Simplifiying Economic Priniciples

There is a current debate going on between Paul Krugman, Nobel Laureate of Princeton and the New York Times and Paulina Tcherneva, an economist at New Economic Perspectives (NEP). NEP is run by people from the University of Missouri, Kansas City, and its contributors include people like Bill Black, who put a lot of shysters in jail after the Savings and Loan crisis; Michael Hudson, an economist who has been helping many foreign countries facing austerity crises; and many other from UMKC that are listed at the blog.

Both parties agree that creating money to stimulate the economy can lead to a devaluation of the currency. But, they disagree on whether or not this can lead to a government default and what the the money should be spent on. To date, essentially all the money has been spent on buying junk bonds from banks to increase their reserves so they can ride out the storm, while taxpayers pick up the tab in the form of higher taxes and reduced services later. Little or nothing has been spent on employing idle labor and other productive resources. Both parties have favored stimulus, but Krugman seems more accepting of what has been done than Tcherneva.  She believes the money should have been spent on putting people back to work with government programs. Tcherneva contends that the government will always be able to pay all its bills, including Social Security benefits, because it can print money. It’s just a question of what that money will be worth in purchasing real goods at a later time.

So, the bottom line is, what is the right course in the long run. If we continue to just bail out the banks we’ll have to continue buying  consumer products from overseas. To do so we’ll have to exchange those inflated dollars for the yen or yuan, so they won’t buy as much. But, if we invest now in putting the unemployed to work  restoring our domestic infrastructure and production capacity, later we can produce those goods ourselves and don’t need to take the hit on the currency exchange to buy them from foreign countries. Tcherneva makes the point in a quite wonkish way, but I think she wins the argument.

The Distorted Picture of Tax Equity

I would like to see a tax analysis organization initiate a project to present a true picture of tax equity which I have been unable to find anywhere.

There is a lot of misunderstanding and controversy over tax policy in this country because people don't have a clear picture of who is paying the taxes and whether or not it comports with their share of income. Most of the interest centers on the income tax, whereas payroll, sales, and property taxes have an equally important role in fairness. If people knew that taxes were being levied fairly and used properly they would more easily see and understand the need for taxes.

What organizations that analyze taxes need to do is present a complete picture of the total taxes people pay vs. their income. Current presentations of this picture use only the income tax and broad categories, the smallest being the top one percentile. Other taxes need to be included and the picture at very high incomes to 0.1 to 0.01 percentile brackets need to be shown.

Consideration also needs to be given to the disparity between taxes on earned income and capital gains. If capital is in short supply capital gains taxes should be lower. If consumer demand is low taxes on earned income need to be lower. In the present situation we have glut of capital and a shortage of demand, yet capital gains taxes have remained much lower than taxes on earned income.

Tax analysts need to do a better job of presenting a true picture of tax equity if we expect to minimize tax avoidance and prevent tax revolts.

As an example compare the two tables below. The top one is from the Tax Foundation. Looking at the shares of income and taxes you would think people in high tax brackets are overpaying their taxes. But, if you assume that taxes should be paid on net income rather than gross income the picture looks much fairer as shown in the bottom table. In this case it is assumed that it is necessary for a taxpayer to be making at least $33,000, the income of the median return, to hold a job, provide a home, transportation, and other expenses necessary to stay employed. Since other taxes are less progressive than income taxes the picture will appear even less fair if these taxes are included. We need fresh thinking on tax policy.

You may argue about what income it takes stay healthy and hold a job, so $33,000 may not be the right number. But, it’s certainly closer to the truth than the exemptions and deductions we now allow for low income people, while corporations get to deduct their martini lunches and other expenses that could hardly be considered necessary in the normal course of business. If everyone below the median tax return were taken off the tax rolls and all the deductions and exemptions were removed think of the money that could be saved on wheel spinning to avoid taxes. This together with higher taxes on the highest 0.1 percent of earners would go a long way to making up the taxes lost by taking everyone below the median return off the tax rolls.

Is a Depression Inevitable?

We find ourselves in a situation where capitalists and the financial industry run our country and many other countries in the world. Over the last several decades the industry has deregulated itself and reduced its tax rates to allow it too concentrate the wealth of the country in its hands. At the same time it has allowed, through globalization, labor rewards to seek a level set by the lowest wage worldwide.  In the process, it has destroyed the buying power of the great masses of the world population. To compensate, it has stimulated the demand for debt and hidden risk through the use of collaterization and derivative insurance products. This was a prescription for asset and debt bubbles and ultimate failure of the financial system, which has been prevented from collapsing totally only by the offloading of the debt onto governments.

