Week in Review
Investors like rising stock prices. They don’t like falling stock prices. Which is why Wall Street likes inflation. And fear deflation. Even though the economy is still sluggish with more and more people dropping out of the labor market (which is why the unemployment rate fell) investors are bullish. Because of the Federal Reserve and all of their quantitative easing.
The more the Fed increases the money supply the more inflation there will be. Investors like that. Because inflation increases prices. Such as the prices of their stocks. As well as gasoline and groceries. Making the current economic times odd. For the stock market recently reached a record high. Even though the labor participation rate (see THE EMPLOYMENT SITUATION —FEBRUARY 2013, page 4) continues to fall. It is now at 63.5%. Which means 89,304,000 people are not in the labor force. A record high. But you wouldn’t know this by looking at the official unemployment rate. Or the stock market (see Stocks And Inflation: The End Of An (Abnormal) Affair? by James Picerno posted 3/69/2013 on Seeking Alpha).
The positive correlation between the market’s inflation forecast and the stock prices appears a bit looser these days, but it’s premature to declare that the link has been broken…
Normally, rising/high inflation doesn’t inspire the bulls. But the last several years have been less than normal in terms of the macro backdrop. The crowd has remained worried about disinflation/deflation, which means that signs of higher inflation in the future have soothed anxious traders…
And why not? For when have inflationary policies ever caused an asset bubble? That burst into a long and painful recession? Except the housing bubble that brought about the 1990-91 recession. The dot-com bubble that brought about the 2000-01 recession. And that other housing bubble that brought about the 2007-09 recession. AKA The Great Recession. So there is no worry that these record highs in stock prices aren’t just another bubble. Just waiting to burst. Bringing on another deflationary recession. I mean, what are the odds of that happening again?
Actually, the chances are pretty good that 2013 will have a very painful recession. Because we don’t have any real economic growth. These gains in the stock market aren’t because businesses are expanding and hiring. Not with a falling labor participation rate. No. For all intents and purposes we are still in the 2007-09 recession. Only we should probably call it the 2007-(end date to be determined) recession. Because the president’s economic policies haven’t helped the economy yet. And probably never will.
There’s no reason to believe that the fifth year will be any better than the previous four years. In fact, it will probably be worse. In fact one would almost get the impression that he is not trying to help the economy. But, instead, trying to destroy the Republican Party. So he can win the House of Representatives back in 2014. So he can pass even more anti-business policies. To transform the country into something it was never before. Less prosperous than communist China.
Tags: asset bubble, bubble, deflation, housing bubble, inflation, investors, labor participation rate, money supply, prices, recession, stock market, stock prices, the Fed, unemployment rate, Wall Street
The Federal Reserve increased the Money Supply to Lower Interest Rates during the Roaring Twenties
Benjamin Franklin said, “Industry, perseverance, & frugality, make fortune yield.” He said that because he believed that. And he proved the validity of his maxim with a personal example. His life. He worked hard. He never gave up. And he was what some would say cheap. He saved his money and spent it sparingly. Because of these personally held beliefs Franklin was a successful businessman. So successful that he became wealthy enough to retire and start a second life. Renowned scientist. Who gave us things like the Franklin stove and the lightning rod. Then he entered his third life. Statesman. And America’s greatest diplomat. He was the only Founder who signed the Declaration of Independence, Treaty of Amity and Commerce with France (bringing the French in on the American side during the Revolutionary War), Treaty of Paris (ending the Revolutionary War very favorably to the U.S.) and the U.S. Constitution. Making the United States not only a possibility but a reality. Three extraordinary lives lived by one extraordinary man.
Franklin was such a great success because of industry, perseverance and frugality. A philosophy the Founding Fathers all shared. A philosophy that had guided the United States for about 150 years until the Great Depression. When FDR changed America. By building on the work of Woodrow Wilson. Men who expanded the role of the federal government. Prior to this change America was well on its way to becoming the world’s number one economy. By following Franklin-like policies. Such as the virtue of thrift. Favoring long-term savings over short-term consumption. Free trade. Balanced budgets. Laissez-faire capitalism. And the gold standard. Which provided sound money. And an international system of trade. Until the Federal Reserve came along.
The Federal Reserve (the Fed) is America’s central bank. In response to some financial crises Congress passed the Federal Reserve Act (1913) to make financial crises a thing of the past. The Fed would end bank panics, bank runs and bank failures. By being the lender of last resort. While also tweaking monetary policy to maintain full employment and stable prices. By increasing and decreasing the money supply. Which, in turn, lowers and raises interest rates. But most of the time the Fed increased the money supply to lower interest rates to encourage people and businesses to borrow money. To buy things. And to expand businesses and hire people. Maintaining that full employment. Which they did during the Roaring Twenties. For awhile.
The Roaring Twenties would have gone on if Herbert Hoover had continued the Harding/Mellon/Coolidge Policies
The Great Depression started with the Stock Market Crash of 1929. And to this date people still argue over the causes of the Great Depression. Some blame capitalism. These people are, of course, wrong. Others blamed the expansionary policies of the Fed. They are partially correct. For artificially low interest rates during the Twenties would eventually have to be corrected with a recession. But the recession did not have to turn into a depression. The Great Depression and the banking crises are all the fault of the government. Bad monetary and fiscal policies followed by bad governmental actions threw an economy in recession into depression.
A lot of people talk about stock market speculation in the Twenties running up stock prices. Normally something that happens with cheap credit as people borrow and invest in speculative ventures. Like the dot-com companies in the Nineties. Where people poured money into these companies that never produced a product or a dime of revenue. And when that investment capital ran out these companies went belly up causing the severe recession in the early 2000s. That’s speculation on a grand scale. This is not what happened during the Twenties. When the world was changing. And electrifying. The United States was modernizing. Electric utilities, electric motors, electric appliances, telephones, airplanes, radio, movies, etc. So, yes, there were inflationary monetary policies in place. But their effects were mitigated by this real economic activity. And something else.
President Warren Harding nominated Andrew Mellon to be his treasury secretary. Probably the second smartest person to ever hold that post. The first being our first. Alexander Hamilton. Harding and Mellon were laissez-faire capitalists. They cut tax rates and regulations. Their administration was a government-hands-off administration. And the economy responded with some of the greatest economic growth ever. This is why they called the 1920s the Roaring Twenties. Yes, there were inflationary monetary policies. But the economic growth was so great that when you subtracted the inflationary damage from it there was still great economic growth. The Roaring Twenties could have gone on indefinitely if Herbert Hoover had continued the Harding and Mellon policies (continued by Calvin Coolidge after Harding’s death). There was even a rural electrification program under FDR’s New Deal. But Herbert Hoover was a progressive. Having far more in common with the Democrat Woodrow Wilson than Harding or Coolidge. Even though Harding, Coolidge and Hoover were all Republicans.
