World War I, Gold Standard, German Reparations, Hyperinflation, Credit-Anstalt, Keynesian Policies and the Great Depression

Posted by PITHOCRATES - March 13th, 2012

History 101

Nations abandoned the Gold Standard to Borrow and Print Money freely to pay for World War I 

Banks loan to each other.  They participate in a banking system that moves capital from those who have it to those who need it.  It’s a good system.  And a system that works.  Providing businesses and entrepreneurs with the capital to expand their businesses.  And create jobs.  As long as all the banks in the system go about their business responsibly.  And their governments go about their business responsibly.  Sadly, neither always does.

World War I changed the world in so many ways for the worse.  It killed a generation of Europeans.  Bankrupted nations.  Redrew the borders in Europe as the victors divvied up the spoils of war.  Setting the stage for future political unrest.  Gave us Keynesian economics.  Saw the beginning of the decline of the gold standard.  A deterioration of international trade.  A rise of protectionism and nationalism.  Punishing German reparations.  To pay for a war that they didn’t necessarily start.  Nor did they necessarily lose.  Which created a lot of anger in Germany.  And provided the seed for the Great Depression.

A set of entangling treaties brought nations eagerly into World War I.  There was great patriotic fervor.  And a belief that this war would be Napoleonic.  Some glorious battles.  With the victors negotiating a favorable peace.  Sadly, no one learned the lessons of the Crimean War (1853-1856).  Which killed approximately 600,000 (about 35% of those in uniform).  Or the American Civil War (1861-1865).  Which killed approximately 600,000 (about 20% of those in uniform).  The first modern wars.  Where the technology was ahead of the Napoleonic tactics of the day.  Modern rifled weapons made accurate killing weapons.  And the telegraph and the railroads allowed the combatants to rush ever more men into the fire of those accurate killing weapons.  These are the lessons they didn’t learn.  Which was a pity.  Because the weapons were much more lethal in World War I (1914-1918).  And far more advanced than the tactics of the day.  Which were still largely Napoleonic.  Mass men on the field of battle.  Fire and advance.  And close with the bayonet.  Which they did in World War I.  And these soldiers advanced into the withering fire of the new machine gun.  While artillery rounds fell around them.  Making big holes and throwing shredded shrapnel through flesh and bone.  WWI killed approximately 10,000,000 (about 15% of those in uniform).  And wounded another 20 million.  To do that kind of damage costs a lot of money.  Big money.  For bullets, shells, rifles, artillery, machine guns, warships, planes, etc., don’t grow on trees.  Which is why all nations (except the U.S.) went off of the gold standard to pay for this war.  To shake off any constraints to their ability to raise the money to wage war.  To let them borrow and print as much as they wanted.  Despite the effect that would have on their currency.  Or on foreign exchange rates.

As Countries abandoned the Gold Standard they depreciated their Currencies and wiped out People’s Life Savings

Well, the war had all but bankrupted the combatants.  They had huge debts and inflated currencies.  Large trade deficits.  And surpluses.  A great imbalance of trade.  And it was in this environment that they restored some measure of a gold standard.  Which wasn’t quite standard.  As the different nations adopted different exchange rates.  But they moved to get their financial houses back in order.  And the first order of business was to address those large debts.  And the ‘victors’ decided to squeeze Germany to pay some of that debt off.  Hence those punishing reparations.  Which the victors wanted in gold.  Or foreign currency.  Which made it difficult for Germany to return to the gold standard.  As the victors had taken most of her gold.  And so began the hyperinflation.  As the Germans printed Marks to trade for foreign currency.  Of course we know what happened next.  They devalued the Mark so much that it took wheelbarrows full of them to buy their groceries.  And to exchange for foreign currency.

Elsewhere, in the new Europe that emerged from WWI, there was a growth in regional banking.  Savvy bankers who were pretty good at risk evaluation.  Who were close to the borrowers.  And informed.  Allowing them to write good loans.  Meanwhile, the old institutions were carrying on as if it was still 1914.  Not quite as savvy.  And making bad loans.  The ones the more savvy bankers refused to write.  Weak banking regulation helped facilitate these bad lending practices.  Leaving a lot of banks with weak balance sheets.  Add in the hyperinflation.  Heavy debts.  Higher taxes (to reduce those debts).  Trade imbalances.  And you get a bad economy.  Where businesses were struggling to service their debt.  With many defaulting.  As a smaller bank failed a bigger bank would absorb it.  Bad loans and all.  Including an Austrian bank.  A pretty big one at that.  The largest in Austria.  Credit-Anstalt.  Which was ‘too big to fail’.  But failed anyway.  And when it did the collapse was heard around the world. 

As banks failed the money supply contracted.  Causing a liquidity crisis.  And deflation (less money chasing the same amount of goods).  Currency appreciation (further hurting a country’s balance of trade).  And low prices.  Which made it harder for borrowers to service their debt with the lower revenue they earned on those lower prices.  So there were more loan defaults.  Bank runs.  And bank failures.  Spreading the contagion to Amsterdam.  To Warsaw.  Germany.  Latvia.  Turkey.  Egypt.  Britain.  Even the U.S.  Soon countries abandoned the gold standard.  So they could print money to save the banks.  Lower interest rates.  Depreciate their currencies.  And wipe out large swathes of wealth denominated in that now depreciated currency.  What we call Keynesian policies.  People’s life savings became a fraction of what they were.  Making for a longer working life.  And a more Spartan retirement. 

Abandoning the Gold Standard didn’t fix the U.S. Economy in 1971

Meanwhile in the U.S. the government was destroying the U.S. economy.  Trying to protect domestic prices they passed the Smoot-Hawley Tariff.  Raising the price for businesses and consumers alike.  And kicking off a trade war.  Both of which greatly reduced U.S. exports.  New labor legislation keeping wages above market prices while all other prices were falling.  And higher taxes to pay for New Deal social programs.  Wiping out business profits and causing massive unemployment.  Then came the fall in farm prices due to increased farm productivity.  Thanks to farmers mechanizing their farms and greatly increasing their harvests.  Thus lowering prices.  Making it hard to service the bank loans they got to pay for that mechanization.  Thus leading to bank failures in the farming regions.  That spread to the cities.  Causing a liquidity crisis.  And deflation.

