsed them and they came back empty handed the government printed paper money backed by no specie.  For there was nothing more dangerous than disgruntled and unpaid soldiers.  The idea was to redeem them with future taxation.  But they never did. 

Thomas Jefferson believed that the Combination of Money and Politics was the Source of all Evil in Government 

During the American Revolutionary War the Americans were starving for specie.  They were getting some from the French but it was never enough.  So they turned to printing paper money.  Backed by no specie.  They printed so much that it became worthless.  The more they printed the more they devalued it.  And the fewer people would take it in payment.  Anyone paying in these paper Continentals just saw higher and higher prices (while people paying in specie saw lower prices).  Until some just refused to accept them.  Giving rise to the expression “not worth a Continental.”  And when they did the army had to take what they needed from the people.  Basically giving them an IOU and telling the people good luck in redeeming them.

Skip ahead to the War of 1812 and the Americans had the same problem.  They needed money.  So they turned to the printing presses.  With the aid of the Second Bank of the United States (BUS).  America’s second central bank.  Just as politically contentious as the First Bank of the United States.  America’s first central bank.  The BUS was not quite like those early bankers.  The goldsmiths.  Whose deposits were backed by a 100% specie reserve.  The BUS specie reserve was closer to 10%.  Which proved to be a problem because their bank notes were redeemable for specie.  Which people did.  And because they did and the BUS was losing so much of its specie the government legislated the suspension of the redemption of bank notes for specie.  Which just ignited inflation.  With the BUS.  And the state banks.  Who were no longer bound by the requirement to redeem bank notes for specie either.  Enter America’s first economic boom created by monetary policy.  A huge credit expansion that created a frenzy of borrowing.  And speculation.

When more dollars are put into circulation without a corresponding amount of specie backing them this only depreciated the dollar.  Making them worth less, requiring more of them to buy the same stuff they did before the massive inflation.  This is why prices rise with inflation.  And they rose a lot from 1815 to 1818.  Real estate prices went up.  Fueling that speculation.  Allowing the rich to get richer by buying land that soared in value.  While ordinary people saw the value of their currency decline making their lives more difficult.  Thanks to those higher prices.  The government spent a lot of this new money on infrastructure.  And there was a lot of fraud.  The very reason that Thomas Jefferson opposed Alexander Hamilton’s first Bank of the United States.  The combination of money and politics was the source of all evil in government.  And fraud.  According to Jefferson, at least.  Everyone was borrowing.  Everyone was spending.  Which left the banks exposed to a lot of speculative loans.  While putting so much money into circulation that they could never redeem their notes for specie.  Not that they were doing that anyway.  Bank finances were growing so bad that the banks were in danger of failing.

Most Bad Recessions are caused by Easy Credit by a Central Bank trying to Stimulate Economic Activity 

By 1818 things were worrying the government.  And the BUS.  Inflation was out of control.  The credit expansion was creating asset bubbles.  And fraud.  It was a house of cards that was close to collapsing.  So the BUS took action.  And reversed their ruinous policies.  They contracted monetary policy.  Stopped the easy credit.  And pulled a lot of those paper dollars out of circulation.  It was the responsible thing to do to save the bank.  But because they did it after so much inflation that drove prices into the stratosphere the correction was painful.  As those prices had a long way to fall.

The Panic of 1819 was the first bust of America’s first boom-bust cycle.  The first depression brought on by the easy credit of a central bank.  When the money supply contracted interest rates rose.  A lot of those speculative loans became unserviceable.  With no easy credit available anymore the loan defaults began.  And the bank failures followed.  Money and credit of the BUS contracted by about 50%.  Businesses couldn’t borrow to meet their cash needs and went bankrupt.  A lot of them.  And those inflated real estate prices fell back to earth.  As prices fell everywhere from their artificial heights.

It was America’s first depression.  But it wouldn’t be the last.  Thanks to central banking.  And boom-bust cycles.  We stopped calling these central banking train wrecks depressions after the Great Depression.  After that we just called them recessions.  And real bad recessions.  Most of them caused by the same thing.  Easy credit by a central bank to stimulate economic activity.  Causing an asset bubble.  That eventually pops causing a painful correction.  The most recent being the Great Recession.  Caused by the popping of a great real estate bubble caused by the central bank’s artificially low interest rates.  That gave us the subprime mortgage crisis.  Which gave us the greatest recession since the Great Depression.  Just another in a long line of ‘real bad’ recessions since the advent of central banking.

