Oh. Wow. (Follow up to fake Paul Krugman post.)

I posted earlier this morning about the fake Paul Krugman post.

Now I found "the rest of the story" from the person who faked it.

Interesting and disturbing analysis!

Elsewhere, someone wrote,

I don't know whether the imposter intended this, but his joke has a stroke of brilliance.

By making the outrageous comment, he indirectly compels Krugman to respond to it, and say for the record whether or not he accepts it. The beauty is that no matter what Krugman says, it will make him look like an idiot.

If he says he does not accept it, then he contradicts his own worldview, because the comment is exactly in line with Krugman's orthodoxy. It wasn't an advocacy, it was simply an argument of economics.

If he says he does accept it, then he will just reconfirm what everyone already knows. That he's crazy.

If he fails to say he rejects or accepts it, then that will insinuate that he has something to hide, which conveys the impression that he secretly accepts it and is too embarrassed to explicitly admit it.

Since Krugman seems to imply in the NYT blog that the fake comment is "really stupid [and] outrageous," (although we can't be sure, and I bet Krugman carefully worded his column so that he doesn't explicitly say the comment is really stupid and outrageous, but at the same time denying he said it), then the imposter has succeeded in getting Krugman to contradict himself.

"Bring on more and stronger earthquakes! It would be good for the economy!"

Nobel Prize-winning economist Paul Krugman was recently spoofed as having made such a suggestion:

People on twitter might be joking, but in all seriousness, we would see a bigger boost in spending and hence economic growth if the earthquake had done more damage.

It turns out those words were definitely not written by Paul Krugman.

However, Krugman has made several comments virtually identical to them.

"Ghastly as it may seem to say this, the (9/11 Twin Towers) terror attack -- like the original day of infamy, which brought an end to the Great Depression -- could even do some economic good. . . . Now, all of a sudden, we need some new office buildings. . . ." (New York Times, 14 September 2001)

"Think about World War II, right? That was actually negative social product spending, and yet it brought us out [of the Depression]." (CNN Global Public Square, 12 August 2011)

"If we discovered that space aliens were planning to attack and we needed a massive buildup to counter the space alien threat and really inflation and budget deficits took secondary place to that, this slump would be over in 18 months. And then if we discovered, oops, we made a mistake, there aren't any aliens, we'd be better [off]." (Same CNN article/broadcast; note that the actual video where these comments appear begins at about 13:35 into the video in the article.)

If a Nobel Prize-winning economist can make these kinds of comments with a straight face, it should not surprise us when "regular" citizens suggest "solutions" to our economic difficulties similar to those Krugman dishes out on a regular basis. (In the referenced New York Times column, for example, Krugman wrote, "[T]he attack opens the door to some sensible recession-fighting measures. For the last few weeks there has been a heated debate among liberals over whether to advocate the classic Keynesian response to economic slowdown, a temporary burst of public spending. . . . Now it seems that we will indeed get a quick burst of public spending, however tragic the reasons.")

Check out this brief, well-done video about The Broken Window Fallacy--a fallacy first noted by Frédéric Bastiat in 1850:



For a further nuanced discussion of the limitations of The Broken Window Fallacy (because there is a point at which one does want to see some broken windows!), please read the Wikipedia article on the subject, and especially Section 2.2, Limitations. . . . But keep reading through 2.3, The opportunity cost of war and 2.4, The cost of special interests and government.

Kind of mind-blowing!

Ben Bernanke's speech . . .

I got an email this morning from "Big A" of ETF Trend Trading titled "Academy Award Nomination: Ben Bernanke":

Have you ever watched someone lie to your face and know it the whole time? I’m sure you have, we all have, but if not get ready for a big one today as good old Ben puts on the performance of a lifetime.

The reason the market just isn't doing much is simple. Bernanke will be out with his statement on interest rates, the state of the economy, and inflation at 12:30 EST today.

The market will be hanging on his every word. We all know that inflation is completely out of control. If you don’t agree with that your head is in the sand. The market is waiting to hear what he has to say with regards to future rate increases that many are now worried about due to this runaway inflation
problem.

After he makes his announcement he will then take on a question and answer session for the whole world to hear starting at 2:15 EST. It's going to be one of the greatest Academy Award-winning speeches as he looks in the camera and tells us that inflation has increased some, but it's not bad at all. Not that bad! I believe the real inflation rate is double the posted rate, but I’ll save that for another day.

You'll have to try hard not to laugh out loud, or cry out loud, whichever one seems to fit the moment. He'll also lie and tell us that things are improving quite a bit and maybe, just maybe, he can start to raise rates slowly.

Nothing dramatic, just that our economy is rolling along well enough that he can now raise rates a tad. If he told the truth he'd say that inflation is like a gasoline fueling a huge forest fire, and that he needs to increase rates so a gallon of milk won't cost $12 in the near future. He won't tell the truth because, if he did, the stock market would take a nose dive into a deep pit.

So stick around for later today if you want to see what a true boldfaced liar looks like in real life. In fact he will be so convincing that you might even find yourself believing him if you had not read this email. Inflation comes from printing money and the US does a ton of that, it’s really that simple.

It'll also be a most interesting day to see how the market responds to his lies.

After that build-up, I wanted to see how Bernanke's performance went.

So I went to Google and did a search on bernanke youtube.

For some reason, my eye was drawn to Bernanke - Every Breath You Take. Got to the page and hit play.

I was a bit nonplussed that it began with George Bush nominating him for the position. Clearly, there was some political commentary coming my way.

But then there was a picture of a cigarette burning, and a Wall Street Journal, and the music started: "Every breath you take."

Oh, yeah! This should be fun. Or good. Or something.

Nice voice-over.



Uploaded April 27.

But . . . wait a second! 1,763,580 views!?!?!!!

Yep.

Today!?!?!

.

.

.

.

Oh.

No.

In the last five years.

But, y'know. Somehow the commentary seems very up-to-date.

Enjoy!

Economics à la Bill Watterson's Calvin

Lemonade at "15 bucks a glass?!" Susie explodes, dumbfounded at Calvin's audacity.

"That's right! Want some?"

"How do you justify charging 15 dollars?!" asks Susie.

"Supply and demand," says Calvin.

"Where's the demand?! I don't see any demand!" says Susie.

Oh, replies Calvin. "There's lots of demand!"

"Yeah?" challenges Susie.

"Sure!" says Calvin. And he proves his point.

Supply-Side Economics: What is it? (Econoclasts, Part IV)

#5 in an ongoing series on Brian Domitrovic's Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity. First post in the series: Econoclasts: The Rebels Who Sparked the Supply-Side Revolution, Intro. Previous post: The Terrible 1970s, Part II (Econoclasts, Part III)

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The ruling orthodoxy amongst government economists worldwide, pretty much from the 1930s and, mostly, even until today, is what is known as Keynesianism (CANE-zee-en-izm; after John Maynard Keynes [CANES])). Keynes had taught that unemployment and inflation are inverse twins: when unemployment is high, you can expect little if any pressure toward higher prices, i.e., price inflation will be low to nonexistent. Indeed, you may experience deflation--in which prices fall. Conversely, when there is little unemployment (i.e., when most people are employed), you can expect a serious trend toward higher prices, i.e., price inflation.

With these observations in mind, Keynes proposed some policies for governments to pursue. Most particularly, when economic activity falls and unemployment rises, governments need to step in and increase demand for goods and services. They can do this by means of "fiscal stimulus"--primarily tax cuts and/or deficit spending--and/or through "monetary policy"--reducing interest rates and/or increasing money supply (i.e., inflating the currency). As Domitrovic puts it,

In the Keynesian teaching, inflation is tolerable because it means that people are out there spending money vigorously, demanding, pushing up prices in the name of growth. Taxes, in turn, take money from people who might save it rather than spend it, and then give that money to the one entity that will assuredly spend it: government.

Keynesian economics was de rigueur in the '60s and early '70s. Very few economists of any note were willing to question it.