Then came Credit-Anstalt.  And all the woe that followed.  Which caused a speculative run in Britain.  Which made the British decide to leave the gold standard.  To stem the flow of gold out of their country.  Which destroyed whatever confidence was still remaining in their banking system.  People thought that the U.S. would be next.  But the Americans defended the dollar.  And instead raised interest rates (by reducing the money supply).  To keep the dollar valuable.  And to protect the exchange rate.  Making it less attractive to exchange cash for gold.  And to restore confidence in the banking system.  Of course, this didn’t help the liquidity crisis.  Which Keynesians blame for the length and the severity of the Great Depression.

Of course, it wasn’t the gold standard that caused the fall of Credit-Anstalt.  It was poor lending practices.  A weak banking regulation that allowed those poor lending practices.  And a lot of bad government policy throughout Europe.  Especially those punishing German reparations.  And the gold standard didn’t cause the economic collapse in the United States.  For it worked well the previous decade.  Providing all the capital required to produce the Roaring Twenties that modernized the world.  It was government and their intrusive policies into the free market that caused the economic collapse.  And abandoning the gold standard wouldn’t have changed that.  Or made the economy better.  And we know this because leaving the gold standard didn’t solve all of the countries woes in 1971.  Because the government was still implementing bad Keynesian policies.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Big Trouble for the Euro as Massive Greek Debt may be too much for the German People to Endure

Posted by PITHOCRATES - September 11th, 2011

Loans aren’t Gifts, you have to Pay them Back

Tax. Borrow. Print. And spend. The social democracies of Europe have been doing it for years. Thanks to central banking. And fiat money. And a little of John Maynard Keynes. You can keep interest rates artificially low. Deficit spend at will. Sell bonds forever and ever. And even print money. That’s Keynesian economics. Liberal Democrats in America were so enamored with the Europeans that they followed their example. And with government having the power to monetize debt, what could go wrong?

Apparently, a lot. Standard and Poor’s just downgraded U.S. sovereign debt. Citing high debt. And growing deficits. Leading them to believe that the U.S. may have trouble paying back what they’ve borrowed. Saying the U.S. government was living beyond their means. Just because they were spending more money than they had.

You mean we can’t do whatever we want? That’s right. You can’t. Because debt has consequences. You can’t keep borrowing more every year. Because people loan money (i.e., buy bonds) expecting you to pay back that loan. Yeah, I know. Crazy talk. But true nevertheless. Loans aren’t gifts. You have to pay them back.

The Root Problem within the Eurozone is Excessive Government Spending, Deficits and Debt

The U.S. has some financial problems. Record deficits. And record debt. Used to finance ever growing government spending. Yes, things may be bad in America, but they pale in comparison to the problems they have in the Eurozone (see German Dissent Magnifies Uncertainty in Europe by Liz Alderman posted 9/11/2011 on The New York Times).

Despite repeated pledges by Chancellor Angela Merkel to keep Europe together, the cacophony of dissent within her country is becoming almost deafening. That is casting fresh doubt — whether justified or not — over the nation’s commitment to the euro.

“The German electorate is not in the mind-set to undertake actions it sees as subsidizing less worthy nations,” said Carl Weinberg, the chief economist of High Frequency Economics in Valhalla, N.Y. “As a result, the government is moving in a very isolationist way to try to establish a fortress Germany that’s economically secure despite the risks in its European Union partners.”

This weekend, Der Spiegel reported that the German government was starting to prepare for a Greek insolvency and was devising various responses to handle a potential default, including allowing Greece to abandon the euro and return to the drachma. The government in Berlin would not comment, but such reports only add to the doubts bedeviling the euro monetary union.

The root problem within the Eurozone is excessive government spending, deficits and debt. Especially in Greece. Where they’ve borrowed heavily to pay for a very generous public sector. And state benefits.

There were strict requirements to join the monetary union. To change their currency to the Euro. The Euro Convergence Criteria required an annual government deficit of 3% of GDP. Or less. And total debt of 60% of GDP. Or less. Deficit and debt above these limits endangered a nation’s financial stability. And the common currency. The Euro. Which would spread one country’s irresponsible ways to the other countries in the Eurozone.

And that’s exactly what happened. Greece ‘fudged’ their numbers. So while they passed themselves off as fiscally responsible they were anything but. Their deficit and debt far exceeded the Euro Convergence Criteria. And when the global financial crisis of 2008 hit, it hit Greece hard. A couple of years later, with their economy depressed, S&P downgraded their sovereign debt. Increasing their borrowing costs. Which they couldn’t afford. So they had to turn to the international community for help. And it came. With a price. Austerity. Which the Greek people didn’t like.

Because of the common currency, Greece’s problems were now Germany’s problems. Because they were the strongest economy in the union. And the German people are growing tired of picking up the tab for Greece. And they’re not alone.

Finland, the Netherlands and Austria have all spoken with dissonant voices on the Greek bailout, revealing deep divisions among Europe’s strongest countries about how far they should go to save their weaker neighbors.

Continued fears over the state of European banks, and French ones in particular, have also roiled financial markets, especially after Christine Lagarde, the managing director of the International Monetary Fund, warned that European banks needed substantial additional capital.

Meanwhile, fears over Greece are only likely to intensify this week, after Mrs. Merkel’s finance minister, Wolfgang Schäuble, warned that Germany, for one, would not approve new financial assistance to help Athens continue to pay its bills through Christmas unless the Greek government fulfilled the conditions of its first bailout.

Can you blame them? Would you want to loan more money to a family member that continues to spend beyond their means? People want to help others. But they don’t want to finance the irresponsible ways that caused their problems in the first place. Austerity isn’t fun. But others are doing it. As they try to adjust their budgets to live within their means.