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Venture Capital and Private Equity

Posted by PITHOCRATES - May 28th, 2012

Economics 101

An Idea is only an Idea unless there’s Capital to Develop it and a Business Plan

People put money in the bank to save it.  And to earn interest.  To make their savings grow.  So they can afford a down payment on a house one day.  Or start up a business.  To start a college fund.  Or a variety of other things.  They put their money into a bank because they have confidence that the bank will repay that money whenever they want to withdraw it.   And confident that the bank will earn a profit.  By prudently loaning out their deposits in business loans, mortgages, equity loans, etc.  So the bank can pay interest on their savings.  And make it grow.  While not risking the solvency of the bank by making risky loans that people won’t be able to repay.  With responsible saving and responsible lending both parties achieve what they want.  And the economy grows.

A high savings rate means banks can make more loans.  And businesses can borrow more to expand their businesses.  This is a very critical element in capitalism.  Getting capital to the people who need it.  Who can do incredible things with it.  Create new jobs.  Develop a new technology.  Find a better way to use our limited resources.  Bringing consumer prices down and increasing our standard of living.  Because when prices go down we can buy more things.  So we don’t have to sacrifice and go without.  We have a higher standards of living thanks to capitalism.  And the efficient use of capital.

As technology advanced individuals had more and more brilliant ideas.  But an idea is only an idea unless there’s capital to develop it.  And a business plan.  Something a lot of brilliant entrepreneurs are not good at.  They may think of a great new use of technology that will change the world.  Their mind can be that creative.  But they don’t know how to put a business plan together.  Or convince a banker that this idea is gold.  That this innovation is so new that no one had ever thought of it before.  That it’s cutting edge.  Paradigm shifting.  And it may be that and more.  But a banker won’t care.  Because bankers are conservative with other people’s money.  They don’t want to loan their deposits on something risky and risk losing it.  They want to bet on sure things.  Loan money to people that are 99% certain to repay it.  Not take chances with new technology that they haven’t a clue about.

Venture Capitalists make sure their Seed Capital is Used Wisely so it can Bloom into its Full Potential

Enter the venture capitalists.  Who are the polar opposite of bankers.  They are willing to take big risks.  Especially in technology.  Because new technologies have changed the world.  And made a lot of people very wealthy.  Especially those willing to gamble and invest in an unknown.  Those who provide the seed money for these ventures in the beginning.  That’s their incentive.  And why they are willing to risk such large sums of money on an unknown.  Something a banker never would do.  Who say ‘no’ to these struggling entrepreneurs.  And tell them to come back when they are more established and less risky. 

This is responsible banking.  And this is why people put their money into the bank.  Because bankers are conservative.  But there is a price for this.  Lost innovation.  If no one was willing to risk large sums of money on unknowns with brilliant ideas the world wouldn’t be the same place it is today.  This is what the venture capitalists give us.  Innovation.  And a world full of new technology.  And creature comforts we couldn’t have imagined a decade earlier.  Because they will risk a lot of money on an unknown with a good idea.

Most venture capitalists have been there before.  They were once that entrepreneur with an idea that turned it into great success.  That’s part of the reason they do this.  To recapture the thrill.  While mentoring an entrepreneur into the ways of business.  Like someone once did for them.  But it’s also the money.  They expect to make a serious return on their risky investment.  So much so that they often take over some control of the business.  They do what has to be done.  Make some hard decisions.  And make sure they use their investment capital wisely.  Sometimes pushing aside the entrepreneur if necessary.  To make sure that seed capital can bloom into its full potential.  Perhaps all the way to an initial public offering of stock.  And when it does everyone gets rich.  The entrepreneur with the good idea.  And the venture capitalist.  Who now has more seed capital available for other start-ups with promise.

The Goal of the Private Equity Firm is to Get In, Fix the Problems and Get Out

Venture capital belongs to the larger world of private equity.  Where private equity investment firms operate sort of like a bank.  But with a few minor differences.  Instead of depositors they have investors.  Instead of safe investments they have risky investments.  Instead of low returns on investment they have high returns on investment.  And instead of a passive review of a firm’s financial statements by a bank’s loan officer they actively intervene with business management.  Because private equity does more than just loan money.  They fix problems.  Especially in underperforming businesses.

