Articles by " David Russell"
24 May
2010
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Inflation and the politics of fear

Something funny is happening with inflation… or isn’t happening: Despite more than two years of interest rates near zero percent and vast amounts of “liquidity” being pumped into the system, consumer prices are falling.

On Wednesday the Labor Department reported an unexpected -0.1% drop in April, the first decline since March 2001. So-called “core inflation,” considered a better long-term indicator because it excludes volatile food and fuel costs, is also grinding lower. It increased just 1% from a year earlier, the lowest reading since May 1963.

This phenomenon raises some major question for people who worried that all of the Fed’s “easy money” and “low interest rates” would cause an inflationary spiral. Instead the opposite thing seems to be underway, and is remarkably similar to what started in Japan 20 years ago. In both countries, debt-fueled bubbles collapsed and central bankers responded by attempting to prop up asset prices by “increasing the money supply.”

Given that “monetary conditions” are now much more “accommodative” than they were in the 1980s or even 1990s when inflation was higher, it’s becoming clear that these policies are an utter failure. However that shouldn’t surprise anyone because they’re actually based on the philosophy of the welfare state and the Democrat party.

Most people are still trapped in the intellectual paradigm of Milton Friedman, who famously said “inflation is always and everywhere a monetary phenomenon.” While this may be inherently true, the problem is that most observers — including economists — don’t really think about what money is.

The conventional wisdom is that central banks such as the Federal Reserve “create” money, either by printing paper or by allowing the accumulation of bank reserves. But this view assumes that a government agency can, in fact, create money. In this belief, allegedly free-market economists such as Friedman and countless others place unlimited confidence in the authoritarian power of the state. While they might argue against any government fiat in areas such as education, agriculture and housing, they unthinkingly accept the idea that the government can create, with the stroke of a pen, not only something of value, but the very essence of value.

Consider the case of prisoner camps during WWII, where cigarettes were used as money. In a famous article from 1945, economist R.A. Radford describes cycles of inflation and deflation fluctuating along with the supply of Red Cross packages. Even prisoners who hated smoking started accumulating Camels and Lucky Strikes as a means of savings and to exchange for goods and services.

Where was the Fed? Where was the Open Market Committee? Where were Ben Bernanke and his wise beard? How about Alan Greenspan and his famous stack of papers?

They were nowhere to be seen. Money in prisoner camps came into existence like language or culture. People needed to express value, and they found a medium to do so.

Let’s take it one step further: If money can exist without a central bank, it’s logical that a central bank can exist without money.

Once economists accept this basic, indisputable fact, they need to refine Friedman’s problematic dictum. The consequences are scarier than most mainstream analysts are willing to accept.

Friedman’s may have been right. But his error could be in assuming that the central bank creates money. In reality, central banks create currency. What’s the difference?

Money has two essential characteristics: It must be interchangeable and wanted (or scarce). Take away either attribute, and it’s no longer money. For instance land is wanted but cannot serve as money because it isn’t easily interchangeable. And cigarettes today are still interchangeable, but many fewer people want them, so they no longer serve as money. (Plus dollar bills are much more convenient and the bank will take them.)

Fiat currency by definition will always be interchangeable. The question is whether it’s wanted or scarce?

There was a time when people did want dollars, for instance in the 1980-2000 period, when you could often earn more than 5% after inflation just by keeping money in the bank. Now, however, interest rates are essentially zero and central bankers are comfortable creating trillions of dollars out of thin air to help ailing banks.

Of course, there will always be plenty of need for greenbacks because it’s legal tender. The same thing can be said for the yen, the Venezuela Bolivar and the Zimbabwean dollar. But in the end the only thing backing them up is the force of law: government fiat and the tax code.

Most economists, including Friedman, would agree that government fiat cannot spur real investment, innovation or economic growth. Conservatives already know that government crushes human genius when it tries to run industry and or tells people how to live their lives. Why then do we accept the government setting the price of our money?

Just as government bureaucrats ruin every other business they touch, the Fed is destroying the U.S. dollar’s ability to serve as money. They are destroying its scarcity and its dearness – one of the two key things it needs to be money.

This isn’t hurting ordinary consumption — or at least not yet. The real danger is that it prevents people from saving and kills capital formation. That means less investment, less income growth and less demand. Japan-style deflation, here we come.