By the mid-1970s, however, it was becoming obvious to all that Keynesian orthodoxy was unworkable. The United States was suffering ever higher unemployment together with ever increasing price inflation. Meanwhile, the government was spending at unprecedented levels beyond its income.

And, withal, there was widespread talk of doom, of permanent stagflation and “the necessity of adjusting to 'diminished expectations.'

It was in this context, then, that several key players--almost all relatively young--came forward to question the reigning orthodoxy.

And they were soon labeled “supply-siders”--a name originally attached to them with derision, but, ultimately, adopted by proponents as a badge of honor.

Why "supply-side"?

Catch the juxtaposition with (or against) Keynesianism. Keynes had taught that demand--not enough buyers--was the key economic problem.

The "supply-siders" said there was plenty of demand . . . if only the government would get out of the way and permit investors to supply what the economy needs: most particularly, investment capital.

I mentioned that Keynes had taught, at least at one point in his career, that the cause of economic recessions--or depressions--is a lack of demand, i.e., a lack of people willing to spend money. And so governments need to use fiscal (taxing and spending) and monetary (interest rates and money supply) policies to increase demand.

“Supply-side” economics also speaks of fiscal and monetary policies, but approaches them from almost the exact opposite direction. According to “supply-side” economics,

Inflation [i]s by its very nature an inducement not to work and produce, but to consume and demand, to spend one's dollars before they [devalue]. . . . If inflation [is] conquered, people [will] seek to gain income through work and investment, because in the context of stable prices, income holds its value. [However, note well!] work and investment [will] be for naught if new income [is] then confiscated by taxes. Hence, a monetary policy aimed at maintaining stable prices [must be] coupled with a tax policy aimed at stimulating personal initiative . . . in order to cure stagflation.

--p. 15

The two leading supply-side economists, Robert Mundell and Arthur Laffer,

said that the stagflation crisis . . . had originated with government. . . . First, the government had taken to destabilizing the means of exchange--the dollar--by printing it with abandon. This was the origin of inflation. Second, the government had jacked up tax rates, particularly on income that people earned as they got richer. This brought about disincentives to work and poisoned the well of capital formation. Unemployment was the necessary result.

The solution to the problem [they suggested] was clear: stabilize the dollar and cut taxes.

--p. 10

Okay. Stabilize the dollar and cut marginal [highest-end] tax rates. These, says Domitrovic, are the cornerstones of supply-side economics.

Next time: Tax cuts v. tax cuts

The Terrible 1970s, Part II (Econoclasts, Part III)

#4 in an ongoing series on Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity. First post in the series: Econoclasts: The Rebels Who Sparked the Supply-Side Revolution, Intro. Previous post: The Terrible 1970s (Econoclasts, Part II)

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--Continued from The Terrible 1970s (Econoclasts, Part II).

. . . With capital investments being taxed at such high rates, people who had money to invest did the only reasonable thing they could do in such circumstances: they invested in tangible assets rather than stocks and bonds. Put another way, the '70s saw . . .

5. A preference for "stuff" over saving.

We could go into more detail but let me quote just one section from Econoclasts:

[C]onsumerism was rampant in the 1970s. Sales of all sorts of things, useful goods and especially novelties such as recreational vehicles, were robust in the Carter years. Given inflation, this was only logical. If one bought immediately on getting paid, one exchanged money for goods. If instead one saved one's pay, that money largely evaporated. Savings could not reasonably be held in bank accounts, whose rates lagged behind inflation. . . . Savings could be put in gold, commodities, and land, and indeed they were. But as always these were tricky investments, with land having an excise tax attached to boot. Saving money became a fine art, an option foreclosed to the masses. So the masses spent.

--pp. 180-181

6. A preference for commodities and "stuff" over capital investment.

Domitrovic provides many examples of this point, but one particularly caught my eye: the story of U.S. Steel. That's partially because of a book I read several years ago that suggested the decline of the U.S. steel industry occurred because the American manufacturers were unwilling to adopt mini-mill technology, a low-cost, efficient technology that their competitors from overseas were using, first to produce pig iron, then rebar, and then, slowly, up the chain of quality until, finally, they could produce even high-end steel. The author of the book I read referred to "low-end disruptive" technology and suggested that the American steel industry was kind of "caught unawares."

Domitrovic suggested something else was at work. The federal government's tax policies made it uneconomical to invest in capital improvements. It made more sense to put one's resources elsewhere.

In the 1970s, U.S. Steel declined to make the big capital investments that technological innovation had made necessary in the race to keep up with its competition, especially foreign competition.

In particular, U.S. Steel chose not to buy the (expensive) basic oxygen process (BOP) furnaces and continuous casting machines for its plants. The storied Homestead Works near Pittsburgh went to its grave in 1987 having never replaced its Carnegie-era open-hearth furnaces with a "BOP shop," nor its ingot molds with a caster. This had easily made Homestead irrelevant in the international steel market by 1980. But by that date, U.S. Steel had found a better use for the capital it could have spent on steelmaking machines. It set aside $6 billion to acquire Marathon Oil, whose petroleum reserves increased in value with inflation. Had U.S. Steel bought capital equipment with that $6 billion, it would have been killed by taxes and inflation. Thus did the company, soon to be called "USX," forsake steel for oil.

After 1982, when the [Marathon Oil] transaction cleared, approximately 160,000 steel workers lost their jobs. This was precisely the future that began to worry workers in the early 1970s in Buffalo and Lackawanna, New York, Lake Erie towns that were home to massive Bethlehem Steel plants, today as shuttered as Homestead.

--pp. 133-134

Domitrovic provides other examples of this shift from capital investments into tangibles. He describes General Electric's temptation to abandon "manufacturing in such areas as power generation, engines, and medical devices" in favor of "the small natural-resources segment of its business portfolio" that was producing "exceptional profits" (p. 152).

In the late 1970s, the commodity play appeared a plausible strategy. In 1978, for example, GE's natural resources business accounted for 5 percent of the total sales of the company, yet 15 percent of its profits.

--p. 218

GE's main competitor, Westinghouse, actually pursued this strategy. "In the 1980s, Westinghouse decided to wind down its core competency, nuclear power, and gobble up land out west, as if it were a time for survivalism" (p. 259). Once inflation was slain--just at the time that Westinghouse was moving into tangible assets--that particular strategy turned out to be counterproductive. GE surged ahead while Westinghouse "edged to the brink of bankruptcy in the late 1980s and 1990s and was forced to reverse-merge into a shell" (ibid.).

Domitrovic tells the story of the experience that convinced Congressman Jack Kemp, during his freshman year in Congress, to seek a major reduction in capital gains taxes. Kemp said he saw a help-wanted sign on a machine shop in his district. It included an unusual requirement of anyone who was to be a successful candidate. He had to be able to "Bring own lathe." Clearly, the machine shop owner didn't want to take the risk--or pay the price--to buy equipment for his employees. He figured it would be a bad investment: "I'm willing to hire you, but I'm not willing to buy the tools you'll need to do your job."

For me, one of the most striking concepts having to do with investment in commodities v. capital equipment arose from the research and thinking of a Northwestern Mutual Life Insurance Company economist. Domitrovic says Harvey Wilmeth "discovered a Federal Reserve publication that detailed the 'balance sheet' of the nation." According to this document, by the late '70s, more than half of all assets in the United States were "tangible assets--hard assets such as real estate, collectibles, commodities, and consumer durables."

Domitrovic says this is, was, and, from a forward-looking perspective, ought to be, abnormal. "Under ordinary circumstances, financial assets [stocks and bonds should] dwarf tangible assets in value" (pp. 216-217).

Why?

"Stuff" is what has already been produced. "Securities" or "financial assets"--stocks and bonds--are claims on what will be produced in the future. The ratio of stuff to securities is a measure, therefore, of confidence in the economic future. If the ratio is getting higher, as it was in the late 1970s, the message is that expectations are declining about the future production of stuff.