A mature business that has seen better days is the ideal candidate for private equity.  The business is struggling.  They’re losing money.  And they’ve run out of ideas.  Management is either blind to their problems or unable (or unwilling) to take the necessary corrective action.  They can’t sell because business is too bad.  They don’t want to go out of business because they’ve invested their life savings to try and keep the business afloat.  Only to see continued losses.  Their only hope to recover their losses is to fix the business.  To make it profitable again.  And selling their business to a private equity firm solves a couple of their problems fast.  First of all, they get their prior investments back.  But more importantly they get hope. 

The private equity firm uses some of their investment capital to secure a large loan.  The infamous leveraged buyout which has a lot of negative connotations.  But to a business owner about to go under and lose everything the leveraged buyout is a blessing.  And it’s so simple.  A private equity firm buys a business by taking on massive amounts of debt.  They put that debt on the business’ books.  Debt that future profits of the business will service.  Once the equity firm does its magic to restore the business to profitability.  Starting with a new management team.  Which is necessary.  As the current one was leading the firm to bankruptcy.  They may interview people.  Identify problems.  Find untapped potential to promote.  They may close factories and lay off people.  They may expand production to increase revenue.  Whatever restructuring is necessary to return the firm to profitability they will do.  Their goal is to get in, fix the problems and get out.  Selling the now profitable business for a greater sum than the sum of debt and equity they used to buy it.

But with great risk comes the chance for great failure.  When it works it works well.  Producing a huge return on investment.  But sometimes they can’t save the business.  And the firm can’t avoid bankruptcy.  The business then will be liquidated to repay the banks who loaned the money.  While the equity the firm invested is lost.  Which is why they need to make big profits.  Because they suffer some big losses.  But they typically save more businesses than they fail to save.  And the businesses they do save would have gone out of business otherwise.  So in the grand scheme of things the world is a better place with private equity.

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Democrat (dĕm’ə-krăt’), n., A member of the Democrat Party, the more liberal of the two major political parties in the United States.

Posted by PITHOCRATES - November 17th, 2011

Politics 101

The Planter Elite was a Small Minority in the South but these Southern Democrats Wielded the Political Power

People often say that the Democrat Party is for the working man.  Which is rather ironic as it has more often been the party of privilege.  It was also the party of slavery.  The party of Jim Crowe Laws.  The party of segregation.  And the party to have an Exalted Cyclops of the KKK as a high-ranking member of Congress.  Senator Byrd.  Who later filibustered against the 1964 Civil Rights Act.  Which is another irony.

Black voters tend to vote Democrat despite this history.  At the time of the Civil War it was Northern Republicans against Southern Democrats.  The Southern states seceding from the Union to keep their slaves.  And the institution of slavery.  For the plantation system was a throwback to Old World aristocracy.  Only with slaves instead of peasants.  The Planter Elite was a small minority in the South.  But they wielded the political power.  And owned all of the good land.  Like in any landed aristocracy.  And slavery worked that good land.  That peculiar institution that survived long past the 20 years the Founding Fathers thought it would.  Of course, the Founding Fathers never counted on Eli Whitney.  Or his cotton gin.

Today’s Democrats can trace their lineage back to Thomas Jefferson’s Republican Party.  And to the man who wrote “all men are created equal.”  The hero of the yeoman farmer.  The backbone of the new republic.  Only Thomas Jefferson was more equal than most.  He was part of the landed aristocracy of the South, the planter elite.  Wealthy.  Refined.  A bit of a dandy.  And a hypocrite.  To some.

Thomas Jefferson saw the Corruption Resulting from Mixing Money and Government

Thomas Jefferson was brilliant.  Well read.  And had strong beliefs.  He understood politics.  And he knew world history.  He hated bankers and merchants.  Saw the corruption resulting from mixing money and government.  And especially hated Alexander Hamilton.  The secretary of the treasury.  And puppet master of George Washington.  Or so he believed.

Hamilton was a capitalist.  He understood money.  And the power of capital.  Ergo he was a sneaky bastard.  Corrupt.  And possibly the devil.  In Jefferson’s eyes.  So he worked tirelessly to destroy Hamilton.  Put a man on the federal payroll to help fund an opposition newspaper.  And slandered the hell out of him.  Exposed the affair with Mrs. Reynolds but left out the part about the Reynolds being crooks.  Mrs. Reynolds seduced Hamilton so Mr. Reynolds could blackmail him.  She did.  He did.  And Hamilton paid.  With his own money.  But Jefferson accused him of embezzling from the treasury to pay off the Reynolds.  And later lamented that Hamilton was such a good thief that they found absolutely no evidence of his heinous crimes.