Most conventional economists have no paradigm to deal with this process because they simply assume that entrepreneurs will start companies. What they fail to understand is that capital must first accumulate in large pools risk-free before being deployed. If you don’t create a hospitable environment, this simply won’t happen. Capital is like fish eggs: If the water isn’t the right temperature or doesn’t have the right pH balance, the fish don’t hatch and then migrate elsewhere. They’re simply never born.

The other thing most economists fail to appreciate is that the collapse of bad companies creates opportunities for good ones. Failure imposes discipline by teaching people what works and what doesn’t. Higher rates would cause many banks to implode and force the liquidation of their real-estate assets. This would trigger wholesale foreclosures and bankruptcies across the country. Entire towns would be wiped off the map and the people who move elsewhere. Their schools and government offices would close.

That isn’t as bad as it sounds because hundreds, if not thousands, of towns emptied of people and faded into the frontier in the 19th century (ghost towns). It didn’t keep us from going on to win two World Wars, splitting the atom, inventing rock and roll and becoming a global superpower in the following century.

So why don’t we raise interest rates now? Because we are afraid, that’s why. We’re afraid banks will fail and people will lose their jobs. We’re afraid government workers and their unions will be unemployed. We’re afraid of recession. We’re afraid of higher interest payments.

One political party in this country has always survived by pandering to people’s fears: fear of Wild Indians, fear of free blacks, fear of foreigners, fear of Catholics, fear of economic reality, fear of weather, fear of war, and — most importantly — fear of failure.

With leaders such as Andrew Jackson, Woodrow Wilson, Fernando Wood, Nathan Bedford Forrest, Robert Byrd, Al Gore Sr., Lyndon Johnson and Jimmy Carter, it’s not hard to guess which party I’m talking about.

The truth is that the country would benefit from many government employees losing their jobs and their pensions. Instead of sitting around and literally “doing time” until they collect their retirement money, those people would be forced to learn new skills, invent new products and grow as human beings. Now they are being coddled in the prime of their lives, so how will they ever achieve greatness and help society progress?

None of these issues can be separated, but it all starts with money. It’s time to stop sucking our thumbs with low interest rates and to stop embracing the mentality of the welfare state in our financial system. Americans don’t cower in fear when faced with adversity. Only Democrats do.

18 Mar
2010
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Upgrading Social Security

This is the second of six policy proposals I have written for conservatives looking to accomplish our long-term objectives of more freedom and less government.

Enhance the credit rights of Social Security: Instead of each person collecting Social Security from the government, every participant should have a private account holding real Treasury bonds in his or her name.

Under the current system, FICA taxes go the IRS, which then makes them available to the government’s general fund. Under the new system, the money would go directly from your paycheck into an individual fund managed by a company such as PIMCO or Vanguard. The fund would be legally barred from owning anything other than U.S. Treasury bonds. Without stocks or corporate bonds, the system would have the same risk profile as the existing Social Security program.

It would actually increase security for ordinary Americans by placing them on a pari passu (equal) status with foreign investors such as the Chinese and Japanese, who together hold 20 percent of the nation’s sovereign debt. (Foreigners overall owned 48 percent of outstanding Treasuries as of Sept. 30, up from 41 percent as recently as 2004.)

The existing system subordinates ordinary Americans to the foreign investors and the big banks that dominate the Treasury market. If Congress doesn’t have enough money to pay interest to the folks in Beijing, Tokyo and on Wall Street, they’ll reduce the payout to Americans on Main Street — simply by raising the income tax on Social Security benefits. Democrats have done it before, and they’ll do it again.

Under my plan, a lot of the the money paid to recipients would be from the return of principle rather than interest income, so it wouldn’t be eligible to get taxed at all. People would literally get their own money back.

This proposal would necessarily increase the fiscal deficit on paper because Congress now steals more than $900 billion a year from entitlement programs to cover its profligate spending. The good news is that this would force the government to clean up its books, producing a transparency that would be welcomed by investors and credit analysts already concerned about the country’s unfunded entitlement programs.

This idea would also make Americans feel like stakeholders in their own country again. As direct owners of Treasuries, they would be more included to resist excessive spending and debasement of the currency. It would also provide a boost to the asset-management industry.