Outside of Greece, some things have improved, if only haltingly. Italy’s lower house of Parliament is expected to approve a tough new fiscal package in coming days.

France, Portugal and Spain are adopting measures to make it easier to balance budgets, moves intended to reassure investors about their commitments to fiscal prudence.

Which is not helping Mrs. Merkel. For if she continues to try and save the Euro her party may lose power.

Still, Mrs. Merkel must contend with a stark divide between her support for European unity and a German public that sees no reason, in the majority’s view, to pour good money after bad into the indebted countries of southern Europe. Her Christian Democrat Party has now lost five local elections this year. Yet even as many Germans complain bitterly about their southern neighbors, few in business and politics are ready to let the euro zone fall apart.

After all, if the weakest countries were to revert to their original currencies, a German-dominated euro would soar as investors flocked to it as a haven, devastating the business of exporters who have relied on its stability and relatively affordable level against other major currencies.

Then again, if she doesn’t save the Euro, her export economy may tank. A weak Greece is helping to keep the Euro undervalued. And you know what an undervalued currency does. It makes your exports cheap.

Any American who vacationed in Canada understands this well. Back when the U.S. dollar was strong, it was nice crossing into Canada. When you exchanged your strong American dollars for Canadian dollars, you got a lot more Canadian dollars back. In other words, the American dollar bought more in Canada than in the U.S. So people took their vacations in Canada. Which made the Canadian tourism industry boom.

This is the value of a weak currency. When your currency is weak, goods and services in your country, or goods exported out of your country, are cheaper. And the weaker nations in the Eurozone are keeping the Euro undervalued. And German exports strong. But it comes with a price. The taxpayers are basically subsidizing the export industry. By subsidizing the Greece bailout.

In other words, the Germans are damned if they do. And damned if they don’t.

The More the Debt the More the Crisis, the Less the Debt the Less the Crisis

Governments embrace Keynesian economics because it gives them power. It facilities their deficit spending. Legitimizes it. They and their Keynesian economists will dismiss growing debts. Because they’re no big deal. You see, their policy of continuous inflation shrinks that debt in real terms. In other words, as you devalue the currency, old debts are worth less. And easier to repay years later.

But there’s a catch. You need a growing GDP for this to work. When the economy stagnates, tax revenues fall. And if those debts are too big you just may not be able to service those debts. And you know what can happen? Greece. So too much debt can be a bad thing.

And it’s a dangerous game to play. Because as that debt grows so must taxes to service that debt. So they increase tax rates. But higher tax rates work against growing GDP. Flat or falling GDP means less tax dollars. Which leads to more borrowing. So the solution to the problem is more of what caused the problem. Which makes the original problem bigger. It’s a vicious cycle. Until the cycle ends in a credit downgrade. And financial crisis.

Keynesians can say what they want. But one thing they can’t deny is this. If these countries had no debt then they would have no financial crisis. Some countries have less debt and are not in crisis. While the countries in crisis have excessive debt. See the pattern? The more the debt the more the crisis. The less the debt the less the crisis.

Even Keynesians can’t deny this. Then again, Keynesians could. For they do live in denial.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , ,

Obama Threatens Seniors and Veterans if he doesn’t get his Way in the Budget Debate to Raise the Debt Limit

Posted by PITHOCRATES - July 13th, 2011

Hypocrisy is a Two Way Street

Arguing over debt limits is nothing new.  Neither is the hypocrisy.  It’s not about doing the right thing.  It’s about politics.  Always has been (see Debt Crisis Déjà Vu by Howard Kurtz posted 7/12/2011 on The Daily Beast). 

Democratic Sen. Kent Conrad is losing patience with arguments for raising the debt ceiling.

“The question is: Are we staying on this course to keep running up the debt, debt on top of debt, increasingly financed by foreigners, or are we going to change course?” he asked.

But Republican Sen. Chuck Grassley says there is no alternative, with lawmakers facing “a choice between breaking the law by exceeding the statutory debt limit or, on the other hand, breaking faith with the public by defaulting on our debt…”

“To pay our bills,” said John Kerry, who had just lost his presidential bid, “America now goes cup in hand to nations like China, Korea, Taiwan, and Caribbean banking centers. Those issues didn’t go away on Nov. 3, no matter what the results.”

And always will be.  Parties typically stand by their president.  As the Republicans stood with George W. Bush in 2006.  Who then made the same arguments that the Democrats are making now.  And the Democrats are making the same arguments now that the Republicans made then.  Nothing ever changes.  Just their principles change to suit the politics.

In fact, every Senate Democrat—including Barack Obama and Joe Biden—voted against boosting the debt ceiling, while all but two Senate Republicans voted in favor. It was Bush’s fourth debt-ceiling hike in five years, for a total of $3 trillion.

Eric Cantor and John Boehner voted then to raise the ceiling, and on other occasions during the Bush administration; now they’re leading the opposition. Obama, who warned Tuesday in a CBS interview that he can’t guarantee Social Security checks will go out after the August 2 deadline, has said his 2006 vote was a mistake.

Obama and Biden were against raising the debt limit then because it was fiscally irresponsible.  They’re for it now.  Even though the debt is higher.  And more fiscally irresponsible.

Obama said his 2006 vote was wrong?  I guess we can forgive him being that he was young and inexperienced coming into the U.S. Senate.  Of course, he was even more young and inexperienced as far presidents are concerned.  So perhaps his policy is wrong, too, like that 2006 vote.  The stimulus.  The auto bailout.  The Wall Street bailout.  All that Keynesian tax and spend.  Perhaps when he grows up and learns from experience he will be saying he was ‘wrong’ a lot more often.

Monetary Policy fails to Eliminate the Business Cycle

And speaking of all that Keynesian policy, how has it worked?  (see Bernanke: Fed May Launch New Round of Stimulus by Jeff Cox posted 7/13/2011 on CNBC). 