When Jefferson was president, though, he did something very Hamiltonian.  He bought the Louisiana Territory.  Something that Hamilton would have done in a heartbeat.  And something Jefferson would have fought tirelessly against if he tried.

The Democrat Party is the Party of the Working Man as long as that Working Man belongs to a Union

So was Jefferson a hypocrite?  Sort of.  To many he was.  To himself, though, he wasn’t.  In his mind there was no contradiction in any of his actions.  For Jefferson’s mind could believe two conflicting truths at the same time.  He didn’t lie.  He didn’t flip flop.  These were not contradictions.  But paradoxes.  For the truth was nimble and flexible in his pragmatic vision.  And in that vision was an agrarian economy.  No banks.  A weak merchant class.  And a very limited and anemic federal government.  That spoke with a southern accent.  In other words a federal government was okay per se as long as Virginia and the planters of the other southern states controlled it.  Which they did for nearly a century thanks to the Three-Fifths Compromise.  That counted slaves as three-fifths a person for representation (giving the South more representatives per district than the North).  But not for taxation.

Privilege.  Born of the plantation system in America.  Based on the institution of slavery.  Where a small minority wielded great political power.  And exploited people (slaves) to accumulate wealth.  Protect their power.  And their privilege.  Not unlike the modern Democrat Party.  But today, because of the abolition of slavery, they have to do things differently.

Yes, the Democrat Party is the party of the working man.  As long as that working man belongs to a union.  Pays union dues.  And that union supports the Democrat party.  Working men who don’t are scabs.  And don’t deserve to have jobs.  So Democrat legislation favors Big Labor.  And unions.  Makes it hard for nonunion companies to compete for work.  And jobs using federal money have to pay union wages.  Either by union employees.  Preferably.  Or scabs earning union scale thanks to Davis-Bacon.  Which they would rather not have.  Because scabs earning union scale thanks to Davis-Bacon still don’t pay union dues.  But it at least makes it harder to compete against union companies.

Privilege Begets Privilege

This is the formula for most Democrat support.  Automotive workers (UAW).  Health care workers (SIEU).  Public sector workers (public sector unions).  Public school teachers (teachers unions).  And so on.  Privilege begets privilege.  You get favorable legislation as long as part of your union dues goes to Democrat coffers.  And if Democrats win control of Congress they will implement more anti-capitalistic legislation.  Impose tariffs to protect union jobs.  Increasing costs to taxpayers everywhere.  To support this privilege class.  So it’s who you know.  And not your ability.  Just like it was in the good old days.

To bolster their power they have to appeal to others in the electorate who aren’t union employees.  Because there just aren’t enough union employees.  Yet, at least.  So they also delve into crony capitalism.  Picking winners and losers in the private sector.  By supporting companies in favorable industries with grants and loan guarantees.  The winners being those who support Democrat candidates.  Privilege begets privilege.  The losers being those who don’t.  And these poor bastards not only don’t get grants or loan guarantees.  But the government saddles them with costly regulations to boot.  Or the Justice Departments initiates antitrust proceedings against them.  Like Microsoft.

Of course it takes Big Government to play like this.  And Big Government needs a lot of taxes.  For to spend money you have to first tax.  Or play with monetary policy.  Which is why Democrats will always oppose returning to the gold standard.  Because sometimes you can’t tax and spend.  Sometimes you have to print money and spend.  And you can’t do that with a gold standard.  But because of the problems inherent with printing money (inflation), they will tax every last penny they can first.  And their weapon of choice is class warfare.  To get the poor and middle class to agree to increase tax rates on the rich.  Which they are all for.  But what they don’t know is that Democrats are constantly redefining who is rich.  Which they would not be for.  Because a lot of people are being surprised to find out that they are now rich.  Especially modest middle class couples (say a cop and a teacher) whose combined income make them rich.  Much to their surprise.

The Democrat Party is For Sale to the Highest Contributor

The Democrats round out their base by appealing to populist issues.  They play down the God stuff and keep abortion legal to keep the youth vote.  And the feminists.  By showing that the government is not your parents when it comes to sex.  Or drugs (the youth is ever hopeful for the Democrat who finally decriminalizes marijuana).  Which is ironic as that same government acts like parents everywhere else.  Policing what we eat, drink and legally smoke.

