American history between the Revolution and the approach of the Civil War, was dominated by the Constitutional Convention in Philadelphia in 1787. Background rumbling was from the French Revolution. The War of 1812 was merely an embarrassment.
New volume 2012-07-04 13:46:41 description
Second Edition, Greater Savings.
The book, Health Savings Account: Planning for Prosperity is here revised, making N-HSA a completed intermediate step. Whether to go faster to Retired Life is left undecided until it becomes clearer what reception earlier steps receive. There is a difficult transition ahead of any of these proposals. On the other hand, transition must be accomplished, so Congress may prefer more speculation about destination.
Worldwide Common Currency and Corporate Headquarters
The Death of Money
Controlling the Currency
After the election of October 1779, Robert Morris and all of his friends were voted out of office, and a wildly inflationary government replaced them for a year. Lessons learned had been stark: the British army left the capital in disarray, inflation was rampant, price controls caused food shortages approaching famine conditions, trade was blockaded, Charleston was soon to be captured. And the governing establishment of Philadelphia had come very close to assassination at Fort Wilson.
Nevertheless, Morris set about repairing his personal finances with techniques learned or developed during the gun-running pre-Revolutionary days, and quickly became extraordinarily richer. Joseph Reed's incompetent Continental Congress combined with a corrupt and unrealistic Pennsylvania legislature to make Philadelphia a particularly demoralized location. Even unbelievable profits from privateering could not keep pace with inflation constantly fed by printing money, price controls enforced by "tender" laws, and famines induced by price controls. Even two hundred years later, most students of finance seem not to understand the power of the Bank of Pennsylvania to set such matters straight. Nor is it generally recognized why governments have always been hostile to banks, as it was in the case of the Bank of North America, the hostility by Gallitan to the First Bank of the United States, the collision of Nicholas Biddle with Andrew Jackson over the Second Bank, the numerous bank panics of the later half of the Nineteenth century, the Creation of the Federal Reserve system in 1913, the Supreme-Court packing adventure of Franklin Roosevelt in 1937, and even the current central banking crises of the Obama administration. Disputes over the valuation of the currency are the most constant central theme of American politics, with every war we have fought creating an opportunity for someone to shift the balance, in one direction or the other. The first thing to understand is that the Bank of Pennsylvania was not a bank in the sense we now think of banks. And the second is the central role of the Battle of Fort Wilson, where Robert Morris and other members of the Philadelphia establishment were very nearly killed at the corner of Third and Walnut, a week before the October 1779 elections threw them out of office.
Phase One: An early recession, with ominous signs of inflation. (Six months of blind man's buff. Stocks down 8-10%, signs of inflation, moderate foreclosures, house prices decline around 10%, increased unemployment, consumer confidence down, oil and gold up, dollar down.)
Phase Two: Government attempts to put out fires. Priorities are set by emergencies as they arise. So far, lowered interest rates, $600 per person stimulus package, offers to substitute government bonds for securitized debt, expand Fannie Mae. The critical need is to abandon these approaches quickly unless they somehow correct the underlying problem and assist in long-term reforms.
Phase three: Long term reform. Task forces, gathering ideas from all sources, seek to identify the critical issues that caused this problem and keep it from happening again. Dangers: politics (D v R), conflict between East (mainly concerned with fuel prices) and West (mainly concerned with housing surplus), foreign meddling or hostility, collapse of China or other developing economies. We may assign too high a priority to those who are suffering, and neglect to do what will work. Some short-term emergency may get out of hand and disrupt more basic solutions. All problems begin as solutions.
What are the possible underlying problems?
1. We have too much debt and leverage, and far too much is concentrated in home real estate mortgages. Did the slanted tax exemptions do this? Did the innovative mortgage methods do it? Did we develop an excess inventory of houses just by too rapid a pace of good things?
2. The cost of buying a house is greatly in excess of the cost of renting a comparable house, overturning a century of the previous history. Meanwhile, owner equity is less than half of national home prices. If prices decline, owner equity will be even less.
3. Banks and insurance companies are becoming obsolete. Should we rescue them, or put them out of their misery?
4. Wall Street got rich by doing obscure things. Should we punish them, or are they the only people able to save the situation?
5. What will we do if China collapses, the cheap dollar ruins Europe, or international trade is paralyzed by protectionism?
6. Should we revise the entire world monetary system, either by going back to a commodity-based currency, or switching to an equity-based currency? If that is too radical, how do we control a completely debt-based currency now that its flaws are appearing?
About half of the American public pays federal income taxes, and among the half who don't, a great many receive a green government payment check, meaning they have negative income taxes. The tax assistance companies, H. and R. Block and the like, had little for their offices and staff to do in January, February and March until someone hit on the idea of processing "fundable tax credits" for a fee. That is, the lower-income segments of the population get the promise of an April tax "rebate" as the consequence of tax-form preparation, so H. and R. Block just loans them the money, discounted for fees and interest. It keeps staff busy, generates revenue. Hardly anyone in the upper income half of the population is aware of all this, so there is little political friction. This whole system of income redistribution quite effectively keeps the two halves of the population sitting in the same chairs at the tax-preparation offices, but in different months of the year; one half getting paid, the other half coughing up the payments.
It thus becomes possible for two inflammatory slogans to bandy about, without starting fistfights or revolutions. The first was overheard at a local bank, one stranger remarking to another, "Has it ever occurred to you that taxes are a form of consumption?" To which the other person replies, "Yes, and taxes are the largest expenditure I make." A nation which once went to war over a two-cent tax on tea is remarkably passive about the ways things have evolved, but this essay is not devoted to unfairness. Prepare to hear how the upper income brackets might reduce their taxes, whether that counts as decreased consumption or not. Whenever you tax something, you get less of it; if you tax public income more, the public will earn less. So, this little essay is serious when it proposes that we all earn less, so we can get taxed less. And being taxed less, we need save less for our retirements.
The general principle is this: income is usually taxed in the year it is earned, with some exceptions, rebates and deferrals. The exceptional situations are often referred to as "loopholes" and therefore live in political jeopardy. However, if a person spends the money or dies while these deferrals continue to exist, the income may escape taxation entirely. In a sense, the largest loophole of all lies in the present fact that nearly half the population pays no income taxes at all, so saving income earned under those circumstances may lead to investment capital, which is later spent during highly taxed periods of that same person's life. Money earned by a child, usually on investments donated by a relative, is an example. Since at present, a child may receive annual gifts of $13,000 tax-free, as much as a half-million dollars can be accumulated in this way, always at the risk that laws may be changed and, further, at risk of spendthrift abuse by a psychopathic child. Whether these are wise risks for a parent to take, depends in large part on what sacrifices are made for the purpose, especially loss of parental restraint of unwise spending. A much more serious argument grows out of the possibility that money in the hands of children who lack experience in deferred gratification may actually provoke recreational drug use, or other sociopathic behavior.
Finally, lack of planning may create opportunities as much as planning does. A person who has paid little attention to financial planning may arrive at an advanced stage where life expectancy is considerably shorter. Savings at that point may be divided into money on which deferred taxes must be paid when you spend it, and money on which taxes have already been paid. More savings will be consumed if the individual triggers deferred tax liabilities, than if he just uses up money on which taxes have already been paid. Therefore, if he ignores lifetime habits and spends after-tax capital first -- the whole nest egg will last longer. But none of this deferred-income tax issue can compare with the problem of income on which taxation has been completely forgiven at the time it was spent, the so-called tax expenditures. The largest such tax expenditures are on the interest of home mortgages, on employer-paid (but not self-paid) health insurance, and employer-paid retirement income. Of these, the least consequential are the retirement income, because the tax is merely deferred, not completely forgiven. The two biggest items are home mortgages, which lie at the root of the 2007 financial crash, and employer-paid health insurance premiums, which triggered the Obama health proposal of 2009. The Obama plan purports to rein in health costs, but is estimated by the Congressional Budget Office to cost the Treasury $100 billion a year.Extra! In the Fall of 2011, this boring matter suddenly came to the surface, in the form of huge American deficits threatening to bankrupt the country, as they were apparently actually going to do in Greece. As politicians do, many attempts were first made to rename the over-spending issue for partisan advantage. It was, for instance, tax expenditure. It was, possibly, a sovereign debt crisis. In any event, the Congressional Budget Office included such wealth redistribution under the heading of tax expenditure, which totalled a trillion dollars. Since everyone was searching for a painless category to eliminate in order to balance the budget, this term was hard to avoid. As far as Congress is concerned, the national deficit is whatever the CBO says it is, and in this case it lumped a lot of things together which politicians would like to split apart. When you take things in small pieces, it becomes possible to boil the frog by slowly heating it up before it realizes it is cooked. Lumping things together induces the frog to jump out of the pot, but however that may be, it has got lumped together by the referee of such matters, and there is a strong possibility it will stay lumped.
The essential point for accountants to focus on, is that tax expenditures are all counted as revenue when any non-accountant can see they are expenses. For political speech-making purposes, this distinction is vital and no opponent will let another politician wiggle out of it. And the beauty part of it is that it also spotlights three of the most besetting evils of modern politics: the tax exclusion of employer-based health insurance, the home mortgage interest tax exclusion, and the "earned" income tax credit. The first of these is responsible for our health insurance mess, and the other is responsible for our home mortgage crisis; the two main political problems of the day are suddenly plopped into the limelight, just when a lot of people are looking for ways to hide them. Furthermore, this bombshell was fired by a panel of the four outstanding tax economists of the nation, each of them roundly denouncing them as unthinkable ideas that never should have been born in the first place. Alan Greenspan, famous for unintelligible speech, simply said all of these tax expenditures, every one of them, should be eliminated immediately. One would hope that is clear enough. Martin Goldstein, formerly chairman of President Reagan's Council of Economic Advisors, agreed. As did former Governor Engler of Michigan, widely acknowledged to have rescued his state from impending bankruptcy. Senator Nelson, a Democrat from Florida and chairman of the committee, positively beamed with pleasure. It was hard to think this was anything but a turning point in history; let some political candidate disagree, and he can expect to have his audience shown a videotape of this succinct epic in the history of Senatorial hearings. These greybeards said, in what was obviously an unrehearsed moment, just eliminate these three terrible ideas in one stroke, and the national deficit will be reduced by a trillion. That's what they said, and it's easily proved that they had said it.
OCTOBER 4, 1779. The British had conquered then abandoned Philadelphia; an order was still only partially restored. Joseph Reed was President of the Continental Congress, inflation ("Not worth a Continental") was rampant, and food shortages were at near-famine levels because of self-defeating price controls. In a world turned upside down, Charles Willson Peale the painter was a leader of a radical group of admirers of Rousseau the French anarchist, called the Constitutionalist Party, leaning in the bloody direction actually followed by the French Revolution in 1789. Peale was quick to admit he had no clue what to do with his leadership position and soon resigned it in favor of painting portraits of the wealthy. Others had deserted the occupied city, and many had not yet returned. The Quakers of the city hunkered down, more or less adhering to earlier instruction from the London Yearly Meeting to stay away from any politics involving war taxes. About two hundred militia roamed the city streets making trouble for anyone they could plausibly blame for the breakdown of civil order. Philadelphia was as close to anarchy as it would ever become; the focus of anger was against the pacifist Quakers, the rich merchants, and James Wilson the lawyer.