Keynesians have viewed the rescue of the financial system, through large government expenditures, as paramount, but is it just delaying the inevitable? As long as we have the financial system running governments are we ever going to correct the problem of financial system running governments and bailing themselves out on the backs of the masses? This appears to be a question that answers itself in the negative. Keynesianism, the philosophy of the government stepping in to prop up demand as private sector demand wanes may work for normal business cycles, but does it really work to correct structural problems caused by lack of government control by the people?

A couple recent articles have shown that the incentives are all in the wrong direction, and that concentrated wealth in the hands of a few leads to control of all physical resources and inflation of commodity prices. In a recent article by Henry Blodgett in the Wall Street Journal, he demonstrates how the incentives perpetuate the problem. A recent post to The Economic Collapse blog show how commodity prices are skyrocketing. And, lately there have been reports of the buying up of agricultural land in Africa to take advantage of the rising cost of agricultural products. Where will it all end. Are the masses of the world’s population doomed to be serfs to a small percentage of wealthy capitalists? Or, is another depression necessary to wrest control of governments back from the financial industry? Pick your poison.

The Solution to the Housing Problem

“Henry George (September 2, 1839 – October 29, 1897) was an American writer, politician and political economist, who was the most influential proponent of the land value tax, also known as the "single tax" on land. He inspired the philosophy and economic ideology known as Georgism, which is that everyone owns what he or she creates, but that everything found in nature, most importantly land, belongs equally to all humanity. His most famous work is Progress and Poverty written during 1879; it is a treatise on inequality, the cyclic nature of industrial economies and possible remedies.”  (Ref: Wikipedia)

This was a good idea that could never be implemented because all the property was in private hands.

Instead of pouring taxpayer money into banks to keep them from imploding from the devalued loans on their books, why not use the money to buy the land under their homes from the property owners. The homeowner could then use the money to buy down the value of their mortgage to the value of the structure, giving them a monthly payment they could afford, thus enabling them to keep their home. The bank balance sheet problems would be relieved by these buyouts. When the economy recovers and home owners are able to afford a higher monthly payment, the government could then start charging them for the lease of the land. In this way, government revenue will increase to pay off the debts incurred to make the purchase of the land.

If this practice is continued, eventually the government will own enough revenue producing land to pay off the government debt and begin to reduce other taxes. In this way, the Henry George land based economy could be implemented over time.

The program would have a side benefit in that it would allow government to prevent or offset future recessions by reducing rents instead of increasing spending, when private spending wanes in a recession. In boom times, rents could be increased to take some steam out of asset bubbles that were developing.

The program would also limit speculation in land by banks, hedge funds, and other investors, thus slowing the development of asset bubbles and the attendant crises when they burst.

The housing and real estate markets would be stimulated because the cost of a home would only be the cost of the structure, requiring less funding on credit.

The main entities that would suffer would be banks and speculators. Now isn’t that a shame!

The Henry George economy is discussed fully in the link cited above.

The Oil Boom in North Dakota

North Dakota family and friends know all this, but it might be of interest to others. As most of you know, North Dakota is the state that has been least affected by the financial crisis, and it is in no small part due to the oil boom going on there. And, the area where I grew up is right in the center of it.  The first well drilled in North Dakota by Murex Corporation, a company started by two North Dakota residents who became petroleum engineers at North Dakota State University, was drilled right on the farm where I grew up. It was one of the first horizontal wells drilled in the Bakken formation, one of two major new formations being tapped by new oil drilling technology. The Tioga Tribune, the newspaper of the small town where I went to high school has published a pamphlet called, "The Oil Can Extra" that documents the history of Murex and presents other information on oil development in the area. There is a picture of the first Murex well in the document. The Fargo Forum, the newspaper of the largest city in North Dakota, has done a wider ranging project on the state oil industry called, “Running with Oil”.

If you have further interest, click on the links in the text.

What is driving the stock market these days?

I’ve noticed a strong correlation between the daily changes in the Dow Jones Industrial Average (DJIA) and and the changes (against the dollar)  in high yielding currencies used in the carry trade. (The carry trade is the practice of borrowing money in a low yielding currency like the US dollar or Japanese yen and investing it in a high yielding currency.)

The correlation is not true for low yielding currencies like the Japanese yen. To see the correlations visit the following links.

