LESSONS LEARNED #74: “When negotiating it’s important to understand the ‘time value’ of promises. The longer out in time something is promised the less likely that promise will be kept.” -Old Pithy

Posted by PITHOCRATES - July 14th, 2011

Slaying the Inflation Beast

In Washington promises would make a poor currency.  Because they’re very inflationary.  Politicians make a lot of promises.  And they break almost as many as they make.  Promises just don’t hold their value over time.  Especially when it comes to spending cuts.  Any promise for future spending cuts will be worthless by the time that ‘future’ arrives.  Because things change.  The economic picture may change.  And they’ll write new legislation to eliminate those spending cuts.  To adjust for these unforeseen changes in the economy.  Just as those promising those spending cuts knew they would.  That’s why politicians (i.e., Democrats) can be generous when offering future spending cuts in any budget debate.  Because they have no intention of ever keeping those promises.  So Democrats can be very generous in offering ‘future’ spending cuts.  In exchange for tax hikes in the here and now.  It’s a con.  And one of the biggest such cons was the Tax Equity and Fiscal Responsibility Act of 1982 that Ronald Reagan fell for.

Reagan’s poor economy had its roots in the Sixties and LBJ‘s Great Society.  LBJ was a tax, borrow, print and spend liberal.  And he spent.  He exploded government spending for his Great Society.  On top of the massive war spending for Vietnam.  The economy limped into the Seventies.  A bad economy and high taxes left few options to pay for that spending.  So the Fed just printed money.  Which devalued the dollar.  The dollar then was still convertible to gold at $35/ounce.  With the depreciation of their dollar assets, foreign nations converted their dollars to gold, depleting U.S. gold reserves.  To stem this loss of gold Nixon suspended the dollar’s convertibility into gold (the Nixon Shock).  Free from the restraint of a quasi gold standard, Nixon turned the printing presses on high.  Devaluing the U.S. dollar in the process, giving us high inflation. Then the 1973 oil embargo came and made everything worse.

Gerald Ford did little to change things.  Or Jimmy Carter.  They were little more than Keynesians themselves.  And believed in the power of government spending to stimulate the economy out of recession.  So their policies remained Keynesian.  Tax rates were high.  As was government spending.  And then another oil crisis came thanks to the Iranian Revolution.  Things just went from bad to worse for Carter.  Inflation was killing the economy.  Until Paul Volcker came on board after a cabinet shakeup.  He slew the beast.  Eventually.  Starting in the Carter administration.  And finishing the job in the Reagan administration.  For one of the tenants of Reaganomics was a sound currency.  Which Volcker gave him by slaying the inflation beast.

Reagan was not a Keynesian

Inflation is the great big bad side affect of Keynesian economics.  For it’s the only economics system that tells governments that counterfeiting money is a good thing.  So governments do.  And find justification for their actions by the sweet nothings Ivy League economists whisper in their ears.  But once the inflation beast is unleashed it is not easily subdued.  Because the only true antidote for runaway inflation is a good, deep recession.  And a bit of a deflationary spiral to put prices back to normal.  So this was where the economy was in 1982.  In deep recession.  With high unemployment.  And double digit interest rates (reaching as high as 20% on occasion).

Tax receipts fell.  As you would expect them to during a deep recession.  Which increased the deficit.  And this was just a calamity.  The country was facing economic ruin.  They just had to raise taxes.  For it was the only cure.  And the Democrats demanded that Reagan do just that.  Raise taxes.  But being that it went against another tenant of Reaganomics, Reagan refused.  He was not a Keynesian.  His Reaganomics was more of the Austrian School variety.  Low taxes.  Less regulation.  Sound money.  And little government spending.  He believed that the massive government spending was the problem.  And you didn’t fix that problem by giving the government more money to spend.  No, Reagan wasn’t going to abandon principles easily.  They needed something to sweeten the deal.  To make him abandon his principles more easily.  And they came up with a pretty sweet lie.

“Okay,” they said to Reagan.  “You’re right.  We need to cut spending.  We’re all in agreement here.  But the recession is hurting the people.  We can’t hit them with spending cuts now.  We’ll have to ease them in over time.  To make it easier on the people.  So we’ll give you your spending cuts.  A lot of them.  Just not right now.  In the future.  When the people are back on their feet.  You win.  All we ask for in return is that we increase taxes now before this deficit causes some damage that we won’t be able to walk away from.”