Federal Reserve Chairman Ben Bernanke told Congress Wednesday that a new stimulus program is in the works that will entail additional asset purchases, the clearest indication yet that the central bank is contemplating another round of monetary easing…

Markets reacted immediately to the remarks, sending stocks up sharply in a matter of minutes. Gold prices continued to surge past record levels, while Treasury yields moved higher as well.

It hasn’t been working.  But never say die.  Just because QE1 and QE2 failed it doesn’t necessarily mean QE3 will fail.  But it will.  And it will further depreciate the U.S. dollar.  Which is why gold prices and Treasury yields are up.  They’re priced in dollars.  So when you make the dollar smaller, you need more of them to buy things priced in dollars.

The Fed recently completed the second leg of its quantitative easing program, buying $600 billion worth of Treasurys in an effort to boost liquidity and get investors to purchase riskier assets…

“The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support,” Bernanke told the House Financial Services Committee on the first of two days of Capitol Hill testimony.

Bernanke also said it was possible that inflationary pressures spurred by higher energy and food prices may end up being more persistent than the Fed anticipates.

So the Fed is looking at policy to fight both inflation and deflation.  Interesting.  Because you use monetary policy to fight one with the other.

This is the Business Cycle that Keynesian economics purportedly did away with.  As inflation starts rising you contract the money supply via higher interest rates.  As deflation reduces asset value you lower interest rates to stimulate borrowing and asset buying.  There’s only one problem to this Keynesian economics theory.  It doesn’t work.

Playing with interest rates to stimulate borrowing does stimulate borrowing.  People take advantage of low rates, take out loans and buy assets.  Like houses.  In fact, there is such a boon in the housing market from all this stimulated borrowing that house prices are bid up.  Into a bubble.  That eventually pops.  And a period of deflation sets in to correct the artificially high housing prices resulting from artificially low interest rates.

The Dollar Loses against the Embattled Euro

So how bad is the depreciation of the dollar (see Bernanke says more support possible if economy weakens posted 7/13/2011 on the BBC)? 

The dollar extended earlier losses against the euro following Mr Bernanke’s comments, with the euro rising more than a cent to $1.4088.

The Eurozone is teetering on collapse with the Greek crisis.  Especially if their problems spread to the larger economies of Italy and Spain.  Further pressuring the Euro.  The Euro had been falling against the dollar.  It’s not anymore.  Not because the Euro is getting stronger.  But because the dollar is getting weaker.

Tax, Borrow, Print and Spend Keynesians love to Spend Money

And the safe haven from a falling dollar?  Gold (see Gold hits record high on Bernanke, euro worries by Frank Tang posted 7/13/2011 on Reuters).

Gold surged to a record above $1,580 an ounce on Wednesday as the possibility of more Federal Reserve stimulus coupled with Europe’s deepening debt crisis gave bullion its longest winning streak in five years…

Gold benefits from additional U.S. monetary easing because such a move would likely weaken the dollar and stir inflation down the road.

“The worst thing for gold would be to have the economy doing well enough that the Federal Reserve starts to normalize monetary policy, or conditions in the European Community begin to settle down,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott, a broker/dealer with $54 billion in assets.

That’s right.  Gold loves bad monetary policy.  And it loves Keynesian economics.  Because the weaker the dollar gets the more expensive gold gets in U.S. dollars.  Gold says, “Print on, Chairman Bernanke.  Keep printing those dollars.  I’ve never felt so alive and powerful.”

Gold is a tangible asset.  Dollars are just pieces of paper.  Gold gets more valuable during periods of inflation because you can’t print gold.  That’s why Keynesian governments refuse to reinstitute the gold standard.  Because having the power to print dollars lets them spend more money than they have.  And tax, borrow, print and spend Keynesians love to spend money.

Democrats Screwing Seniors and Veterans to get their Way

One government advantage of printing money is reducing the value of dollar-priced assets.  Such as government debt.  Economists call it monetizing the debt.  By making the treasuries and bonds people invest their retirement in worth less, it costs less to redeem them.  This is bad for retirees who have to live their retirement on less.  But screwing retirees helps the government to spend more.

Despite this the debt is at a record level.  They still need to borrow more.  Screwing retirees just isn’t paying the bills anymore.  So President Obama, the Democrats and the Republicans have been bitterly arguing about raising the debt limit.  But making little progress (see Obama walks out of tense debt meeting: aide by Andy Sullivan, Reuters, posted 7/13/2011 on the Chicago Tribune).

President Barack Obama abruptly ended a tense budget meeting on Wednesday with Republican leaders by walking out of the room, a Republican aide familiar with the talks said.

The aide said the session, the fourth in a row, was the most tense of the week as House of Representatives Speaker John Boehner, the top Republican in Congress, dismissed spending cuts offered by the White House as “gimmicks and accounting tricks.”

Gimmicks and accounting tricks are all the Democrats want to offer.  Because they just don’t want to cut back on spending.  It’s not who they are.  Big Government tax, borrow, print and spend Keynesians who love to spend money (see Eric Cantor: Obama abruptly walked out of debt meeting by Jonathan Allen posted 7/13/2011 on Politico).

President Barack Obama abruptly walked out of a debt-limit meeting with congressional leaders Wednesday, throwing into serious doubt the already shaky debt limit negotiations, according to House Majority Leader Eric Cantor (R-Va.) and a second GOP source.

Cantor said the president became “agitated” and warned the Virginia Republican not to “call my bluff” when Cantor said he would consider a short-term debt-limit hike. The meeting “ended with the president abruptly walking out of the meeting,” Cantor told reporters in the Capitol.

That bluff would be, off course, not printing Social Security checks or paying the military.  The Education Department will probably get paid.  But seniors will get screwed.  As those serving in the military.  And veterans.  Because when all else fails, take hostages.  Threaten their wellbeing unless you get what you want.

The Democrats believe it’s all their Money

Why is there such a divide between the Republicans and the Democrats?  It’s because of their underlying philosophies.  Republicans believe that this is a nation of ‘we the people’.  Whereas Democrats believe it’s a nation of ‘we the government’ (see We have a taxing problem, not just a spending problem by Ezra Klein posted 7/12/2011 on The Washington Post). 