Australian Dollar

New Zealand Dollar

Japanese Yen

The first two are often used on the high side of the carry trade. When these currencies follow the market up it means the dollar is depreciating against these currencies, countering a portion of the dollar gains on the stocks.

The reason this is at all of interest to investors is that, if the correlation is strong, it suggests that the market is being driven largely by very large investors like big banks, hedge funds, institutions, etc, because the great mass of small investors seldom use the carry trade. It raises a further question regarding whether the coordination of these large investors is a form of market manipulation. It would be possible for large investors with real time trading and front running tools and acting a coordinated way to move the stock market and currency market up and down to continuously skim profits from investors not so equipped. A low correlation between the carry trade currency changes and the DJIA would suggest that this is not happening.

Eliminating Welfare and Developing a Mixed Economy

It’s been fairly well proven that both totally state controlled or totally free market economies don’t work. Why don’t we just admit it and define what roles government and free enterprise should play in the economy?

People have lost track of what the depression era programs really were. I won’t go through all the details here because they are spelled out in the government document,  Job Creation Programs of the Great Depression.  But, they were carefully thought out programs that were designed not to compete with private enterprise and had control over worker behavior far beyond just the work environment. At the beginning of the depression there was no safety net to speak of so the CCC, WPA, and PWA became the safety net. When workers can’t get work in the private sector, they are willing to settle for less freedom in their lives and lower wages to make a basic living. Conversely, if private sector jobs are available that pay higher wages and give them more freedom they will gravitate toward them. This insures that the private sector will always have a pool of available workers.

What I am proposing is that welfare and unemployment compensation be replaced with permanent versions of the depression era workfare programs and others like them. These programs would be limited to paying the minimum wage and would include government supplied health care similar to Medicare and pensions for retirees similar to Social Security. They would involve closer control over people’s lives, as was the case in the depression era workfare programs. With such a safety net, regulations on business could be relaxed, and businesses that are too big to fail now because they would jeopardize the welfare of the citizenry, could be allowed to fail. The incentive to return to the private sector would always be there due to the higher wages and greater freedom.

In prior posts here I have shown how periodic failures of our economic system, manifested by recessions, depressions, and asset and debt bubbles which collapse, are due to the imbalance of wealth and income between investors and wage earners. The broad middle class creates the demand for products and services which is needed for business to create jobs. Since business and capital sit atop the economic pyramid and decide how the fruits of productivity are allocated they periodically succeed in diverting more and more of the fruits of productivity to investors and managers and less to wage earners. This happened in the late nineteenth century, again in the first half of the twentieth century, and has now happened again in the first part of the twentyfirst century. This happens because the wealth accumulation results in a takeover of government by a wealthy oligarchy. Unless wage earners rebel, there is not much they can do about it.

If a safety net of the type I propose is put in place, any attempt to short change workers, as wealth is transferred to investors and managers, will result in more people ending up on the workfare programs and higher taxes for business and people in the private sector. The workfare workers will still be earning an income to sustain demand, but the private sector will soon see a shortage of workers. They will realize that they will need to pay their workers more to get them off  the workfare rolls and reduce their taxes. This will cause wages to rise again in the private sector allowing taxes to be cut, and rebalancing the income and wealth that is necessary for a healthy economy that is less subject to cyclical crises.

If you have further question about the workfare programs or the interaction of inequality and economic instability read the government document cited above and my prior posts on the subject.

Underlying Problems of the World Economy

We are in a catch 22. Economies of the world need to grow themselves out of the looming deflation that is on the horizon. But, private spending is collapsing, so public spending has to take its place until the economy is turned around. But, public spending is reaching its limits, because private sources of financing are losing confidence in governments ability to meet its obligations. Normally, what would happen under such circumstances, if the problem existing in only one country, is that the country would be forced into austerity measures, all the while being propped up by loans from outside sources such as the IMF, and by devaluation of their currency to stimulate exports,  thereby improving their economic outlook. But, this a worldwide crisis. All countries can’t devalue their currencies simultaneously, and where will the money come from to prop them up while they recover?

The underlying problem is that our productive resources, labor and capital are being employed unproductively in wars and economic endeavors that do not increase our standard of living. In the US we have shifted from an industrial economy that makes useful products to one that imports everything and all we do is sell things to one another. To add to this dilemma, our capital resources are being concentrated in the hands of fewer and fewer people, who hoard them rather than employ them productively. The broad middle class earning and spending power has stagnated as a result.

