Day of Infamy

Last week I wrote about a day of infamy, but did not get around to talking about this. I was too happy about President Obama following through on his pledge to get our military forces out of Iraq. On that same day, the government did something that was not so good. The Fed essentially took control of Citibank.

But wait, we've heard Secretary Geithner and Chairman Bernake both say that they oppose nationalization of our banks, and assure us that what we are doing at Citibank is not nationalization. This is a classic case of mincing words. The Fed has not only assumed a commanding position of ownership, but they have already begun dictating the company's policies. They have remade the board of directors and mandated policies on employee compensation and lending standards. This is de facto control. It's like in The Sopranos when Uncle Junior was the nominal leader of the Jersey mafia, but everybody knew that Tony was calling the shots. This is what has happened with the US and Citibank. The US is Tony and Citibank is the Jersey mafia. The actual executives might as well be old, senile, and in jail.

Now the government has taken control of banks before, most notably in the S&L runs back in the 80's. This was always done to liquidate the assets of the bank. Maybe that is what is going on with Citibank, and the government is misleading the public because ... well who knows.

I do not think so. The government wants banks to loan money. They want businesses to borrow and hire workers. They want consumers to borrow and spend. This is not happening, for many very good reasons. If you are a bank, you need to clean up your balance sheet by increasing your cash and reducing your risky investments. If you are a consumer, you need to increase your savings and reduce your debt. But if the government has control over large banks, they can make the bank forget about increasing cash and reducing risk. They can offer up loan to any and everybody. They can make it really hard on consumers to resist the temptation of free money. Imagine getting a letter in the mail everyday saying that you have been pre-approved for a new credit card with a 0% interest rate and a $100,000 limit! It's the modern day version of the chicken in every pot.

And so it is that I think February 27 will be a day of infamy in American history. It may be the beginning of an era where the government is an essential part of all economic activity in America. Want to buy a house? Ask the government. Want to buy a car? Ask the government. Want to send your kids to college? Oh wait, nevermind on that one. Want to plan for retirement? Umm ...

Keynes vs. Hayek, The Final Round

This is it. Much of the last century has been a showcase of two divergent schools of thought in economics: Keynes and Hayek. Keynes ruled up until the late 70's. The Hayek school found believers in Thatcher and Reagan, but they were both compromised. At best a compromise was struck, with attempts at "supply side" economics that was close to Hayek's Austrian school, along with more Keynesian monetary policy.

Now we have the kind of financial implosion that Austrians have all said was an inevitable consequence of Keynesian monetary policy conducted by central banks. Governments have responded with extreme measures -- extreme Keynesian measures. Austrians aren't willing to say that this won't work, but do say it is only delaying an even worse fate.

The Austrians are smart folks, but they don't like to be measured and tested. They denounce any kind of objective, scientific measurement of their ideas. But they cannot avoid this one. This is it. If you are a follower of Hayek, then you must agree that we will see economic hardship on a grand scale within the next ten years or so. How grand? Again the Austrians will never give you numbers, but you gotta figure we're talking Great Depression kind scale. That would be 25% unemployment, western governments collapsing, democracy giving way to totalitarianism. If we don't have something like that in the next decade, just a run of the mill recession, then the Keynesians (and most of civilization) win.

The Great Bailout

"OMG! The _____ is in trouble! What are we going to do!!!?!"

When government people say things like this, it is always a precursor to the government proposing itself as the solution to the problem. The problem is so dire, that only the government can solve it. Of course they will need more money and more power to solve the problem. Oh, and if you don't think this is all true, then you are too dumb to understand the problem or you are just un-American because you don't care about all of the Americans who could be hurt by this grave danger.

Mr. Dave Winer makes the point that the current administration has used this argument before. Only then it was Colin Powell making the case for war in Iraq. Now it is Henry Paulson doing the same thing but with regards to the banking meltdown. Dave is right on all of this. He then goes out of his mind by suggesting that Bush/Cheney should resign, Nancy Pelosi be made President, and Paulson's plan to move right ahead. The problem is not just Bush/Cheney, and Pelosi is definitely not the solution. The problem is Paulson's request for power and money. It's like saying it would have been ok to listen to Colin Powell and attack Iraq, but only if Al Gore would have been president. It didn't matter who was President, attacking Iraq was wrong in every possible way. 

Of course Ron Paul has some interesting things to say about the bailout. His opinions are largely grounded in the Austrian economic theory that the government makes business cycles more extreme (bigger booms and bigger busts) by causing malinvestments, like buying subprime mortgages for example. Like all things in Austrian economics, it is a matter of "belief" as these are statements that are purposely impossible to scientifically verify. However, it is hard to dispute that the U.S. government has encouraged high risk loands for the purpose of buying real estate, and that the very financial institutions who did this most are now the ones that are going bankrupt.

The point is that our government does not have a good track record here. Maybe it has been the main source of the problem, as Paul suggests, or maybe not, but it certainly has been part of the problem. Now it wants unprecedented (in this country at least) power and money to solve the problem that it has been at least complicit in. Given that, how can we support this idea?