--p. 217; emphasis added

Or put the other way around: If a nation is to have a future, if it is to have positive future expectations, then it ought to have--it needs to have--a greater investment in capital stock than commodities.

Wilmeth realized that the taxes and inflation of the 1970s had increased the cost of holding financial but not tangible assets. Because taxes in general were . . . income taxes, and because inflation buoyed the value of things already produced or in the ground, the rise in income-tax rates along with inflation in the 1970s had led to a tremendous move out of stocks and bonds and into the stuff that presently existed. . . .[F]uture stuff . . . cannot be produced without investments in financial assets. The shift into tangibles thus prefigured a decline in production.

--p. 217; emphasis added

Financial assets--stocks, bonds, mortgages--are bets on people being productive in the future. They have nothing to do with the past. . . . For the market for financial assets to improve, there must be a clear reason for businesses and individuals to believe that there will be stable money, low taxes, and beneficial but spare regulations as new economic initiatives are undertaken.

--p. 291

If you want people investing for future productivity, you can't disincentivize them by taxing such behavior so that it makes more sense for them to buy non-productive "stuff" than to pay for productive assets in hopes that they might produce profits in the future. (I hope I'm not sounding like too much of a broken record. Remember my post on March 14^th: More on taxes and tax avoidance . . . and prosperity? I quoted a speaker who noted that politicians understand how taxes work as incentives (or disincentives) in other areas of life: "We want to decrease the number of people who smoke. Let's raise taxes on cigarettes." Why don't they understand that the same thinking applies to such issues as income and investment?)

7. Resource shortages or scarcities.

At a conference held in May 1974 by the American Enterprise Institute, Robert Mundell

provided a table showing commodities that had risen in price as much as or more than oil in recent years, among them cotton, rice, and wheat, with sugar beating oil's price increase by a factor of three. . . . Since the United States in particular had given up on mooring the dollar to gold in any credible way in the 1960s, and since the convention up to that point had been for the world's currencies to be priced in relation to the dollar, this was the result: "Confidence in currencies in general declined and a shift out of money and financial assets commenced. . . . [Soon] the prices of metals, foods and minerals more than doubled. Shortages of beef, sugar and grains appeared, but gold and oil led to the most dramatic 'crises' and received the most attention from the public."

--p. 108

What was happening? With inflation running rampant, buyers were seeking to acquire everything they could as soon as possible (while their money still had value) . . . while producers were motivated to slow supply as much as possible to get the best (future) price.

8. Terrible unemployment.

We've already told the story of steel workers being thrown out of work.

Inflation plus a progressive tax code that made it impossible to have two things simultaneously: a job and pay. You can have a job, but if you've militated for real pay, the employer would run out of cash and thus have to look for a less labor-intensive business to go into and make the playoffs. Inflation did not cure unemployment in the 1970s; it caused it.

--p. 152

Before 1979, bracket creep combined with inflation had encouraged vigilance on the part of wage earners. They had to get a COLA-plus in order simply to get a COLA. The inflation that came in 1979 and 1980 intensified this requirement beyond all hope. Workers from across the income spectrum were now at best breaking even against inflation and taxes. After the 26 percent inflation of 1979-80, raises had to be in the 30 percent-50 percent range in order to reach par.

If an employee got such a raise, it was a brilliant coup. But it was devastating to his employer. To grant employees raises that kept up with inflation, employers had to ensure that their revenue gains outpaced inflation rates now in the double digits.

--p. 176

And, of course, that proved impossible.

Just how bad was unemployment in the '70s and early '80s?

Well, "Unemployment, which had held at under 4 percent through . . . the late 1960s, went to 5 percent and then 6 percent in 1970 and 1971" (p. 93). "[I]t surged to 9 percent in 1975, easily the highest level since the Depression, a rate that was one-quarter higher than during any postwar recession" (p. 105). "Unemployment hovered at 6 percent in 1978 and 1979 and went to 7 percent in 1980" (pp. 175-176).

Back in the 1960s, Arthur Okun, chairman of President Johnson's Council of Economic Advisors, had almost jokingly produced what he called the "economic discomfort index" (the sum of the inflation rate and unemployment rate--a play on the weather service's "discomfort index" that totals temperature and humidity). In the '60s, Okun's index ran at 6 or 7. "[I]n 1975 it hit an unthinkable 18." And, as Domitrovic says, "This wasn't merely discomfort, so someone recast the metric as the 'misery index'" (p. 105).

"The misery index, at 21 in 1980 thanks to inflation at 14 and unemployment at 7, was 16 in 1982. Eight points of inflation had been traded for three of unemployment." Unemployment actually hit 9.7 percent in 1982 (p. 231). [Let me note--as Domitrovic does--that 1982 was the second year of Reagan's presidency. Not to make excuses for him (Domitrovic, ever the historian, points out several strategic and tactical mistakes Reagan and his advisors--not to mention Congress--made), but it is worth noting here that, following the screaming inflation of the late '70s and 1980 (immediately prior to Reagan's taking office),

The consumer price index rose [only] 3.4 percent (annualized) in the last quarter of 1981, a remarkable achievement. (The full-year 1981 figure was still 10.3 percent.) In 1982, prices in the first quarter rose at an annual rate of only 2.1 percent before yielding to a full-year rate of 6.2 percent. Thus did 1982 end a three-year run of double-digit inflation.

--p. 231

We will return to the issues of inflation and unemployment--the misery index--at a future date, when we consider the results (or lack thereof) of the so-called "supply-side revolution."

Let us "merely" agree, here, that unemployment in the '70s and early '80s was a major problem--worse than at any point in United States' history except for the Great Depression (when, admittedly, it was much worse).

Let us admit, however, one additional point that Domitrovic wants us to acknowledge: when modern pundits claim that the present economic turmoil is unprecedented except for the Great Depression, they are, most definitely, talking without knowledge. The United States' unemployment rate in 2008 to 2010 is not so different from what it was in 1975 and 1982 . . . though those periods of high unemployment were accompanied by far worse inflation. The misery index was far worse than it is today or has been in the last two years or so since the economy started to falter.

9. Property taxes through the roof--and a tax revolt.

Despite all the talk about income taxes, Domitrovic says,

The tax that threatened to turn the '70s funk to the Great Depression was the property tax. In inflationary times, commodities, limited in supply by the earth, increase in price at a rate greater than inflation. . . . Commodities take on the monetary function surrendered by money . . . , that of the "storehouse of value." The one thing that is most limited in supply by the Earth is the earth itself--land. Land values can race far ahead of the price level in inflationary times. The effect is especially acute when the land in question is generally desirable: California land, for example.

In the 1970s, California land prices spiked enormously, just as gold, oil, gas, and other commodities did, but there was a difference in owning land as opposed to a commodity. There was no excise tax on gold, tungsten, copper, and so on, even if there came to be equivalents of such things on oil. There certainly was an excise on California land, namely the local property tax, which averaged about 2.7 percent through early 1978.

Ten years before, in 1968, if you had been a brave California home buyer who stretched your budget to take out a mortgage on a $50,000 home, the tax component of the monthly mortgage payment would've been about $110. Over the next ten years, as the assessors reacted to a fivefold increase in the value of the property, that component would have risen to $550 per month. Inflation had been about 100 percent, but tax inflation had been 500 percent. True, the mortgage would've been reduced in real size by inflation, but that implies that one actually keeps one's COLAs. Given bracket creep, one does not. The bottom line: by 1978, many Californians who had lived in their homes for years realized that they might soon face foreclosure.

Had nothing happened, it would've made for curious history. . . . But . . . California voters . . . passed Proposition 13 in June 1978. Prop 13 collapsed the property tax to 1 percent and underindexed it for future inflation. Henceforth the only time the tax code would treat a house according to its market value would be upon its sale.

--pp. 153-154

10. Government consuming an ever-increasing share of the nation's productive capacity and wealth.

Domitrovic speaks of this issue many times throughout the book, but this section expresses it very well.