Activist Intervention into Market Forces turned a Recession into the Great Depression
One of the things that happened in the Twenties was a huge jump in farming mechanization. The tractor allowed fewer people to farm more land. Producing a boom in agriculture. Good for the people. Because it brought the price of food down. But bad for the farmers. Especially those heavily in debt from mechanizing their farms. And it was the farmers that Hoover wanted to help. With an especially bad policy of introducing parity between farm goods and industrial goods. And introduced policies to raise the cost of farm goods. Which didn’t help. Many farmers were unable to service their loans with the fall in prices. When farmers began to default en masse banks in farming communities failed. And the contagion spread to the city banks. Setting the stage for a nation-wide banking crisis. And the Great Depression.
One of the leading economists of the time was John Maynard Keynes. He even came to the White House during the Great Depression to advise FDR. Keynes rejected the Franklin/Harding/Mellon/Coolidge policies. And the policies favored by the Austrian school of economics (the only people, by the way, who actually predicted the Great Depression). Which were similar to the Franklin/Harding/Mellon/Coolidge policies. The Austrians also said to let prices and wages fall. To undo all of that inflationary damage. Which would help cause a return to full employment. Keynes disagreed. For he didn’t believe in the virtue of thrift. He wanted to abandon the gold standard completely and replace it with fiat money. That they could expand more freely. And he believed in demand-side solutions. Meaning to end the Great Depression you needed higher wages not lower wages so workers had more money to spend. And to have higher wages you needed higher prices. So the employers could pay their workers these higher wages. And he also encouraged continued deficit spending. No matter the long-term costs.
Well, the Keynesians got their way. And it was they who gave us the Great Depression. For they influenced government policy. The stock market crashed in part due to the Smoot Hawley Tariff then in committee. But investors saw the tariffs coming and knew what that would mean. An end to the economic boom. So they sold their stocks before it became law. Causing the Stock Market Crash of 1929. Then those tariffs hit (an increase of some 50%). Then they doubled income tax rates. And Hoover even demanded that business leaders NOT cut wages. All of this activist intervention into market forces just sucked the wind out of the economy. Turning a recession into the Great Depression.
Tags: Andrew Mellon, Austrian, bank failures, banking crises, banks, Benjamin Franklin, capital, capitalism, capitalists, cheap credit, Coolidge, depression, economic activity, economic growth, expansionary policies, farm, farmers, farming, FDR, Federal Reserve, Founding Fathers, Franklin, frugality, full employment, gold standard, Great Depression, Harding, Herbert Hoover, Hoover, industry, interest rates, John Maynard Keynes, Keynes, Keynesians, laissez faire capitalism, mechanization, Mellon, monetary policy, money, money supply, perseverance, prices, real economic activity, recession, Roaring Twenties, speculation, tariff, the Fed, wages, Warren Harding, Woodrow Wilson
The Gold Exchange Standard provided Stability for International Trade
Congress created the Federal Reserve System (the Fed) with the passage of the Federal Reserve Act in 1913. They created the Fed because of some recent bad depressions and financial panics. Which they were going to make a thing of the past with the Fed. It had three basic responsibilities. Maximize employment. Stabilize prices. And optimize interest rates. With the government managing these things depressions and financial panics weren’t going to happen on the Fed’s watch.
The worst depression and financial panic of all time happened on the Fed’s watch. The Great Depression. From 1930. Until World War II. A lost decade. A period that saw the worst banking crises. And the greatest monetary contraction in U.S. history. And this after passing the Federal Reserve Act to prevent any such things from happening. So why did this happen? Why did a normal recession turn into the Great Depression? Because of government intervention into the economy. Such as the Smoot-Hawley Tariff Act that triggered the great selloff and stock market crash. And some really poor monetary policy. As well as bad fiscal policy.
At the time the U.S. was on a gold exchange standard. Paper currency backed by gold. And exchangeable for gold. The amount of currency in circulation depended upon the amount of gold on deposit. The Federal Reserve Act required a gold reserve for notes in circulation similar to fractional reserve banking. Only instead of keeping paper bills in your vault you had to keep gold. Which provided stability for international trade. But left the domestic money supply, and interest rates, at the whim of the economy. For the only way to lower interest rates to encourage borrowing was to increase the amount of gold on deposit. For with more gold on hand you can increase the money supply. Which lowered interest rates. That encouraged people to borrow money to expand their businesses and buy things. Thus creating economic activity. At least in theory.
The Fed contracted the Money Supply even while there was a Positive Gold Flow into the Country
The gold standard worked well for a century or so. Especially in the era of free trade. Because it moved trade deficits and trade surpluses towards zero. Giving no nation a long-term advantage in trade. Consider two trading partners. One has increasing exports. The other increasing imports. Why? Because the exporter has lower prices than the importer. As goods flow to the importer gold flows to the exporter to pay for those exports. The expansion of the local money supply inflates the local currency and raises prices in the exporter country. Back in the importer country the money supply contracts and lowers prices. So people start buying more from the once importing nation. Thus reversing the flow of goods and gold. These flows reverse over and over keeping the trade deficit (or surplus) trending towards zero. Automatically. With no outside intervention required.
Banknotes in circulation, though, required outside intervention. Because gold isn’t in circulation. So central bankers have to follow some rules to make this function as a gold standard. As gold flows into their country (from having a trade surplus) they have to expand their money supply by putting more bills into circulation. To do what gold did automatically. Increase prices. By maintaining the reserve requirement (by increasing the money supply by the amount the gold deposits increased) they also maintain the fixed exchange rate. An inflow of gold inflates your currency and an outflow of gold deflates your currency. When central banks maintain this mechanism with their monetary policy currencies remain relatively constant in value. Giving no price advantage to any one nation. Thus keeping trade fair.
After the stock market crash in 1929 and the failure of the Bank of the United States in New York failed in 1930 the great monetary contraction began. As more banks failed the money they created via fractional reserve banking disappeared. And the money supply shrank. And what did the Fed do? Increased interest rates. Making it harder than ever to borrow money. And harder than ever for banks to stay in business as businesses couldn’t refinance their loans and defaulted. The Fed did this because it was their professional opinion that sufficient credit was available and that adding liquidity then would only make it harder to do when the markets really needed additional credit. So they contracted the money supply. Even while there was a positive gold flow into the country.
