The ekonomics of Fantasyland
by Jim Chaffee
[ opinion - october 08 ]
Were the expense of war to be defrayed
always by a revenue raised within the year, the taxes from which that
extraordinary revenue was drawn would last no longer than the war... Wars
would in general be more speedily concluded, and less wantonly undertaken. The
people feeling, during the continuance of the war, the complete burden of it,
would soon grow weary of it, and government, in order to humour them, would not
be under the necessity of carrying it on longer than it was necessary to do so.
- Adam Smith, The Wealth of Nations, V.iii.50
The private sector got us into this mess. The government has to get us out of it.
- Barney Frank
Itís the ekonomy, stoopid.
- James Carville
If you're reading this at some date significantly beyond October 2, 2008, you will know whether the events of the past weeks were catastrophic on the order of, say, Armageddon or the Great Depression, or just another Chinese fire drill for trained financial and economic "experts." But the orderly, slow motion market collapse of the week following provided a touch of melodrama to the show, more like a series episode in which someone forgot to write in the hero saving the world rather than an international event unfolding live in real-time on television. Whatever the outcome, an interesting aspect of the exercise is the language, particularly by politicians and media "gurus" and "savants." The phrase "simmering credit crisis" pointing at some ill-defined horror lurking on the horizon. The attendant hand wringing over this "unprecedented interference" in the Market, or Free Market, or the advance of Socialism into God's ordained land of pure Capitalism. One buffoon from the Senate actually implied the US was going down the road of France, though I had read somewhere that it's the French who are adopting our own predilection for tasteless prefab high-velocity food.
It leads one to recognize, first and foremost, that humans are not much changed since Neolithic times except they have developed fancier ways of expressing their fundamentally superstitious views of the world.
Perhaps the most amusing hue and cry regards the taxpayers, with this massive debt passed to their children. And grandchildren, and great-grandchildren, ad infinitum, like one of those Old Testament curses of leprosy by the miffed Jehovah. That is as amusing as the fanciful notion that somehow all this money will be borrowed. Much like the illusion that money is borrowed to pay for the wars in Iraq and Afghanistan. Or that money is borrowed to pay for other government spending.
The word borrowed here is euphemism for printed. By which is meant creating money out of thin air, nowadays electronically. Sure, there may be some borrowing by foreigners who are drowning in greenbacks. They send it back to the US in exchange for slips of paper that promise to return it with interest, sometimes low enough that they lose principal to the falling value of the dollar against their own currencies. The taxpayers are not on the hook to repay that which is not really borrowed. So there is no taxpayer fallout, though there are other consequences to a nation willy-nilly printing money. David Hume, among others, had a thing or two to say in this regards. Anent more later.
Milton Friedman described the method by which money is created in the US in modern times. In a little book entitled Money Mischief which even a trained economist or MBA or "political scientist" might understand, he points out that government has only three ways to increase spending. It can raise taxes or borrow money, the first of which is unpopular as hell and the second of which is largely impossible given the amounts required. Both of these options reduce the supply of money in the hands of private citizens, and leave less for the "private sector" to invest. The only other option is to increase the money supply. That is done by borrowing in a very odd way. The Treasury sells bonds. And some of these indeed go to borrowers, of late often Asian nations. But the reality is that mostly the Treasury sells the bonds to the Federal Reserve System (Fed). According to Friedman, the quantity of bonds in such transactions is legally limited, but there is a workaround. The bonds are sold to specialist intermediaries that in turn sell them to the Fed and collect a commission as payment for maintaining the fiction that the government is borrowing from the public.
So in essence one hand of the government borrows from another, with the Treasury inflating the supply of "high powered" money when the Fed credits the Treasury account. Friedman also points out that the Fed is a branch of the government despite the smoke screen of private ownership of district banks. He ought to know, having worked in the Treasury and having spent a lifetime studying the history of these arcane mechanisms.