The Bush tax cuts were not supposed to last forever. Alan Greenspan, whose oracular endorsement was perhaps the single most decisive event in their passage, made it very clear that they were a temporary solution to a temporary surplus. “Recent data significantly raise the probability that sufficient resources will be available to undertake both debt reduction and surplus-lowering policy initiatives,” Greenspan said in 2001.

Okay, so maybe he wasn’t so clear. But everyone knew what he meant. And, broadly speaking, they agreed. We had a big surplus. It was time to do something with it. Brad DeLong, a former Clinton administration official and an economist at the University of California at Berkeley, didn’t want to see the surplus spent on tax cuts. He wanted to see it spent on public investments. “Nevertheless,” he wrote in 2001, “it is hard to disagree with Greenspan’s position that — if our future economic growth is as bright as appears likely— it will be time by the middle of this decade to do something to drastically cut the government’s surpluses.”

The Democrats believe it’s all their money.  Any money they let us keep is ‘government spending’ in their world.  That’s why they call all ‘tax cuts’ government spending.  And not simply returning money to its rightful owners.

But the Republican Party refuses to let any of them expire. And forget admitting that tax cuts meant for surpluses don’t make sense during deficits; they refuse to admit that tax cuts have anything to do with deficits at all.

It’s this belief that stands in the way of a debt deal. “We have a spending problem, not a taxing problem,” Republicans say. If the federal government defaults on Aug. 2, that sentence will be to blame. What a shame, then, that the sentence is entirely, obviously, wrong.

Obviously?  What is obvious is that this person ignores the economic prosperity caused by JFK‘s tax cuts.  Ronald Reagan‘s tax cuts.  And George W. Bush’s tax cuts.  Tax cuts stimulate economic activity.  More economic activity means more tax dollars flowing into Washington.  As history has proven.  And yet the economically naive hang on to Keynesian theories despite their history of failure.  Because they think they are oh so smart.  When in reality they’re not.  Just lemmings unquestioningly following the party line.

The Democrats favor unlimited Taxing, Borrowing and Printing

The budget debate over raising the debt ceiling is not a financial debate.  It’s a political debate.  Currently, the politics have the Republicans opposing the increase.  And the Democrats favoring it.  This is actually more in line with their underlying philosophies.  Democrats believe it’s all their money and they want to keep more.  The Republicans believe the money belongs to the people who earned it and are trying to let them keep more of it.  So you would expect the Democrats to be in favor of unlimited taxing, borrowing and printing.  And Republicans in favor of less taxing, borrowing and printing.  Which is the case in the current budget debate.

The question now is who will blink first?  The Republicans fearing another 1995 government shutdown?  Or the Democrats who are doing the preponderance of bluffing?  (There’s almost $200 billion in cash coming into Washington each month.  If they don’t pay seniors and veterans, people will want to know who they felt was important enough to pay.)

The stakes have never been higher.  What happens in the current debate could very well determine the outcome of the 2012 election.  Oh, and the future of America.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

LESSONS LEARNED #28: “Politicians love failure because no one ever asked government to fix something that was working.” -Old Pithy

Posted by PITHOCRATES - August 26th, 2010

THE TELEVISION SHOW Gomer Pyle, U.S.M.C. aired from 1964-1969.  It was a spinoff from the Andy Griffith Show.  Gomer, a naive country bumpkin who worked at Wally’s filling station, joined the Marines Corps.  And there was much mirth and merriment.  To the chagrin of Sergeant Carter, Pyle’s drill instructor (DI).  Think of Gunny Sergeant R. Lee Ermey’s Sergeant Hartman in the movie Full Metal Jacket only with no profanity or mature subject matter.  Sergeant Carter was a tough DI like Sergeant Hartman.  But more suitable for the family hour on prime time television.

Gunny sergeants are tough as nails.  And good leaders.  They take pride in this.  But sometimes a gunny starts to feel that he’s not himself anymore.  This was the subject of an episode.  And Gomer, seeing that Sergeant Carter was feeling down, wanted to help.  So he stuffed Sergeant Carter’s backpack with hay before a long march.  While the platoon was worn and tired, Sergeant Carter was not.  He was feeling good.  Like his old self.  Until he found out he was not carrying the same load his men were.  He asked Pyle, “why hay?”  He could understand rocks, but hay?  Because if he outlasted his men while carrying a heavier load, he would feel strong.  But knowing he had carried a lighter load only made him feel weak.

This is human nature.  People take pride in their achievements.  They don’t take pride in any achievement attained by an unfair advantage.  Self-esteem matters.  And you can’t feel good about yourself if you need help to do what others can do without help. 

AN OLD CHINESE proverb goes, “Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.”  Let’s say I am a fisherman in a small village.  I catch fish to feed my family and sell/trade for other family needs.  There’s a man in my village who asks me for a fish each day so he can eat.  I’m a caring person.  So I give him a fish each day.  So a pattern develops.  Each day he shows up when I come in from my fishing.  He takes the fish and goes away.  It works out well for him.  He doesn’t have to work.  He can live off of my kind charity.  Then I move.  Without me being there to give him a fish each day, he no longer can eat.  And dies.  If I only had taught that man to fish. 

Kindness can lead to dependency.  And once dependent, you become lazy.  Why develop marketable skills to provide for yourself when someone else will provide for you?  The problem is, of course, what happens when that charity ends?  If you’re unable to provide for yourself and there is no longer someone providing for you, what do you do?  Steal?

Dependency and a lack of self-esteem are a dangerous combination.  And they feed off of each other.  This combination can lead to depression.  Behavioral problems.  Resentment.  Bitterness.  Envy.  Or a defeatist attitude.

These are often unintended consequences of government programs.  A failed program, then, has far reaching consequences beyond the initial economic costs of a program.