The Gold Standard works Great when all of your Trading Partners use it and they Follow the Rules
Those in the New York Federal Reserve Bank wanted to increase the money supply. The Federal Reserve Board in Washington disagreed. Saying again that sufficient credit was available in the market. Meanwhile people lost faith in the banking system. Rushed to get their money out of their bank before it, too, failed. Causing bank runs. And more bank failures. With these banks went the money they created via fractional reserve banking. Further deflating the money supply. And lowering prices. Which was the wrong thing to happen with a rising gold supply.
Well, that didn’t last. France went on the gold standard with a devalued franc. So they, too, began to accumulate gold. For they wanted to become a great banking center like London and New York. But these gold flows weren’t operating per the rules of a gold exchange. Gold was flowing generally in one direction. To those countries hoarding gold. And countries that were accumulating gold weren’t inflating their money supplies to reverse these flows. So nations began to abandon the gold exchange standard. Britain first. Then every other nation but the U.S.
Now the gold standard works great. But only when all of your trading partners are using it. And they follow the rules. Even during the great contraction of the money supply the Fed raised interest rates to support the gold exchange. Which by then was a lost cause. But they tried to make the dollar strong and appealing to hold. So people would hold dollars instead of their gold. This just further damaged the U.S. economy, though. And further weakened the banking system. While only accelerating the outflow of gold. As nations feared the U.S. would devalue their currency they rushed to exchange their dollars for gold. And did so until FDR abandoned the gold exchange standard, too, in 1933. But it didn’t end the Great Depression. Which had about another decade to go.
Tags: bank failures, banking crises, banking system, banknotes, central bankers, credit, depressions, exchange rate, exports, Fed, Federal Reserve Act, Federal Reserve System, financial panics, fractional reserve banking, gold, gold exchange standard, gold standard, Great Depression, great monetary contraction, imports, interest rates, international trade, monetary contraction, money supply, New York, prices, reserve requirement, the Fed, trade deficit, trade surplus
A Depression is an Exceptionally Bad Recession
When campaigning for the presidency Ronald Reagan explained what a recession, a depression and a recovery were. He said a recession is when your neighbor loses his job. A depression is when you lose your job. And a recovery is when Jimmy Carter loses his job. This was during the 1980 presidential election. Where Reagan included that famous question at the end of one of the debates. “Are you better off now than you were four years ago?” And the answer was “no.” Ronald Reagan surged ahead of Jimmy Carter after that and won by a landslide. And he won reelection by an even bigger landslide in 1984.
There are a couple of ways to define a recession. Falling output and rising unemployment. Two consecutive quarters of falling Gross Domestic Product (GDP). A decline in new factory orders. The National Bureau of Economic Research (NBER) in Cambridge, Massachusetts, officially marks the start and end dates of all U.S. recessions. They consider a lot of economic data. It’s not an exact science. But they track the business cycle. That normal economic cycle between economic expansion and economic contraction. The business cycle has peaks (expansion) and troughs (contraction). A recession is the time period between a peak and a trough. From the time everyone is working and happy and buying a lot of stuff. Through a period of layoffs where people stop buying much of anything. Until the last layoff before the next economic expansion begins.
A depression has an even more vague science behind it. We really don’t have a set of requirements that the economy has to meet to tell us we’re in a depression. Since the Great Depression we haven’t really used the word anymore for a depression is just thought of as an exceptionally bad recession. Some have called the current recession (kicked off by the subprime mortgage crisis) a depression. Because it has a lot of the things the Great Depression had. Bank failures. Liquidity crises. A long period of high unemployment. In fact, current U.S unemployment is close to Great Depression unemployment if you measure more apples to apples and use the U-6 rate instead of the official U-3 rate that subtracts a lot of people from the equation (people who can’t find work and have given up looking, people working part-time because they can’t find a full-time job, people underemployed working well below their skill level, etc.). For these reasons many call the current recession the Great Recession. To connect it to the Great Depression. Without calling the current recession a depression.
Whether Inventories sell or not Businesses have to Pay their People and their Payroll Taxes
So what causes a recession? Good economic times. Funny, isn’t it? It’s the good times that cause the bad times. Here’s how. When everyone has a job who wants a job a lot of people are spending money in the economy. Creating a lot of economic activity. Businesses respond to this. They increase production. Even boost the inventories they carry so they don’t miss out on these good times. For the last thing a business wants is to run out of their hot selling merchandise when people are buying like there is no tomorrow. Businesses will ramp up production. Add overtime such as running production an extra day of the week. Perhaps extend the working day. Businesses will do everything to max out their production with their current labor force. Because expanding that labor force will cause big problems when the bloom is off of the economic rose.
But if the economic good times look like they will last businesses will hire new workers. Driving up labor costs as businesses have to pay more to hire workers in a tight labor market. These new workers will work a second shift. A third shift. They will fill a manufacturing plant expansion. Or fill a new plant. (Built by a booming construction industry. Just as construction workers are building new houses in a booming home industry.) Businesses will make these costly investments to meet the booming demand during an economic expansion. Increasing their costs. Which increases their prices. And as businesses do this throughout the economy they begin to produce even more than the people are buying. Inventories begin to build up until inventories are growing faster than sales. The business cycle has peaked. And the economic decline begins.
Inventories are costly. They produce no revenue. But incur cost to warehouse them. Worse, businesses spent a lot of money producing these inventories. Or I should say credit. Typically manufacturers buy things and pay for them later. Their accounts payable. Which are someone else’s accounts receivable. A lot of bills coming due. And a lot of invoices going past due. Because businesses have their money tied up in those inventories. But one thing they can’t owe money on is payroll. Whether those inventories sell or not they have to pay their people on time or face some harsh legal penalties. And they have to pay their payroll taxes (Social Security, Medicare, unemployment insurance, withholding taxes, etc.) for the same reasons. As well as their Workers’ Compensation insurance. And they have to pay their health care insurance. Labor is costly. And there is no flexibility in paying it while you’re waiting for that inventory to sell. This is why businesses are reluctant to add new labor and only do so when there is no other way to keep up with demand.