Most people confuse fractional-reserve banking, which is controlled by the Fed within its own system, with printing money as described above. But banks do not create what is called high-powered money. They inflate it by lending all but some reserve they are required to hold, which does inflate demand accounts, for example. This isnít new, harking back to the days when money was supported by gold and silver, before the advent of purely fiat money. Goldsmith's notes were issued by goldsmiths who held deposits of gold and loaned against it on reserve in 17th century England. (See Herman van der Wee, Monetary, Credit and Banking Systems, in The Economic Organization of Early Modern Europe, edited by E E Rich and C H Wilson for goldsmithís notes and other history, and Karl Brunner, High-powered Money and the Monetary Base, in The New Palgrave Money, edited by John Eatwell, Murray Milgate, and Peter Newman, for a discussion of the concept of high-powered money.)
This wholesale creation of money out of thin air is the basis for Ronald Reagan's famous supply side economics, by which the rising tide raises all boats. But as David Hume might have remarked given his view on printing money, "Aye, laddie, but the rising prices have swamped any trickle down to the wee folk, who are drowning in them." He would have been right, and the ensuing inflation can be seen as a form of clandestine taxation of the most recessive variety. Reaganís massive defense spending, ostensibly the reason for the Soviet disintegration (but as to the reality of that, see for example the discussion in Norman Daviesí Europe: A History, wherein this US myth is effectively deflated), certainly raised a few boats much higher than others. A very few much higher than most, actually, which was perhaps the reason for the gift Reagan received upon leaving office. When Republicans talk cutting taxes via supply side economics as a means to increase the flow of revenue into government, the hidden assumption is that they will print money to augment that flow. Their schemes for balancing the budget have been based on this absurd idea, and the irony is that a Democratic regime eventually realized the balanced budget grail, only to be pissed away by another Republican "conservative."
Note that this monopoly money is not necessarily worthless. It is likely that whether or not you play the game is outside your control, and so the monopoly money is the only currency available. But read Friedman's little book to understand how commodities like cigarettes actually became money in post-WWII Germany when the inflation tax overwhelmed the currency.
Consider a recent historical example to put all this into some kind of perspective.
The Reagan regime inherited a situation called stagflation, high inflation and stagnation (slow growth of measured GDP, whatever that might actually mean), from the Carter regime, the reasons for which are not important here though they likely had something to do with oil and a cartel called OPEC and a recently lost war. Reagan's solution was to boost growth by printing money and distributing it through the Department of Defense (DOD) at record rates in the name of National Defense, though there was no war and little real threat. (Some people believe in a thing called the Cold War, a bogeyman of a few decades past that persisted from the end of WWII until recent times, though whether or not the specter has been laid to rest is an interesting topic for discussion. A study of history indicates that such problems in diplomacy have been common since at least the Greek times and donít merit the term war.) Reaganís Fed chief Paul Volker (also inherited from Carter but reappointed) knew that this money creation program of epic proportions would be inflationary, a dangerous problem given the persistent inflation already infesting the nation. (The Pentagon had so much money allocated to it for Reagan's Star Wars program that it could not spend it fast enough via the issuance of contracts; those were the days before wads of cash were simply handed out to contractors in grocery sacks.) So Volker got creative in extending the Fed's control over its member banks well beyond the silly overnight rates charged between the members. He increased margin requirements, for example, and effectively made it prohibitive to borrow money. This caused a slowdown outside the defense sector, but money flowed through defense contractors like the fuel it was meant to be. Volker saw to it that most of that ended bottled up in a few privileged hands from where some of it might eventually trickle down to the little people. And Reagan got his paper-growth.
Skipping the one-term Bush the Elder for now, William Jefferson Clinton came into office and loosened things up again. His Fed chief, a hand-me-down from the end of the Reagan regime named Alan Greenspan, who had already begun easing up on Volker's tightfisted control, let more money flow out. The money Reagan had printed in such massive quantities that had been shoved out of sight by Volker popped out in a craze of lunatic proportions, handed out to all sorts of children like allowances and rewards for asinine ideas. This was later called the Internet Bubble and these dull children (many well into chronological adulthood) were called entrepreneurs.