[Treasury Secretary William] Simon's last act as treasury secretary, in January 1977, had been to issue a report calling for unconditional tax cuts, including a cut in the top rate of almost half. . . .

In early 1978, . . . Simon's [book] Time for Truth . . . reported . . . [that] government at all levels have benefited from greatly increased revenues in the 1970s because of inflation and bracket creep. Indeed, "the share of gross national product eaten up the government has been inflating feverishly," Simon reported. "In 1930, spending . . . accounted for 12 percent of the GNP. By 1976, as was 36 percent."

Simon marveled that, despite the transfer of wealth from the private sector to government, government was having an ever harder time making ends meet. One of the reasons the Carter deficits were unintelligible to Simon was that they persisted, then increased, in the face of rising tax revenues as a percentage of GDP--not to mention falling military spending. When deficits go up with increasing revenues, and do so consistently, the only expectation can be for further displacement of the real economy by government. Reflecting on this "cannibalistic pattern," Simon wrote that quote no economy can survive a structural war conducted against it by the state."

Finally, one last major problem from the 1970s.

11. Ever-increasing government intrusions into [formerly] private decisions.

A quick summary statement of the problem:

Throughout the long 1970s, the federal government of the United States preoccupied itself with such things as fixing prices, ushering labor unions not to take wage increases, begging shoppers to rein in their spending, mistaking nominal for real income in the tax code, adding regulations, . . . and . . .

We'll stop here with our summary of the worst economic problems of the 1970s in the United States.


*******
Next time: What is supply-side economics?

The Terrible 1970s (Econoclasts, Part II)

#3 in an ongoing series on Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity. First post in the series: Econoclasts: The Rebels Who Sparked the Supply-Side Revolution, Intro. Previous post: "Supply-side" economics was a colossal failure, wasn't it?

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Brian Domitrovic's Econoclasts is a history book from beginning to end. Considering my interests, I had to remind myself several times as I read it because I had a much narrower purpose, going in, than Domitrovic had for writing it.

Part I, a 99-page "Reconsideration of the 20th Century," summarizes American monetary policy from 1913, the year in which the income tax was instituted and the Federal Reserve created, till about 1974. It actually begins in 1974 and describes the sorry state of the American economy at that time, then flashes back to 1913 and tells the story in between.

The history is interesting--Domitrovic talks specifically of government policies throughout the 20th century with particular interest in the post-World War II period. The entire history, I think, is worth one's while. But my personal interests here in my blog are limited enough that I want to focus primarily on the 1970s and following.

So, if you don't mind, I would like to bring you back to the mid-70s.

I am 53. I was still 17 when I first left home and began my freshman year in college. I had turned 18 just a few weeks before OPEC, the Organization of Petroleum Exporting Countries, shut off the oil spigots in October 1973.

If you are my age or younger, you may not have strong memories of many of the worst ravages of the economic upheaval of the mid- to late 1970s. I was aware of the dramatic price increase in gasoline that occurred beginning in October of 1973, and I saw photographs and read about the long lines of cars waiting to be refueled . . . and of gasoline stations completely out of inventory, . . . but these events didn't affect me personally a whole lot . . . I imagine because . . . I was in college, . . . because I rarely drove a car, . . . because my living expenses, overall, were rather low, . . . and, finally, because I was single.

Again, I was aware of the galloping inflation and felt the pall of economic difficulties (although, looking back, I wonder how much I attributed the pall at the time to the emotional impact of living in central Michigan where the winters are cold and interminably gray).

One event that comes to mind: I remember one day being told that Michigan State University might run out of its coal supply . . . which, if it had occurred, would have meant we would have run out of heat, hot water, and much if not all of our electricity on campus. I remember watching the large pile of coal slowly diminish that winter and wondering if the coal would come in time.

Happily, it did.

Domitrovic brought me back and, whether it is due to my more advanced years or, perhaps, because I was actually more impacted than I thought, the data points he shared stirred up some fairly strong emotions.

Perhaps you remember some of the titles of popular books from that era: Paul Ehrlich and his Population Bomb, William and Paul Paddock’s Famine 1975!, the Limits to Growth report from the “Club of Rome,” Lester Thurow’s The Zero-Sum Society, the Christian end-of-the-world blockbuster, The Late Great Planet Earth by Hal Lindsay, . . . and others. I would say the era was surrounded by a general pessimism.

But besides the feelings, on a more practical level, Domitrovic mentions at least eight economic and political problems of the 1970s whose solutions were not clear:

1. Price and wage inflation.
    
2. Tax bracket creep.
    
3. Financial stress for business owners.
    
4. Effective capital gains taxes above 100%.
    
5. A preference for "stuff" over saving.
    
6. A preference for commodities and "stuff" over capital investment.
    
7. Resource shortages or scarcities.
    
8. Terrible unemployment.
    
9. Property taxes through the roof--and a tax revolt.
    
10. Government consuming an ever-increasing share of the nation's productive capacity and wealth.
     
11. Ever-increasing government intrusions into [formerly] private decisions.

I'll try to summarize these briefly, the first four in this post, the last seven (which I felt I was able to summarize in shorter order) tomorrow.

1. Price and wage inflation.

Concerning price inflation:

[I]n October 1973, . . . the Organization of Petroleum Exporting Countries (OPEC) signaled that it would triple the price of oil. The "oil shock" would soon become most economists' convenient catchall explanation for the raging inflation, recessions, and stock-market plunge that characterized the economy in the late Nixon and Ford-Carter eras. But in reality, the inflation crisis was in full swing before the OPEC shock of late 1973. OPEC moved to raise prices precisely because the currency instability emanating from the United States was already troubling the world. In the 12 months before the OPEC announcement, consumer prices in the United States increased by 8 percent, breaking out of the 5 percent range established in Nixon's first term, a rate that itself was quadruple the historical norm. . . .

[T]here was one great commodity, of greater importance even than oil to daily life, whose price rose the most in 1973, transfixing the nation in disbelief. That's commodity was food, which suffered 15 percent inflation that year. Food became the first major commodity to burst out of the 5 percent inflation band and to goad the general index up to unseen levels, a leadership role later assumed by oil, gas, and various metals naturally be limited in supply. The inflation laggard in 1973 was transportation (the price of which increased 3 percent), making it logically impossible that rising "energy" costs were responsible for inflation at the grocery store.

Eggs went up 49 percent in 1972-73, pacing the category of poultry, meats, and fish, which rose 25 percent as a group.

--p. 104

[I]n the recession years of 1974 and 1975, consumer prices somehow increased at World War I rates--11 percent and 9 percent, respectively. At the end of 1975, the economy was only marginally bigger than it had been in 1973, and prices were 25 percent higher.

--p. 105

With respect to wage inflation, Domitrovic reminded me of a term I had pretty well forgotten: COLAs--cost-of-living-adjustments.

I believe it was during this period--the mid-'70s--that COLAs first became bargaining issues in union negotiations. Living in Michigan at the time, and with the auto industry and auto workers being such a large presence in the state's economy at the time, I was very aware of unions, union activities, and strikes. People elsewhere in the country, I'm sure, were also aware. There were a lot of labor actions taking place at the time!

And our presidents--first Nixon, with his staggering, unprecedented-in-peacetime "wage and price controls," then Ford, with his "WIN--Whip Inflation Now" campaign, and, finally, Carter, with his attempts to get labor unions and corporate managers voluntarily to agree not to permit wages or prices to increase more than 7 percent in a year-- . . . our presidents, too, were deeply concerned about galloping inflation.

In high price-inflation environments, you need major adjustments in your salary if you are to be able to buy this year the same amount of "stuff" as you did the year before. And so, as prices rose at astronomical rates, so did wages.

This rise, first in prices and then in wages, created a terrible effect that the federal government at first--and for many years--refused to address. It was the problem of . . .