LIQUIDITY CRISES CAUSE a lot of economic damage.  If capital is not available for businesses to borrow, businesses can’t grow.  Or create jobs.  And we need jobs.  People have to work.  To support themselves.  And to pay taxes to fund the government.  So everyone is in favor of businesses growing to create jobs.  We all would like to see money being easy and cheap to borrow if it creates jobs.

But there is a downside to easy money.  Inflation.  Too much borrowing can create inflation.  By increasing the money supply (via fractional reserve banking).  More money means higher prices.  Because each additional dollar is worth a little less. This can lead to overvalued assets as prices are ‘bid’ up with less valuable dollars.  And higher prices can inflate business profits.  Looks good on paper.  But too much of this creates a bubble.  Because those high asset values and business profits are not real.  They’re inflated.  Like a bubble.  And just as fragile.  When bubbles burst, asset values and business profits drop.  To real values.  People are no longer ‘bidding’ up prices.  They stop buying until they think prices have sunk to their lowest.  We call this deflation.  A little bit of inflation or deflation is normal.  Too much can be painful economically.  Like in the Panic of 1907.

Without going into details, there was a speculative bubble that burst in 1907.  This led to a liquidity crisis as banks failed.  Defaults on loans left banks owing more money than they had (i.e., they became illiquid).  They tried to borrow money and recall loans to restore their liquidity.  Borrowers grew concerned that their bank may fail.  So they withdrew their money.  This compounded the banks problems.  This caused deflation.  Money was unavailable.  Causing bank runs.  And bank failures.  Business failures.  And unemployment grew. So government passed the Federal Reserve Act of 1913 to prevent a crisis like this from ever happening again.  The government gave the Federal Reserve System (the Fed) great powers to tweak the monetary system.  The smartest people at the time had figured out what had gone wrong in 1907.  And they created a system that made it impossible for it to happen again.

The worst liquidity crisis of all time happened from 1929-1933.  It’s part of what we call the Great Depression.  The 1920s had a booming economy.  Real income was rising.  Until the Fed took action.  Concerned that people were borrowing money for speculative purposes (in paper investments instead of labor, plant and material), they put on the brakes.  Made it harder and more expensive to borrow money.  Then a whole series of things happened along the way that turned a recession into a depression.  When people needed money, they made it harder to get it, causing a deflationary spiral.  The Great Depression was the result of bad decisions made by too few men with too much power.  It made a crisis far worse than the one in 1907.  And the Roosevelt administration made good use of this new crisis.  FDR exploded the size of government to respond to the unprecedented crisis they found themselves in.  The New Deal changed America from a nation of limited government to a country where Big Government reigns supreme.

ONE PROGRAM OF the New Deal was Social Security.  Unemployment in the 1930s ran at or above 14%.  This is for one whole decade.  Never before nor since has this happened.  Older workers generally earn more than younger ones.  Their experience commands a higher pay rate.  Which allows them to buy more things.  Resulting in more bills.  Therefore, the Great Depression hit older workers especially hard.  A decade of unemployment would have eaten through any life savings of even the most prudent savers.  And what does this get you?  A great crisis.

The government took a very atypical moment of history and changed the life of every American.  The government forced people to save for retirement.  In a very poor savings plan.  That paid poorly by comparison to private pensions or annuities.  And gave the government control over vast amounts of money.  It was a pervasive program.  They say FDR quipped, “Let them try to undo this.” 

With government taking care of you in retirement, more people stopped providing for themselves.  When they retired, they scrimped by on their ‘fixed’ incomes.  And because Social Security became law before widespread use of birth control and abortion, the actuaries of the day were very optimistic.  They used the birth rate then throughout their projections.  But with birth control and abortion came a huge baby bust.  The bottom fell out of the birth rate.  A baby bust generation followed a baby boom generation.  Actually, all succeeding generations were of the bust kind.  The trend is growing where fewer and fewer people pay for more and more people collecting benefits.  And these people were living longer.  To stay solvent, the system has to raise taxes on those working and reduce benefits on those who are not.  Or raise the retirement age.  All these factors have made it more difficult on our aged population.  Making them working longer than they planned.  Or by making that fixed income grow smaller.

FDR used a crisis to create Social Security.  Now our elderly people are dependent on that system.  It may suck when they compare it to private pensions or annuities, but it may be all they have.  If so, they’ll quake in their shoes anytime anyone mentions reforming Social Security.  Because of this it has become the 3rd rail of politics.  A politician does not touch it lest he or she wishes to die politically.  But it’s not all bad.  For the politician.  Because government forced the elderly to rely on them for their retirement, it has made the Social Security recipient dependent on government.  In particular, the party of government who favors Big Government.  The Democrats.  And with a declining birth rate and growing aged population, this has turned into a large and loyal voting bloc indeed.  Out of fear.

A PROGRAM THAT straddled the New Deal and LBJ’s Great Society was Aid to Families with Dependent Children (AFDC).  Its original New Deal purpose was to help widows take care of their children.  When program outlays peaked in the 1970s, the majority of recipients were unmarried women and divorced women.  Because this was a program based on need, the more need you had the more you got.  Hence more children meant more money.  It also reduced the importance of marriage as the government could replace the support typically provided by a husband/father.  Noted economist Dr. Thomas Sowell blames AFDC as greatly contributing to the breakdown of the black family (which has the highest incidence of single-parent households).

With the women’s liberation movement, women have come to depend less on men.  Some affluent women conceive and raise children without a husband.  Or they adopt.  And the affluent no doubt can provide all the material needs their children will ever need.  Without a husband.  Or a father for their children.  But is that enough?

The existence of ‘big brother’ programs would appear to prove otherwise.  Troubled children are often the products of broken families.  Mothers search for big brothers to mentor these fatherless sons.  To be role models.  To show an interest in these children’s lives.  To care.  When no such role models are available, some of these troubled children turn to other sources of acceptance and guidance.  Like gangs.

AFDC has compounded this problem by providing the environment that fosters fatherless children.  And another government program compounds that problem.  Public housing.