The genius of the Clinton regime was recognizing that indeed a new mania had gained control of the populace (during Reagan's regime the craze was, not surprisingly, a round of the same sort of witch hunt that had afflicted Salem a few centuries earlier, with similar trials and similar outcomes) who believed that the New Economy had arrived and that they were all to become blessedly wealthy with 401ks. Taking advantage of this temporary insanity or faith, depending on your point of view, people were encouraged to switch their 401ks to ROTH accounts, paying taxes on the money they had on deposit. This would allow them to pay taxes in the present on money that would grow to huge fortunes in a few years without further tax burden, thereby exercising their propensity to avoid taxes while paying taxes. I personally found it amusing to talk to people who borrowed to pay those taxes on accounts that would soon be worth less than those taxes. I had to work to keep from laughing at their tears of chagrin. But Clinton used this trick to balance the budget, and he did it with the money Reagan had printed less than a scant decade earlier.
Contrast Reagan with Bush the Younger, who has also constructed a massive budget deficit and swollen government bureaucracy and who also prints copious quantities of money for "Defense." Money that is practically thrown in the streets to create easy credit and large debt to feed the propensity to consume of the average clown eschewed in the 80s by Volker. This has led, in part, to the crisis alluded to in the first paragraph. But there is more to that.
At any rate, the muddle-headed Market-intoxicated "conservatives" in Congress who rail against the "bailout" of private sector banks as an incursion into the rightful role of the Market are a funny lot. (It is probably best to drop the term conservative here and replace it with Republican, for which it has become a synonym. Liberal is a synonym for Democrat. Neither word has any objective significance beyond these affiliations.) Jim Bunning, former jock and US Senator, said "the free market for all intents and purposes is dead in America." Which is hilarious, since he is right. But this is not the death-knell, since the Free Market has been dead since at least WWII and probably longer. In fact, it isn't clear there has been such a thing anywhere ever. After all, Adam Smith only saw it in a vision.
Funny also is Republican candidate for President John McCain, expressing his ire at those greedy characters on Wall Street. He is supposedly an educated man who somehow missed Adam Smith's Revelation of Free Market Capitalism as driven by greed, invoking an invisible hand to direct something or other. For Smith, an ethicist, this utopian system produces good behavior from its citizens by combining free markets with greed. It is not clear what is meant by free markets, but so far as I can determine Smith meant by good behavior some sort of sheepish conformity to social norms.
In reality the US is not now a capitalist nation, at least not in the classical sense of the word capitalism. Since the time of Reagan (and perhaps nascent since WWII), the US has become a military-socialist nation, or as some call it to point out how this variant of socialism is mechanized, a military-Keynesian nation.
Yet the loudest cries of Market! Market! come from big-defense Republicans, not that they are a singularity in delusions. But their most public genuflecting and invoking of the Free Marketplace to save us all would certainly be a form of idolatry to the Old Testament prophets. Perhaps a visit by a modern prophet to these back-sliders along the lines of Elijahís dealing with the Baal priests in chapter 18 of 1 Kings would be appropriate. Certainly these Republicans have endorsed the prophet Adam Smith, and their religion of the Market is similar to Baal worship in that they think they are offering up their offspring to unbridled government intervention in the Marketplace. Itís likely they know as little or less of Smith's work as they know of the Old or New Testament. They decry government spending even as they authorize massive spending projects in the name of National Defense, a perfect example of blind hypocrisy, an inability to see oneself (or to remove the rafter from one's own eye before removing the straw from one's neighbor's).
These competing superstitions make the Republicans quite entertaining just now. The events are even more hilarious to anyone who knows the Old Testament since Treasury Secretary Hank Paulsonís apocalyptic vision and warning is as acceptable to the people to whom he preaches as were those of the Biblical prophets to their audiences. His own people, the Republicans, throw back cries of "...we are getting away from the True Marketplace..." and "...the reward and punishment of the Marketplace..."