2. Tax bracket creep.

Domitrovic explains:

By the late 1970s, everybody had become acquainted with . . . bracket creep, [a term that] referred to the progressivity of the tax code in combination with inflation. . . . Inflation ran at 7.5 percent per year, 45 percent total, from 1973 to 1978. If a worker making $19,000 in 1973 had cost-of-living adjustments (COLAs) equal to the rise in consumer prices, the worker was making about $27,500 after five years. In 1973, a worker making $19,000 had an income tax rate that topped out at 25 percent. Yet in 1978, the worker would have found that every dollar of his cumulative $8,500 raise--a raise that covered only his rise in living expenses--was taxed at higher rates. The first $4,000 was taxed at 28 percent, the next $4,000 at 32 percent, and the remaining dollars at 36 percent.

The COLA meant to keep the worker even with inflation, but it failed. For the COLA was additional income, and higher marginal rates applied to that additional income. To have been a real COLA, it should have been taxed at the average rate of tax for all the worker's income, in this case 17 percent. But that is not how a progressive tax system works. All new income is taxed at the highest rate an income earner is subject to. A COLA could even vault earners into a higher marginal rate bracket than that at which their last dollar of income, pre-COLA, was taxed. . . .

The numbers were grim. For our 1973 worker to have maintained the same standard of living against inflation, the worker would have had to arrange for something like $29,400 of income in 1978. That is, a 55 percent raise (8.7 percent per year) was required to keep up with inflation as it mixed with the tax code.

For most workers, this was unthinkable.

--pp. 150-151

Domitrovic references research by Paul Craig Roberts who was working for Orrin Hatch at the time. Roberts noted that someone whose average income tax rate was 10% needed a raise 11% above the rate of inflation (i.e., if inflation was 7%, he would need a 7.77% wage increase) just to stay even. Better-paid workers would need raises worth 40% or more above the rate of inflation (if inflation was running at 7%, the better-paid worker would require a raise of at least 9.28%) to stay even.

A syndicated columnist at the Boston Herald-American described the cases of specific workers whose real purchasing power went down as their wages increased. "A businessman named 'Lawrence K.,' . . . saw his income go up by half in ten years and his after-tax purchasing power [went] down by a third."

And if the average wage-earner felt pressure, consider the . . .

3. Financial stress for business owners.

Domitrovic writes:

Since the 45 percent inflation of 1973-78 required a 55 percent increase in salaries, firms seeking to give real COLAs to their employees faced cash-flow problems, if not the stalking horse of bankruptcy . . . (p. 152).

In [the] ten-year period [of 1973 to 1982], the steel wage rate climbed 179 percent, while inflation rose 132 percent. Unless there was supercharged productivity, raises of this order meant raids on business profits. And given the way depreciation was treated in the tax code, there was not supercharged productivity. The stock market took due note and encouraged the likes of U.S. Steel to bail out to commodities. (p. 176)

We'll be telling the story of U.S. Steel in a few moments. For now, let's discuss the problem of depreciation.

4. Effective capital gains taxes above 100%.

Early in his book, on page 13, to be exact, Domitrovic makes a comment that blew me away when I first read it. "No way!" I said to myself.

In the 1970s, income derived from work was being taxed at a particularly acute rate. So was entrepreneurialism (in the form of a capital-gains tax that in many cases, incredibly, exceeded 100 percent).

It took me a while to find the data to back up this claim. Domitrovic provides it on pages 132 to 134 as he references work by economist Norman Ture (too-RAY) in Ture's The Effects of Tax Policy on Capital Formation.

In one of Ture's examples, a business owner contemplated buying a piece of machinery for $1,000. Because the top bracket taxed income at 48 percent, this business, if run by a top earner who took a salary, would have to earn $1,923 to buy the machinery. Yet this was only the first step in the long gauntlet of taxation.

Ture assumed, generously, that the machinery would yield 12 percent per year in profits, or $156. This $156 would itself be dunned at tax time. Ture crunched the numbers and concluded that to make a profitable investment in capital equipment of $1,000, this business owner would have to commit $2,450 of pretax income. If the owner spent the money instead, all that would be required was the original $1,923. The effective tax penalty on investment in lieu of consumption for a business owner was $500 for each $2,000 invested--an absurdity.

Depreciation told an even sadder tale. . . . [D]epreciation schedules . . . were extended to a standard of thirteen years . . . in the 1970s. This was brutal. Inflation averaged 9 percent in the stagflation era. After thirteen years, 9 percent inflation means that an initial price is depreciated, in the end, to 33 percent. On a depreciation schedule, this requires that businesses he ducked less and less of the real purchase price of equipment every year, culminating in a deduction that is one-third of the equipment's real value. . . .

Another example: A [privately owned] company gains income less expenses of $1,000. The corporate income tax takes 48 percent and the rest is paid out as dividends to shareholders, who must pay [if they were in the top bracket at that time] 70 percent tax on that type of income. The $1,000 [corporate net income before taxes] first becomes, because of the corporate rate, $520 [corporate net income after taxes], then $156 [net income after taxes to top income bracket shareholders] because of the dividend rate; $844 goes to the IRS.

Okay. The federal government got 84.4 percent of the this hypothetical company's $1,000 income.

Let me simply note that at those kinds of rates, I'm not highly motivated to invest in my company.

But remember, Domitrovic claimed, back on p. 13, that capital gains taxes could often exceed 100%. How does he come up with that number?

He suggests we take the same company we just described and look at expenses.

To make his example more understandable, I am going to make up some numbers. I am not going to attempt to create an illustration that perfectly matches the tax codes of the '60s and '70s/ I am simply trying to illustrate the general principle.

Suppose the company we just described had purchased a machine 13 years before that, at the time, cost $20,000. Now suppose, after 13 years, the company still had $1,000 of the original $20,000 purchase price to write off as depreciation. . . . --Here's where things get interesting.

Keep in mind that there was a lot--a lot--of inflation over the course of the 13 years since the company purchased that equipment! In current money, the machine that cost $20,000 13 years ago would now cost $60,000. I.e., every $1,000 of the original price should "really" be counted as $3,000 in today's money!

Therefore,

[I]f inflation had denuded the depreciation allowance by, say, two-thirds [i.e., the $1,000 depreciation allowance was worth one-third of what it "should" have been had the original $20,000 been valued at $60,000 in today's inflated currency--JAH]. . . , the real depreciation allowance should have been $3,000. [And i]f depreciation schedules . . . had been indexed for inflation, the company would have not reported a profit of $1,000, but a loss of $2,000, on account of a proper depreciation allowance of $3,000.

We have, in this case, a company and its owners paying $844 in taxes on a loss of $2,000.

--p. 133

That is a specific example of a single imaginary company's owners' predicament. On an aggregate (economy-wide) level, economist Martin Feldstein of Harvard wrote in the Wall Street Journal (July 27, 1978), "We found that in 1973 individuals paid capital-gains tax on $4.6 billion of nominal capital gains on corporate stock. When the costs of these shares are adjusted for the increase in the consumer price level since they were purchased, this gain becomes a loss of nearly $1 billion. The $4.6 billion of nominal capital gains resulted in a tax liability of $1.1 billion."

Domitrovic comments,

Feldstein found that only about half of the $1.1 billion in capital-gains tax revenue that went to the federal government was taken from investments that had made money in real terms. The other half had been taken from investments that merely kept up with inflation, in whole or in part. "Many individuals paid a substantial capital-gains tax," Feldstein wrote, "even though, when adjustment is made for the change in the price level, the actually receive less from their sale than they had originally paid."

Most disturbing according to Feldstein: "The mismeasurement of capital gains is most severe for taxpayers with incomes under $100,000" (p. 163).

Domitrovic multiplies these examples. The point, however is this: Anyone with the ability to invest in the stock market--i.e., anyone with the means to provide capital for start-up companies--realizes that it is all but impossible to come out ahead when inflation is galloping along and you'll be taxed not only on your investment's real returns but on the phantom "gains" of inflation.

With capital investments being taxed at such high rates, people who had money to invest did the only reasonable thing they could do in such circumstances: they invested in tangible assets rather than stocks and bonds. Put another way, the '70s saw . . .