Democrats are Liars

And they made a deal.  Tax hikes now.  For spending cuts later.  And a lot of them.  For every new dollar in taxes they would cut $3 of spending.  It was some unprecedented spending cuts.  So Reagan accepted the deal.  Tax hikes now for spending cuts later.  He signed the Tax Equity and Fiscal Responsibility Act of 1982 into law.  He only made one mistake.  He trusted the Democrats.  And didn’t see them twisting their evil mustaches while they were making their deal.  Nor did he see them rub their hands together as they made a sinister laugh.

A Democrat’s promise to cut taxes isn’t worth the paper it’s written on.  For it starts to depreciate before the ink even dries.  And the numbers prove this.  According to CBO, tax revenue in 1982 (the year of the tax hikes) was $617.8 billion dollars.  At the end of Reagan’s second term in 1988, tax revenue rose to 909.1 billion.  For an increase of $291.5 billion.  Supply-siders (of the Austrian School) will say it was Reagan’s massive tax cuts in 1981 (Economic Recovery Tax Act of 1981) and 1986 (Tax Reform Act of 1986) that that generated this tax revenue by creating more taxpayers.  Keynesians will say it was the Tax Equity and Fiscal Responsibility Act of 1982 that generated this revenue by taking more from each taxpayer.  For the sake of argument, let’s say the Keynesians are right.  And all that new tax revenue is from the higher taxes.  So, according to the deal he made with Democrats to get this tax increase, government spending for the same period should have gone down by three times this amount, bringing total outlays at the end of that period to a negative $128.8 billion. 

Now we know that didn’t happen.  Government spending didn’t go to less than zero.  So if they didn’t honor their 3-1 pledge, how much did they cut spending?  Well, in 1982 government outlays were $745.7 billion.  In 1988 that increased to $1.06 trillion.  For an increase in spending of $318.8 billion.  Clearly something is amiss here.  For this is not spending reduction.  It’s a spending increase.  For every new tax dollar Congress collected they increased spending by $1.10.  That’s not the promised spending reduction.  It’s quite the opposite.  More spending.  A lot more spending.  That $3 gain in spending cuts turned out to be a $4.10 loss.  The Democrats lied.  And Reagan would never fall for this trick again.  For he learned the hard way that there are no such things as future spending cuts with Democrats.  And that Democrats are liars.

Don’t trust Democrats when they Promise to make Spending Cuts 

Of course, we could say that the supply-siders were right in regards to that increase in tax revenue.  The reason the Democrats failed to follow through on their promise was due to the success of Reagan’s tax cuts.  It just created so much money above and beyond what the tax hikes brought in.  They may have delivered their promised cuts but you can’t see them looking at the aggregate numbers.  Because Reaganomics created such great economic activity that it showered Washington with dollars.

It is an interesting choice.  Either the Democrats are liars and renege on their promises.  Or they are incompetent and follow failed Keynesian economic policies.  Perhaps it’s a little of both.  They’re both liars.  And incompetent.  For it would explain a lot.  Such as how their policies never make the economy any better.

Either way the lesson learned is for certain.  Don’t trust Democrats.  Especially when they promise to make spending cuts.  Because whatever may happen, one thing is clear.  What won’t happen are the spending cuts.

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LESSONS LEARNED #17: “The raison d’être of federalism is to keep big government small.” -Old Pithy.

Posted by PITHOCRATES - June 10th, 2010

ALEXANDER HAMILTON WAS a real bastard.  John Adams hated him.  Thomas Jefferson, too.  George Washington looked at him like a son.  Aaron Burr killed him.  Politics.  It can get ugly.

Hamilton’s father was having an affair with a married woman in a loveless marriage.  Fathered two children with her.  First James.  Then Alexander.  Both born on the British island of Nevis in the Caribbean.  His father then moved the family to the Danish island of St. Croix.  Shortly thereafter, Hamilton’s father abandoned his family.  Alexander was 10ish (there is some disagreement about his year of birth). 

At age 11ish, Alexander became a clerk at Cruger and Beekmen, an import-export firm.  There he learned about business and commerce.  People noticed his talent and ability.  Soon, they collected some money and sent him off to the American colonies for a college education.  Hamilton’s fondest memory of his childhood home was seeing St. Croix disappear into the horizon from the ship that delivered him to America.

Hamilton’s father did have some nobility in his lineage but he squandered it before it could do Alexander any good.  He was an illegitimate child (a real bastard).  His father abandoned him.  His mother died while he was young.  He had little but ability.  But that was enough to take him from St. Croix to the founding of a new nation.