Oh, but what is the alternative? I don't know, and I don't think the government knows either. Yes, there will be banks that go under. Does that mean that we'll all be out of money? No, of course not. Anyone's savings are already guaranteed by FDIC. Not to mention that even in the case of bankruptcy, creditors (that would be people that bank borrowed money from, i.e. depositors) have first priority. Nobody is going to lose their savings. 

But surely there will be other disasters, right? If so many go out of business, how will we get loans for houses, cars, or new businesses? Well perhaps not all of the banks will go out of business. Certainly there are those that have been buying up these insolvent banks. Or maybe other companies will take the opportunity to expand into the banking vacuum created by the insolvent banks. I'm not sure, but I'm not willing to let FUD from the government convince me to give the government the kind of virtually unlimited power that they are asking fo.

Government Interference

Gilly had some fun making this Friedman video:

The Economics of Dr. Paul

My biggest reason for supporting Ron Paul is because I am sure he will get us out of Iraq. The war in Iraq is the most important issue of the day. It is the first time in America's history that we have attacked another country without provocation, conquered the country, and the installed a government there backed by our military. Everything else pales in comparison to Iraq.

However, Dr. Paul is also well known for his economic principles. I don't always agree with all of these, so I thought I would dissect his new plan for economic revitalization.

Also, I would like to openly challenge my "collectivist" friend to give his own thoughts on Dr. Paul's plans.

Tax Reform -- This is the biggest part of his plan, clearly. Now several of his tax cuts sound a lot like typical Republican "Reaganomics". For example, eliminate taxes on dividends and savings, eliminate capital gains tax, accelerate depreciation on investment, repeal the estate tax. All of these would benefit wealthy individuals and corporations much more than middle class Americans. The idea is that they would encourage economic growth.
In principle, I favor the first two issues. Taxes on dividends, savings and capital gains are all cases of double taxation. You pay taxes on your income. You take some of that income and invest it, and then get taxed again on that investment. Yes, this will favor the rich, but so what? Do we support something that is logically unfair just because the unfairness is concentrated on a minority group (rich folks) ?
I am more neutral on the other two issues. Reducing corporate tax rates seems like a more direct way to encourage growth, but I would probably put much lower priority on this. The estate tax is "unfair" in the sense that it only taxes estates worth over $2M. It is also a case of double taxation. Again, this would benefit the rich (folks with estates worth over $2M) more than anybody else, but so what? Also, hard coded numbers like $2M are always dubious. You could live where I live and have an estate worth over $2M without being very rich at all.
Spending Reform -- I definitely favor reducing overseas commitments. Well in particular, just get us out of Iraq and stop spending $800M/day there. Freezing non-defense and non-entitlement seems a little too cut n' dry. I would favor freezing or cutting many of those things, but maybe not all. It's hard to know, and hence my reservation from using a simplistic qualifier like "non-defense and non-entitlement."
Monetary Policy Reform -- Yes please! People should know what the heck is going with the Fed (or any other powerful agency.) How can you oppose this? As for allowing precious metals to be used as money ... it would be an interesting experiment to say the least.

Regulatory Reform -- I definitely favor repealing Sarbanes/Oxley. I can tell you first hand that this has a hugely negative effect on companies big and small. It was a classic case of knee-jerk legislation. Now for "Remove Costly and Unnecessary Federal Regulations"... sounds good on paper! More details should be given. I do favor HR 1869, though.

Milton Friedman 1912-2006

This week saw the passing of the great economist, Milton Friedman. There is a nice homage to him on Cato. I can proudly say that I am one of the many people influenced by Friedman. I double majored in economics for three years in college, before I wimped out and settle for a single degree in math. The economics classes at Caltech were definitely tilted to the highly analytical theories of Keynes. I would often find myself dreaming of IS-LM curves. I knew about Hayek and the Austrian School, but they seemed to be saying "it's too hard to use math on economics, so don't even try." A lot of their theories were reactionary ones to the rise of fascism and communism as well, so they seemed dated in the 90s. Then I read Friedman.

Actually it was Friedman's writings on health care and the AMA that really got to me. When I learned this was from his book Free to Choose, I had to read that. It made me question some of the "traditional" interpretations of the causes of the Great Depression. It occurred to me that it was a revisionist view that the Depression was caused by "capitalism gone wild" and that it was government regulation, particularly the Federal Reserve monetary policy, that had really aggravated the Depression. Suddenly the Depression was no longer an IS-LM consequence, and the kind of "solution" implied by that kind of analysis actually made the Depression worse.

Now I can't say that Friedman turned me into a Republican or even a Libertarian. I know he advised Regan, but I really don't think Reagan's economic policies reflected the kind of theories presented by Friedman in Free to Choose. I am still convinced that despite Friedman's opposition to communism, that his theories were totally incompatible with Reagan's policies towards the former Soviet Union. Embargo and massive military spending had no place in Free to Choose. I will say that my opposition to public education is tied to my interpretation of Friedman's theories.

So I must pay my respects to Friedman. A lot of people claim that times has shown that Friedman was wrong and that Keynes was right. What's funny to me is the revisionism at work. The great success of capitalism in the 90s has been racked up to successful monetary policy. They say that Keynes stood for this, not the fiscal policy of the New Deal or the socialist democracies of Western Europe. That's the real legacy of Friedman. He's caused history to change its version of Keynes.