However, the most important thing is that it would give Americans the same rights as the Chinese, Russians and Saudis. While that’s obviously anathema to the Democrat Party, it should be a key priority for the Republican Party.

15 Mar
2010
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More money for government workers!!!

This is the first of six policy proposals I have written for conservatives looking to accomplish our long-term objectives of more freedom and less government.

Public-sector bonuses: Conservatives should promote a policy that gives all public-sector workers the right to identify wasteful spending and collect personal bonuses equivalent to one-third of the public spending saved, up to $100 million per individual. Because the bonuses would result from individual initiative rather than collective bargaining, none of the bonus money could be taken for union dues.

This idea, developed from a suggestion by Pittsburgh talk-show host Jim Quinn, would instill responsibility and initiative in a workforce plagued with a lack of accountability. It would also give civil servants the ability to defend their jobs and pensions from the small number of their corrupt colleagues who rob the system with impunity. The average government worker, after all, knows that pink slips won’t be distributed fairly when the axes fall.

If enacted, public-sector bonuses would win converts to the Republican Party from a group of voters who now resist conservatism because they fear losing their jobs. This would help split Democrat Party’s most reliable voting bloc.

Even more important, this idea will change the culture in Washington and state capitols across the nation: Once employees hear about a low-ranking DMV clerk or school administrators becoming multimillionaires by saving taxpayer money, it will inspire them to do the same. This will cause a wave of accountability, self-interest and responsibility to sweep the public sector. Government workers will start acting like everyone else in the economy, focused on the bottom line and efficiency, rather than just punching the clock until their pensions kick in.

14 Mar
2010
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Conservatism for the new decade

Conservatives need fresh policy ideas. Despite the movement’s new energy and passion, as embodied by the Tea Party, it’s still based on the simple concepts of lower taxes and less government. While these are fine goals, they are not strategies.

The adversaries are well entrenched in their positions, surrounded by high walls of special-interest groups and defended by armies of public-sector unions and lobbyists. While our numbers are vastly superior, we need more than simply a frontal assault to conquer their hilltop fortress. After all, they have grown stronger despite the legacy of Reagan and the 1994 Repubublican Revolution. And, they continue erecting their barricades even now, despite the elections in New Jersey and Massachusetts.

Just as the canon rendered castles defenseless, Republicans need a new weapon to defeat the pork-infested, yet heavily defended, Democratic castle.

Over the next several postings, I will discuss several specific policy ideas that I think would redefine the political landscape and make the Left’s position untenable. My ideas may seem radical or unconservative at first, but each is carefully designed to chip away at the masonry of the enemy’s reboubt. Some could become like tremors that break the stones free, while others would be like artillery, blasting away entire constituencies and voter blocs while leaving the Pelosis, Reids and Obamas of the world isolated and weak.

First, I will focus on why the established agenda of tax cuts is outmoded,. The in subsequent posts, I will list specific policy ideas.

So, first of all, what’s wrong with tax cuts?

The answer is that a growing number of voters no longer pay any income tax thanks to years of targeted tax cuts, credits and exemptions. The Tax Foundation found that only 68 percent of Americans paid federal income tax in 2007, the smallest proportion since at least 1950. That contrasts with levels over 80 percent when the Reagan Revolution swept America.

Data for 2008 and 2009 isn’t available, but the percentage of people who pay taxes will be even smaller because unemployment has doubled from 5 percent to 10 percent in the past two years. In other words, the natural constituency for Americans who will benefit from tax cuts has shrunk by about one-quarter from the Gipper’s glory days:

Source: The Tax Foundation

The second reason why lower income taxes are losing their luster is that many voters will face higher state and local taxes. Thirty-five of the 50 states plan to raise taxes or fees to cover their massive budget deficits, according to Stateline.org. Americans are about to get slammed by higher property taxes, sales taxes and fees on everything from vehicles to hunting and fishing licenses. Conservatives must offer a solution to the bigger problem of government waste rather than simply focusing on lower marginal income taxes.

The third reason is that many people believe the religion of liberalism, which says “the rich should pay more.” Never mind the fact that most truly wealthy have the ability to pay minimal taxes. Millions of people simply love the notion of a progressive tax because it sounds “fair” to them. No amount of logic will persuade them otherwise. As a result it’s best to change the message. Our agenda isn’t simply lower taxes. After all, it smaller government and more liberty. All of my posts in coming days will focus on those objectives.