Hamilton served in the Continental Army.  He served as General Washington’s aide-de-camp.  Hamilton was in the know as much as Washington.  His understanding of business, commerce and money made him acutely aware of the financial disarray of the Army.  And of the Continental Congress.  What he saw was a mess.

The Continental Congress was a weak central government.  It could not draft soldiers.  It could not impose taxes to pay her soldiers.  It could only ask the states for money to support the cause.  Contributions were few.  The congress tried printing money but the ensuing inflation just made things worse.  The Army would take supplies for subsistence and issue IOUs to the people they took them from.  The Congress would beg and borrow.  Most of her arms and hard currency came from France.  But they ran up a debt in the process with little prospect of repaying it.  Which made that begging and borrowing more difficult with each time they had to beg and borrow.

The army held together.  But it suffered.  Big time.  Washington would not forget that experience.  Or Hamilton.  Or the others who served.  For there was a unity in the Army.  Unlike there was in the confederation that supported the Army.

WARS ARE COSTLY.  And France fought a lot of them.  Especially with Great Britain.  She was helping the Americans in part to inflict some pain on her old nemesis.  And in the process perhaps regain some of what she lost to Great Britain in the New World.  You see, the British had just recently defeated the French in the French and Indian War (aka, the 7 Years War).  And she wanted her former possessions back.  But France was bleeding.  Strapped for cash, after Yorktown, she told the Americans not to expect any more French loans.

Wars are costly.  The fighting may have been over, but the debt remained.  The interest on the debt alone was crushing.  With the loss of a major creditor, America had to look elsewhere for money.  The Continental Congress’ Superintendent of Finance, the guy who had to find a way to pay these costs, Robert Morris, said they had to tax the Americans until it hurt they were so far in debt.  He put together a package of poll taxes, land taxes, an excise tax and tariffs.  The congress didn’t receive it very well.  Representation or not, Americans do not like taxes.  Of the proposed taxes, the congress only put the tariffs on imports before the states.

Rhode Island had a seaport.  Connecticut didn’t.  Rhode Island was charging tariffs on imports that passed through her state to other states.  Like to Connecticut.  Because they generated sufficient revenue from these tariffs, their farmers didn’t have to pay any taxes.  In other words, they could live tax free.  Because of circumstance, people in Rhode Island didn’t have to pay taxes.  Connecticut could pay their taxes for them.  Because of the Rhodes Island impost.  And the Robert Morris’ impost would take away that golden goose.

As the congress had no taxing authority, it would take a unanimous vote to implement the impost.  Twelve voted ‘yes’.  Rhode Island said ‘no’.  There would be no national tax.  ‘Liberty’ won.  And the nation teetered on the brink of financial ruin. 

DEFALTION FOLLOWED INFLATION.  When the British left, they took their trade and specie with them.  What trade remained lost the protection of the Royal Navy.  When money was cheap people borrowed.  With the money supply contracted, it was very difficult to repay that debt.  The Americans fell into a depression.  Farmers were in risk of losing the farm.  And debtors saw the moneymen as evil for expecting to get their money back.  The people demanded that their state governments do something.  And they did.

When the debtors became the majority in the state legislatures, they passed laws to unburden themselves from their obligations.  They passed moratoriums on the collection of debt (stay laws).  They allowed debtors to pay their debts in commodities in lieu of money (tender acts).  And they printed money.  The depression hit Rhode Island hard.  The debtors declared war on the creditors.  And threw property laws out the window.  Mob rule was in.  True democracy.  Rhode Island forced the creditors to accept depreciated paper money at face value.  Creditors, given no choice, had to accept pennies on the dollars owed.  No drawbacks to that, right?  Of course, you better pray you never, ever, need to borrow money again.  Funny thing about lenders.  If you don’t pay them back, they do stop lending.  The evil bastards.

Aristotle said history was cyclical.  It went from democracy to anarchy to tyranny.  Hamilton and James Madison, future enemies, agreed on this point.  A democracy is the death knell of liberty.  It is a sure road to the tyranny of the majority.  If you don’t honor written contracts, there can be no property rights.  Without property rights, no one is safe from arbitrary force.   Civilization degenerates to nature’s law where only the fittest and most powerful survive.  (In the social utopias of the Soviet Union and Communist China, where there were no property rights, the people’s government murdered millions of their people).