The Fed tries to Remove the Recessionary Side of the Business Cycle with Small but ‘Manageable’ Inflation
As sales dry up businesses reduce their prices to unload that inventory. To convert that inventory into cash so they can pay their bills. At the same time they are cutting back on production. With sales down they are only losing money by building up inventories of stuff no one is buying. Which means layoffs. They idle their third shifts. Their second shifts. Their overtime. They shut down plants. A lot of people lose jobs. Sales fall. And prices fall. As businesses try to reduce their inventories. And stay in business by enticing the fewer people in the market place to buy their reduced production at lower prices.
During the economic expansion costs increased. Labor costs increased. And prices increased. Because demand was greater than supply. Businesses incurred these higher costs to meet that demand. During the contraction these had to fall. Because supply exceeded demand. Buyers could and did shop around for the lowest price. Without fear of anything running out of stock and not being there to buy the next day. Or the next week. And when prices stop falling it marks the end of the recession and the beginning of the next expansion. When supply equals demand once again. Prices, then, are key to the business cycle. They rise during boom times. And fall during contractions. And when they stop falling the recession is over. This is so important that I will say it again. When prices stop falling a recession is over.
Jimmy Carter had such a bad economy because his administration still followed Keynesian economic policies. Which tried to massage the business cycle by removing the contraction side of it. By using monetary policy. The Keynesians believed that whenever the economy starts to go into recession all the government has to do is to print money and spend it. And the government printed a lot of money in the Seventies. So much that there was double digit inflation. But all this new money did was raise prices during a recession. Which only made the recession worse. This was the turning point in Keynesian economics. And the end of highly inflationary policies. But not the end of inflationary policies.
The Federal Reserve (the Fed) still tries to remove the recessionary side of the business cycle. And they still use monetary policy to do it. With a smaller but ‘manageable’ amount of inflation. During the great housing bubble that preceded the subprime mortgage crisis and the Great Recession the Fed kept expanding the money supply to keep interest rates very low. This kept mortgage rates low. People borrowed money and bought big houses. Housing prices soared. These artificially low interest rates created a huge housing bubble that eventually popped. And because the prices were so high the recession would be a long one to bring them back down. Which is why many call the current recession the Great Recession. Because we haven’t seen a price deflation like this since the Great Depression.
Tags: business cycle, contraction, demand, depression, economic contraction, economic decline, economic expansion, economic good times, Great Depression, Great Recession, high unemployment, inflation, inflationary policies, inventories, Jimmy Carter, Keynesian, Keynesian economics, labor costs, layoffs, monetary policy, prices, production, recession, recovery, Ronald Reagan, sales, subprime mortgage crisis, supply, the Fed, unemployment
Week in Review
The solution to the Eurozone debt crisis is easy. All the European nations have to do is surrender their sovereignty (see The eurozone’s long reform wishlist by Laurence Knight posted 6/24/2012 on BBC News Business).
A US-style federal budget may be needed to cover the cost of recessions, so that individual governments don’t risk going bust when their national economies get into trouble. For example, the cost of a minimum level of social security – especially unemployment benefits – could be permanently shared across the eurozone, paid for by a common income tax.
Welcome to the new world order. At least the new country of Europe. Made up from the former European nations. And, unsurprisingly, the answer to all their problems is a new tax. Not just any tax. But a European income tax paid to a distant central power. The kind of thing that embroiled Europe in wars to prevent going as far back as the Roman Empire. And beyond.
The European Central Bank may need to have its mandate changed so that it has an explicit dual target to support employment as well as price stability, just like the US Federal Reserve does, as proposed by the new French President Francois Hollande.
Because it has worked so well in the United States. The Fed was in charge during the Great Depression. The Fed was in charge during the stagflation of the Seventies. The Fed was in charge during the irrational exuberance of the Nineties. And the Fed was in charge during the great housing bubble that gave us the subprime mortgage crisis. Few people in the US think the Fed should be supporting anything these days. For they feel they’ve done enough damage.
All Europeans (and especially southerners) are having to implement structural reforms that will increase their long-term growth and strengthen government finances, including removing restrictions on market competition, raising the retirement age, laying off (over many years) a lot of state employees, and making it much easier to hire and fire employees.
Really? Something the individual European nations couldn’t do (cut back generous state benefits) a European country can? Students in France took to the streets when they added a year or so to the retirement age. Students took to the streets in Britain when they tried to make students pay for a part of their college education. And Greece’s answer to austerity? Riots. It is easy to say what they must do. Getting them to do it is another thing. And they’ve clearly shown they don’t like doing it. And so far have chosen not to.
In the same way that Washington has helped out struggling US states, the southern European governments may need to be given money (given, not lent) by the rest of the eurozone via direct fiscal transfers, so that they can afford to prop up their economies until they have regained competitiveness. These transfers could end up taking the form of bailout loans that are never repaid.
The US government can’t afford to bailout any states. The state of California is in trouble. As are some of our big cities. Such as Chicago. And New York City. They have the same problem Greece has. They have far more spending obligations than they can afford to pay. As did the state of Wisconsin. Whose governor implemented the kind of structural reforms suggested for the new European country. And the opposition party and the federal government attacked them for it. Organized a recall drive to kick out the governor. And undo those structural reforms. But the recall failed. The governor won the recall election by a large margin. Showing the people are no longer going to pay for other people’s irresponsible spending. As the European people probably won’t want to either.
To make a full banking, fiscal and monetary union work, the eurozone governments would need to hand power to a central authority (the European Commission) that can pay for and supervise all of the above, while national governments accept that in future they have to keep their own spending strictly within their limited means.
As most of the above reforms involve Germany sharing its wealth with the rest of Europe (and all European nations handing power to Brussels), Berlin is insisting on the principle of no taxation without representation – in other words a move towards full federalism, with spending and regulation controlled by a directly elected presidency of the European Commission.
Few European governments like hearing Germany tell them to implement structural reforms. They’re not going to like it any better coming from Brussels. Federalism wasn’t easy in the US. We had to fight a civil war. Go through reconstruction. To this day we’re still fighting regional conflicts. The Midwest is strongly union while the southern states are not. And the federal government recently intervened on the side of the unions when Boeing tried to build a new aircraft manufacturing plant in the South. In fact, those in the federal government refer to those states as flyover country. Which is all they want to see of that country. Flying overhead as they go between the east and west coasts. Where the big government people live.