24 Feb
2010
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Declaration of Tea Party Independence

Declaration of Tea Party Independence

(Posted by David Russell. Written by the Tea Party movement.)

 I. As the course of human events winds its way through History, it has found some paths lead to Tyranny and some to Liberty. In seeking a path to Liberty, a great and powerful movement is now rising from every corner of our land. Created by the Will of the American People, it rejects unconstitutional domination by the Government that is supposed to be its servant. This movement has arisen, in large part, because our elected officials have failed us.

For much of its history the United States has been a land of prosperity and liberty, sound policies such as fiscal responsibility, constitutionally limited government and a belief in the free market have safeguarded this condition. In recent years however, Congress, the President, the Federal Reserve Board and the Courts have replaced those practices with profligate government spending and expansion of the government power beyond what is
constitutionally permissible.

This course, if not reversed, can only lead to economic collapse and tyranny.

Therefore, Individuals acting through the Tea Party Movement, seek to restore the policies, which are proven to safeguard liberty and prosperity for all. We will organize, demonstrate and vote until this restoration has been achieved. We will stay focused on this goal and remain INDEPENDENT from any persons or political parties who seek to distract us from this end.

Many seek to define this Movement, to use it, to lead it, to co-opt it, to channel it, to control it, to defeat it.

WE WILL NOT LET THIS HAPPEN.

The Tea Party Movement is in agreement with our Founders that the government that governs least governs best. We believe that Capitalism – NOT GOVERNMENT – is essential to the creation of wealth and a vastly reduced government provides the foundation for a thriving Capitalist system.

The Tea Party Movement of America embraces and serves people of all races, creeds, religions, and political affiliations, and we declare ourselves to be independent of all those forces that seek to manipulate our actions or control our destiny.

II. We Declare ourselves INDEPENDENT of the Democrat Party and its power drunk junta in Washington DC, which is currently seeking to impose a Socialist agenda on our Republic.

We reject arrogant Left-wing politicians who furtively hide from public scrutiny, as they cut corrupt deals loaded with earmarks and pork in order to produce 2000 page pieces of legislation so purposely incomprehensible, they do not even bother to read them before foisting them upon us.

We reject the endless creation of myriad federal government agencies that drown free enterprise and local control in the swarms of education, energy, ecology, and commerce bureaucrats who style themselves “czars” sent to harass us. We reject the creation of federal govern­ment regulations and agencies which demand the States pay for unfunded Federal mandates.

We reject a Democrat Party which refuses to give credence to our demands for just redress of grievances and which insults and seeks to demonize our legal right to peacefully protest the unjust laws it inflicts upon us.

We reject a profligate Government that is spending TRILLIONS of dollars on worthless socialist schemes designed to bankrupt us and put the American people in a position of dependence on the State, as peasants begging for their very sustenance from self-styled “educated classes” and so-called “experts”.

We reject a foreign policy which bows and scrapes and apologizes before the world for America.

We reject an Attorney General of the United States who offers succor and rights to vicious terrorist murderers and seeks to protect them with a mock civilian trial when such enemy combatants, captured on the field of battle, should be tried in secure military courts.

We reject the claims of an un-elected Federal Judiciary to violate the separation of powers by demanding its decisions be enforced by the other coequal branches of government, regardless of how unconstitutional the other branches of government may think those decisions are.

We reject all acts that ignore or diminish the 2nd and 10th Amendments to the US Constitution and we seek to have all powers not delegated to the United States by the Constitution to be reserved to the States respectively, or to the people.

III. We Declare ourselves INDEPENDENT of the Republican Party, which has in the past manipulated its Conservative Base to win election after election and which then betrays everything that Base fought for and believed.

We reject the idea that the electoral goals of the Republican Party are identical to the goals of the Tea Party Movement or that this Movement is an adjunct to the Republican Party.

We reject the Republican Party professionals who now seek to use the Tea Party Movement for their corrupt and narrow political purposes.

We acknowledge that standing on our principles does not mean throwing out our common sense; we will NOT abandon our principles in the name of a nonexistent bipartisanship or a misguided devotion to an illusion of “pragmatism”, which disguises a desire to betray us in its name.