WINNING A WAR did not make a nation.  Before and after the Revolution, people thought in provincial terms.  Not as Americans.  Thomas Jefferson hated to be away from his country, Virginia.  Unless you served in the Continental Army, this is how you probably thought.  Once the common enemy was defeated, the states pursued their own interests.  (Technically speaking, they never stopped pursuing their own interests, even during the War).

In addition to all the other problems a weak Continental Congress was trying to resolve, states were fighting each other for land.  A localized war broke out between Pennsylvania and Connecticut over the Wyoming region in north east Pennsylvania.  And a region of New York was demanding their independence from that state.  Hamilton helped negotiate a peaceful solution and the confederacy admitted the new state, Vermont.

There were problems with the confederation.  And people were getting so giddy on liberty that that they were forgetting the fundamental that made it all possible.  Property rights.  States were moving closer to mob rule with no check on majority power.  And the smallest minorities held the legislation of the Confederate Congress (the Continental Congress renamed) hostage.  Land claims were pitting state against state with the Congress unable to do anything.  Meanwhile, her finances remained in shambles.  She had no credit in Europe.  And creditors wanted their money back. 

They were choosing sides.  And you can probably guess the sides.  Hamilton had no state allegiances, understood finance and capital, saw how an impotent congress was unable to support the Army during war, saw provincial interests hinder national progress and threaten civil war.  George Washington, Virginia’s greatest son, had long looked to the west and saw America’s future there.  Not Virginia’s future.  His war experience only confirmed what he believed.  America had a great future.  If they could only set aside their provincialism and sectional interests.  James Madison saw the tyranny of the majority in the Virginian State House first hand.  He liked partisanship.  He liked competing ideals debated.  He did not want to see a majority stampede their vision into law.

These were the nationalists.  Madison wanted a strong federal government to check the tyranny of the states.  Hamilton wanted to do away with the states altogether.  Washington wanted what was best for these several united states as a whole after so many labored for so long during the Revolutionary War.  Ultimately, he wanted to capitalize the ‘u’ and the’s’ in united states and make it a singular entity.

On the other side were many of the old 1776 patriots.  Many of who did not have any army experience.  Such as Thomas Jefferson.  In them, the Spirit of ’76 was alive and well.  The Revolutionary War was to free the states from the yoke of British oppression.  They remained provincials.  They did not spend up to 8 years in an army made up of soldiers from different states.  They had no sense of this nationalism.  They saw everything through the eyes of their state.  And a strong central government was just another yoke of oppression in their eyes.

THE ANSWER TO all of their concerns was federalism.  Shared sovereignty.  The states would give up a little.  And the new central government would take up a little.  The drafters of the Constitution set up a 3-branch government.  It included a bicameral legislature.  Membership in the House of Representatives would be proportional to a state’s population.  They would have power of the purse.  Including the authority to levy taxes.  In the Senate, each state would get 2 senators.  They would be chosen by the states’ legislatures (a constitutional amendment changed this to a popular vote).  This was to keep the spending of the House in check.  To prevent mob-rule.  And to check national power.  Each chamber would have to approve legislation for it to become law.  But each chamber did not need to have unanimous approval. 

That was in the legislature.  In the executive branch, the president would be head of state and execute the laws written by the legislature.  He would also conduct a uniform foreign policy.  The president could veto legislation to check the power of the legislature.  And the legislature could override the president’s veto to check the power of the president.  Where the law was in dispute, the judiciary would interpret the law and resolve the dispute.

At first glance, the people didn’t love the U.S. Constitution.  Those at the convention didn’t either, but they thought it was the best they could do.  To help the ratification process, James Madison, Alexander Hamilton and John Jay wrote a series of essays, subsequently published as the Federalist Papers making the case for ratification.  Those opposed wanted a Bill of Rights added.  Madison did not think one was necessary.  He feared listing rights would protect those rights only.  If they forgot to list a right, then government could say that it wasn’t a right.  He acquiesced, though, when it was the price to get the Virginian Baptists on board which would bring Virginia on board. 

Madison promised to add a Bill of Rights after ratification.  So the states ratified it.  And he did.  The final document fell between what the nationalists wanted and what the ‘states’ government’ people wanted. 

OVER THE FOLLOWING years, each side would interpret the document differently.  When Hamilton interpreted broadly to create a national bank, to assume the states’ debts and to fund the debt, the other side went ballistic.  Madison, the father of the Constitution, would join Jefferson in opposition.  For they believed the point of the constitution was to keep big government small.  Hamilton was interpreting the ‘necessary and proper’ clause of the Constitution to make government big.  Nasty, partisan politics ensued.  And continue to this day.

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