Wilson had enraged the radicals by defending Tories in court, much as John Adams got in trouble for defending British troops involved in the Boston Massacre; Ben Franklin advised Wilson to leave town. It is still possible to walk the full extent of the battle of Fort Wilson in a few minutes, and the tourist bureau has marked it out. Begin with the Quaker Meeting at Fourth and Arch. A few wandering militiamen caught Jonathan Drinker, Thomas Story, Buckridge Sims, and Matthew Johns emerging from the Quaker church, and rounded them up as prisoners. The Quakers were marched down the street for uncertain purposes when the militia encountered a group of prominent merchants emerging from the City Tavern. Unlike the meek Quakers, Robert Morris and John Cadwalader the leader of the City Troop ordered the militia to release the prisoners, behave themselves, and disperse; Timothy Matlack shouted orders. It was exactly the wrong stance to take, and about thirty prominent citizens were soon driven to retreat to the large brick house of James Wilson, at the corner of Third and Walnut, known forever afterward as Fort Wilson. Doors were barred, windows manned, and Fort Wilson was soon surrounded by an armed, shouting, mob. Lieutenant Robert Campbell leaned out a third story window and was soon dropped dead by a lucky bullet. It remains in dispute whether or not he fired first. Crowbars were sought, the back door forced open, but the angry attackers scattered after fusillades from inside.
Down the street came President Reed on horseback, ordering the militia to disperse, with Timothy Matlack at his side; both men were well-known radicals, here switching sides to maintain law and order. The City Troop arrived, an order was given the cavalry to Assault Every Armed Man. The radicals were finally dispersed by this makeshift cavalry charge, cutting and slashing its way through the dazed militia. When it was over, five defenders were dead and about twenty wounded. Among the militia, the casualties were heavier but inaccurately reported. Robert Morris took James Wilson in hand and retreated to his mansion at Lemon Hill; Wilson was the founder of America's first law school. Among other defenders huddled in Fort Wilson were some of the future framers of the Constitution from Pennsylvania: General Thomas Mifflin, Wilson, Morris, George Clymer. Equally important was the deep impression left on radical leaders like Reed and Matlack, and Henry Laurens, who could see how close the whole war effort was to dissolution, for lack of firm control. Inflation continued but the center-productive price control system was abandoned and never revived; the Patriots had a bad scare, and the heedless radicals forced to confront the potentially disastrous consequences of their own amateur performance when entrusted with the power and responsibility they had just been demanding. It was one of those rare moments in a nation's history when the way suddenly opens to previously unthinkable actions.
The Battle of Fort Wilson was the only Revolutionary War battle fought within Philadelphia city limits; a revolution within a revolution, every participant was a Rebel patriot. Reed and Matlack were the two most visibly appalled by the whole uproar, forced by circumstances to attack the forces of their own political persuasion. But it seems very certain that Robert Morris and the other prosperous idealists were also left with an indelible conviction that even a confederation must maintain central command and discipline with an iron will, or all might be lost. A knowledgable French observer estimated that Robert Morris then owned assets worth eight million dollars, an almost unimaginable sum for the time. But he would lose every penny if effective political control could not be restored. A few days later in the October election, he and all the other Republican (conservative) officials lost their seats. It did not matter; Morris then knew what to do, and his opposition didn't.
Two centuries after our present narrative, when President William Clinton once proposed a financial adventure, Robert Rubin replied, "The bond market won't let you do it." In this way, the former Wall Street investment banker educated his politician boss that the most powerful wealth of any nation is hidden, locked up in homes, businesses, infrastructure, population education and other long-term assets. Such wealth normally transforms into cash only when the Treasury borrows it (usually by selling government bonds) because by Constitutional intention the alternative of raising taxes is essentially confiscatory. By contrast, the use of bonds requires only an agreement on price. Bond use is thereby related to supply and demand, with the government generally selling bonds and the public generally buying them. The government sells as many bonds as it pleases, but the price received will immediately sink if too many bonds are for sale. Viewed another way, bond prices announce the market's daily assessment of probable government solvency, because the isolated bond market is solely interested in the probability of being repaid.
In modern wars, the longest purse must generally determine the event.
|George Washington, May, 1780|
In 1779 there was no bond market, so Robert Morris set about creating one. Acting then as only a private citizen, but faced with his government being run into the ground, Robert Morris proposed the creation of a "bank", the Bank of Pennsylvania, created, owned and managed by private citizens. The first bank in the nation didn't take retail deposits and was unlike banks we have today in other ways. Modelled more like a bond fund of the Twenty-first century, the Bank of Pennsylvania got its funds through fairly large subscriptions from wealthy people. Robert Morris himself was probably the heaviest subscriber. A bond market was thus created, with subscriptions flooding in when the public was pleased with its government, and flooding out when the public didn't like the looks of things. Naturally there was a profit: the bonds the bank sold to subscribers were priced higher than the bonds the bank bought from the government. In this way, the public was assured the process of setting prices remained in neutral hands. The government could print bonds freely, but the Bank of Pennsylvania couldn't buy them unless somebody gave it some money, and that wouldn't happen unless prices rose to the "market clearing level," of agreement between potential buyers and sellers. The nature of the deal didn't change much when later banks got their funds from deposits, and one later enduring feature also didn't change: Governments hate banks, because banks are in a position to frustrate governments intent on spending what they please.
Quite soon, the public could be visualized as composed of debtors and creditors; the two main political parties have mostly had a matching composition. Progressive politicians, like Albert Gallatin, Thomas Jefferson, Andrew Jackson, Robert LaFollett, William Jennings Bryan, Woodrow Wilson and Barack Obama have demonized banks, often threatening to nationalize or eliminate what is basically a neutral book keeping function. Adam Smith had written The Wealth of Nations three years earlier; Morris gave copies to friends and had obviously read the book, as had Alexander Hamilton. Morris also entered into excited correspondence with Jacques Necker, the Swiss/ French banking genius, but Necker soon died, leaving it uncertain how much influence he had on America. This group of people gave us a system in which the public markets set the price of currency, not the other way around. In the 1779 case, galloping inflation quickly came under control and goods soon reappeared in the markets, although the continuing war exerted relentless pressure until 1783 for the government to do more borrowing.
In another irony, during the year he was totally out of office (conservatives were restored to power in the October 1780 election), Morris enjoyed his greatest personal prosperity and exerted almost total personal control of the currency; it was fruitless to accuse him of using government office for private gain when he held no office. During this brief interval Morris also created the first American corporate conglomerate, the series of partnerships called Peter Whitesides and Company. At least as profitable were his personal relationships with the French Ambassador Luzerne and the emissary from Havana, Juan de Miralles, who introduced him to large pools of investment capital from abroad. His American businesses became almost too numerous to count, again highlighting his prodigious ability to work. Meanwhile, his social life was as active as anyone's, extending his hospitality and affability world-wide, and anticipating a return to public life. All of this took about a year.
During this period, his sole civic activity was the Bank of Pennsylvania. As a bank it had a relatively short life. As a subtlety of government, it would be hard to find its equal in any other empowerment of the people. Many centuries of history had formerly taught the lesson that public office was the way to get seriously rich. Morris flaunted a brand new American banner: public corruption was a waste of time, like any other zero-sum game.
A DOZEN episodes from American revolutionary times might be called pivotal, but a single debate in the Pennsylvania Legislature seems to have begun our political parties in their present form. Two debaters, their topic, and its consequences all rise to dramatic, even operatic, heights. In another place, we intend to explore the clashing philosophies of the Eighteenth century, with Hegel and Hume at the apex, but two quotations from Adam Smith are more intelligible. Charles Dickens nearly ran away with the topic in his novel A Tale of Two Cities, but Charles Brockton Brown and Hugh Henry Brackenridge were local authors, Pennsylvanians present at the scene. John Adams and Thomas Jefferson debated for decades about which of them was the main protagonist. But all of that is background for one operatic scene at Independence Hall, where the real David and Goliath were William Findlay and Robert Morris.
Robert Morris, it must be remembered, was probably the richest man in America, a signer of the Articles of Confederation, the Declaration of Independence, and the Constitution. He was one of three men, including Ben Franklin and George Washington, about whom it could be said: the Revolution could not have been won without them. Morris essentially invented American banking, founded the first bank, the Pennsylvania Bank, invented investment banking, corporate conglomerates, American maritime insurance, and dozens of financial innovations. His merchant house probably had 150 ships sunk by the enemy. George Washington lived in his house for years. Today, he is mostly remembered for going bankrupt at the end of a busy life.
William Findlay, on the other hand, was a Scotch-Irish frontiersman with a flamboyant white hat, elected by others like him from the Pittsburgh area to promote inflation through state-issued debt paper, so as to finance land speculation in the West. He had no education to speak of, no accomplishments to mention. He made no secret of his self-interest in land speculation, and therefore no secret of his opposition to rechartering the Bank of North America, which Morris had founded for the purpose of restraining inflation and speculation. Findlay wanted the bank to disappear, get out of his way, and he boldly denounced Morris for his self-interest in promoting a bank where he owned stock. He utterly denied that Morris had any motive other than the profit he would make for the bank, so in his opinion they were equal in self-interest. Let's vote.
Prior to that time, Findlay had politically defeated Hugh Brackenridge, using the two strong arguments that Brackenridge had gone to Princeton, and written poetry; how could such a person possibly represent the hard-boiled self-interest of frontier constituents?
Morris was positively apoplectic at this sneering at everything he stood for. As for the country's lack of trust in a man who had risked everything to save it, well, what has he done for us, lately? America had lately thrown off the King, but what it had really discarded was aristocracy. Every man was as good as every other man, and each had one vote. Under aristocratic ideals, a man was born, married and educated in a leadership class, expected to be utterly disinterested in his votes and actions, scrupulous to avoid any involvement in trade and commerce, where temptations of self-interest were abundant. Washington never accepted any salary for his years of service and even agonized for months when he was awarded stock in a canal company, wanting neither to seem ungrateful nor to make private profit. John Hancock, who came pretty close to having as much wealth as Morris, gave up his business when he was made Governor of Massachusetts. Benjamin Franklin was only accepted into public life when he retired from the printing business, to live the life of a gentleman. That's how it was, everywhere; every nation had a king, and depended on rich aristocrats to supply the leadership for war and public life. But, now, America had become a republic where every man was equal. Morris, and the Federalists he represented, wanted to turn the clock back to an era that would never return.