They increase welfare spending to keep the poor dependent.  And voting Democrat.  They appeal to special interests (environmentalists, gays and lesbians, etc.) to get their support, too.  By painting their opponents as vicious monsters who want to destroy the environment.  Who want to criminalize being gay.  And who want to bring back the Spanish Inquisition.

You see, the modern Democrat Party has to buy votes.  Or lie to scare people.  Because people don’t willingly vote to give privilege to others.  Unless there’s something in it for them.  And this is where the modern Democrat Party breaks from Thomas Jefferson.  Jefferson did things to prevent money from influencing power.  And he did some pretty shady things.  But they were for a higher purpose.  To keep the spirit of 1776 alive.

The higher purpose of the Democratic Party?  The Democratic Party.  And unlike Jefferson, they’re all for influencing power with money.  In fact, the Democrat Party is for sale to the highest contributor.

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If Corporations are Vile and Evil why do Democrats/Feminists want Women to Run Them?

Posted by PITHOCRATES - October 30th, 2011

Week in Review

The Occupy Wall Street movements linger on.  In their battle against capitalism.  Bankers.  And corporations.  The greatest scourge known to human kind.  President Obama has expressed some support for these protesters.  And the Democrats are on board with them.  To teach corporate America a lesson.  All the while trying to put more women into the CEO positions of these evil, vile corporations (see Number of female ‘Fortune’ 500 CEOs at record high by Laura Petrecca posted 10/26/2011 on USA Today).

If no women step down before the end of 2011, there will be 18 women running Fortune 500 companies in 2012. Previously, there haven’t been more than 16 female CEOs at Fortune 500 firms at the same time.

Yet, while the upcoming ascensions are notable, the gender gap between men and women in the workplace remains vast, with females struggling to get the mentors they need and the pay to equal their male counterparts.

If these are so evil and vile why is it so important to get more women running them?

The Democrats claim the feminists.  They are always fighting for the equality of the sexes.  Yet it is the Democrats throwing in with the Occupy Wall Street protesters.  Those people who hate these evil, vile corporations.  So are corporations bad?  And if so why do Democrats want women running them?

Anecdotally speaking, men are also more apt to quickly say “yes” to a career-enhancing assignment that could affect their personal life, while women tend to consider how the opportunity could affect home situations such as elder care or child care, Catalyst’s Soon says.

In turn, the next time a manager has a job to offer, he or she may remember that woman’s hesitation and consider going with another candidate, she says.

So I guess there are differences between the sexes.  One cares about children and parents.  The other doesn’t.  They’re just a bunch of selfish bastards.  So that’s why we pay men more.  Because they put career ahead of children and parents.  The selfish bastards they are.

Of course, in choosing a CEO for a corporation, being that kind of selfish bastard is definitely a plus.  Besides, corporations are vile and evil.  Better a selfish bastard run them than a selfless, good woman.

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FUNDAMENTAL TRUTH #86: “Smug, all-knowing condescension camouflages a vacuous philosophical basis.” –Old Pithy

Posted by PITHOCRATES - October 4th, 2011

Did the Ivy League make George W. Bush an Idiot?  And, if so, is Barack Obama also an Idiot?

Have you ever been belittled by a liberal?  After getting pulled into a conversation, say, about George W. Bush?  Or Ronald Reagan?  I have.  And often.  So often that I avoid these debates with liberals anymore.  Because you can’t debate with liberals.

I remember after George W. Bush won reelection.  Two liberals were having a discussion near me at work.  They just couldn’t believe how stupid the American people were.  One was a fifty year old hippy who still dressed like she was 20.  The other had a love affair with France.  Even loved Napoleon.  Funny.  As she hated George W. Bush for waging war.  And he didn’t wage half the war Napoleon did.

Anyway, I piped up.  I said why are Americans so stupid?  For reelecting George W. Bush?  They said because George W. Bush was an idiot.  I asked them to elaborate.  They did not.  Apparently, there was nothing more to say.  No specific examples.  No discussion of underlying philosophies.  Just that George W. Bush was an idiot.  Case closed.  An idiot, I might add, that was educated in their beloved liberal Ivy League.  The same Ivy League that educated Barack Obama.  And the majority of the power players in Washington.