Real Ekonomics lurks unseen behind this veil of superstitions, likely jumbled up as cobwebs within the conventionally packaged small brains of the crowd. But at least current Fed Chairman Ben Bernanke does not seem to be a believer. Clear-eyed, he seems to see a planned economy of unintended consequences and collateral damage, all but acknowledging that this crying out to The Market for salvation is nonsense. He says markets, not Market. And he talks about market mechanisms. The man seems to be a realist, not a market intoxicated dogmatist. Which is interesting in its own right, as the irony is the impossibility for those "educated" inside the box of conventional Economics to understand the actual workings of what is misleadingly called the economy. It takes a heap of education before one shakes off the brainwashing of compulsory miseducation.
Facing reality means acknowledging that the US is in constant bailout mode. Without government spending of enormous proportions based on freshly printed money, the consumption churn that keeps it all afloat would freeze up. And don't let anyone argue with bogus nonsense about the velocity of money. During the Reagan spending times the velocity of money seemed immeasurable, so much of it was choked off with Volkerís tourniquet. The idea is nonsensical anyway, though Friedman seemed to love it (perhaps due to his worship of Irving Fisher, but for an alternative discussion see Velocity of Circulation by J S Cramer in The New Palgrave Money, op cit.
What happens to markets when the government pours stupendous amounts of freshly printed money into the society? Well, that government spending is much like fuel for a motor on a huge ship. What most of the "free market" advocates seem to mean by a free market is that the ship has no controls, except an accelerator and some nearly useless braking system akin to dragging a foot in the water. But fueling this vessel with money influences the markets. People, after all, go where the money is.
The key systems description of the US "economy" is monopsony fueling oligopoly with consumers spending money obtained on credit. (For some discussion of these terms and their implications, see for example Elementary Economics: A Mathematical Approach by Ralph W Pfouts for a grade school level approach, or A Course in Microeconomic Theory by David M Kreps for a high school level approach; I don't believe the term "theory" in Kreps' title is meaningful, for what itís worth.) The credit part of this system is where much of the current "crisis" comes from, due mostly to a fear of the feedback problems inherent in a widespread inability to pay on debt and to the amazingly obscure way the debt has been "structured," that structure thanks perhaps in part to the silly application of extensions of the mathematical Black-Scholes theory. The single buyer in the monopsony is the US government, and most of the sellers are clustered around the teat of DOD contracts, though there are other players. Freshly printed money pours into the system in the name of National Defense, trickling down in a variety of ways to consumers buying from corporations. The $700 billion "bailout" bill recently passed is simply another avenue for funneling money, the reason for which will become clear upon further reading.
This makes an absurdity of the idea of free markets. When the government chooses where to pump the money by buying from select elements of the "economy," markets are created and steered. That the government does not know what the hell the effects of its steering are does not make it a free market economy. It makes it an incoherently planned economy inspired by fear of bogeymen. Smith allowed for defense as part of government's expenditures, but he didn't predicate massive, continuous government spending because he knew it would influence the markets. Smith believed in an invisible hand that steered free markets, not bogus markets invented and funded by government. And though just what a free market might be seems not knowable, it is clear that a market created and funded by government in monopsony is not it. This is not seriously debatable within the context of economics. Any attempt to say otherwise is sign of pure ignorance or blind ignorance. The argument that the National Defense must be funded for the security of the nation is irrelevant, since necessity does not change the fact that there can be no free market under such circumstances, real threat or no real threat. This is not capitalism in the Smithist sense, but economic planning.
My reading of Smith indicates his vision of free market capitalism was what is called perfect competition, and in perfect competition profit is impossible. Hence the shrinking corporate oligopoly does not meet the criteria in any case, given their profits. In particular, the statement that huge profits are a part of capitalism is not within Smith's Revelation.
It is clear to a disinterested analyst that while spending for military preparedness is the politically palatable means of socializing the US, the actual fighting of wars is economically counterproductive. Ironically enough, the US cannot really afford to fight war because DOD is the main conduit for fueling the "economy." When actual war is fought, less money is given to contractors inside the system and more to those with boots and other shit on the ground in foreign locales. Clinton knew this. So did Bush the Elder, who chose to terminate his little foray into the land of the Oil Sheiks. And hence the $700 billion alluded to above that has caused so much hypocritical crying out to The Market out for salvation.