5. A preference for "stuff" over saving.

. . . --To be continued tomorrow.

Econoclasts: The Rebels Who Sparked the Supply-Side Revolution, Intro

As I noted back on February 19th, I received an e-mail from the Intercollegiate Studies Institute with a sidelink to a brief (36:48) lecture by Dr. Brian Domitrovic, assistant professor of history at Sam Houston State University in Huntsville, Texas. I was so impressed by Dr. Domitrovic’s presentation that I ordered a copy of his book, Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity.

The book turned out to be, in many ways, much more than I bargained for, but I finally finished it on Saturday, and I'm glad I took the time!

I read the book because I was hoping to understand what the "supply-side revolution" was really all about: What did the proponents believe? How did they argue their case? and What were the results? I got all those things, for sure, but I also read way more details than I really wanted to take the time for, including lots and lots of names (along with brief biographical sketches), and article titles, and journal paper summaries, and descriptions of cocktail parties, and narratives about the personal feelings of participants at various points. Just "more than I wanted to know."

Still. Domitrovic wrote the book in hopes of filling a void. As he writes in his concluding chapter:

Economic crises caused by loose money and high taxes were cured by [supply-side] policy mix[es] in 1922, 1962, and 1981. Likewise, similarly caused crises that did not call forth the [supply-side] response--the recessions of 1969-70 and 1974-75--festered until the proper cure came.

There is not one word of historical scholarship on any of this. . . . In academic history, the secondary literature on supply-side economics is nil. Many things have been written about supply-side economics, but none of them falls in the category of "literature" as the term is used by historians.

Econoclasts, p. 292

Domitrovic notes that this lack of historical research has some serious (negative) practical implications for those of us alive today. (And I'm talking about today, in 2010.

[A]s the economic crisis deepened in 2008 and 2009, public officials were quick to compare it with the 1930s. It was as if the Great Depression were the only economic crisis, and the New Deal the only solution, they had ever heard of. How could it have been otherwise? What serious books could be read, what courses taken, on the new vehicles of economic stabilization that had been pioneered since JFK's time? Economists tracked this history to some degree, but their specialty is still distance and models. Documenting what policymakers did in the past, and why, is a job for historians.

What might history teach President Obama and the favorably inclined Congress he enjoys? First, it is time to understand what great Democrats achieved in the past. It is difficult to believe that had FDR honored George Washington's precedent and not sought a third term, he would be regarded today as anything short of a grand failure. The recession that started right after FDR's reelection in 1936 canceled all gains made by the New Deal and perpetuated the Great Depression until the clouds of war came. For all the make-work programs of the Works Progress Administration and the crusades against big business, the New Deal in its classic--1933-39--did nothing to restore prosperity.

JFK, in contrast, took all the right advice and knew when and how to defy it. His ambition was such that he was going to have spectacular growth on his watch, no matter whom he had cut deals with--even if that meant the Chamber of Commerce and Ford Motor, as opposed to this orders of the neoclassical synthesis who made up his Council of Economic Advisors. . . .

JFK's is the result Obama should aspire to, not FDR's.

Econoclasts, pp. 292-293

Domitrovic urges five specific policy recommendations. I intend to return to them in a future post after I have summarized some of the content of the book that most impressed me.

This post is merely to "forewarn" you of subject matter I hope to deal with in the days to come.

I hope you find it interesting and, perhaps, inspirational!

---

Next post in this series: "Supply-side" economics was a colossal failure, wasn't it?

More on taxes and tax avoidance . . . and prosperity

I was working in the yard on Saturday and, as I usually do when working outside, I listened to a few lectures--at high speed.

The series I was listening to came from the November Sovereign Society Offshore Advantage Academy meeting in Los Cabos, Mexico.

One of the speakers, Dan Mitchell, Senior Fellow and Chairman for Freedom and Prosperity at the CATO Institute, got talking about tax policy and tax avoidance.

Remember my post on tax avoidance as a civic good back in December? Miller made much the same point about the value of tax competition. As it has become easier for people to move around the world; as the world has become more "open," tax rates in many countries have actually fallen.

Miller noted that, on average, top income tax rates have dropped 26 percent over the last 20 years or so. Corporate tax rates have dropped by more than 20 percent on average. Moreover, there have been significant reductions in double taxation. As Miller put it, "Globalization is making it easier for the geese that lay golden eggs to escape oppression."

And, said Miller, all of these are good things.

He showed a number of graphs that demonstrate the differences that an average annual shift of just one percent in growth can produce over a few years' time.

As I've also been reading in the last couple of days in Phil Town's book Payback Time, you can calculate how quickly a certain percentage rate will double the underlying value by dividing 72 by the average rate of growth (or inflation or interest . . .). It's called the Rule of 72.

For example: Suppose you are making $35,000 a year today. At 3% inflation, how long will it take before you need to be making $70,000 a year . . . just to remain even with your current income?

Divide 72 by 3: there's your answer. In other words, at 3% average inflation, it will take 24 years before you need to be making $70,000.

But suppose inflation ratchets up just a couple of percent. Let's make it a 5% rate of inflation. Divide 72 by 5 and you're looking at a salary of $70,000 to break even within about 14 years.

Seven percent inflation? 10 years. Ten percent inflation, 7 years.

Pretend you're facing no inflation but the economy grows at 3% per year? --Participants in your economy will, on average, be twice as wealthy 24 years from now as they are today.

Push your economic growth two percent higher? --You're twice as wealthy in 14 years.

Two percent lower (as America's government is threatening to do with its confiscatory tax policies): at 1% average growth rate per year (discounting inflation!), America will take 70 years to become twice as wealthy as it is today.

Miller noted that it is these (apparently) small percentage differences that have made dramatic differences in economic prosperity on the world's stage--just in the space of our own lifetimes (or a little longer).

Argentina, which was the 10th most prosperous country in the world on a GDP per capita basis as late as 1949, had fallen to 50th by 1992 . . . while Hong Kong, in the same time, rose from about 53rd to 10th!

Or take Ireland and France. In 1975, the per capita income (as calculated by dividing Gross National Product by population) in Ireland was about $8,000; in France, it was just over $15,000--almost twice as high. The two countries maintained a nearly equivalent nominal disparity in income till about 1990 . . . and then Ireland started catching up. Between 1990 and 1995, Ireland's rate of growth remained consistent with where it had been in the previous five years; France, meanwhile, slowed down a bit. And then, right about 1995, Ireland took off. In five years, the average income in Ireland rocketed from approximately $18,500 to a bit over $30,000 . . . while France's average income plodded along, growing from about $23,000 to not quite $26,000. In 2004, France sat at an average of about $27,000, while Ireland was a bit over $35,000--a huge disparity brought about by a small percentage difference in growth rates over a few years' time.

And what can make these kinds of differences?

Often: tax policies of the government. As Miller noted, "A smaller burden of government translates into more opportunity and higher living standards."

Consider: Based on a Rule of 72 calculation, the U.S. economy has been growing at an average of between 2% and 3% per year for the last 50 years . . . during a time when the government, on average, consumed about 20% of everything our economy produced.

"Today, the burden of the federal government is more than 27 percent of GDP," Miller said, "up from 18.5 percent when Clinton left office.

"Because of Social Security, Medicare, and Medicaid, federal spending is projected to jump from 22 percent-plus of GDP today to 45 percent to 67 percent of GDP after the baby boom generation is fully retired." Meanwhile, "State and local governments will consume – at a minimum – another 15 percent of GDP."

Socialism, anyone? Poverty, anyone?

Miller noted that politicians understand how taxes work as incentives (or disincentives) in other areas of life: "We want to decrease the number of people who smoke. Let's raise taxes on cigarettes." Why don't they understand that the same thinking applies to income?

If you want people to be motivated to produce, you don't raise taxes on income!

"High tax rates reduce incentives to engage in productive behavior, meaning less work, saving, investment, and entrepreneurship. This means less taxable income."

Miller illustrated the reverse of this "equation" with the real-world example of Reagan's policies.