Liberals know Everything and can Say Anything no matter how Silly and Asinine it Is

Of course, it didn’t end there.  Because I didn’t accept ‘he’s an idiot’ as an intelligible response to my question why were Americans so stupid, guess what?  I was stupid.  I was one of the great uneducated masses who should not be allowed to vote in their preferred world.  Then the ridicule came.

Their only response to my question was name calling.  Of the president.  And the American people.  No ideological discussion whatsoever.  And they laughed at me with that all knowing condescension.  They were liberals.  They knew everything.  And could say anything.  No matter how silly and asinine it was.  And because I question them I hated the poor.  I was a warmonger.  And a fascist.

The last was rather amusing.  Because I was a conservative.  Still am.  And conservatives hate fascism.  Or corporatism.  Big time government involvement in the private sector economy.  Like they want.  Making them the fascists.  Not me.  From what I could glean they were in favor of the state redistributing wealth.  Taking from the rich to give to the poor.  Like the hippy protestors of the Sixties.  They just wanted to stick it to the man.  Have sex (the old hippy had a bumper sticker saying something about being proud to be an ex-porn star.  I don’t think she was.  She just liked being provocative.  And having lots of sex.  Based on the conversations she had within earshot).  And, of course, decriminalize pot.

Liberals hate Corporations, Bankers and Republicans

They were your quintessential liberals.  Ignorant.  They hated Republicans because they want to take their freedoms away.  Because it’s Republicans that keep drugs illegal.  It’s Republicans that want to criminalize abortion.  Take away your welfare.  Who refuse to raise the minimum wage to a living wage.  Who let people get rich.  And refused to confiscate rich people’s wealth when they get rich.

They hate Republicans because they are too friendly to corporate America.  Who think more of their shareholders (the corporation owners who hire people for the express purpose of making a profit for them).  Than the American people.  And enslave the American people to maximize profits.  By charging high prices for expensive goods.  Charging interest on loaned money.  And tricking American people into living beyond their means and accumulating debt.  That they charge interest on.

Liberals hate corporations.  And Republicans.  They would like to abolish interest.  And all debt.  From sovereign debt.  To credit card debt.  Just make it go away.  And let the evil bankers just write it off.  They would like to have free health care for everyone.  And a minimum living wage for everyone.  Whether they work or not.  That’s their kind of freedom.  Of course, to have it they’ll have to bring back the institution of slavery.

Liberals Created an Aristocracy for themselves by Taxing the Productive People to Excess

Yes, you heard right.  Their freedom is another’s slavery.  For they want a welfare state.  Where the poor get everything they could ever want from cradle to grave.  And how do you pay for all of this free stuff?  By taxation, of course.  Before the government redistributes any wealth someone has to create it first.  People with jobs.  Or who own businesses.  People that have value that trade with others who have value in the free market economy.  We are traders.  And you can’t trade with someone who doesn’t produce anything of value.

Money came into being as a way to make this trading things of value easier.  People traded their things of value (goods and/or services) for money.  Then traded that money for other things of value they wanted.  It made going to the market a whole lot easier.  You didn’t have to find people to trade with who had what you wanted while having what they wanted.  You simply found what you wanted.  And paid for it.  With the money you had from selling your things of value.

Government grew from taxing these productive people.  At first just enough to provide the public goods of society.  Then liberals created an aristocracy for themselves by taxing the productive people to excess.  For liberals don’t create anything of value.  They get worthless college degrees and get worthless jobs.  In the public sector.  Or in the private sector that survives on public sector funding, i.e., crony capitalism.  They are parasites.  Living off of the productive people.  Who pay for the welfare state.

Houses are Built when Productive People Trade different Sets of Skill for Money

So let’s play make believe.  Let’s say the liberals get their way.  Like the old hippy and France lover.  Let’s say they take all the wealth from the rich.  They abolish all debt.  Make it a crime to loan money.  What will that do?  Make home owning a thing of the past for one.  Because most Americans could never buy a house without a mortgage.