The 13 original American states had only about 200 years of history before they joined the federal union. The European people have over 2,000 years of history. It is unlikely that they will willingly choose to become flyover country. No, there isn’t any easy solution to their problem. If there was they would have already done it. A currency union without a political union may just prove to have been a bad idea. A political union isn’t likely. Unless the people of Europe are more willing to give up their 2,000 years or so of history than the Americans were willing to give up their 200 years or so of history. And if they’re not they should really think long and hard about creating something even bigger than the Eurozone. That may be even more difficult to fix. Should it follow US history too closely. Where that first hundred years proved to be a bitch.
Tags: American states, austerity, currency union, European nations, Eurozone, Eurozone debt crisis is, federal government, Federalism, flyover country, Germany, political union, regional conflicts, sovereignty, state benefits, the Fed
Monetary Policy created the Housing Bubble and the Subprime Mortgage Crisis
Those suffering in the fallout of the Subprime Mortgage Crisis can thank monetary policy. That tool used by the federal government that kept interest rates so low for so long. Following the old Milton Friedman idea of a permanent level of inflation (but small and manageable) to stimulate constant economic growth. Why? Because when people are buying houses the economy is booming. Because it takes a lot of economic activity to build them. And even more to furnish them. Which means jobs. Lots and lots of jobs.
But there is a danger in making money too cheap to borrow. A lot of people will borrow that cheap money. Creating an artificial demand for ever more housing. And not for your parent’s house. But bigger and bigger houses. The McMansions. Houses 2-3 times the size of your parent’s house. This demand ran up the price of these houses. Which didn’t deter buyers. Because mortgage rates were so low. People who weren’t even considering buying a new house, let alone a McMansion, jumped in, too. When the jumping was good. To take advantage of those low mortgage rates. There was so much house buying that builders got into it, too. House flippers. Who took advantage of those cheap ‘no questions asked’ (no documentation) mortgages (i.e., subprime) and bought houses. Fixed them up. And put them back on the market.
Good times indeed. But they couldn’t last. Because those houses weren’t the only thing getting expensive. Price inflation was creeping into the other things we bought. And all those houses at such inflated prices were creating a dangerous housing bubble. So the Federal Reserve, America’s central bank, tapped the brakes. To cool the economy down. To reduce the growing inflation. By raising interest rates. Making mortgages not cheap anymore. So people stopped buying houses. Leaving a glut of unsold houses on the market. Bursting that housing bubble. And it got worse. The higher interest rate increased the monthly payment on adjustable rate mortgages. A large amount of all those subprime mortgages. Causing many people to default on these mortgages. Which caused the Subprime Mortgage Crisis. And the Great Recession.
The Federal Reserve System conducts Monetary Policy by Changing both the Money Supply and Interest Rates
Money is a commodity. And subject to the laws of supply and demand. When money is in high demand (during times of inflation) the ‘price’ of money goes up. When money is in low demand (during times of recession) the ‘price’ of money goes down. The ‘price’ of money is interest. The cost of borrowing money. The higher the demand for loans the higher the interest rate. The less the demand for loans the lower the interest rate.
So there is a relationship between money and interest rates. Adjusting one can affect the other. If the money supply is increased the interest rates will decrease. Because there is more money to loan to the same amount of borrowers. When the money supply is decreased interest rates will increase. Because there will be less money to loan to the same amount of borrowers. And it works the other way. If the interest rates are lowered people respond by borrowing more money. Increasing the amount of money in the economy buying things. If interest rates are raised people respond by borrowing less money. Reducing the amount of money in the economy buying things. We call these changes in the money supply and interest rates monetary policy. Made by the monetary authority. In most cases the central bank of a nation. In the United States that central bank is the Federal Reserve System (the Fed).
The Fed changes the amount of money in the economy and the interest rates to minimize the length of recessions, combat inflation and to reduce unemployment. At least in theory. And they have a variety of tools at their disposal. They can change the amount of money in the economy through open market operations. Basically buying (increasing the money supply) or selling (decreasing the money supply) treasury bills, government bonds, company bonds, foreign currencies, etc., on the open market. They can also buy and sell these financial instruments to change interest rates. Such as the Federal funds rate. The interest rate banks pay when borrowing from each other. Moving money between their accounts at the central bank. Or the Fed can change the discount rate. The rate banks pay to borrow from the central bank itself. Often called the lender of last resort. Or they can change the reserve requirement in fractional reserve banking. Lowering it allows banks to loan more of their deposits. Raising it requires banks to hold more of their deposits in reserve. Not used much these days. Open market operations being the monetary tool of choice.
There is more to Economic Activity than Monetary Policy
Fractional reserve banking multiplies these transactions. Where banks create money out of thin air. When the Fed increases the money supply a little this creates a lot of lendable funds. As buyers borrow money from some banks and pay sellers. Then sellers deposit that money in other banks. And these banks hold a little of these deposits in reserve. And loan the rest. Borrowers create depositors as buyers meet sellers. And complete economic transactions. When the Fed reduces the money supply a little this process works in reverse. Fractional reserve banking pulls a lot of money out of the economy. Some treat these economic transactions, and the way to increase or decrease them, as simple math. Always obeying their mathematical formulas. We call these people Keynesian economists. Named for the economist John Maynard Keynes.
Big interventionist governments embrace monetary policy. Because they think they can easily manipulate the economy as they wish. So they can tax and spend (Keynesian fiscal policy). And when economic activity declines they can simply use monetary policy to restore it. But there is one problem. It doesn’t work. If it did there would not have been a Subprime Mortgage Crisis. Or any of the recessions we’ve had since the advent of central banking. Including the Great Depression. As well as the Great Recession.
There is more to economic activity than monetary policy. Such as punishing fiscal policy (high taxes and stifling regulations). Technological innovation. Contracts. Property rights. Etc. Any one of these can influence risk takers. Business owners. Entrepreneurs. The job creators. The people who create economic activity. And no amount of monetary policy will change this.
Tags: banks, Big Government, buyers, central bank, demand, deposits, economic activity, economic growth, economic transactions, economy, federal, Federal Reserve, fractional reserve banking, Great Recession, House, housing, housing bubble, inflation, interest rates, jobs, Keynesian, loans, McMansions, monetary, monetary policy, money, money supply, mortgage, mortgage rates, mortgages, open market operations, policy, recessions, subprime mortgage crisis, subprime mortgages, supply, the Fed
Falling Oil Prices and you at the Gas Pump
Here’s something you don’t see every day. Oil prices have fallen (see Special report: What really triggered oil’s greatest rout by Matthew Goldstein, Svea Herbst, Jennifer Ablan, Emma Farge, David Sheppard, Claire Milhench, Zaida Espana, Robert Campbell and Josh Schneyer posted 5/9/2011 on Reuters).