• In 1980, there were 116,800 rich people.
   
• Those rich people reported $36.2 billion of income to the IRS.
   
• They paid $19.0 billion of income tax to the federal government.

Under Reagan, tax rates were dropped and . . . by 1988 . . .

• There were 723,700 rich people.
   
• Those rich people reported $353.0 billion of income to the IRS.
   
• They paid $99.7 billion of income tax to the federal government.

Want to see the principle operating in reverse?

Yesterday afternoon, after listening to Miller's presentation in the morning, I bumped into this article about "Maryland's Mobile Millionaires" from the Wall Street Journal:

Illinois Governor Pat Quinn is the latest Democrat to demand a tax increase, this week proposing to raise the state's top marginal individual income tax rate to 4% from 3%. He'd better hope this works out better than it has for Maryland.

We reported in May that after passing a millionaire surtax nearly one-third of Maryland's millionaires had gone missing, thus contributing to a decline in state revenues. The politicians in Annapolis had said they'd collect $106 million by raising its income tax rate on millionaire households to 6.25% from 4.75%. In cities like Baltimore and Bethesda, which apply add-on income taxes, the top tax rate with the surcharge now reaches as high as 9.3%—fifth highest in the nation. Liberals said this was based on incomplete data and that rich Marylanders hadn't fled the state.

Well, the state comptroller's office now has the final tax return data for 2008, the first year that the higher tax rates applied. The number of millionaire tax returns fell sharply to 5,529 from 7,898 in 2007, a 30% tumble. The taxes paid by rich filers fell by 22%, and instead of their payments increasing by $106 million, they fell by some $257 million.

What's going on? Is it just the lousy economy? No. No way.

People cheating on their taxes? Not likely.

Read the article for an analysis.

The same thing can happen--as it has--on the international stage.

Economic Crises, Then and Now . . .

The Intercollegiate Studies Institute (ISI) sent me an email with a sidelink to a brief (36:48) lecture by Dr. Brian Domitrovic, assistant professor of history at Sam Houston State University in Huntsville, Texas, and author of Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity. (I didn't know anything about him from the sidelink. I was just intrigued by the title of the lecture: Economic Crises, Then and Now.)

Domitrovic begins with an observation I had thought of several times in the past, but had quit thinking about in the last many months: The media keep telling us that we are in "the worst recession since the Great Depression." But is this so? Are we really in "the worst recession since the Great Depression"?

Domitrovic's answer: No! No way! Not even close!

But, then, why do the media pundits keep talking about it in such terms?

I only listened to Dr. Domitrovic's lecture once--at high speed, so perhaps he answers this question. But I don't remember him attempting to explain why they say it. He was far more interested in demonstrating that it is not the worst. And, more, how we can avoid making it worse than it is.

But while we're on the subject, I'd like to state that it, from my perspective, there is one reason why the federal government is happy to feed this line to the media: Being able to fight "the worst recession since the Great Depression" gives the government implicit "permission" to do whatever they want, to build the government ever bigger and spend more money than ever: "We're in a crisis, you know!"

But Domitrovic gives a brief history of the financial ups and downs of American history--both before the Great Depression and after. And he provides a worthwhile historical perspective on things.

There is a way out of the wilderness, he says. And--surprise, surprise!--history teaches us that the way out is not through more government intervention. Indeed, additional government intervention is what will lead to greater disaster.

Don't believe him? Check out his stats. Take the time to listen to his presentation on MP3. And/or do as I have just done: order a copy of his book.

The financial future of the United States

Last Saturday evening, Sarita and I went out to dinner with some old friends. He works at a major aerospace company. Whenever we talk with this couple, I know I have to be careful about touching on subjects that could be touchy from a security/secrets perspective.

At some point in the conversation, we got talking about the state of American technology and infrastructure. He mentioned that his group is doing very little truly transformative, new development but is, instead, always having to write code to work around equipment that is breaking down.

????!!!!????

I didn't understand. It didn't make sense to me.

"Wait a second. You're saying the equipment--computer processors--are breaking down? Why wouldn't your clients either get new equipment or fix what they already have? I mean, computing power is getting less and less expensive. . . ."

"But suppose we can't get to the equipment . . . ," he suggested.

????

"Suppose, for example, that we're talking about, say, a communications satellite in geosynchronous orbit. . . ."

"Yes . . . "

"Well, you can't get to it."

"Why not?"

"It's out about 26,000 miles."

"So? . . . I mean, the Earth is only--what?--about 18,000 miles around the equator. So it's not that far. . . ."

So we got talking about the space station and the Hubble Telescope--which are only a couple hundred miles above the Earth's surface--and how difficult and expensive it is for us to get to them to make fixes and adjustments.

Now push that distance out by a factor of 130 times.

The conversation drifted pretty quickly, then, to other subjects, including, for some reason, the interstate highway system: Could the United States possibly do, today, what it did in the mid-50s and through the very early '70s?

We all agreed that such exploits would be virtually impossible.

We could not build another interstate highway system. We could not send a mission to the Moon beginning from scratch (the way the U.S. did back in the '60s). . . .

As Sarita and I were driving home, we drove along a small portion of an interstate highway and the road was pretty broken up.

As we drove across a bumpy section of soaring interstate bridge, I got thinking about the crumbling infrastructure of the United States--how so many hundreds of bridges in the U.S. are in serious need of maintenance, repair, or replacement.

I realized the U.S. can't afford to maintain, repair or replace these roads or bridges, partially because it has never fully paid off the original costs of these bridges . . . since it borrowed money to buy the roads and bridges in teh first place.

But/and now it's 40 or 50 years later, and the U.S. government is like the family that bought a car beyond its means, hoping and praying it would be able not only to pay it off before they figured they would need a new car in five or seven or 10 years, but, perhaps, they would even be able to lay aside some money to have a bit of extra cash on hand to pay for the next vehicle.

Too bad for the family: Having signed up for a $17,000 loan when they first bought the vehicle 17 years ago, they have never really paid it off. Oh, yes, the original debt instrument is no more. But in order to finish their payments, they "simply" bought more of their then-current food, clothing, furniture, toys, etc., etc., on credit (using their credit cards) and used the cash that had thus been "freed up" to pay off the vehicle.

Today, they are still driving the car they bought 17 years ago; it is in truly horrible condition. They have have $35,000 in credit card debt, a $247,000 home mortgage, and . . . well . . . the screws are tightening.

That's the U.S. Most especially at the federal government level.

The U.S. federal government hasn't paid off a lick of debt in 80 years.

And its acknowledged debt obligations amount to almost $13 trillion. Add in all the unfunded Social Security promises it has made (in case you are unaware: the government has saved absolutely nothing for Social Security; it has absolutely no investments set aside to make its promised payments), and the unfunded Medicare and Medicaid promises, and the retirement payment promises it has made to federal employees (who, on average, as wage-earners, earn twice what people in the private sector make), and the . . . well, let's not go into all the details . . . --But if we add in all the unfunded promises the federal government has made--promises to pay that no private company would be permitted to make if it hadn't set aside resources to pay them: the federal government is well over $110 trillion underfunded and/or in debt as we speak.

And who is going to pay these bills?

You and me? People over 40? Not likely!

It's our children, grandchildren, and great grandchildren who will, somehow, have to shoulder the burden. Oh, and some Boomers and X-ers as well, I imagine, as we, who have failed to make preparations for ourselves, will find the government cannot fulfill its promises in any form we might expect based on the government largesse of the '60s, '70s, '80s, and '90s.

A Parable for Our Day

I happened to locate an article yesterday that placed what I had already begun to feel into stark, concrete, historical terms. It's sub-titled Your Future of Blackouts and Shortages as the U.S. Becomes a Third World Country. James Dale Davidson, the author, lives in Buenos Aires, Argentina, and, he says, "There is perhaps no better place on earth to contemplate economic decline than in" Buenos Aires.

In essence, he says, beginning in the late 19th century, and up until 1929, Argentina was a very wealthy country. One of its great advantages: It was in close relationship to Great Britain.