Wait a minute, the liberals will scream.  That won’t happen.  Because government will just give houses to the people.  Really?  But who will build them?  If people can’t get a mortgage to pay a builder, how will the builder pay the carpenters, electricians, plumbers, roofers, etc., who build these houses?  People don’t work for free.  You see, these skilled trades trade their skills (carpentry, electrical, plumbing, etc.) with builders.  Builders trade their skill (financing and construction management) with skilled trades.  Banks trade their skills (mortgage banking) with builders.  This is how people build houses.  Productive people trade different sets of skill for money.  The end result is that people can get a mortgage and buy a house.  With the money they earn from trading their skills.

So if the liberals get their way and get rid of the things they hate then there is only one way to build houses.  Slavery.  Forcing carpenters, electricians, plumbers, etc, to work for the state.  For free.  Like a slave.  So the state can redistribute their wealth (i.e., their skill) to others.  Because people won’t willingly give their skills away for free.  That’s why they join unions.  To get the best deal they can get for their skills.  Which is another thing liberals will have to get rid of to live in their utopia.  Unions.

Liberals are about as Ignorant as they Come and have no Understanding of Basic Economics

Liberals have a smug, all-knowing condescension for people who don’t share their views.  In their minds they are brilliant people.  Because they parrot what other liberals say.  Because in their minds they think that makes them sound brilliant.  But they’re not.  They are about as ignorant as they come.  They have no understanding of basic economics.  And their pretentious airs only camouflage a vacuous philosophical basis.

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LESSONS LEARNED #82: “Too much debt is always a bad thing.” – Old Pithy

Posted by PITHOCRATES - September 8th, 2011

Thomas Jefferson hated Alexander Hamilton for his Assumption and Funding Plans 

Thomas Jefferson hated Alexander Hamilton.  For a variety of reasons.  He thought he was too cozy with the British.  And too anti-French.  He also thought Hamilton was too cozy with the merchant class and bankers.  Jefferson hated them, too.  For he thought honest Americans farmed.  Not buy and sell things other people made.  Or loaned money.

But Hamilton was not a bad guy.  And he was right.  George Washington, too.  America’s future was tied to the British.  Trade within their empire benefited the fledging American economy.  And the Royal Navy protected that trade.  For they ruled the seas.  They couldn’t get that from France.  Especially with a France waging war against everyone.

But there was something especially that Jefferson hated Hamilton for.  Assumption.  And funding.  The new nation’s finances were a mess.  No one could figure them out.  There was pre-war debt.  And war debt.  State debt.  And national debt.  The Americans owed their allies.  Neutral nations.  And the former enemy they just won their independence from.  Getting their hands around what they owed was difficult.  But important.  Because they needed to borrow more.  And without getting their finances in order, that wasn’t going to happen.

Thomas Jefferson Understood that a Permanent Debt gave a Government Power 

Hamilton was good with numbers.  And he put America’s financial house in order.  A little too well for Jefferson.  The new federal government assumed the states’ debts (assumption).  And serviced it (funding).  Giving great money and power to the federal government.  Far more than Jefferson believed the Constitution granted.  And this really stuck in his craw.  Because this was the source of all the mischief in the Old World.  Money and power.  The Old World capitals were both the seats of political power.  And the centers of commerce and banking.

Jefferson understood that a permanent debt gave a government a lot of power.  Because debt had to be serviced.  And you serviced debt with taxes.  The bigger the debt the greater the taxes.  Which didn’t sit well with this revolutionary.  I mean, excessive taxation was the cause for rebellion.  Taxes are bad.  And lead to political corruption.  Because the more taxes the government collects the more it can spend on political favors.  Patronage (good paying government jobs for political allies).  Giving rise to a politically-connected ruling class.  Like the Old World aristocracies.  Government grows.  As does their control over the private sector economy.

It’s a process that once started moves in only one direction.  Greater and greater debts.  Paid for by greater and greater taxes.  Until the debt becomes unsustainable.  Like in Revolutionary France.  In present day Greece.  And even in the United States.  Who, in 2011, saw its sovereign debt rating downgraded for the first time in American history.  Because of record deficits.  And record debt.  Caused by excessive spending.  Everything that Jefferson feared would happen.  If government had a permanent debt.

Baseline Budgeting guarantees Permanent Growth in Government Spending

Big Government spending took off in America in the Sixties.  Historically government receipts averaged 17.8% of GDP.  During the Fifties and the Sixties, GDP grew while debt remained flat.  Of course, if GDP grew then so did tax dollars coming into Washington.  For 17.8% of an expanding GDP produced an expanding pile of cash in the government’s coffers.