We reject the scare tactics of the Republican Party, which seeks to herd us into voting for candidates who supposedly represent the “lesser of two evils” in the name of fealty to the principle of small government and then having to suffer such candidates as they betray that principle.  We are not well served by parasites whose livelihoods depend on the very State whose power to reward or sanction we elected them to limit and proscribe.

We insist that the Tea Party Movement does NOT consider the election of Republicans in and of itself to be necessarily beneficial to our goals.

We demand the Republican Party understand that we reject its attempts to co-opt us.

WE WILL WORK AGAINST THEM when they oppose our views by trying to force Repub­licans In Name Only (RINO) on us. When Republicans are in accord with their Conservative Base as well as the Independent voters who align with it, IT WINS; when they are NOT in accord with the Conservative Base and the Independent voters who align with it, IT LOSES.

We reject RINO money; we reject RINO “advice”; we reject RINO “professional experi­ence”; we reject RINO “progressivism”; we reject RINO support of Big Government; we reject RINO back room deal making; we reject RINO pork spending; we reject false RINO profes­sions of Conservative views and we reject the RINO’s statist subversion of the principles of small government for which the Republican Party is supposed to stand.

Republican Party attempts to ignore the will of the Base, as it did in 1976, 1992, 1996, 2006 and 2008, resulted in disaster; when it embraces the will of the Base, as it did in 1980, 1984 and 1994, it wins historic victories.

We demand the Republican Party recognize that while the Tea Party Movement cannot guarantee their aid will help them win elections, it is very likely WE CAN MAKE THEM LOSE if they are disdainful of our goals.

IV. We Declare ourselves INDEPENDENT of the Media, which has proved itself to be anything BUT a fair and balanced enterprise and which focuses more on entertainment, fear mongering and shock value than investigation and unbiased fact.

We reject the fiction that an unbiased media still exists; there is friendly media and there is unfriendly ENE-media. The Tea Party Movement refuses to give false credence to the self-aggrandizing, self-deluding lie that ANY PART of the Fourth Estate is free of the self-serving agendas of those who own them.

V. We Declare ourselves INDEPENDENT of self-styled “leaders” who claim to speak for the Tea Party Movement. This movement is not a brand name to be used to sell product; nor is it a logo to be used to justify profiting off its name.

We reject those who seek to personally capitalize on our popularity and momentum by trying to asso­ciate with our cause.

We reject the idea that the Tea Party Movement is “led” by anyone other than the millions of average citizens who make it up. The Tea Party Movement understands that as a Free People, we need to SAVE OURSELVES, BY OURSELVES, FOR OURSELVES.

The Tea Party Movement is not “led.” The Tea Party Movement LEADS.

VI. We are united in our common belief in Fiscal Responsibility, Constitutionally Limited Government and Free Markets. This threefold purpose is the source of our unity in the Tea Party Movement.

We reject the idea that the Tea Party Movement must all be unanimous in our specific policy views in order to win.  We recognize that the current situation requires we come together in confederation to achieve the MANY MUTUAL GOALS we all seek to accomplish.

We recognize that the current situation requires that we concentrate on the many things we have in common rather than those few things about which we may disagree.

We are the Tea Party Movement of America and we believe in American Exceptionalism.

We believe that American Exceptionalism is found in its devotion to the cause of Liberty.

We believe that Liberty is based in rational self-interest, in freedom of thought, in free markets, free association, free speech, a free press and the ability granted us under the Constitu­tion TO DIRECT OUR OWN AFFAIRS FREE OF THE DICTATES OF AN EVER EXPAND­ING FEDERAL GOVERNMENT WHICH IS AS VORACIOUS IN ITS DESIRE FOR POW­ER AS IT IS INCOMPETENT AND DANGEROUS IN ITS EXERCISE.

We believe that either fate or history has chosen this Country to be a beacon of freedom and prosperity to the whole world because of America’s belief in and vigorous defense of political and economic Liberty. The United States has been the instrument of Liberty against the many tyrannies that have threatened the people of this world.

The Tea Party Movement rejects the idea that America has to apologize to a far guiltier world that has been largely unappreciative of the sacrifices made on their behalf by the brave and noble members of our Armed Forces, whose sacrifice and patriotic service in our defense makes all else possible.

The Tea Party Movement rejects the imposition of “transformational change” performed on our Nation by smug elites who call themselves the “educated class”.