Never before had crude oil plummeted so deeply during the course of a day. At one point, prices were off by nearly $13 a barrel, dipping below $110 a barrel for the first time since March.
Apparently the speculators aren’t all that eager to buy and hold oil right now. Something must have spooked them. Because it’s May and the summer driving season is about to ramp up. People driving around to enjoy their summers. Some 3-day holiday weekends. And a vacation or too. Demand for oil should be up. Not down. So what happened?
A routine report on U.S. weekly claims for unemployment benefits spooked investors, showing the labor market in worse shape than expected. That fed a growing pessimism about the resilience of the global economy after industrial orders slumped in Germany and the massive U.S. and European service sectors slowed. Then the European Central Bank surprised with a more dovish statement on interest rates than expected, signaling its wariness about the euro zone outlook. The dollar rose sharply.
Oh. So that’s what spooked them. Recession. Which is another name for continued high unemployment. Looks like people will be taking more ‘staycations‘ this year. Just like last year. Which means people won’t be gassing up the family car for those long trips. Instead of gas they’ll be buying more expensive groceries. So the speculators don’t want to buy oil. Demand for oil will drop. And something with low demand has a low price.
A range of factors, both economic and political, were also at play. The recent rise in raw goods has been fueled in part by the U.S. Fed pumping cash into the markets by purchasing $600 billion in bonds. This program has pushed interest rates extraordinarily low, making borrowing essentially free once adjusted for inflation. Investors have been using the super-cheap money to buy into commodity markets. But the Fed’s program is slated to end on June 30.
The U.S. Fed in their infinite wisdom printed more money to entice business owners to expand business and hire more people. Unfortunately, this also created inflation. Made our money worth less. And this raised prices. So we bought less. And if we’re buying less, businesses aren’t going to expand. They’re going to contract. To reflect the falling consumer demand. So where did all that printed money go? Wall Street. Investors borrowed the money ‘for free’ and invested in commodities. Which drove the prices up. And oil is a commodity. Now that the Fed is shutting off the ‘free money’ spigot, they’re not buying anymore. They’re selling. Hence the fall in oil prices.
China, the world’s fastest-growing consumer of commodities, also is tightening monetary policy to tamp growth rates and control inflation, raising the prospect of a slowdown in demand for oil.
And one of the big things that triggered the huge run up in oil prices back in 2008, an explosion of Chinese demand, is reversing itself. They are trying to control inflation. By slowing their economic growth. And, of course, slower growth requires less energy. And less gasoline for cars.
Put all of this together and it explains why oil prices are falling. Which is typically what happens in a recession.
Recession and Tight Monetary Policy always lowers Gas Prices
The greatest factor in the cost of gasoline is the cost of oil. Oil goes up and gas soon follows. Oil goes down and gas follows. Eventually (see Just say no to $5 gasoline by Myra P. Saefong posted 5/6/2011 on MarketWatch).
Despite Thursday’s drop, crude futures are still more than 9% higher, year to date. Crude oil makes up 68% of the price of gasoline at the pump, according to the EIA.
Overall weakness in the dollar is also to blame for rising gasoline prices. “The U.S. dollar has an inflationary impact on U.S. buyers, while also triggering increased buying in equities and commodities to stave off lost currency value,” said Telvent DTN’s Milne.
And there’s an “overlap” between refinery maintenance and a cluster of bad luck for Gulf Coast and Midwestern refineries, including electrical outages and storm-induced shutdowns, said Kloza. “This is the catalyst for the last leg [of the gasoline-price rise], which may take us to $4-$4.11, but also should soon stall.”
So we’re not going to see a corresponding fall in gasoline prices right away. But it’s coming.
Still, gasoline prices may hold a $5 average in California, where a strict gasoline formula makes the state more susceptible to higher prices, and in New York, due to tax issues, he said.
Of course, there’s always concern over the start of the Atlantic hurricane season, which begins on June 1, given the potential for disruptions to oil production and refineries in the Gulf of Mexico.
Be grateful you don’t live in California or New York. At least, when you’re buying gas. The environmentalists have added about $1 a gallon to the price of gas in California. And New York is just tax-happy. Add that to the recent storm damage, heavy rains and Mississippi flooding, prices won’t be coming down anytime soon. But they’ll be coming down. Because they always do during a recession. As long as the Fed stops printing money (which was President Carter‘s problem. Prices stayed stubbornly high in the Seventies despite recession until Paul Volcker finally tightened monetary policy).
Drill Baby Drill
Supply and demand determines the price at the pump. That’s why prices go up during the summer driving season. And down when much of the world is shoveling snow. Oil is the biggest factor in the price of gas (68%). Therefore, the less oil on the market the higher gas prices go. And the more oil on the market the lower gas prices go. Simple supply and demand. Which provides a very easy solution to bring gas prices down. Drill, baby, drill. The next best thing we could do to keep prices down is to increase refinery capacity. The more capacities available to refine crude oil the less storm damage will affect the price at the pump. Finally, roll back environmental regulations and cut taxes. Californians could easily see a drop of a dollar a gallon. Even with current oil production and refining capacities.
Energy policy can be very easy if only you can separate the politics from it. But when your political base is defined by those politics, that ain’t going to happen. So get use to high gas prices. Because they’re being kept artificially high for political reasons. And enjoy your staycation this year. And next year.
Tags: commodities, consumer demand, crude oil, drill baby drill, Energy Policy, gas, gas prices, gas pump, gasoline, gasoline prices, inflation, oil, oil prices, price at the pump, printing money, recession, refinery, refinery capacity, speculators, supply and demand, the Fed
Great Depression vs. Great Recession
Ben Bernanke is a genius. I guess. That’s what they keep saying at least.
The chairman of the Federal Reserve is a student of the Great Depression, that great lesson of how NOT to implement monetary policy. And because of his knowledge of this past great Federal Reserve boondoggle, who better to fix the present great Federal Reserve boondoggle? What we affectionately call the Great Recession.
There are similarities between the two. Government caused both. But there are differences. Bad fiscal policy brought on a recession in the 1920s. Then bad monetary policy exasperated the problem into the Great Depression.