Goaded too far, Morris impulsively resigned his business interests, to prove he had the nation's interest at heart in opposing inflation. It didn't help. Findlay won the vote, and the Bank of North America was closed. America was ashamed of how it behaved after the Revolution, but not ashamed enough to change.
|Robert Morris: Financier of the American Revolution: Robert Morris: Charles Rappleye: ISBN-10: 1416570926||Amazon|
IN 1783 the Revolution was over, in 1787 the Constitution was written, but the new nation would not launch its new system of government until 1790. It was a fragile time and a chaotic one. Earlier, just after the British abandoned their wartime occupation of Philadelphia in 1778, Robert Morris had been given emergency economic powers in the national government, whereas the state legislatures were struggling to create their own models of governance, often in overlapping areas. While the Pennsylvania Legislature was still occupying the Pennsylvania State House (now called Independence Hall) in 1778, it -- the state legislature -- issued the charter for America's first true bank the Bank of North America, and in 1784 the charter came up for its first post-war renewal. Morris was a member of the Pennsylvania Assembly both times. Although he was not a notable orator, it was said of him that he seldom lost an argument he seriously wanted to win. Keeping that up for several years in a small closed room will, unfortunately, make you many enemies.
|Tavern and Bank|
Morris was deeply invested in the bank, in many senses. He had watched with dismay as the Legislature squandered and mismanaged the meager funds of the rebellion, issuing promissory notes with abandon and no clear sense of how to repay them, or how to match revenues with expenditures. There was rioting in the streets of Philadelphia, very nearly extinguishing the lives of Morris and other leaders, just a block from City Tavern. Inflation immediately followed, resulting in high prices and shortages as the farmers refused to accept the flimsy currency under terms of price controls. Every possible rule of careful management was ignored and promptly matched with a vivid example of what results to expect next. Acting only on his gut instincts, Robert Morris stepped forward and offered to create a private currency, backed by his personal guarantee that the Morris notes would be paid. The crisis abated somewhat, giving Morris time to devise The Pennsylvania Bank, and then after some revision the first modern bank, the Bank of North America. The BNA sold stock to some wealthy backers of which Marris himself was the largest investor, to act as last-resort capital. It then started taking deposits, making loans, and acting as a modern bank. Without making much of a point of it at the time, the Bank interjected a vital change in the rules. Instead of Congress issuing the loans and setting the interest rates as it pleased, a commercial bank of this sort confines its loans to a fraction or multiple of its deposits, and its interest rates are then set by the public through the operation of supply and demand. The difference between what the Legislatures had been doing and what a commercial bank does, lies in who sets the interest rates and who limits the loans. The Legislature had been acting as if it had the divine right of Kings; the new system treated the government like any other borrower. As it turned out, the government didn't like the new system and has never liked it since then. Today, the present system has evolved a complicated apparatus at its top called the Open Market Committee of the Federal Reserve, most of whose members are politically appointed. Several members of the House Banking Committee are even now quite vocal in their C-span denunciations of the seven members of the Open Market Committee who in rotation are elected by the commercial banks of their regions. Close your eyes and the scene becomes the same; agents of the government feel they have a right to control the rules for government borrowing, while agents of the marketplace remain certain governments will always cheat if you don't stop them. This situation has not changed in two hundred years and essentially explains why some people hate banks.
That's the real essence of Morris's new idea of a bank; other advantages appeared as it operated. The law of large numbers smooths out the volatility of deposits and permits long-term loans based on short term deposits. Long-term deposits command higher loan prices than short-term ones can; higher profits result for the bank. And a highly counter-intuitive fact emerges, that making a loan effectively creates money; both the depositor and the borrower consider they own it at the same time. And finally, there is what is called seigniorage. Paper money (gold and silver "certificates") deteriorates and gets lost; the gold or silver backing it remains safe in the bank's vault, where it can be used a second time, or even many times.
For four days, Morris stood as a witness, hammering these truisms on the witless Western Pennsylvania legislators. At the end of it, scarcely one of them changed his vote, and the bank's charter was lost. But at the next election, the Federalists were swept back into the majority, defeating the opponents of the bank. Although, as we learn the way democracy works, still leaving them unconvinced of what they do not want to believe.
Although Alexander Hamilton's arresting slogan that "A national debt is a national treasure" has diverted attention to the underlying idea toward him, Robert Morris had introduced and argued for the same insight in the preamble to his 1785 "Statement of Accounts". The key sentence was, "The payment of debts may indeed be expensive, but it is infinitely more expensive to withhold payment." This fatherly-sounding advice was surely a distillation of a long life as a merchant, and the gist of it may have been passed down to him as an apprentice. Failure to pay your debts promptly and cheerfully results in the world assigning a higher interest rate to your future credit; it is not long before compounded interest begins to drag you down. It doesn't exactly say that, but that's what it means.
Another way of looking at this folk wisdom is that it leads to a simplified method of organizing the finances of an organization. Because higher rates of interest are demanded of long-term borrowing than short-term, it becomes efficient to segregate them. That is, to establish a cash account for every-day transactions, and a separate bond account for a long term, or capital, debt. As bills arrive, they need only be verified for accuracy and sent for payment from either a cash account or a capital account. The original responsibility for agreeing to such debts lies with top management, not the treasurer. The job of the treasurer's office is to pay legitimate bills as quickly and cheerfully as possible, ignoring any imprudence of earlier agreeing to them; rewards will come from lower interest charges and improved credit rating. An unexpected benefit of thus organizing institutions and governments is to make the accounting profession possible. Accountants perform the same function in every business, whether the business is selling battleships or parsnips. The accounting profession made itself computer-ready, two hundred years before the computer was invented.
In the same document, the retiring national Financier was advising the wisdom of "funding" the war debts, which were largely owed to France, with whom relations were rapidly souring. Lump them all together into a fund, issue bonds and sell them as representations of the nation's capital at the time of issue. Disregard what the money was used for, by either the debtor or the creditor. In spite of appearances, money sequestered in a fund for later payment belongs to the creditor the moment it is promised, not the moment it is transferred. Morris and Hamilton discovered that the fund itself had the property of a bank, in creating money. As long as the creditor did not cash your bonds, he could use them as money, in effect doubling the amount of money you yourself can spend. It was this discovery which so exhilarated Alexander Hamilton, causing him to over-praise the methodology to an already suspicious Congress. Tending toward the teachings of Shakespeare's Polonius, Hamilton's excitable manner caused them to remember, neither a borrower nor a lender is. But Congress was eventually persuaded. The federal government lumped the states' debts together in an "assumption of debts" , consolidated all these various little debts into a single "funded debt", and made the deal work with changing the "residency" of the nation's capital from Philadelphia to the banks of the Potomac. It was called the Great Compromise of 1790.
Morris well understood that a funded system requires some final payor of last resort. Such a payor need set aside only a small portion of the debt for dire contingencies, but his name gets first attention on the list presented to prospective creditors. In 1778 Morris had offered his own personal wealth as that last resort, which the public at the time trusted far more than the Treasury of the United States. Over the next twenty years, he came to realize that the last resort of established nations, no matter what the paper said, was the aggregate underlying wealth of the whole nation. With a vast continent stretching to the West, and countless immigrants clamoring to join from the East, the wealth supporting the debt of the United States in 1790 seemed endless. After two hundred years we have finally begun to accumulate a national debt which equals our Gross Domestic Product, and have only begun to pull back as we observe what happens to other nations who got to that point sooner. Let's hope devising an automatic check and balance does not require a second Robert Morris. Men like him can be hard to find, so limit your debts -- or your nation's debts -- to sixty percent of your assets. Financial geniuses are invited to devise a better debt limit, if they can.
|Constitutional Convention 1787|
TRUE, George Washington was the presiding officer of the Constitutional Convention. But Pennsylvania was the host delegation, so the role of presiding host should have fallen to Benjamin Franklin, the President of Pennsylvania. However, Franklin was getting elderly and turned the job over to Robert Morris, who among other things was rich enough to host some necessary parties. The rules of decorum at that time thus kept Washington and Morris out of the floor debates. The proceedings were, in any event, kept the secret, so occasional frowns or encouraging smiles are not recorded for history.
But Morris had been an active debater in the Assembly and other meetings, so he knew enough to line up a consensus in advance for the matters he thought were essential. Obviously, Morris was strongly in favor of giving the national government power to levy taxes for defense purposes, and Washington whose troops had suffered severely from the inability of the Continental Congress to pay them also regarded this taxing power as the central reason for changing the rules. By making it the central argument for holding the convention at all, Washington, Franklin, and Morris had made taxation power a foregone conclusion. And by giving them what they wanted from the outset, the rest of the convention was in a position to do almost anything else it wanted without open comment from the Titans. The sense of this trade-off was captured by Gouverneur Morris, the editor of the Constitution, in Article I, Section 8:
The Congress shall have Power To lay and collect Taxes, Duties, Imposts, and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts, and Excises shall be uniform throughout the United States;This formulation had the effect of greatly empowering James Madison, the only participant who had studied the inside details intensively and cared about every comma. It also encourages the military to believe that federal taxation was mainly their entitlement, whereas those whose main goals are defined as "the general Welfare" tend to regard defense spending as an unnecessary deduction from their share.
|Pawn Broker Sign|
Most of the convention delegates had experience with state legislatures, and Franklin and Morris had spent decades struggling with the weaknesses of legislators. A wink or a quip in a tavern was as good as an hour's speech for reminding the delegates what they already knew about human nature. What was designed as a dual system of powers of taxation, with federal oversight of balanced state budgets combined with federal power to tax on its own in emergencies or unforeseen situations. Since the members of the first few congresses after 1789 were largely the same people as the members of the constitutional convention, many details of this balance were worked out over a few following years. State powers to tax and borrow were tightly constrained, only the federal government could tax and borrow without limit. Since government borrowing is merely the power to defer taxes until later, the borrower of last resort was the U.S. Congress, alone empowered to encumber the wealth of the whole nation in a federal pawn shop window called the funded National Debt. For almost two centuries, this pawn shop window seemed able to support any imaginable expense. Today, we monitor this as the ratio of national debt to Gross Domestic Product (GDP), and we now have a clearer idea what level of that ratio flirts with hopeless inability to pay the federal government's debt. The experts say it's close to a 60% ratio, and unfortunately, almost every nation on earth now exceeds that limit. The system continues to lack an unchallenged definition of its limit, but the system is nevertheless still Morris's system, wrapped in a mountain of descriptive detail by Alexander Hamilton. If a nation borrows more than that and clearly will never repay it, that nation is to some degree a slave to its creditors, with war its only hope if creditors are unrelenting. Perhaps another way to refine the thought is to say that if the nation wishes to mortgage everything it owns down to the last shoe button, the creditors will only accept additional debt if it is proposed by someone with the power to pawn the last shoe button. To foreigners, the proof of who has what power is much more certain if written down. Morris's protege Alexander Hamilton went even further: "credit" is established when creditors can see that somebody is in the habit of getting the nation's bills paid, and "credit" is injured whenever anyone in charge, welches.
|Relic of the Past?|
EVER since we finally went off the gold standard completely during the Nixon Administration, the Federal Reserve has adjusted our money supply to create a fairly steady 2% inflation. If inflation is ever less than 2%, the Fed puts more money into circulation. Since many bonds are paying less than a 2% dividend, everybody who buys and holds them at par will lose money in "real" terms. That is, everyone who buys bonds when they are issued and sells them when they mature will lose spending power. Since they fluctuate in the meantime, it is possible for a trader to buy them when they are undervalued by the market. That trader will possibly make money, but only because someone else lost money. Something like that occurred during the recent financial crash bailout, when interest rates declined from 3% to less than 2% but were repurchased by the Fed as "Quantitative Easing", effectively giving speculators a 33% profit at government expense. But that doesn't happen often, and just guess who ultimately lost the money the speculators made. There is also that daunting question: when the time comes for the Federal Reserve to disgorge them, just who is going to buy all these cheapened bonds? In Japan, bonds paid a dividend of less than the rate of inflation for more than a decade; it's hard to think of a reason why the same thing could not happen in America. So it's also hard to imagine a reason why buy-and-hold investors should not abandon bonds, perhaps suddenly all at once, at some unknown time in the future. At that point, many of them will resolve never to try that, again. The whole idea is troubling.
It's particularly troubling in view of the lack of success, so far, of TIPS. These vehicles are new; perhaps the algorithm is set to ignore minor inflation and will over-respond to more major inflation, ultimately rewarding those who buy them. But at least so far, they are a disappointment. Furthermore, TIPS are quite cleverly designed to be inflation-protected, while unfortunately inflation usually does not follow a straight line but is volatile, or saw-toothed; the jury is still out. The jury better hurry up, because all investors look for net income after expenses, which include brokerage costs, taxes, and inflation. A long-term bond might have to pay a dividend approaching 4%, just to emerge with the same net value it started with; after five years of 4%, you could be 20% behind. And yet, the bond market with or without inflation protection is far larger than the stock market and compares in size with all other kinds of market. Who buys them, especially in these huge quantities?