Liking the taste of this money, government kept spending.  So much so that they adopted baseline budgeting in 1974.  Where current spending is automatically added to for next year’s spending.  Guaranteeing permanent growth in government spending.  To pay for LBJ‘s Great Society.  The Vietnam WarApollo.  And other spending programs.  The spending was so out of control that the debt started to creep up.  And what they didn’t borrow they printed.  Leading to the Nixon Shock.

The Nixon Shock (ending the quasi gold standard) unleashed inflation.  Which Paul Volcker and Ronald Reagan defeated.  With inflation tamed and the Reagan tax cuts, the Eighties saw solid GDP growth.  And record deficits.  The Democrats liked all that cash coming into Washington.  And they spent it faster than it came in.  But to reduce the deficit they made a deal.  For each dollar in new taxes the Democrats would cut three dollars in spending.  Of course they lied.  Because Democrats don’t cut taxes.  They got their new taxes.  But Reagan didn’t get any spending cuts.  In fact, the deal went the other way.  For every dollar in new taxes there were three dollars in new spending.  The deficit grew bigger.  And for the first time the debt grew at a greater rate than GDP.  As shown here:

(Source:  GDP, Debt, Receipts)

The Obama Stimulus gave us Record Deficits and Record Debt

After the 1994 midterm elections, Bill Clinton and the new Republican House compromised.  They reined in spending.  Implemented welfare reform.  And rode the dot-com bubble on the good side.  Before it burst.  It was capital gains galore.  Put all of this together and GDP rose and flooded Washington with tax receipts.  While debt remained flat.  In fact, there were budget surpluses forecast.  But then that dot-com bubble burst.

George W. Bush started his presidency with recession.  A couple of tax cuts later and GDP was tracking up again.  But 9/11 changed things.  And gave us two costly wars (Iraq and Afghanistan).  On top of an expensive Medicare drug program.  Record deficits took debt to new heights.  Then the Housing Bubble burst.  Followed by the subprime mortgage crisis.  And President Obama used this crisis to advance a dormant Democrat agenda.

It was an $800 billion stimulus.  Something he promised would have no pork or earmarks.  Nothing but shovel-ready projects.  Of course, it was nothing but pork and earmarks.  And those shovel-ready projects?  There’s no such thing.  So the stimulus didn’t stimulate anything.  Other than record deficits (surpassing Bush’s).  And record debt.  Debt increasing at a greater rate than GDP.  And equal to or greater than GDP in dollars.  Not seen since World War II.

Hamilton and Jefferson would have United in Opposition against Barack Obama

Debt fell as a percentage of GDP following World War II.  It fell from above 90% to below 40% around the end of the Sixties.  GDP was rising during this period while debt remained flat.  So the flat debt became a smaller and smaller percentage of a growing GDP.  The ‘growing your way out of debt’ phenomenon.  But that process stopped and reversed itself during the Seventies.  When Congress spent with a fury.  As noted above.  Debt grew.  Back to the level of GDP it was during a world war.  Only now there is no world war.  And we’re not spending to save democracy.  We’re spending to end democracy.

(Source:  GDP, Debt $, Debt %)

It is what Jefferson feared most.  Out of control government spending.  Racking up massive debt.  The kind that is impossible to pay off.  And is permanent.  And it was being done not for a war to save democracy from fascism.  But to change America.  To make it a different kind of nation.  No longer one of limited government.  But Big Government.  One with a ruling class.  A ruling class that now has a claim on 100% of GDP.  To pay for everything they gave us.  Where there is no choice but fair-share sacrifice.  Where everyone pays their ‘fair share’ of taxes.  Which is government-speak for raising taxes on everyone.  To flood government coffers with more private sector wealth.

The country is not what it was.  And it will never be what it once was again.  Not with this level of spending.   This is the kind of spending nations see in their decline.  It’s what toppled Louis XVI.  It’s what roiled Greece in riots.  It’s what downgraded U.S. sovereign debt.  For the first time.  Even Alexander Hamilton wouldn’t approve of this.  For his Big Government idea was all about making the nation an economic superpower.  Not bringing back feudalism.

So if you’re not a fan of Barack Obama, here’s something you can credit him for.  His policies would have reconciled two of our most beloved Founding Fathers.  For Hamilton and Jefferson may have hated each other.  But they would have united in opposition against Barack Obama.

 www.PITHOCRATES.com

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