Following WWI, however, with the decline of the British Empire, it didn't fare so well. Still, many analysts believe that, even in 1929, Argentina was one of the wealthiest countries in the world per capita. It was certainly ahead of Germany, France and, of course, Japan (since Japan was still a backward "developing" economy at the time).

In the meantime, however, Argentina has fallen hard. It is now far behind Europe, North America and Japan. The United States ought to look to Argentina as an object lesson for what will happen if we follow the siren song of government salvation.

Human nature being what it is, however, I'm afraid we are going to follow Argentina's path to destruction.

Like the US today, Argentina entered the Great Depression in 1929 heavily dependent on foreign capital, with highly unequal income dispersion, wide political resentments and lots of what would become bad debts in the banking system.

The path Argentina took out of depression led from bank bailouts to runaway budget deficits, hyperinflation and decades of negative compound growth.

An open, free economy was replaced by a closed system, hobbled by intervention and inward-looking strategies after the Great Depression.

Argentine economist Mauricio Rojas writes in his book, The Sorrows of Carmencita (p. 89), “The [Argentine] government couldn’t pay its bills, so it tried to inflate them away. The rise in prices between 1976 and April 1991 was an incomprehensible 2.1 billion times. During approximately the same period, per capita income sank by over 25% and the poverty rate among Argentine households soared from 5% to 27%.”

Argentine pesos worth a billion dollars in 1976 were worth only 47 cents 15 years later. And this was the result of ongoing government deficits averaging only 14% of GDP. Sound familiar?

Of course, it was not merely government borrowing that got Argentina into trouble. It was also government policies.

To illustrate his thesis, Davidson summarizes the sad story of Unión Telefónica del Río de la Plata Ltd., the British-owned Argentine telephone company that operated efficiently and profitably far into the 20th century . . . until the Argentine government under Perón bought it, renamed it Empresa Nacional de Telecomunicaciones (ENTel), and drove it into the ground. (By 1990, Davidson says, ENTel's service was "arguably the worst in the world, even worse than the poorest African countries. Argentines had to wait as long as 15 years to obtain a phone line, and then installation cost as much as $1,500.")

Davidson also describes the Huemul Project--a government program that was supposed to produce nuclear fusion. Energy produced by the process, Perón believed, would be able to be delivered in milk-bottle sized containers for use in airplanes and other vehicles. "Success was proclaimed; but no proof was given. When independent scientists investigated Perón’s Huemul Project to provide nuclear fusion in milk bottles, they revealed the project was a fraud."

[Will the United States endure similar frauds under the ever-louder siren call of research projects "needing" to be funded by the government in order to meet the legislated deadlines of alternative energy? Davidson asks.]

As decision-making power here in the United States becomes ever more centralized, I think Davidson is correct: We can expect greater and greater inefficiency, greater corruption, more and more serious repercussions from every decision that is made.

• The "punitive cap-and-trade carbon taxes" being urged by certain big-government environmentalists, "will make Al Gore richer," Davidson suggests (see this article and this one, too, for some perspective on Gore's expected windfall); but will it make you and me poorer? (Hate to say it, but I think most likely!)
   
• "When Perón took office, Argentina had the world’s second largest gold reserves. But these were soon squandered nationalizing industries and funding politicized investments, like the Huemal Project." (Kind of off-subject, here, but I think it's interesting: I just read that in 1940, when paper dollars were actually redeemable for silver (the face of a silver certificate said, "This certifies that there is on deposit in the Treasury of the United States of America one dollar in silver payable to the bearer on demand."), the United States government held 6 billion ounces of silver--to fulfill its promise. Today, with the "dollar" meaning, really, nothing more than a sheet of paper with printing on it that declares "This note is legal tender for all debts, public and private," the government holds no silver. None. Nada. . . . As for gold, it holds just over a quarter of a billion ounces. . . . A lot of people will say: "Who cares? No one--well, no one who counts--thinks money needs to be tied to precious metals. There are other ways to value currencies" . . . and they will mention land, labor, energy, and other things of value [how about, "a force-backed claim on . . . the productive power and wealth-producing capacity of the sovereign economy on the whole"--i.e., a government's ability to extract wealth from its subjects?] that might be pledged as the foundation for the currency's intrinsic worth. And maybe they are correct. Though it sure feels crazy that an entity like the Federal Reserve can create "money" out of nothing whenever the U.S. government asks. . . .
  
  But while we're on the subject, let me note that, while a quarter billion ounces of gold sounds like a lot, it's really not. At today's prices [just over $1,000 per ounce], that amounts to only slightly more than a quarter of a trillion dollars: "nothing more than pocket change on the Federal balance sheet," the equivalent of little more than "a rounding error . . . and irrelevant to overall governmental finances," according to Bill Zielinski.)
   
• "As the US follows the same policy path as Argentina," Davidson suggests, "it will obtain similar results. Perverse policies will destroy prosperity and inspire thinking people to get out, and/or get their money out." ("This is already happening," says Davidson. "In 2008, more than two million Americans emigrated, marking the first time that net legal and illegal migration . . . reduced the population of the US.")
   
• As more people seek escape, Davidson suggests, the federal government will do what Perón's government did: impose exchange controls. Moreover, "Soon after, the government will demand that people who had the foresight to take their money out bring it back."
   
• "Although the U.S. government will resort to draconian measures to tax the 'rich,' . . . destructive economic policies will diminish tax revenues even as government spending runs amok."
  
  "Diminish tax revenue"? Davidson notes that,
  

  Among other consequences of runaway budget deficits and hyperinflation was the virtual disappearance of the income tax in Argentina. It shrank to just 1% of GDP as the value of the previous year’s income became pocket change by the time taxes were due.

   
• Next consequence? Wage and price controls.
   
• . . . And so on and so forth.

In sum: As the government's true bankruptcy becomes more and more obvious, the U.S. will not be a pleasant place in which to live. And, I might add, it will be especially unpleasant for those of us who grew up here because so few of us have ever lived with any real deprivation. We are not used to the kind of basic living arrangements that so many people around the world experience. We "expect" better. We "demand" better. The government--at least many of us seem to believe--"owes" us better. Y'know, it "owes" us things like free health care.
*******

For more on the subject of the economic future of the United States, I recommend the following articles I discovered in the midst of researching and writing the above:

• What you must know about bankruptcy of the United States--an interesting and, I dare say, informative analogy between the federal government today and General Motors three years ago, before it went bust.
   
• For a brief, crisp summary of Argentina's demise, see Stephen Cox's review of Rojas' The Sorrows of Carmencita: Once a Great Nation.
   
• 20 Reasons Why The U.S. Economy Is Dying And Is Simply Not Going To Recover--a concise, and graphically-rich summary of significant economic data.
   
• Another alarming article by James Dale Davidson, this one from February 2009, subtitled Why the U.S. Banking System is Toast. Davidson offers analogies to and perspectives from the bankruptcy of Iceland in October 2008 . . . and the trillion percent hyperinflation in Brazil during the '80s and '90s . . . to Japan's economic downfall in '89 (from which it has yet to recover) . . . to the Great Depression in the U.S. --To save a bit of time, begin reading from the paragraph that starts "A decade and a half ago there were few subprime mortgages."

I'll stop here. Sorry to have gone on so long.

[NOTE: If you are reading this article on Facebook and can't use links or don't see photos, please realize it originally appeared and is still available on my personal blog.]

Whither the US dollar?

I just ran across this interview between Martin Weiss and Larry Edelson. I think it is well worth your consideration.

Conducted in late October last year, it is titled "Washington's Secret War on the Dollar"--but it actually begins by noting that the U.S. government is only one among many entities that have declared war on the dollar.

Caveat Emptor! (Buyer[s of dollar] Beware!)

. . . Besides laying out the true risks associated with being invested in dollar-denominated assets, Weiss and Edelson also recommend some general--though relatively specific--guidelines for avoiding problems with dollar-denominated assets.