Somebody must maintain statistics which answer this question, but as a guess, the main buyers are insurance companies, endowments, annuities, hedge funds, banks. And foreigners, of course, to whom our follies seem trivial compared with their own. The great argument for bonds is the safety of principal, and although safety is in question anywhere there is inflation when the topic is cash flow, safety is definitely an issue. Cash shortages are what cause bankruptcies, which are mainly useful in providing time to liquidate underlying wealth to pay restless creditors. The management of a non-profit organization must meet its payroll out of cash flow, so non-profits protect themselves from dissolution by having a regular flow of nominally secure bond dividends. Income from donations and contributions can be particularly weak during times of economic stress. Since most for-profit organizations also experience variable periods of time without profits, their situation does not differ greatly from nonprofits. That's particularly true when a for-profit organization has a vocal, activist stockholder group, who will protest fiercely if the management retains abundant cash. For such a predicament, holding bonds creates safety by some definition. The price of that safety is the long-term average loss on the bond portfolio; the company's alternative losses are whatever it takes to maintain a stable work force during unstable times. The business school assessment of this tradeoff is that bond losses can usually be passed through to the customers as a business cost, while layoffs and strikes may not be.
To restate the characteristics of willing bond purchasers, they are governments and corporations who have no common stock issuance alternatives, but regularly face a need to have money available for payroll. They also include borrowers and lenders at nominal interest rates like banks and insurance companies, who can afford to ignore inflation because their own liabilities are in nominal dollars, or come due at a date certain. And then, there are a host of beneficiaries of special-interest bond provisions, like "Flower bonds", state and municipal governments, foreign aid, student aid, etc. As an overall statement, natural bond buyers are those who either do not possess steady equity (common stock) alternative to offer investors or else are shielded in some way from the inflation and tax costs of buying bonds. Speculators and traders are excluded from the discussion because fixed-income trading is a zero-sum game, something you should teach your children to avoid. Other than these special niche opportunities, bonds should be regarded by the ordinary investor as trading opportunities when interest rates get too high, which is roughly every fifteen years or so.
Things in the bond market were not always so bad; Robert Morris, Jr. was a genius for devising this market in 1784. But the equity market was then not so well developed, life expectancies were shorter, and a minimum 2% inflation was not guaranteed by the Federal Reserve. The income tax had not been invented. It was possible to enjoy the promised benefits of lending in those days, for decades or even lifetimes. It was much harder to find investments of superior performance, without getting involved in business management. Meanwhile, the bond market just got huger and huger. Modifying or dismantling it in logical ways would have enormous disruptive effects. So enormous, the Congress has just adopted the stance called "kicking the can down the road", which is a debt you never seriously intend to repay.
Are we waiting for the bond market, the bond vigilantes, or speculators to find some vital vulnerable flaw, and topple it all into the ashcan of history? Or is there some better plan that no one has mentioned?
|13th Century Magna Carta|
NATIONAL constitutions are mainly an outgrowth of the 18th Century Enlightenment, even though similar features are to be found among ancient legal codes. Those who trace the origins of the American constitution to the 13th Century Magna Carta will usually point to a central sentence of clause 39:
No free man shall be arrested, or imprisoned, or deprived of his property, or outlawed, or exiled, or in any way destroyed, nor shall we go against him or send against him, unless by legal judgement of his peers, or by the law of the land.
That's a pretty good beginning, a good example of a needed legal principle, but unrecognizeable as what we would today call a Constitution. It states what a government may not do, but does not define the nature of a government which does the job best. Nor do even the many Enlightenment philosophers of government take that final step of outlining where their notions should take us, until the American Constitution had been written and defended in the Federalist papers. Nowhere among the writings of Montesquieu (The Spirit of the Laws, 1748), Catherine the Great (Nakaz, Instructions to the All-Russian Legislative Commission, 1767), Diderot (Observations About Nakaz, 1774), James Madison (1787), John Dickinson(1763) or Gouverneur Morris(1787) can there be found much tightly described definition of a constitution. Certainly there is no definition within the writings of Adam Smith, if we look for rule-making among Enlightenment thinkers whose ideas were influential on the 1787 Philadelphia document. The American constitution was the product of many minds, before and after 1787. The outlines of its final form converged, and emerged, from the Constitutional Convention of the summer of 1787, with Gouverneur Morris as the penman of record. To him we certainly owe its succinctness, which is a main source of affection for the document. That probably understates matters; in his diary of the secret meetings, James Madison records that Gouverneur Morris rose to speak about 170 times, more than any other delegate. Lots of thought and debate; ultimately, few words.
The Elizabethan Sir Francis Bacon has the greatest claim on devising a theory of law and law-making in the Anglosphere tradition. But his elegant modification of Galileo's scientific method, the English Common Law, is more a methodology for creating good laws than an outline of a nation's legal principles. Anyway, tracing the American Constitution back to an underlying British one tends to stumble when the British Constitution fails to meet a definition which would include our own. The British Constitution is said to be "unwritten" to the degree it is a consensus of revered documents. It can be amended by Parliament at will, has a variable history of defining just who is covered by it, and in order to define constitutional principles seems to rely on sentences extracted from difficult context. If the two constitutions had been written and compared at the same time, one would say the British had sacrificed coherence out of respect for tradition. In fairness, some features of the American constitution are also perhaps unnecessary for every constitution, but by surviving as the oldest constitution of the modern form, have become its model. That would be:
A set of principles governing the legitimacy of a nation's laws, and firmly standing above them. It defines its own domain, geographically and by membership of a defined citizenry. Except as otherwise defined, it supersedes all other governance within its domain. It defines and defends its own origins. It includes a description of how to amend it, which is intentionally infrequent and difficult. It goes on to outline the structure of the laws it regulates, with subtle modifications made to channel the type of power structure which will govern.
In the American case, history and culture generated several other instabilities so central they justified heightening the difficulty to amend them to a Constitutional level, thus conferring undisputed dominance over competing principles of governance. That would be:
A separation of government powers weakened all potentially offending branches of government, and thus enhanced citizen liberty. A separation of church from state, for like purpose. A right of citizens to bear arms, to strengthen citizens' defense against internal or external attack, and perhaps also warning that revolt must be possible, even endorsed, as some final extremity of protection for citizen sovereignty.
|Russia's Catherine the Great|
It enhances our comprehension to contrast the outcomes of competing 18th Century implementations of the Constitution idea. Russia's Catherine the Great proposed a constitution steeped in the traditions of the Enlightenment, but ultimately designed to define and strengthen the role of the monarch. Denis Diderot her French protege recoiled at this viewpoint, substituting other views resembling those of Jean Jacob Rousseau. He opened Observations About Nakaz his commentary to the Queen, with the following declaration:
There is no true sovereign except the nation; there can be no true legislator except the people. Whether looking back to the English Civil War, or forward to future disputes between the Executive and Legislative branches, it makes clear the Legislative branch was dominant, with the Executive branch acting as its agent.
With this ringing warcry, the French model nevertheless ushered in the extremes of the Terror, the Guillotine, and the Napoleonic conquests. The consequences of the French constitution undermined world confidence in the benevolence of public opinion, at least deeply confounding those for whom democratic rule was not totally discredited. Once more new life was breathed into allegiance for the monarchy, military rule, and dictatorship. Public opinion, it seemed, was not either invariably benign or comfortably far-seeing. The noble savage, mankind naked of tainted civilization, was not necessarily wise or worthy of trust. Edward Gibbons, the 1776 author of The Decline and Fall of the Roman Empire was pointing out where it all might lead, if we completely believed in the collective goodness of the human condition. At the least, the failure of the French Revolution complimented the viewpoint of the Scottish philosopher, Adam Smith, who also in 1776 emphatically urged a switch in that reliance toward a sense of enlightened self-interest, as follows:
It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest.
|Terror, the Guillotine,|
It is not surprising that Diderot rejected the Leibniz view of things that "All is for the best, in this best of all possible worlds." And, in view of his dependence on Catherine, not surprising he did not publish his rejection of it until 1823. Thomas Jefferson was in France as ambassador during the time of the American Constitutional Convention, fearing to confront George Washington; and likewise keeping his conflicting views private for several years. Eventually they surfaced in the creation of an anti-Federalist political party along with the conflicts which kept the new nation in a turmoil for the following forty years. It is surely a testimony to the strength of the Constitution's design that the country was able to shift between such extreme governing philosophies but still hold together without changing the governing statement of purpose. Indeed, it is plausible to contend that our two political parties still continuously debate the useful tension between these two differing opinions.
WHEN mysteriously crashing financial markets caused transactions to freeze in terror in 2008, no one was brave enough to explain what had happened, because no one was sure. It had happened before and in many nations, but no comprehensive theory was acknowledged to exist for all such crises, and certainly no coherent explanation existed for this one. That is an assessment some people might dispute, of course. But during the worst of the crisis, chairmen of major financial houses, professors of economics, and assorted other notables were asked by the news media to explain the situation, and most of them confessed they really didn't know. As the crisis continued, tentative partial explanations were offered, and eventually, political partisans or competitors were emboldened to assign blame to indignant participants in various financial trades, apparently using the logic that if no one really knew the answer, then everybody was permitted to offer one. Gradually, however, some serious theories have been announced, along with reasonably credible evidence, but no more than that. After the dust had settled somewhat in November 2012, Walt Bettinger published an article in the Opinion pages of the Wall Street Journal which plausibly helps explain a piece of it.
Mr. Bettinger is the CEO of Charles Schwab Corp., which owns several large money market funds, and he credibly offers a theory about the money market part of it. Briefly, it is that large institutions with both sizeable investments in money market funds, as well as strong computer and mathematical resources, were in a position to withdraw their investments during the days of chaos, whereas smaller public investors have to wait until the end of the trading day to learn that a fund had abruptly developed too few assets to justify paying out a dollar for every dollar's worth of obligation. That is, in a "mark to market" situation there weren't enough reserves to cover the liabilities. If the public became aware of this situation, it might suddenly withdraw its deposits and throw the fund into bankruptcy; that is, it might start a run on the bank. In the past, this sort of thing has happened to money market funds from time to time, and the institution which owns or sponsors the money market fund has -- so far -- supplied its own money to prevent potential disaster from a bank run. However, in a serious crash with uncertain causes, someday that might not be their choice or their assets might not be sufficient to stop the run. The consequences are uncertain, but the dangerous potential is clear.
The remedies for this situation might well be numerous, but the simplest one would be to isolate large investors from small ones by setting a top limit for large accounts, perhaps even automatically transferring large accounts to a large-account fund at the instant the account exceeds some limit. Apparently, similar proposals have been made privately, and there is opposition whose validity must be addressed. However, in the confines of an Op-ed article, a fully exhaustive discussion of a technical proposal is not possible. Ideally, this sort of proposal could be adopted privately, using the advance consent of the two involved parties, the bank, and the big customer. No doubt there is some legitimate concern that widespread publicity might trigger unfortunate legislative over-reaction. After all, most members of the public are unaware that "breaking the buck" is even a possibility. If the possibility of a run can be eliminated by skipping the alarming discussion of whether it potentially exists, or how serious it might or might not become, it would be a mercy. It only seems to be required that the parties agree it is a risk worth avoiding.