Bad monetary policy played a more prominent role in the present crisis. It was a combination of cheap money and aggressive government policy to put people into houses they couldn’t afford that set off an international debt bomb. Thanks to Fannie Mae and Freddie Mac buying highly risky mortgages and selling them as ‘safe’ yet high-yield investments. Those rascally things we call derivatives.
The Great Depression suffered massive bank failures because the lender of last resort (the Fed) didn’t lend. In fact, they made it more difficult to borrow money when banks needed money most. Why did they do this? They thought rich people were using cheap money to invest in the stock market. So they made money more expensive to borrow to prevent this ‘speculation’.
The Great Recession suffered massive bank failures because people took on great debt in ideal times (low interest rates and increasing home values). When the ‘ideal’ became real (rising interest rates and falling home values), surprise surprise, these people couldn’t pay their mortgages anymore. And all those derivatives became worthless.
The Great Depression: Lessons Learned. And not Learned.
Warren G. Harding appointed Andrew Mellon as his Secretary of the Treasury. A brilliant appointment. The Harding administration cut taxes. The economy surged. Lesson learned? Lower taxes stimulate the economy. And brings more money into the treasury.
The Progressives in Washington, though, needed to buy votes. So they tinkered. They tried to protect American farmers from their own productivity. And American manufacturers. Also from their own productivity. Their protectionist policies led to tariffs and an international trade war. Lesson not learned? When government tinkers bad things happen to the economy.
Then the Fed stepped in. They saw economic activity. And a weakening dollar (low interest rates were feeding the economic expansion). So they strengthened the dollar. To keep people from ‘speculating’ in the stock money with borrowed money. And to meet international exchange rate requirements. This led to bank failures and the Great Depression. Lesson not learned? When government tinkers bad things happen to the economy.
Easy Money Begets Bad Debt which Begets Financial Crisis
It would appear that Ben Bernanke et al learned only some of the lessons of the Great Depression. In particular, the one about the Fed’s huge mistake in tightening the money supply. No. They would never do that again. Next time, they would open the flood gates (see Fed aid in financial crisis went beyond U.S. banks to industry, foreign firms by Jia Lynn Yang, Neil Irwin and David S. Hilzenrath posted 12/2/2010 on The Washington Post).
The financial crisis stretched even farther across the economy than many had realized, as new disclosures show the Federal Reserve rushed trillions of dollars in emergency aid not just to Wall Street but also to motorcycle makers, telecom firms and foreign-owned banks in 2008 and 2009.
The Fed’s efforts to prop up the financial sector reached across a broad spectrum of the economy, benefiting stalwarts of American industry including General Electric and Caterpillar and household-name companies such as Verizon, Harley-Davidson and Toyota. The central bank’s aid programs also supported U.S. subsidiaries of banks based in East Asia, Europe and Canada while rescuing money-market mutual funds held by millions of Americans.
The Fed learned its lesson. Their easy money gave us all that bad debt. And we all learned just how bad ‘bad debt’ can be. They wouldn’t make that mistake again.
The data also demonstrate how the Fed, in its scramble to keep the financial system afloat, eventually lowered its standards for the kind of collateral it allowed participating banks to post. From Citigroup, for instance, it accepted $156 million in triple-C collateral or lower – grades that indicate that the assets carried the greatest risk of default.
Well, maybe next time.
You Don’t Stop a Run by Starting a Run
With the cat out of the bag, people want to know who got these loans. And how much each got. But the Fed is not telling (see Fed ID’s companies that used crisis aid programs by Jeannine Aversa, AP Economics Writer, posted 12/1/2010 on Yahoo! News).
The Fed didn’t take part in that appeal. What the court case could require — but the Fed isn’t providing Wednesday — are the names of commercial banks that got low-cost emergency loans from the Fed’s “discount window” during the crisis.
The Fed has long acted as a lender of last resort, offering commercial banks loans through its discount window when they couldn’t obtain financing elsewhere. The Fed has kept secret the identities of such borrowers. It’s expressed fear that naming such a bank could cause a run on it, defeating the purpose of the program.
I can’t argue with that. For this was an important lesson of the Great Depression. When you’re trying to stop bank runs, you don’t advertise which banks are having financial problems. A bank can survive a run. If everyone doesn’t try to withdraw their money at the same time. Which they may if the Fed advertises that a bank is going through difficult times.
When Fiscal Responsibility Fails, Try Extortion
Why does government always tinker and get themselves into trouble? Because they like to spend money. And control things. No matter what the lessons of history have taught us.
Cutting taxes stimulate the economy. But it doesn’t buy votes. You need people to be dependent on government for that. So no matter what mess government makes, they NEVER fix their mess by shrinking government or cutting taxes. Even at the city level.
When over budget what does a city do? Why, they go to a favored tactic. Threaten our personal safety (see Camden City Council Approves Massive Police And Fire Layoffs Reported by David Madden, KYW Newsradio 1060, posted 12/2/2010 on philadelphia.cbslocal.com).
Camden City Council, as expected, voted Thursday to lay off almost 400 workers, half of them police officers and firefighters, to bridge a $26.5 million deficit.
There’s a word for this. And it’s not fiscal responsibility. Some would call it extortion.
It’s never the pay and benefits of the other city workers. It’s always the cops and firefighters. Why? Because cutting the pay and benefits of a bloated bureaucracy doesn’t put the fear of God into anyone.
Here we go Again
We never learn. And you know what George Santayana said. “Those who cannot remember the past are condemned to repeat it.” And here we are. Living in the past. Again.
Tags: aggressive government policy, bad debt, bad fiscal policy, bad monetary policy, bank, bank failures, bank runs, Ben Bernanke, buy votes, cheap money, cut taxes, derivatives, easy money, economic activity, economic expansion, extortion, Fannie Mae, Federal Reserve, financial crises, financial crisis, fiscal policy, fiscal responsibility, Freddie Mac, Great Depression, Great Recession, home values, interest rates, international debt bomb, international trade war, lender of last resort, lessons of history, lower taxes stimulate the economy, monetary policy, money supply, protectionist policies, recession, risky mortgages, stimulate the economy, tariffs, the Fed, weakening dollar
The Fed’s $600 billion government bond Purchase may Worsen the Recession
The Fed is preparing to buy some $600 billion in government bonds. They call it quantitative easing (QE). The goal is to stimulate the economy by making more money available. The problem is, though, we don’t have a lack of money problem. We have a lack of jobs problem. Unemployed people can’t go to the store and buy stuff. So businesses aren’t looking to make more stuff. They don’t need more money to borrow. They need people to go back to work. And until they do, they’re not going to borrow money to expand production. No matter how cheap that money is to borrow.