POOR HOUSING CONDITIONS hurt families.  They especially hurt broken families.  Without a working husband, these families are destined to live in the cheapest housing available.  These are often in the worst of neighborhoods.  This is an unfair advantage to the children raised in those families.  For it wasn’t their fault they were born into those conditions.  So, to solve that problem, government would build good public housing for these poorest of the poor to move into.  Problem solved.

Well, not exactly.  Public housing concentrates these broken families together.  Usually in large apartment buildings.  This, then, concentrates large numbers of troubled children together.  So, instead of having these children dispersed in a community, public housing gathers them together.  Where bad behavior reinforces bad behavior.  It becomes the rule, not the exception.  Making a mother’s job that much more difficult.  And because these children live together, they also go to school together.  And this extends the bad behavior problem to the school.  Is it any wonder that public housing (i.e., the projects) have the worst living conditions?  And some of the highest gang activity? 

Government didn’t plan it this way.  It’s just the unintended consequences of their actions.  And those consequences are devastating.  To the poor in general.  To the black family in particular.  AFDC and public housing enabled irresponsible/bad behavior.  That behavior destroyed families.  As well as a generation or two.  But it wasn’t all bad.  For the politicians.  It made a very large constituency dependent on government.

THERE ARE SO many more examples.  But the story is almost always the same.  Dependency and a lack of self-esteem will beat down a person’s will.  Like an addict, it will make the dependent accept poorer and poorer living standards in exchange for their fix of dependency.  Eventually, the dependency will reach the point where they will not know how to provide for themselves.  The dependency will become permanent.  As will the lack of self-esteem.  Conscious or not of their actions, Big Government benefits from the wretched state they give these constituencies.  With no choice but continued dependence, they vote for the party that promises to give the most.  Which is typically the Democrat Party.

But how can you fault these politicians?  They acted with the best of intentions.  And they can fix these new problems.  They’ll gather the brightest minds.  They’ll study these problems.  And they will produce the best programs to solve these problems.  All it will take is more government spending.  And how can you refuse?  When people are hungry.  Or homeless.  Or have children that they can’t care for.  How can anyone not want to help the children?  How can anyone not have compassion?

Well, compassion is one thing.  When the innocent suffer.  But when government manufactures that suffering, it’s a different story.  Planned or not the result is the same whenever government tries to fix things.  The cost is high.  The solution is typically worse than the original problem.  And the poorest of the poor are pawns.  To be used by Big Government in the name of compassion. 

Of course, if Big Government were successful in fixing these problems, they would fix themselves right out of existence.  So as long as they want to run Big Government programs, they’ll need a stock of wretched, suffering masses that need their help.  And, of course, lots of crises.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

LESSONS LEARNED #27: “Yes, it’s the economy, but the economy is not JUST monetary policy, stupid.” -Old Pithy

Posted by PITHOCRATES - August 19th, 2010

WHAT GAVE BIRTH to the Federal Reserve System and our current monetary policy?  The Panic of 1907.  Without going into the details, there was a liquidity crisis.  The Knickerbocker Trust tried to corner the market in copper.  But someone else dumped copper on the market which dropped the price.  The trust failed.  Because of the money involved, a lot of banks, too, failed.  Depositors, scared, created bank runs.  As banks failed, the money supply contracted.  Businesses failed.  The stock market crashed (losing 50% of its value).  And all of this happened during an economic recession.

So, in 1913, Congress passed the Federal Reserve Act, creating the Federal Reserve System (the Fed).  This was, basically, a central bank.  It was to be a bank to the banks.  A lender of last resort.  It would inject liquidity into the economy during a liquidity crisis.  Thus ending forever panics like that in 1907.  And making the business cycle (the boom – bust economic cycles) a thing of the past.

The Fed has three basic monetary tools.  How they use these either increases or decreases the money supply.  And increases or decreases interest rates.

They can change reserve requirements for banks.  The more reserves banks must hold the less they can lend.  The less they need to hold the more they can lend.  When they lend more, they increase the money supply.  When they lend less, they decrease the money supply.  The more they lend the easier it is to get a loan.  This decreases interest rates (i.e., lowers the ‘price’ of money).  The less they lend the harder it is to get a loan.  This increases interest rates (i.e., raises the ‘price’ of money). 

The Fed ‘manages’ the money supply and the interest rates in two other ways.  They buy and sell U.S. Treasury securities.  And they adjust the discount rate they charge member banks to borrow from them.  Each of these actions either increases or decreases the money supply and/or raises or lowers interest rates.  The idea is to make money easier to borrow when the economy is slow.  This is supposed to make it easier for businesses to expand production and hire people.  If the economy is overheating and there is a risk of inflation, they take the opposite action.  They make it more difficult to borrow money.  Which increases the cost of doing business.  Which slows the economy.  Lays people off.  Which avoids inflation.

The problem with this is the invisible hand that Adam Smith talked about.  In a laissez-faire economy, no one person or one group controls anything.  Instead, millions upon millions of people interact with each other.  They make millions upon millions of decisions.  These are informed decisions in a free market.  At the heart of each decision is a buyer and a seller.  And they mutually agree in this decision making process.  The buyer pays at least as much as the seller wants.  The seller sells for at least as little as the buyer wants.  If they didn’t, they would not conclude their sales transaction.  When we multiply this basic transaction by the millions upon millions of people in the market place, we arrive at that invisible hand.  Everyone looking out for their own self-interest guides the economy as a whole.  The bad decisions of a few have no affect on the economy as a whole.

Now replace the invisible hand with government and what do you get?  A managed economy.  And that’s what the Fed does.  It manages the economy.  It takes the power of those millions upon millions of decisions and places them into the hands of a very few.  And, there, a few bad decisions can have a devastating impact upon the economy.