This-here speaker at the Right Angle Club began a discussion of the "Fiscal Cliff" razzle-dazzle of 2012, by changing his mind about the causes of the financial crash of 2007. Originally, it seemed as though globalizing 500 million Chinese out of poverty had destabilized the exuberant American mortgage market by flooding it with cheap credit. Supplanting that idea, or perhaps only supplementing it, must now be added the overextension of national debt itself to a point of bringing national borrowing to a halt.
Early in the Eighteenth century the Dutch and English had monetized national assets through a system of national borrowing formalized by Necker in Europe, and Robert Morris and Alexander Hamilton in America. Aside from a handful, no one could understand what they were talking about. Try reading that sentence a second time.
It amounted to guaranteeing all the private credit in the banking, investment, and commerce systems, with a national debt (in the form of Treasury bonds) which monetized all the assets of the whole nation. That action more or less doubled their value, just as any bank loan is seemingly owned by two people at the same time. Carried to an extreme, it might imply that America could turn Guam and Hawaii over to China if we defaulted on our debt. That was never actually intended to happen, and it never has, because all nations now fear the deflation which could result from triggering a massive exchange of national assets. The nebulous issue of "National Sovereignty" interferes with territorial transfers by any means other than war. If one nation defaults against a second nation which is afraid to go to war, it is just the stronger nation's hard luck about the debts it has chosen to support unless a transfer of assets actually happens. The Treaty of Versailles did transfer assets to the victors, and set off World War II, although it is considered bad manners to mention it. That's a simplified view of our international financial system, which admittedly skirts uncertainty about how much national debt is too much.
In fact, no one knows how much is too much until everyone runs for the exits. Now that politicians have control of computers and "big data", a modern description places the blame on Alan Greenspan the former Chairman of the Federal Reserve. For eighteen years Greenspan produced delicious world prosperity by steadily increasing American national debt faster than the American economy was growing. Sooner or later this approach was going to uncover how much was currently too much Federal debt. With silver and gold removed from the equation, one could see that default would certainly loom whenever the size of the debt became so large it could never be serviced by the Gross Domestic Product (GDP), and possibly sooner than that, if enough people could guess what was coming. This reality might be obscured temporarily by reducing interest rates, modifying international trade balances, and inflation. When the stars were in alignment however, the system just had to collapse and start over. Because it happened gradually, perhaps it would unwind gradually. In 2007 what happened was that everybody tried to get out the door at the same time. Essentially, our two political parties made opposite assessments: the party of Hamilton -- Republicans -- announced this system was doomed, while Democrats --the party of Andrew Jackson -- announced they could stave off disaster by making the rich Republicans pay for it. Both parties were partly right but essentially wrong, and the Democrats hired a better magician.
It will take months or even years to be certain just what strategy was pursued. It would appear the Democrats chose to repeat the performance of the Obamacare legislation, eliminating national debate by eliminating the Congressional committee system of examining details in advance of a vote. Given one day to digest two thousand pages prepared by the Executive branch, no time was allowed for public opinion to form about Obamacare. In the case of the fiscal cliff episode, Congress was given less than one day to consider 150 pages allegedly prepared the day prior to the vote. Some will admire the skill of the executive branch in orchestrating this secret maneuver, but eventually, it must become apparent that policy decisions have been transferred from the legislative to the executive branch of government. Perhaps the Congressional Republicans are as stupid as the Democrats portray them to be, but it is also possible that a decision has been made to tempt the Democratic leaders into repeating this performance several times until eventually, the public is ready to consider impeachment for it. No matter what the strategy, we are now threatened with imagining some moment when gun barrels come level and live rounds slide home. We may pass up the opportunity to criticize Henry Clay for concentrating undue power in the Speaker of the House, or to uncover the way Harry Reid was persuaded to surrender Senate power to the Executive; both miscalculations are fast becoming irrelevant in the flurry of events. We came close to borrowing too much, exceeding our means to pay it back, that's all. A New York Times editorial economist feels we can "grow" our way out of this flirtation with danger, and we all certainly hope so.
Seemingly, there are only two ways to cope with over-borrowing, once we step over the invisible line. A nation may cheat its citizens with inflation, or it may cheat foreign citizens by defaulting on their currency. We are indebted to Rogoff and Reinhart for pointing out there is no difference between inflation and default except the identity of the cheated creditor; so most politicians prefer to cheat foreigners. Either way, cheating makes deadly enemies. Two centuries ago, Alexander Hamilton suggested a third way out of the problem, which we would today call "growth". But here, cheating is pretty easy: If the limit is some ratio of debt to GDP, find a way to increase nominal GDP.
|Shale Gas and Argentina|
The most astonishing current example of the power of "growth", is shale gas. It may not be totally clean, but it is cleaner than oil or coal, and far cheaper. We suddenly have so much of it the price of energy is artificially lowered, and we talk, not merely of energy independence, but of restoring the balance of international payments by exporting it. Germany is constructing steel mills to utilize iron ingots made in America with gas instead of coal. Pittsburgh was once the center of steel production because that's where the coal was, the most expensive ingredient to transport. Suddenly it is now apparently cheaper to transport the energy source to wherever you find limestone and iron ore. JP Morgan got rich the other way, transporting limestone and iron ore to Pittsburgh, where the coal was. Russia now finds it has lost its leverage over Eastern Europe's energy supply, and the Arabs (?Iranians?) will no longer have a monopoly to provide the wealth supporting Middle-Eastern mischief. China may lose interest in Africa. And in America we may develop the courage to rid ourselves of the corn subsidies for gasoline; cutting the wind and sunlight fumbles also emerge as obvious ways to cut the deficit. That's what we mean by growth. It's so powerful it makes action by any American President seem trivial by comparison.
Presumably, President Obama does not welcome being upstaged by an economic force he doggedly resisted. He may seek ways to imply it was his idea all along. When that happens, rest assured that everyone else is then a fracker. But there is another alternative Presidential path, which in extreme form is emerging in Argentina without much media attention. In short, Argentina discovered signs of oil deposits but was unable to exploit them. A European oil company was enticed to develop the oil reserves at its own expense, and effectively did so in expectation of reward from the resulting oil sales. Suddenly, the Kirchner government expropriated the oil company, paying for it with Argentine bonds. The ink was scarcely dry before the Argentine government abruptly turned around and offered to buy back the bonds for 24 cents on the dollar. And unless someone is willing to send gunboats, the previous owners of the oil company are just out of luck. Appeals to the UN are futile; because on the one-nation, one-vote principle, there are more expropriator votes in the UN than potential victims. The only thing visible which could save capitalism in South America from the revolution in shale gas competition. Presumably, Argentina has lots of shale gas, but who will lend them the money to frack it?
Traditionally, the biggest financial problem for governments -- whether kings or democracies -- have been paying for wars. The Revolutionary War (Robert Morris and the King of France), the War of 1812 (Stephen Girard), and the Spanish American War (J.P. Morgan) were essentially financed by a single institution allied with the government. However, the Civil War, World Wars I and II, were so big that ways of spreading the debt had to be found. In all wars, monarchs seek to maintain control of the nation in spite of their own uneasy dependence on funding sources. The Federal Reserve founded in 1913 was thus founded as a private institution with a Federal partner; it was a public-private partnership.
The enormous sums involved created temptations to extend the Fed's power beyond wars into other cataclysmic financial events. The nature of war changed, both as a cause and a consequence. However, in a sense, politics never change. We hear congressional chairmen ask why the private sector has so much to say, and we hear bankers announce the government has no place in private finance. The Federal Reserve itself maneuvers within boundaries of its "independence". Most central banks have a mission statement limiting them to maintaining price stability (against both inflation and deflation), but the United States Federal Reserve has the additional mission of reducing unemployment. Recently, the targets are stated to be 2% inflation and 6.5% unemployment. The Fed Chairman, Ben Bernanke, now seems to feel the traditional tool of manipulating interest rates is inadequate for severe economic shocks, and perhaps inadequate to maintain both goals indefinitely. He has therefore introduced a novel approach, mysteriously called Quantitative Easing.
Acting as the lender of last resort, central banks have used their regulatory power over banks and currency to manipulate short-term interest rates. Because commercial banks make a profit in the spread between low short-term borrowing and higher long-term lending, the "yield curve" controlling short term rates is ordinarily an adequate lever for Fed purposes to control long rates indirectly. This is possible because so many short-term loans are rolled over repeatedly; the extra interest for a similar long-term bond represents public attitudes about the risks of the future. However, in major financial upheavals adjusting short term rates may become inadequate, and Bernanke sought a way to control long term rates directly throughout the private economic sector.
By controlling both ends of the spread, Bernanke gained more control, but with lessened market guidance, he acquired a greater risk of misjudgment. In any event, the Federal Reserve began to accumulate huge amounts of dubious or "distressed" debt. Andrew Mellon once advised Herbert Hoover to "wring the rottenness out of the system". Mellon meant that any bank foolish enough to offer loans to weak counterparties, deserved to go bankrupt, while those foolish enough to accept such loans deserved to be punished. Although such utterances by a very rich man were politically unacceptable during a depression, Mellon was surely correct in observing that extreme financial panics were basically a psychiatric problem. Irrational exuberance occasionally drives markets too high, panic then drives them too low. The modern twist is, at the turn, when everyone tries to get out the door at the same time, markets can freeze up. Mr. Bernanke civilized Mr. Mellon's approach somewhat, but the underlying idea was the same: get the bad loans out of circulation, so bankruptcies and foreclosures stop feeding public overreaction. Underneath this approach runs the assumption most people are not hopelessly overextended; the economy is basically sound. However, bankruptcy has one advantage here, over gentler kinder ways of isolating bad from further injuring the good. When an institution disappears, its problems are permanently removed from the economy. To a large degree, "sterilizing" operations are only useful if market crises are really artificial ones, which fail to notice how sound the economy really is. As our measuring systems get more precise, of course, market crises might someday actually represent the facts of the matter.
Three signal events extended Mr. Bernanke's latitude to act. His personal credibility had been enhanced by successful QE1 management of the 2008 freeze-up of financial markets. He had loaned when others were reluctant, unfroze the markets, and returned a profit for the government. Secondly, the two-decade Japanese recession showed how "zombie banks" resulted from paralyzed inaction on bad loans. And third, the Scandinavian countries had a glamorous recovery from a brief depression, apparently as a result of adopting Calvinistic punishment of economic exuberance. It was a fearsome "good bank, bad bank" approach. The general public may not have this view of events, but they meant a great deal to the Federal Reserve Board of Directors. His credibility allowed Bernanke to survive his unsuccessful attempt through QE2 to stimulate the economy with trillions of dollars in make-work employment financed by the public sector. In essence, QE3 consisted of buying every bond the market refused to buy, even including billions of dollars of mortgage-backed bonds where politicians were excoriating into accepting prices lower than their probably worth. The Federal Reserve accumulated trillions in bonds but did not pay for them by printing money, but rather by increasing the reserves of commercial banks. This allowed them to pay essentially zero interest rates, but maintain a steep interest curve (between short and long term) as an inducement to the banks to loan. So far at least, banks have refused to loan, partly because banks are trying to de-leverage thirty years of excessive lending, and partly because chastened borrowers refuse to borrow. Meanwhile, the "hard goods" the public had accumulated, autos and refrigerators, mergers and infrastructure, were gradually wearing out; someday they would need to be replaced and constitute "growth". In the meantime, the Fed seems to plan to retain the bad debts in its vaults, safely immune to "marking them to market", which is to say holding them until the bond markets assign them higher values while proclaiming their current market value is temporarily under-appreciated. Nevertheless, these bonds will eventually reach their expiration date, and the market price at that moment will reveal the true cost of replacing them with new loans. With charming modesty, Mr. Bernanke admits there are many outcomes he is unable to predict.