The Tea Party Movement understands that our Nation is NOT the same thing as our government and that America is much more than simply a militarily and economically powerful State.

The Tea Party Movement sees America as something exceptional, as something unique, as something that came into existence to fulfill the hope of all previous generations that longed for freedom.

It came into existence because it is more than simply a country with land and population and riches and armaments. America came into existence because LIBERTY is an eternal con­cept in the mind of both God AND Man.

The United States of America came into existence because Mankind needs freedom the same way it needs food and air and property and security and love.

And what is freedom other than the RIGHT to be free of the tyranny of Government and the elitist, self-styled aristocrats who seek to run it at our expense and to our detriment?

The Tea Party Movement will fight this danger to our Liberty as long as its members have breath in their bodies.

When America didn’t exist men and women were compelled to invent it, BECAUSE MANKIND CANNOT EXIST WITHOUT FREEDOM AND STILL BE FULLY HUMAN.

To this goal we mutually pledge to each other, as our Founding Fathers did over two centuries ago, our Lives, our Fortunes, and our sacred Honor.

1 Feb
2010
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The Democrats’ war on children

Democrats always say they care about the children (at least those who have been born), but some recent news stories show how empty those words truly are.

First, lawmakers in Albany prevented the state from receiving $700 million of federal education money because they didn’t want teachers to be paid according to their achievements. Never mind the fact that most other people in our society are compensated according to their skill. And, never mind the fact New York is facing a budget deficit of more than $7 billion. It’s far more important to appease the teachers unions, which according to the New York Post, effectively vetoed the money.

Just in case you didn’t know, Democrats outnumber Republicans by more than 2 to 1 in the state legislature.

Then today, the 15-20 people who read the New York Times awoke to the following headline:

Obama to Seek Sweeping Change in ‘No Child’ Law

That’s right: Less than two weeks after New York State was denied taxpayer money because its unionized teachers refuse to live under the same rules as the rest of society, the White House plans to scrap the law. The statute in question, of course, is No Child Left Behind, signed into law by former President George W. Bush in 2002.

According to the Times, Obama wants to “eliminate or rework many of the provisions that teachers’ unions, associations of principals, school boards and other groups have found most objectionable.”

Someone might respond: That was exactly the point. Teachers unions, associations of principals and school boards have been doing a terrible job in this country for a long time. That’s why Bush wanted to inflict a modicum of accountability on the system.

One also has to ask whether any of the normal hand-wringers on the Left will bemoan this action by the Democratic Establishment. After all, NCLB enjoyed strong support from the late Ted Kennedy, who helped push it through the Senate. First the Democrats are incapable of passing Kennedy’s beloved health-care takeover. Now will they further dishonor his memory by throwing out one of his top legislative achievements? I’m not holding my breath for David Gergen to raise that question.

We Republicans cannot let voters forget how much harm the Democrats have done to the state and its children. Not only have they abandoned any hope of raising the bar for our students — especially those trapped in inner-city districts. Their utter subservience to the unions has also caused them to walk away from a large infusion of federal money at a time of unparalleled fiscal crisis. They are incompetent as fiduciaries, and unworthy of public office.

Given the short time between New York State rejecting the funds and Obama’s new desire to change the law, it’s hard not to see a link: Democrats lose two big elections in solidly blue states like New Jersey and Massachusetts. They then take an action that could cause them to lose big in the key stronghold of New York. So, instead of taking responsibility for the decision, why not simply blame the law? We didn’t lose the $700 million because we were in bed with the unions. It was a bad law anyway!

Judging by their name, Democrats should stand for government by the people, of the people and for the people. But these actions clearly show that the only group they care about is the first one. For them, it’s government by the government, of the government and for the government.

This is why everyone in this club needs to get involved in campaigns this year. Unlike Republicans, the Democrats care about nothing but power at all cost. But they can only have power if we let them. They’ve already taken $700 million to appease a tiny sliver of the population. How much more will we let them take?

29 Jan
2010
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The problem with Ben Bernanke

The Senate voted on Thursday 70-30 to reconfirm Ben Bernanke as Chairman of the Federal Reserve. It was the closest vote ever for a Fed chairman, and reflects a growing unease in the country about the state of our monetary affairs.