TO PAY FOR World War I, Woodrow Wilson and his Progressives heavily taxed the American people.  The war left America with a huge debt.  And in a recession.  During the 1920 election, the Democrats ran on a platform of continued high taxation to pay down the debt.  Andrew Mellon, though, had done a study of the rich in relation to those high taxes.  He found the higher the tax, the more the rich invested outside the country.  Instead of building factories and employing people, they took their money to places less punishing to capital.

Warren G. Harding won the 1920 election.  And he appointed Andrew Mellon his Treasury secretary.  Never since Alexander Hamilton had a Treasury secretary understood capitalism as well.  The Harding administration cut tax rates and the amount of tax money paid by the ‘rich’ more than doubled.  Economic activity flourished.  Businesses expanded and added jobs.  The nation modernized with the latest technologies (electric power and appliances, radio, cars, aviation, etc.).  One of the best economies ever.  Until the Fed got involved.

The Fed looked at this economic activity and saw speculation.  So they contracted the money supply.  This made it hard for business to expand to meet the growing demand.  When money is less readily available, you begin to stockpile what you have.  You add to that pile by selling liquid securities to build a bigger cash cushion to get you through tight monetary times.

Of course, the economy is NOT just monetary policy.  Those businesses were looking at other things the government was doing.  The Smoot-Hartley tariff was in committee.  Across the board tariff increases and import restrictions create uncertainty.  Business does not like uncertainty.  So they increase their liquidity.  To prepare for the worse.  Then the stock market crashed.  Then it got worse. 

It is at this time that the liquidity crisis became critical.  Depositors lost faith.  Bank runs followed.  But there just was not enough money available.  Banks began to fail.  Time for the Fed to step in and take action.  Per the Federal Reserve Act of 1913.  But they did nothing.  For a long while.  Then they took action.  And made matters worse.  They raised interest rates.  In response to England going off the gold standard (to prop up the dollar).  Exactly the wrong thing to do in a deflationary spiral.  This took a bad recession to the Great Depression.  The 1930s would become a lost decade.

When FDR took office, he tried to fix things with some Keynesian spending.  But nothing worked.  High taxes along with high government spending sucked life out of the private sector.  This unprecedented growth in government filled business with uncertainty.  They had no idea what was coming next.  So they hunkered down.  And prepared to weather more bad times.  It took a world war to end the Great Depression.  And only because the government abandoned much of its controls and let business do what they do best.  Pure, unfettered capitalism.  American industry came to life.  It built the war material to first win World War II.  Then it rebuilt the war torn countries after the war.

DURING THE 1980s, in Japan, government was partnering with business.  It was mercantilism at its best.  Japan Inc.  The economy boomed.  And blew great big bubbles.  The Keynesians in America held up the Japanese model as the new direction for America.  An American presidential candidate said we must partner government with business, too.  For only a fool could not see the success of the Japanese example.  Japan was growing rich.  And buying up American landmarks (including Rockefeller Center in New York).  National Lampoon magazine welcomed us to the 90s with a picture of a Japanese CEO at his desk.  He was the CEO of the United States of America, a wholly owned subsidiary of the Honda Motor Company.  The Japanese were taking over the world.  And we were stupid not to follow their lead.

But there was no invisible hand in Japan.  It was the hand of Japan Inc.  It was Japan Inc. that pursued economic policies that it thought best.  Not the millions upon millions of ordinary Japanese citizens.  Well, Japan Inc. thought wrong. 

There was collusion between Japanese businesses.  And collusion between Japanese businesses and government.  And corruption.  This greatly inflated the Japanese stock market.  And those great big bubbles finally burst.  The powerful Japan Inc. of the 1980s that caused fear and trembling was gone.  Replaced by a Japan in a deflationary spiral in the 1990s.  Or, as the Japanese call it, their lost decade.  This once great Asian Tiger was now an older tiger with a bit of a limp.   And the economy limped along for a decade or two.  It was still number 3 in the world, but it wasn’t what it used to be.  You don’t see magazine covers talking about it owning other nations any more.  (In 2010, China took over that #3 spot.  But China is a managed economy.   Will it suffer Japan’s fate?  Time will tell.)

The Japanese monetary authorities tried to fix the economy.  Interest rates were zero for about a decade.  In other words, if you wanted to borrow, it was easy.  And free.  But it didn’t help.  That huge economic expansion wasn’t real.  Business and government, in collusion, inflated and propped it up.  It gave them inflated capacity.  And prices.  And you don’t solve that problem by making it easier for businesses to borrow money to expand capacity and create jobs.  That’s the last thing they need.  What they need to do is to get out of the business of managing business.  Create a business-friendly climate.  Based on free-market principles.  Not mercantilism.  And let that invisible hand work its wonders.

MONETARY POLICY CAN do a lot of things.  Most of them bad.  Because it concentrates far too much power in too few hands.  The consequences of the mistakes of those making policy can be devastating.  And too tempting to those who want to use those powers for political reasons.  As we can see by Keynesian ‘stimulus’ spending that ends up as pork barrel spending.  The empirical data for that spending has shown that it stimulates only those who are in good standing with the powers that be.  Never the economy.

Sound money is important.  The money supply needs to keep pace with economic expansion.  If it doesn’t, a tight money supply will slow or halt economic activity.  But we have to use monetary policy for that purpose only.  We cannot use it to offset bad fiscal policy that is anti-business.  For if the government creates an anti-business environment, no amount of cheap money will encourage risk takers to take risks in a highly risky and uncertain environment.  Decades were lost trying.

No, you don’t stimulate with monetary policy.  You stimulate with fiscal policy.  There is empirical evidence that this works.  The Mellon tax cuts of the Harding administration created nearly a decade of strong economic growth.  The tax cuts of JFK were on pace to create similar growth until his assassination.  LBJ’s policies were in the opposite direction, thus ending the economic recovery of the JFK administration.  Ronald Reagan’s tax cuts produced economic growth through two decades. 

THE EVIDENCE IS there.  If you look at it.  Of course, a good Keynesian won’t.  Because it’s about political power for them.  Always has been.  Always will be.  And we should never forget this.

www.PITHOCRATES.com

Share

Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

  Next Entries »