This isn’t hard to understand. We all get it. If we lose our job we don’t go out and buy stuff. Instead, we sit on our money. For as long as we can. Spend it very carefully and only on the bare necessities. To make that money last as long as possible to carry us through this period of unemployment. And the last thing we’re going to do is borrow money to make a big purchase. Even if the interest rates are zero. Because without a job, any new debt will require payments that we can’t afford. That money we saved for this rainy ‘day’ will disappear quicker the more debt we try to service. Which is the opposite of what we want during a period of unemployment.
Incidentally, do you know how the Fed will buy those bonds? Where they’re going to get the $600 billion? They going to print it. Make it out of nothing. They will inflate the money supply. Which will depreciate our currency. Prices will go up. And our money will be worth less. Put the two together and the people who have jobs won’t be able to buy as much as they did before. This will only worsen the recession. So why do they do it?
Quantitative Easing May Ease the Global Economy into a Trade War
A couple of reasons. First of all, this administration clings to outdated Keynesian economics that says when times are bad the government should spend money. Print it. As much as possible. For the economic stimulus will offset the ‘negligible’ inflation the dollar printing creates. The only problem with this is that it doesn’t work. It didn’t work the last time the Obama administration tried quantitative easing. As it didn’t work for Jimmy Carter. Of course, when it comes to Big Government policies, when they fail the answer is always to try again. Their reason? They say that the government’s actions that failed simply weren’t bold enough.
Another reason is trade. A cheaper dollar makes our exports cheaper. When the exchange rates give you bushels full of U.S. dollars for foreign currency, those foreign nations can buy container ships worth of exported goods. It’s not playing fair, though. Because every nation wants to sell their exports. When we devalue the dollar, it hurts the domestic economies of our trading partners. Which they want to protect as much as we want to protect ours. So what do they do? They fight back. They will use capital controls to increase the cost of those cheap dollars. This will increase the cost of those imports and dissuade their people from buying them. They may impose import tariffs. This is basically a tax added to the price of imported goods. When a nation turns to these trade barriers, other nations fight back. They do the same. As this goes back and forth between nations, international trade declines. This degenerates into a full-blown trade war. Sort of like in the late 1920s. Which was a major factor that caused the worldwide Great Depression.
Will there be a trade war? Well, the Germans are warning this action may result in a currency war (see Germany Concerned About US Stimulus Moves by Reuters). The Chinese warn about the ‘unbridle printing’ of money as the biggest risk to the global economy (see U.S. dollar printing is huge risk -China c.bank adviser by Reuters’ Langi Chiang and Simon Rabinovitch). Even Brazil is looking at defensive measures to protect their economy from this easing (see Backlash against Fed’s $600bn easing by the Financial Times). The international community is circling the wagons. This easing may only result in trade wars and inflation. With nothing to show for it. Except a worse recession.
Businesses Create Jobs in a Business Friendly Environment
We need jobs. We need real stimulus. We need to do what JFK did. What Reagan did. Make the U.S. business friendly. Cut taxes. Cut regulation. Cut government. And get the hell out of the way.
Rich people are sitting on excess cash. Make the business environment so enticing to them that they can’t sit on their cash any longer. If the opportunity is there to make a favorable return on their investment, guess what? They’ll invest. They’ll take a risk. Create jobs. Even if the return on their investment won’t be in the short term. If the business environment will reward those willing to take a long-term risk, they will. And the more investors do this the more jobs will be created. And the more people are working the more stuff they can buy. They may even borrow some of that cheap money for a big purchase. If they feel their job will be there for awhile. And they will if a lot of investors are risking their money. Creating jobs. For transient, make-work government jobs just don’t breed a whole lot of confidence in long term employment. Which is what Keynesian government-stimulus jobs typically are.
We may argue about which came first, the chicken or the egg. But here is one thing that is indisputable. Jobs come before spending. Always have. Always will. And quantitative easing can’t change that.
Tags: $600 Billion, Big Government, borrow money, business environment, business friendly, business friendly environment, businesses, cheap dollars, cheaper dollar, China, Chinese, create jobs, currency war, cut government, cut regulation, cut taxes, debt, depreciate our currency, devalue the dollar, dollar, dollar printing, domestic economies, easing, economic stimulus, Economics, exchange rates, exported goods, exports, Germany, global economy, government bonds, Great Depression, import tariffs, imported goods, imports, inflation, international community, international trade, Jimmy Carter, job, jobs, Keynesian economics, lack of jobs, lack of money, money, money supply, money to borrow, money will be worth less, Obama administration, period of unemployment, prices will go up, QE, quantitative easing, recession, stimulate the economy, stimulus, take a risk, tariffs, the Fed, trade, trade barriers, trade war, trading partners, unemployed people, unemployment, worsen the recession
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.
Tags: 1920s, 1930s, 1970s, 3rd rail, abortion, AFDC, affluent women, aged population, Aid to Families with Dependent Children, America, American, annuities, assets, baby bust, bad behavior, bank failures, bank runs, banking, banks, banks failed, big brother, Big Government, Big Government, birth control, birth rate, black family, booming economy, borrow, broken families, bubble, bubbles burst, Business, business failures, business profits, businesses, capital, charity, children, constituencies, create jobs, crisis, declining birth rate, default, deflation, deflationary spiral, Democrat Party, Democrats, dependency, dependent on government, divorced women, dollar, easy money, economic costs, father, fatherless sons, FDR, Federal Reserve Act, Federal Reserve System, fixed incomes, fractional reserve banking, Full Metal Jacket, Gomer Pyle, government control, government programs, Great Depression, Great Society, history, human nature, husband, illiquid, inflation, jobs, labor, LBJ, life savings, limited government, liquidity, liquidity crisis, Marines Corps, monetary system, money, money supply, neighborhoods, New Deal, old Chinese proverb, overvalued assets, Panic of 1907, plant and material, politically, politician, politicians, politics, prices, private pensions, public housing, R. Lee Ermey, raise taxes, real income, real values, retirement, retirement age, Roosevelt, savings plan, school, self-esteem, Sergeant Carter, Sergeant Hartman, single-parent households, Social Security, solvent, speculative, speculative bubble, taxes, the Fed, Thomas Sowell, Troubled children, unemployment, unfair advantage, unintended consequences, unmarried women, voting bloc, women's liberation movement, working husband