The concern makes a lot of sense. Somewhere deep in their bones, the American people know something is wrong. But they still can’t put their finger on the problem.

The basic crisis runs to the philosophy of the Fed and its monetary policy. Almost every economist or investor you can find will declare without question that low interest rates spur economic growth and that high interest rates slow the economy. Even beyond Wall Street, most Americans unthinkingly accept this notion. What most people don’t realize is that it runs contrary to both classic economic theory and recent examples in other countries.

Classic economic theory says that if a country wants to encourage investment, it needs high interest rates to attract capital. This doctrine was widely embraced in the 19th and early 20th centuries, during which several financial crises resulted from interest rates being too low in the U.S. relative to other countries. For instance, the Panic of 1907 partially resulted from the Bank of England raising interest rates, which drew gold away from New York and threatened to cause a run on the banks.

World War I changed everything because the U.S. accumulated so much gold from exporting war materiel that it was no longer needed foreign capital. As a result Americans have forgotten this basic principle of capital flows.

However, the rule still applied elsewhere: Asia’s emerging markets in the 1990s, for example, used high interest rates to attract large amounts of foreign capital in the 1990s. A similar pattern appeared in China as recently as 2007, when foreigners smuggled money into the mainland to earn higher rates of return. These so-called “hot money” flows increased the credit available in the Chinese economy and were considered a source of inflationary pressures. That’s right: High rates caused inflation.

Low rates can also have the opposite effect. Reacting to its own financial crisis in the early 1990s, Japan has maintained a policy of interest rates close to 0% for more than a decade. The Japanese citizenry has responded by shipping trillions of yen to countries such as Australia and New Zealand, where they could make more money. The result has been a completely stagnant domestic economy, worsening employment and all the related social problems, such as rising suicide rates and plunging fertility.

As I said, the U.S. stopped relying on foreign capital during WWI. That situation largely continued until the 1990s, when Asian countries starting earning billions of dollars exporting electronics, shoes and automobiles to the U.S. This left them flush with dollars, which they used first to buy first Treasury bonds, then Fannie Mae and Freddie Mac securities and finally corporate bonds and private-label mortgage-backed securities — also known as subprime debt.

The numbers speak for themselves: Foreign money accounted for less than 20% of U.S. borrowing every year between 1952 and 1986. It first broke above 30% in 1992, above 40% the next year and then spiked over 50% in 1996. By the 2000s, the U.S. was routinely getting about half its money from other countries. (All of these numbers are derived from Tables F.1 and F.107 of the Fed’s quarterly Flow of Funds report.)

While reality changed, economic theory stood still. The country has returned to financial system that more resembles the 19th century than the 20th century, yet most economists still cling to a paradigm that died more than a decade ago. There is perhaps no greater bastion of the old religion than the Federal Reserve under Ben Bernanke.

These numbers might sound abstract, but they have real-world consequences. The most important point is that capital is both mobile and dynamic. If it isn’t treated well in one country, it will leave or even die.

Imagine you had a brokerage account at a company like Charles Schwab or Merrill Lynch. Imagine they told you: You have to be invested in stocks all the time, and you will be charged 5% every time you hold cash in the safety of a money-market fund. Would you ever put any funds in brokerage account like that, knowing that you had to be invested all the time? Deprived of safety, most people wouldn’t risk investing at all.

Yet, this is precisely what the Fed’s, or the Bank of Japan’s, low interest rates are doing: causing capital flight and making money stream out of the country. That’s a big reason why countries like Brazil and China saw their stock markets soar 500-1000% last decade while the U.S. lost value. It’s also why companies have focused on overseas growth, and why everyone is buying gold. All of these developments show money is leaving the U.S. financial system, where it gets no respect.

Another way to think about it is to imagine a rabbit that lives underground, and emerges everyday to hunt for food. The rabbit can survive challenges like long periods of hunger and outrun predators. However, it still must return to the safety of its hole. Take away its secure place to rest, and the animal will soon die. Even worse, it will fail to raise its young and the species will go extinct.

Your bank account is like the rabbit’s hole in the ground. The best way to rebuild a base of capital is to raise interest rates, which encourages people to accumulate money. At a certain point, those savings will be put to use building businesses and driving investment, just as baby rabbits one day emerge after reaching the necessary size and strength underground.