Although Ben Bernanke has not announced it, he seems presently willing to hold these bad debts indefinitely. Interest rates are low, so not only is it cheap to hold them, but their value is artificially overstated. Presumably, however, he is unwilling to run a Zombie Federal Reserve indefinitely. Interest rates will, therefore, return to normal, sending the interest cost to the government soaring. Somehow, the public repeatedly fails to appreciate that lowering interest rates increases the market value of bonds by making money appear like magic, whereas raising interest rates depresses bond values by making money vanish. It requires a vibrant economy to withstand such a shock, so raising interest rates can easily precipitate a deep recession. At the first sign of interest rates rising, the prices of all bonds could plummet. Almost every investment advisor in the nation is already advising clients to "lighten up" on bonds. Meanwhile, the elderly small savers holding their savings in banks, are suffering from lack of income; it is remarkable there has been so little complaint, but when it comes, it will persist and have political force. Somewhere the spring is coiling. One real danger is the economy will still be unready for normal interest rates when politics force them to go up. It is frequently estimated to require ten years to be sure that (unlike 1937) a major second depression will not emerge when short-term government debts come due. The big problem with all borrowing that never changes is that someone expects you to pay it back.
Another bleak possibility is that a currency war will break out during the vulnerable interval. The U.S. dollar recently declined sharply, and other countries responded immediately with devaluations of their own. That may have been a test, but if it was, we failed. Just as industries will move to a U.S. state with low taxes, they will move to nations with undervalued currencies. The new multinational corporation permits rapid internal transfers within companies that they need not move their headquarters. Immigrants do move, and if forcibly restrained, will start riots or even revolutions. Currency wars are also very bad news, powerfully inhibiting government action. Consequently, there is a tendency to substitute international debt default, which is the same thing as devaluation in being sudden and done with, unlike inflation which can be insidious. Since it cheats foreigners more than local citizens, politicians prefer devaluation of the currency. But otherwise, there is no great difference between devaluation and inflation.
To repeat, there is little difference between Country A inflating, and Country B defaulting. Mr. Bernanke has temporarily sterilized the inflation alternative by funding his QE3 by expanding bank reserves rather than printing currency. Unfortunately, this has so far hardly stimulated bank lending at all, which itself is beginning to tempt private investors to get directly into the banking business because it offers them a chance for high yield. However, if any significant number of university endowments or pension funds try their hand at being bankers, they are apt to learn there is more to banking than they imagine.
If Quantitative Easing becomes widespread in a world-wide recession, some nation is going to prove to be insolvent. That is, when the central bank has sold off the profitable or break-even securities in the portfolio, the probability exists that some country will find it cannot service its debt. That debt anyway has been shown to be worthless because no one will buy it. Its credit may then be worthless, its currency without value, its markets in an uproar, and its people in revolt. Other countries will be urged to support the failing one, and who knows how panic will spread. Somewhere along the line, the bond markets may take "the bull by the horns" and -- and what? If foreign governments try to intervene, their own currency could plummet. There is, indeed, quite a lot we don't understand.
So it all boils down to two disastrous alternatives for the Federal Reserve to start liquidating QE3 bonds before the economy recovers. Either the bond markets intervene, or the Federal Reserve just continues to hold those trillions of bonds indefinitely, as a Zombie central bank. We could have a second recession, or another rush to get out the door. The prospects are so horrifying that we all have to hope Mr. Bernanke keeps his cool, and gets lucky. As a fallback, whether all that sequestered debt could be transformed into the international reserves for a new Bretton Woods agreement, is now too distant a prospect for outsiders to have a reasoned opinion about. Nevertheless, the interest earnings of debt that large might be able to moderate considerable deflation. Further, the seemingly unlimited ability to create or destroy money through interest rate manipulation should be able to modulate considerable volatility of currencies, perhaps of economies. Ever since the gold window was closed in 1971, it has been asked whether currencies without the backing of some commodity can survive, and the present economic travail may be the test of it. But since an international currency exchange probably cannot be created except in a crisis, let's hope we never have to learn the answer.
|First Bank of Philadelphia|
Some things are easier to understand when they start before they get complicated. That's true of banking, where it can now be puzzling to hear there was a strong inclination to forbid banks by law. While we were still a colony, the British discouraged bank formation, fearing strong concentrations of wealth at a great distance could lead to ideas of independence. Anti-bank sentiment was thus a Tory characteristic, although as the Industrial Revolution progressed, Karl Marx and Fredrick Engels stamped it permanently with a proletarian flavor. Large owners of farmland were displeased to see their power weakened by urban concentrations of wealth, while poor recent settlers of America wanted to buy and sell land cheaply, so they favored a currency that steadily declined in value. People with wealth have an incentive to keep money stable, but people with debts have an incentive to pay them off with cheap money. After these battle lines clarified and hardened, the debate has transformed from an original dispute about banks, into catfights about a strong currency. As Rogoff and Rheinhart have pointed out, inflation is a way for governments to cheat their citizens, devaluation is a way of cheating foreigners. Naturally, politicians prefer to cheat foreigners, but national tradition curiously seems to favor one style more than another. Essentially, they are the same thing with the same motive, although outcomes may be different. One is restrained by fear of revolution, the other by fear of an international currency war.
While George Washington was America's first president, Alexander Hamilton was Secretary of the Treasury and Thomas Jefferson was Vice President; the cabinet contained only four members. Although Hamilton was born poor, the bastard brat of a Scottish peddler in the view of John Adams, he had learned about practical finance in a counting-house, and later gained Washington's confidence on the headquarters staff; Washington eventually made him a general. Jefferson was part of the slaveholding Virginia planter elite, elegant in writing style and knowledge of art and architecture, sympathetic to the French Revolution; eventually, he died bankrupt. Early in the Washington presidency, Hamilton produced three long and sophisticated white papers, advocating banks and manufacture. Jefferson was opposed to both, one facilitating the other, which we would today describe as taking a green, or leftish position. Banks were described as instruments for accepting deposits in hard currency, or specie, and lending it out as paper money. The effect of this was a degrading of gold into paper money, or if not, an inflationary doubling of currency. Banks would be able to create money at will, a capriciousness Jefferson felt should be confined to the sovereign government. Just keep this up, and one day some former banker from Goldman Sachs would be able to tell the President of the United States, "The bond market won't let you do that." In this sense, the bank argument became a dispute about public and private power.
Hamilton, a former clerk of a maritime counting house, could observe that sending paper money on a leaky wooden boat kept the real gold in the counting-house even after the boat was lost at sea. To him, prudent banking transactions enhanced the safety of wealth, reducing risk rather than enlarging it. Later on, he learned from Robert Morris that a bank floating currency values on the private market disciplined the seemingly inevitable tendency of governments to water the currency. Once more, banks should enhance overall safety in spite of being vilified for creating risk. To both Hamilton and Jefferson, all arguments in an opposing direction seemed specious, designed to conceal ulterior motives.
Banks came and went for a century. By the time they almost were a feature of every street corner, banks were taking paper money (instead of gold and silver) as deposits and issuing loans as paper money, too; the gold was kept somewhere else, ultimately in Fort Knox, Kentucky. With experience, deposits could stay with the bank long enough that only a rare run on the bank would require more than 20% of the loans to be supported by physical ownership of gold. By establishing pooling and insurance of various sorts, banks persuaded authorities it was safe enough for them to hold no more than 20% of their loan portfolio in reserves. By this magic, loans at 6% to the customer could now return 30% to the bank. A few loans will default, a reserve for defaults was prudent, so the bank with a 2% default rate could settle for a 20% return rate. A bank which was deemed "too big to permit it to default" was invisibly and costlessly able to trim its reserves, and thus receive a 25% return by relying on the government to bail it out of an occasional bank crisis. With this sort of simple arithmetic, it is easy to see why multi-billion dollar banks were soon arguing that 5:1 leveraging was too small, a reserve of gold and silver was unnecessary, and the efficiencies of large banks were needed to compete with big foreign banks. By the time of the 2007 crash, many banks were leveraged fifty-to-one, which even the man on the street could see was over-reaching. The ideal ratio was uncertain, but 50:1 was certain to collapse, probably starting with the weakest link in the chain.
This brings the banking arguments more or less up to date. Except in 1913, an "independent" Federal Reserve Bank was created. It was a private reserve pool balanced by a public partner, the government. In time, the need for gold and silver was eliminated entirely, by the wartime Breton Woods Agreement, and the Nixon termination of it. The predictable inflation which could be expected to result from a world currency without physical backing was prevented by allowing the Federal Reserve to issue, or fail to issue as necessary, the currency in circulation. This substitution was deemed possible by having the Fed monitor inflation, and adjust the flow of currency to maintain a 2% inflation rate. Although 100% paper money was an historic change, it has endured; it has withstood efforts by the politicians to re-define inflation, undermine the indices of its measurement, and brow-beat the vestal virgins appointed to defend the value of the dollar. The old definition of money has changed: it is no longer a store of value, it is only a medium of exchange. The store of value is a nation's total assets. Jubilant politicians have added an additional burden of preventing unemployment, to the original one of defending price stability. In practical terms, the goal is defined as maintaining a 2% inflation rate, while achieving a 6.5% unemployment rate. It remains to be seen whether the two goals can exist at the same time, particularly if the definitions of inflation and unemployment become unrecognizably undermined.
And it even remains to be seen whether the black-box system can be undermined from within. The Federal Reserve is so poorly understood by the public that his enemies now accuse Alan Greenspan of causing the present recession. It is argued that the eighteen years of banking quiet which his chairmanship enjoyed, was only gradual inflation, deeply concealed. It is contended that the unprecedented steady rise of the stock market during those eighteen years was financed by a small but steady loosening of credit by the Federal Reserve. Perhaps what this means is: the definition of inflation must be tightened so its target can be made and adjusted, not to 2%, but to some number slightly less than that, measured to three decimal places. Or that the 6.5% unemployment target must be jettisoned in order to preserve the dollar. With that prospect including international currency wars as its corollary, it will be an interesting debate, and immigration policy is related to it. Because one alternative could become the abandonment of the fight against inflation, in order to sustain the new objective of reducing unemployment, Jefferson would have won the argument.
|The History of the United States: Course 8500, 15 Hamilton's Republic: ISBN: 156585763-1||The Great Courses|
|This Time Is Different: Eight Centuries of Financial Folly: Kenneth Rogoff, Carmen M. Reinhart: ISBN-13: 978-0691152646||Amazon|
Nobody likes to execute a guilty prisoner, but in finance, it is surely true that allowing bad debts to remain unresolved harms the whole economy. It makes little difference whether a bank fails to mark its debts to market, whether debts are "extended", or insolvent institutions are subsidized. Andrew Mellon once advised Herbert Hoover that he should "wring the rottenness out of the system", but that is such poor politics that even Hoover rejected it. In time, the process of "good bank, bad bank" was devised to isolate bad debts into a single institution so the rest of the economy could begin to recover. QE3 is a version of a good bank, bad bank. Unfortunately, the public is easily misled in these matters, so although all three Q's involve the Federal Reserve buying long bonds, QE1 unfroze a frozen financial marketplace (successfully), QE2 meant to stimulate the economy (unsuccessfully), but QE3 seems to have much grander ambitions. So it is unfortunate that three different activities share the same name, and still more unfortunate that name is made so mysterious. Let's forget about the first two, and concentrate on QE3.