Recall or read about the time of Bush the Elder, who wanted to cash in the mythical "peace dividend" from the end of the so-called "cold war." He and his Secretary of Defense Richard Cheney cut all the defense projects that had a relationship to fighting the Soviet Union. Tanks, aircraft, lots of programs and a lot of military bases disappeared. The Honorable Jerry Lewis (not the famous professional Bozo of Dean Martin and telethon fame, but a political bozo) talking about the peace dividend made several points in a speech:
"Defense cuts are people cuts... Defense reductions are job cuts... There are no quick fixes by which defense cuts can be immediately available for redistribution to other Federal programs." (The complete text can be obtained from the Dirksen Center).
Now this comedian is of Republican persuasion, and complained of these cuts by a Republican regime. These cuts continued into the Clinton regime by legal commitment from the Bush regime after the latter ended in good measure because of the recession the cuts helped cause. Also because Bush the Elder felt he ought to expand government spending with taxes, something that is not allowable within the ideology of supply side economics (remember, that relies on printing money) and because he crawled around on his hands and knees at a state dinner and puked on the shoes of the Prime Minister of Japan. Another irony here was Dick Cheney campaigning against Clinton on the basis of defense cuts made due to Bush the Elder and Cheneyís legislative carry-over.
The point is that even Jerry Lewis acknowledged the real reason for spending on National Defense. Not for wars, but for jobs. Money distribution. Keep that "economy" fueled. In essence, the funding of DOD is a type of permanent WPA program for middle class and connected wealthy. Middle class welfare combined with huge handouts for the right people. And the major recipients ought not be military personnel, since they are not the optimal spenders. Optimal distribution is salaries via large corporations with overhead to fund buildings and retirement programs and health care and social security and most especially executive compensation for those who buy more stuff than your average soldier. One major DOD contractor I worked for carried a ratio of one president or vice-president for every fifteen employees, and all those folk were overhead. At one time, the company wanted to become nothing but executives who managed for other DOD contractors, producing no work, only overhead and G&A. As it was, like most defense contractors their major product was reams of poorly-written and well-bound reports and proposals.
So Bush the Younger, guided by what have come to be called Neocons, invested in war, an investment akin to putting a tooth under a pillow for the Tooth Fairy to reward. This has diverted some good measure of the printed money flow, but the Neocons argue it is a form of investment in the future. For the Empire. If the Empire can control the universe and all that, they will have an easier time keeping the nation fueled with that other necessity, energy. Mostly in the form of petroleum, though one must not discount the importance of the strategic position of Iraq in the Middle East which seems to be seen as the new pivot point or center of gravity or whatever is the current meaningless military jargon.
This means there are a lot of ironies in the fire, to make a horrible pun. For example, many of the worshipers of the Market who profess belief in the Smithist vision of a self-regulating economy that optimizes something or other are loath to believe in self-regulating natural selection via genetics. Nature requires some guidance by God, whereas the economy requires none; perhaps they identify the invisible hand of The Market in Smith's Revelation with God. No matter, since that is a small irony.
The bigger and more dangerous irony can best be illustrated by returning to bad television, taking the metaphor from the ridiculous series Star Trek in its later incarnation. The belief in war as an investment was brought to naught by self-delusion. The Neocons somehow saw themselves as Klingon leaders of a nation of Klingons. But clearly the Bush administration inner circle is composed of sniveling, cowardly, devious, lying Ferengis. Karl Rove is so Ferengi in temperament he might have been a model for the series if one believes in the future affecting the past. So is Cheney, passed along by Bush the Elder; so are those in the background, like Richard Perle and Paul Wolfowitz. Just who is the Grand Nagus in this crew is not clear, but my bet it is likely Cheney and not Bush the Younger. Cheney seems to have the bigger ears.
Reality is that the US is a nation of Ferengis, not Klingons. And so a final irony is that the "Cold War" ought to have been approached Ferengi style. The US could have bought the successors of the real Greatest Generation who defeated Hitler, the Soviet Red Army. They would be the real Klingons. And the investment in war could have been cheaply managed without a hiccup in the force-feeding of money into the homeland via "Defense Spending."