Money, like nature, is dynamic. Unfortunately most economists and policymakers still embrace a zero-sum view of human behavior.

That’s why they doubted Reagan’s tax cuts. Despite all their degrees and textbooks, they didn’t understand that lower tax rates would stimulate economic activity and give the government even more money. The Gipper, along with advisers like Art Laffer and Larry Kudlow, understood that if the government punishes prosperity with high taxes, it will destroy wealth.

Likewise, Americans need to realize now that if the Fed punishes savings with low interest rates, it will destroy capital.

The example of Japan is staring us in the face like a red and yellow flashing neon sign, warning us that low interest rates spell economic atrophy and death. Will we heed the example, or will ignore reality, as the liberals do?

Yes, some people argue that high rates will hurt the banks. I’ll address that issue in another posting soon.

25 Jan
2010
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Time to say bye-bye to Bernanke

The past three months have seen major upsets to the Left, including improbable Democratic losses in the New Jersey governor’s race and the Massachusetts Senate seat. This week, conservatives should also wish a similar fate upon Ben Bernanke, a man who has done more to grow the U.S. federal government than perhaps FDR and LBJ put together.

Yes, Bernanke was appointed chairman of the Federal Reserve by George W. Bush. And yes, he tended to fall more on “the right” when it came to issues such as self-regulation of the banks and supporting free trade. But he has also followed a socialist path of subsidizing failure at the expense of the general public, and used government fiat to distort prices in a way that would make Jimmy Carter blush. Just as Americans decided that four years of gas lines and limp-wristed foreign policy under Carter was enough, we should also hope that Senators on both side of the aisle find their senses and show Bernanke the door before he’s allowed to run roughshod over our economy and savings for another term.

The first problem with Helicopter Ben is that he’s followed an established tradition of subsidizing failure. Ever since the 1980s, regulators and central bankers have bent over backwards to shield the financial system from its own mistakes. As a result, institutions and doctrines that should have perished decades ago have survived unpunished, and in some cases come back stronger than ever to harm the system again and again.

The first instance was the Latin American debt crisis of the 1980s, which according to the FDIC could have sunk major lenders such as Citicorp and BankAmerica. Instead, the authorities allowed them to fudge their numbers to avert panic. They also pushed for the creation of the Brady Bond system, under whic the prestige and diplomatic power of the United States were used so that banks could magically remove toxic assets from their balance sheets. Most Americans don’t even know it happened.

The second instance was the Savings and Loan Crisis, when banks again faced major solvency problems. This time the Federal Reserve lowered short-term interest rates, allowing financial institutions borrow cheaply and make free money by investing in risk-free Treasury bonds. That allowed them to overcome big losses resulting from bad commercial-real estate loans across the country. This policy, which also forced millions of Americans to accept artificially low interest rates on their bank deposits, is being replicated today in spades.

Another kind of bailout occurred in 1998 after the collapse of Long Term Capital Management. This time instead of rescuing a single institution, the Fed saved bad ways of thinking: mathematical modeling and unscrupulous accounting. After all, LTCM used egg-headed academic theories to predict outcomes with an imagined certainty. The model would say, for instance, that  certain prices will always converge. Deluded by this imagined certainty, LTCM borrowed huge amounts of money and used more than $1 trillion of off-balance sheet instruments to finance its bets.

Yes, LTCM was allowed to perish. However, the doctrines of modeling and off-balance sheet financing came back with vengeance less than a decade later in the mortgage bubble.

In each case, the power of the Fed and other arms of the government were used to shelter corporations, their leaders and analysts from the consequences of their own actions. In so doing, they embraced the principles of big-government liberals who offer rent subsidies and food stamps. Just as welfare is immoral because it pays people to be unproductive and sends the message that it’s ok not to learn new skills, the Fed has taught the financial system that failure will not be punished.

That’s why no self-respecting conservative should support an official such as Bernanke, who has allegedly “averted crisis,” but in reality done little more than embrace the philosophy of the welfare state. Next column we’ll knock down the assumption that he’s even helped the country.

Just as voters in New Jersey and Massachusetts have sent a message to the Democratic establishment, our Senators should send a message to the financial establishment that we’ve been rewarding failure and incompetence for long enough. It’s time for Bernanke to go.

Next post: How Bernanke is hurting you