The Federal Reserve is well along in a program of buying huge quantities of questionable long bonds and has announced it is going to keep buying huge quantities until either inflation exceeds 2.5% or unemployment falls below 6.5%. That's not exactly the same as buying every bad bond in existence, but it could come to that. Instead of letting the holders of those bonds go bankrupt, the Fed is buying the bonds out of circulation, which could rescue a great many investors. Small businesses do not ordinarily issue bonds, so there is some bias in favor of large businesses and banks, but surely not an intentional bias. The effect is to make the Federal Reserve both a good bank and a bad bank at the same time. The main difference between this and wringing the rottenness out is that bankrupt institutions cannot come back to haunt you, while in the more benign purchase of bonds, you have assumed an obligation to pay them back. When you sell them back you drive the price down and the money disappears. Furthermore, when the price of bonds declines, interest rates will rise and the national debt will increase more rapidly. If the economy cannot withstand higher interest rates, a recession will deepen. You have to get the timing right, and the world is in such a delicate state that it is impossible to get the timing entirely right for everybody. Because interest rates are now essentially zero, they cannot go lower, so investment advisors are increasingly advising clients to sell some bonds while they still can. If that gets out of hand, it could start a panic.
|United States Federal Reserve|
However, the United States Federal Reserve is not an investor, it controls the currency and can print unlimited amounts of it. There is nothing which can force it to sell its bond holdings, ever. Without going into the details of the Bretton Woods Treaty, the tie to gold was eliminated nearly fifty years ago. Meanwhile, its bonds are paying interest, which at the moment it is returning to the U.S. Treasury to reduce the national debt. It can reduce this outflow more or less at will, and it can increase it by raising interest rates (ie by selling bonds, as described). With a few extra steps, this enormous pot of debt could become the basis for an international currency reserve. At the least, it could bring a halt to an international currency war. If it chooses, it can decide to wait as long as fifteen or twenty years for economic demand to recover from a century of overleveraging, and then pay it back by letting the bonds reach maturity. But there is at least one big flaw in this dream.
At some point, the bond market may decide to take the bull by the horns and raise rates before the Federal Reserve wishes to. Political appointees come and go, and the bond market could easily decide that a misjudgment has been made by somebody. It could easily happen that public apprehension could grow that something doesn't smell right. In that climate, a few heavy sales could trigger a panic. And then everyone will try to get out the door at the same time.
|The Bretton Woods conference in 1944|
Stripped of its mystery and irrelevant details, the Bretton Woods conference agreed that all nations would make their currency convertible into U.S. dollars, and the U.S. would make its currency convertible into gold. Since World War II had left the United States with the only major working economy, it sold goods to the rest of the world and the rest of the world sent us their money to be converted into dollars; we had a "favorable balance of trade." Somewhere in the 1960s the rest of the world got on its feet, and we began to have an unfavorable balance of trade. After a while, foreigners started converting their dollars (the "reserve" currency) into gold. By 1971, the depletion of gold from Fort Knox became alarming, and the United States stopped converting its currency into gold. From that point onward, all currencies became effectively computer notations, whose value as a medium of exchange was what their government said it was.
Paradoxically, it is hard to see how this system would work without a government in charge of it, although private substitutes would probably soon appear if governments relaxed their monopoly on currency. Since a great many people dislike their governments for one reason or another, they chafe at a system which forces them to keep their governments in order to prevent commercial chaos. For those who do not adequately understand this, governments all stand ready to maintain themselves with force, and many other people dislike that feature even more. Since it took place at the same time, the Vietnam protest movement may have had some relation to this major change in the nation, misunderstood perhaps, but viscerally perceived. In view of President Nixon's central role in all of this, one is even tempted to speculate that his electoral promise of a secret means to end the Vietnam conflict, coupled with the subsequent peaceful surge of China and the financial recycling of Chinese money through Treasury bond purchases, may all have been subjects discussed during his historic trip to China.
However that may be, it is a fact that the Vietnam War ended, the Chinese economy flourished with American help, and the deposit of Chinese money in our economy helped fuel a massive economic bubble, and the weakest links in the chain -- mortgage-backed securities -- were the place the bubble burst. Not much of this could have occurred with a gold standard, and in many circles, this was regarded as proof that gold was a barbarous relic. In retrospect, few would deny we had been leveraging our economy to dangerous heights, for nearly fifty years. In 1996, Alan Greenspan denounced our "irrational exuberance", and yet the bubble did not burst for another twelve years. If we succeed in deleveraging our economy until it reaches 1996 levels, it will be regarded as a remarkable success. But the Chairman of the Federal Reserve at that time described it as a dangerous level. And looking back over the centuries, an indescribable number of kings were dethroned or beheaded because they evaded the rather irrational restraints of a scarce, hence precious, barbarous relic. Balanced against that, a billion Asiatics have been raised out of poverty, and the economy of the world overall would seem opulent to our grandfathers. Somehow, we must find the wit and the self-restraint to solve this problem.
|The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order:z Benn Steil: ISBN-13: 978-0691149097||Amazon|
Tourists like to banter about their favorite place in the whole world; until recently, mine was Cyprus. It's an eastern Mediterranean island, where it was possible to swim from beaches in the morning, ski in the afternoon, and luxuriate in an inexpensive but posh hotel in the evening. The locals had their ethnic rivalries, but what would tourist care. Since I was last there, apparently Russian and other billionaires discovered the place, and now three local banks are bigger than the GNP of the nation. Like Ireland, Hungary, Iceland, and several other small European nations, this dystrophic growth made it impossible for the government to guarantee the assets of the banks, as the familiar "lender of last resort" because the banks were bigger than the government. Accordingly, the local government was forced to declare a protracted bank holiday, to forestall what was certainly going to turn into a run on the banks as depositors all tried to get out the door at the same time. International stock markets immediately dropped a noticeable number of points, as the whole world suddenly discovered Cyprus wasn't such a nice place to put your money after all. The Russians might possibly be nasty people, but in this matter of bank deposits, people all link arms internationally like brothers.
There have been lots of other bank panics in small nations without much agitation, so what seems to have bothered the markets was the decision of the Central European Bank to tax the depositors 10% to support the system. Christine Lagarde, the head of the International Monetary Fund, said she thought it was a good idea to tax depositors, and that really upset a lot more people. Ms. Lagarde is French, but the IMF which she heads is located a few blocks from the U.S. White House, so the suspicion grew that Mr. Obama might approve of placing a tax on bank deposits, too. As things started to get out of hand, everyone hastily dropped the whole idea, and even the Cypriote Parliament voted against it. There was no time for even the large organizations devoted to managing the news to manage this one. World opinion was instantaneously mobilized, and thunderous in voicing its low opinion of taxing bank deposits, by anyone, anywhere. What was accidentally aroused was the realization that since the World went off the gold standard in 1971, the world's money is backed by nothing at all except a computer notation? Irrevocably taxing it in bank accounts could be done in an hour.
In 1944 the international conference held at Bretton Woods, New Hampshire, agreed that other nations could exchange their currency for American dollars, but only the U.S. dollar could be converted into gold. As long as the U.S. ran a trade surplus, the gold remained undisturbed in Fort Knox. But when other nations began to export their goods in the 1960s, their dollars began to be changed into gold. Gresham's Law took over quickly since when two currencies of unequal value circulate together, the more valuable one will quickly disappear; the shifting balance of trade had made gold more valuable than dollar bills. When President Nixon began to see that Fort Knox was soon going to be emptied, he put a stop to the exchange. He "closed the gold window". At that point, we were all off the gold standard, but nothing much happened. It remained possible to continue to speak of gold as a "barbarous relic", and by implication, any standard like silver or oil or land was also a barbarous relic. But the experience of Cyprus taught the world that everyone did want the value of a currency to be independent of the whims of government, and like the Emperor's suit of clothes, was just waiting for someone to point it out. A system of monetary exchanges, or exchanges of goods and services, really can be run without backing by anything except the word of government. But inflation targeting does need a government to run it, and thus governments have acquired a power over currencies which centuries of experience had taught people not to trust for a moment. North and South American hemispheric trade had been comfortably run without governments for centuries, as long as there were Spanish pieces of eight in actual circulation. But the modern Cyprus government could not run for a week without the trust of depositors, and neither can any other government. Conversely, it is impossible to run an economy without a government to guarantee the international value of money. People don't like that situation, and the threat of chaos in the streets is not much different in any place in the world which does not run a brutal military system. When you reach a point where even the soldiers refuse to be paid with paper money, you are about at the point General George Washington found himself after the Revolution. Robert Morris convinced him it would be possible to base a currency on the credit of the nation, and General Alexander Hamilton had been taught how to run such a thing. The rest of the country didn't understand what that meant, but they did understand that it seemed to work. But it would only work if the people trusted their Constitution, and the government is designed. But then, our government never tried to put a tax on bank deposits. In fact, it took another hundred years before the American public was completely certain you could trust banks even to exist. The good ol' mattress, that's where to keep your money. If it's in gold coins, that is. Paper money might just as well be in a bank because its value is only symbolic of a government promise.
|The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order: Benn Steil: ISBN-13: 978-0691149097||Amazon|
|Robert Morris: Financier of the American Revolution: Charles Rappleye: ISBN-10: 1416570926||Amazon|
|Bitter Lemons: Lawrence Durrell: ISBN-13: 978-1604190045||Amazon|
|Dr. Ronald J. Granieri|
Dr. Ronald J. Granieri of the office of Secretary of Defense, recently spoke to the Right Angle Club about recent threats to the unification of Western Europe. One of his more striking points was that the 1989 collapse of the Soviet Union ending the Cold War, may have unintentionally thwarted the plans for a European Union. The Iron Curtain running from the Baltic to the Black Sea had served as an Eastern boundary for European dreams. When the curtain suddenly disappeared, the European Union was flooded with applications for membership from the recently liberated, formerly Communist dominated, Eastern bloc. It was understandable why these countries would wish to get away from Russia, and equally understandable that Russia would be annoyed. But bedazzling expansion was quite unexpected by the European Founding Fathers, who were having enough trouble without doubling their number with weak economies. If Napoleon or Bismarck or some other empire-builder had been in charge at that time, Europe would either have been expanded by brute force, or its borders slammed shut with brute force. But in the clutch no one was thinking big. Acquiring twenty new nations was an undreamed-for opportunity, but a technical headache for academic theorists. It called for bold action at a time when bold actors were not in charge.
Although it hurts European pride to admit they were following the American model, most of the problems they were encountering were the same problems our own Founding Fathers encountered in 1789. There were two main differences, however, one of which had been written into our Constitution. The other went largely unnoticed. The written difference was we had a bicameral legislative branch, designed to address the issue of voting rights straddling three big states and nine little ones. Pennsylvania had already gone through a dispute over the unicameral Pennsylvania Legislature, which proved to have so much power it unbalanced the three-branch system of government. Consequently the Philadelphia Constitutional Convention, held in that same building, was already uneasy about unicameral legislatures. It was John Dickinson the delegate from little Delaware, who went to James Madison (of Virginia, then the largest state) and told him bluntly that if Virginia persisted in demanding a unicameral Congress with representatives elected by population size, well, there just wasn't going to be any Union. The three big states refused to participate in any one-state, one-vote, system, while the nine small states wouldn't submit to large-state domination by population size. Either voting by state or voting by population would inevitably result in one side winning every hotly contested vote in a unicameral legislature. So, we had solved our problem by having two legislative houses, one of each kind, and agreeing that legislation would only proceed if both houses were in agreement. What made any legislation possible under these terms, was the informal system of "log rolling", in which informal agreements on seemingly unrelated matters would compensate the loser branch of government, and the states they represented. Since in modern Europe, any group of ten or twenty states in a union would surely have memberships of unequal size, bicameral legislatures seem to Americans to be a perfectly sensible arrangement, so get on with it. The insistence by the League of Nations and the United Nations for one-vote, one-nation arrangements, is a major reason the United States never permitted these supranational forums to have much power.
It's an unspoken truth however, that other nations do not see it our way. That's partly because the German and other parliaments going all the way back to the Roman Senate had established a unicameral tradition in Europe. The other main but unwritten cause of Constitutional differences between the two continents is that we had been surrounded by thousands of miles of ocean, and never had to consider the danger that external and internal enemies would join forces to frustrate our decisions. It is true that many attempts were made to do just this, but they were immediately recognized and easily quashed in the past. As long as the Iron Curtain was operational, Europe thought it might have such ocean-like protection as well, but events in 1989 swept that idea away. With a large addition of formerly hostile states, some members were occasionally bound to join forces with Russia or China, even though they were nominally loyal citizens of the EU. Traitorous behavior had long been an underlying cause of splinter parties and brutal suppression, but that was when Communists were thought by everyone to be agents of a hostile foreign power. With the end of the Cold War they might become misguided local citizens exercising freedom of speech, claiming a right to argue for behavior which would have formerly been denounced as traitorous. Nations harboring few such inclinations soon became cautious about joining government with nations who had a great many of them. Citizens of recently enslaved nations were particularly resistant to soothing arguments about unity. It must be confessed that the example of our own Civil War lends force to this feeling of what might happen.
|Baltic and Black Seas|
It may be claiming too much to describe the fall of the Iron Curtain, as the major reason for decline of interest in forming a political union in Europe. That decline did occur, and was replaced by the rather weak stratagem of leaving unified government to another time. In its place appeared a strategy of economic unification, hoping the benefits to everyone would become so apparent that unified nationhood would follow. A substrategy emerged, narrowing it to a unified currency, the Euro. Bankers and other financial experts argued that such unification would be fairly simple and effective. And so it proved, until the same difficulty appeared in a different form. The design of the Euro Currency Zone had apparently underestimated the problems of a foreign currency operating together with the Euro, and variants of Gresham's Law surfaced. Small nation members like Iceland and Cyprus found their small banking systems could not cope with huge inflows of flight money, escaping to tax havens within the Euro zone. As well, underdeveloped member nations actually romanced non-member capital to relocate to their shores. Since local currency is ultimately supported by the full faith and credit of the nation, local banks and economies cannot easily deny equal protections to foreign capital, except temporarily while exchange controls are applied. But when a sufficiently small nation is thus forced to guarantee a sufficiently large amount of foreign money, local banks and markets will be destined to crash. If, in addition, the member nations are deprived of the ability to devalue their currency as the Euro zone could, some type of informal arrangement for a two-value currency had to be devised unless more prosperous members like Germany were willing to subsidize the money flows. When two currencies of unequal value circulate together, said John Gresham to Queen Elizabeth I, the more valuable one will quickly disappear.
|Governor Chris Christie|
The November 2013 elections have been widely accepted to be a spectacular win for New Jersey Governor Chris Christie, suddenly making him a presidential front-runner for 2016. The only other significant election was a close win in the Virginia gubernatorial race for a fund-raising crony of Bill Clinton over the Attorney General who started the Supreme Court Case over Obamacare. In the view of the news media, there were only two elections in this off-year -- a landslide in New Jersey, and a dead heat in Virginia, for Governor.
Well, as a matter of fact, there was also an election in New Jersey for all of the members of the legislature, which means that I was running against the Democratic majority leader in the 6th Legislative District. I got 19,000 votes, but I needed more to win. At least in my family, it was a big event, particularly since no one else in New Jersey contributed a dime to my campaign, and while Governor Christie may have whispered a few encouraging words to me, there was no evidence of his assistance. But you can forget about that, too, because this election was really about the minimum wage.
The first inkling I got that something was up was receiving a sample ballot, three days before the election, where there was a referendum question about the minimum wage that no one had told me about, although it could scarcely have been a secret to get it on the ballot. And secondly, on election day there was scarcely any evidence of campaigning for Democrat candidates except for a few yard signs, but literally, dozens of campaign workers poured into the subway stations, handing out great volumes of campaign literature about the minimum wage. Even that went past me unnoticed, because who in the world would vote for a proposal which would increase unemployment during a severe recession? When I expressed the same sentiment to my Democratic friends, I was surprised to discover they all knew about it in advance. In retrospect, that was a fairly good indication that the Internet had selectively urged support of this proposition to the party faithful, but had not said one word in campaigning for it. It won endorsement by a heavy margin, as things soon turned out. What's worse, what had been endorsed by referendum had been to amend the constitution to this effect, automatically indexing it to the cost of living. It's going to be pretty hard to reverse that since all constitutions have been written to make it very hard to amend them.p> In the week after the election, I notice that several other states have been considering raising the minimum wage. An article appeared on the editorial page of the New York Times arguing that research showed there was no evidence that raising the minimum wage caused unemployment, and a few days later, Paul Krugman had a learned column on the Times editorial page to the effect that smart people all knew there was no reason to expect unemployment from raising the minimum wage, and only the hopelessly ignorant rubes would imagine there was reason to think so. Having spent some time with editorial writers, it seemed pretty evident to me that there was a nationally coordinated effort to convert this into a truism, accepted so widely it would be futile to argue against it. When it is also possible to see the existence of a campaign to impose a maximum wage (and not merely in Switzerland, where it was defeated on a ballot), the trajectory of a rising minimum wage meeting a falling maximum wage easily led to conjectures that what was really afoot was a campaign to take wages out of the marketplace. Or was that really the goal?
For months, the Federal Reserve Chairman has been emphasizing that the Fed must obey two mandates: to maintain price stability and to minimize unemployment. Meanwhile, the dirty little secret among economists has been that unemployment is the main obstacle to inflation in the face of a massive enlargement of the money supply. Unemployment is currently at 7.1% and falling, while the Fed has lifted the veil of "transparency" to reveal it made a promise in double-speak to start selling some of the bonds it issued to combat the recession when unemployment reaches 6.5%. As time has gone on, Mr. Bernanke has seemed to back away from that promise. He is not so sure that unemployment is a good measure of unemployment, other measures may be a better measure of what we are driving at. He never meant to start selling bonds when unemployment reached 6.5%, he only meant that he might reduce the number he planned to buy. He never meant to make a promise, he only was being transparent about the current thinking of the Board. And anyway, Janet Yellen will take over his job in a month, so you can't very well bind your successor to do anything at all. What's this tap-dancing all about?
Well, it simply won't do, to suggest that the Federal Reserve isn't as independent of politics as it pretends to be. But everyone noticed that the stock market had a bad fainting spell when he suggested a few months ago that the Board had been discussing the matter; just imagine what it would do if he actually made a promise to act, let alone actually taking an action. By itself, such an announcement would probably send interest rates on a rise toward normal levels. The stock market mostly anticipates the future, so it would jump ahead of whatever action was taken. Since the United States is now the largest debtor on earth, a rise of interest rates would immediately add huge amounts to the current deficit and the projected national debt. The stock market would almost surely drop, possibly severely, in response to such commotion in the debt markets. And the national economy would certainly feel the deflationary effect of such activity in the financial markets, sending markets even lower. Fear of such a reaction would surely persist longer than the real need for monetary easing, making the resultant inflation even worse than it had to be.
Is it possible the Obama Administration prefers a little extra unemployment, to risking a stock market crash before a coming election?
|Minimum Wage Uproar|
In an era of desperate experimentation with the simultaneous solutions of several problems at once, perhaps the best conservative response to this paper is to seek ways to relax its inflexibility. The political process, particularly the amendment of state constitutions, is a lengthy and cumbersome impediment to agile management of the economy. It is fairly unlikely that a secret springing of a referendum trap can be repeated. The greater risk is that we will know what should be done, but become unable to do it quickly.
Meanwhile, the politicians are designing things and politicians like things simple. The Republican solution is to pass a minimum wage, but keep its benefit slightly below the entry-level wage; they get credit for passing it, but it has almost no applicability. The Democrat approach is to make a big noise about passing a meaningless bill, promising they will make it up with off the balance sheet entitlements, like health care and college tuition. Either way, usually nothing much happens after the election is over.
|Posted by: Carrieann | Jul 29, 2011 1:34 PM|
Taxes as a Form of Consumption
Most people find taxes are their biggest expense. Why not reduce them?
Fort Wilson: Philadelphia 1779
History was made at 3rd and Walnut, but so far, is unmarked.
Private Sector Disciplines Congress
"The bond market won't let you" has disciplined American governments for two hundred years. Robert Morris invented the idea. The nation's first bank was really its first bond fund.
The Revolution is Over, Every Man for Himself
Although his personal wealth in modern equivalents approached that of Bill Gates today, Robert Morris abruptly quit his business after a debate in the Legislature, just to show he had no personal bias. It ruined him, but John Hancock and George Washington did much the same thing. Ben Franklin agreed, but was shrewder about it.
Morris Defends Banks From the Bank-Haters
To understand why lots of people today reflexly hate bankers, it's useful to review the courtroom defense of the man who invented America's first bank, facing ruin if he proved unconvincing.
Funding the National Debt
Funded debt, otherwise known as Capitalism, was a gift to the nation from Robert Morris, Jr.
Morris at the Constitutional Convention
Robert Morris knew that credit is only extended to someone with a reputation for paying his bills.
Bonds--Do They Have A Future?
It's increasingly hard to imagine why investors buy bonds because it's increasingly difficult to imagine an end to inflation.
What Is the Purpose of a National Constitution?
It could be said the framers of any constitution seek to return future generations to the reasons for founding the nation.
Breaking the Buck
Several years after the financial crash of 2008, the question is raised whether money-markets might have played an unsuspected role. If so, what should be done about it?
National Debt, Presidential Hat Tricks, Shale Gas and Argentina
The Franklin Inn Club discusses Obama's maneuvers in the context of what might have been a better approach.
Federal Reserve Power Play
Evidently, the Federal Reserve feels it never has to restore those bonds it holds to the private sector. The bond market may not stand for it, so hold your breath.
Why Jefferson Hated Banks and Hamilton Loved Them
For centuries, Americans have quarreled about whether banks are good or evil. Some of the arguments are good and bad, but hardly any are new.
Bernanke's QE3: A New Titanic, or A New Bretton Woods?
Ben Bernanke is crossing Niagara Falls on a tightrope.
The Bretton Woods conference in 1944 was very simple. The U.S. dollar alone was convertible into gold, but all other currencies were convertible into U.S. dollars. To prevent Fort Knox from being completely depleted of gold, the convertibility of dollars into gold was also soon discontinued. Effectively, all money everywhere was thus just a computer notation, controlled by the U.S.government. Temporarily, the dollar became a reserve currency, supplementing gold. Effectively, we were testing whether we needed a metallic standard at all.
Stress Tests for the European Union
Ending the Cold War in 1989 may have generated an unexpected obstacle to European unification.
Minimum Wage Fangdoodle
While no one was looking, mandating a minimum wage turned into a contrivance to maintain low-interest rates.