The solution will ultimately be forced upon us as the middle class is driven into poverty. We will either become more like Mexico or we’ll change our ways by reducing our expenditures for foreign wars and products that are of marginal utility and get back to basics. We will have to rebuild our industrial base and contract our financial base to balance capital with the need for capital and to employ our population productively. This will require a  more progressive tax structure like we had in the fifties, enabling workers to share in the prosperity of the country. We can either plan for this, or go the way of Mexico, where the wealth is concentrated in the hands of a few and the population flees to other countries to make ends meet.

Leisure World

Sometimes it helps to understand a concept by considering what would happen in the extreme. Suppose, for example, what would happen if technology allowed us to do all normal work without human interaction. The first objection to such an assumption would be that this is impossible. Some human interaction would be needed to monitor the automated system. But, let’s take that up later.

In a society, there are people that are employed or whose time must be devoted to work, and those who live off investments. Of course, those who live off investments must monitor their investments just as there must be people to monitor a fully automated system. But, again lets take that up later.

For the moment, the question is, who should reap the rewards of a fully automated system? Should all share equally in them, or do some deserve more than others. Should those with greater needs, such as people with larger medical expenses be allotted more than people without such needs? Should people who are talented and admired by people for their personal traits be  allotted more? Should people who are already wealthy get less than people who are not? These are questions that must be answered when faced with the prospect of a fully automated system.

We can now draw parallels with what is happening in the society now, that is only partially automated. As robots have taken over many of the functions that people used to perform in the automotive industry, what has happened to the people that have been displaced? And, where have the rewards of greater automation gone. Have investors received most of the rewards, or have prices of the cars gone down so consumers can participate in the rewards. Judging by the rising inequality in the last several decades,  the sustained or increased prices of automobiles, and the reduced incomes of displaced workers forced to migrate to other work, it appear investors and management have gotten the best of the deal.

Going back to our idealized automated society, obviously the people necessary to monitor the automated system must be compensated. And, investors must be compensated for the time they spend monitoring their investments. But, we have not answered any of the questions raised regarding how the rewards of automation should be shared. This is the dilemma was face in our current society and that we are not addressing. We seem content to just let the money flow to the people that are closest to the source and who control the process, namely investors and managers. Is it any wonder that wages have stagnated, capital has accumulated beyond the need for it, assets are bid up to artificially high levels, and average people are forced into debt to survive. The resulting assets and debt bubbles have burst and we are facing a collapse of whole system.

Isn’t it time to reconsider tax policy to balance the accumulation of capital with the need for it, and to address the need for a redistribution of income resulting from the rewards of automation? As we have seen, in the limit of full automation, we should all be better off, not just a few people who happen to control the process in getting to a more automated society.

A Project for the UN and WTO

The Kyoto environmental accords failed and little progress has been made on world poverty. The US administration is pushing cap and trade as an alternative to Kyoto and has no defined program to reduce world poverty.

Cap and trade is a corporate program, subject to market manipulation that we’ve seen in other commodity markets, and that is pushing marginal farmers into survival mode in Brazil as corporations buy up large tracts of land for it’s carbon trade potential.

Maria Cantwell has a better idea: Cap and Dividend. It would add a carbon fee on all hydrocarbon products and rebate the collected funds to individuals to compensate them for the increased prices of petroleum products. The only problem is, it’s only a national program. American consumers would continue to buy the products at the same rate  if they are compensated for the increase in price.

A better answer is an international program, where rebates would go to many people living on a dollar a day and not using any petroleum products. Such a program would fight carbon buildup while at the same time fighting poverty, a win-win for the world.

Instead of beating their heads against the wall trying to sell climate change to people who won’t get interested until it affects them, environmentalists should be working in a world forum like the UN and the WTO to sell the benefits of carbon reduction in, not only improving the environment, but reducing world poverty.

Petroleum products have a world market. Petroleum producers are multinational corporations. The world is suffering wars in the name of petroleum resources and third world countries are benefiting little from them. It’s time for an international efforts to combat climate change and world poverty in a unified program.

The Tea Party Doublethinkers

Doublethink is the ability to hold two contradictory thoughts simultaneously. The credo of the Tea Party is lower taxes and smaller government. By shrinking the structure that was designed to protect them they are committing economic suicide. The business community has been successful in duping quite a large number of people into thinking that government is the problem, but it certainly hasn’t been a problem for business. They have been successful in turning the people against the government,  while at the same time lobbying to capture the government for themselves.

Business promotes expenditures and taxation for the military industrial complex and for bailing out banks while condemning them for any purpose benefitting people. It has successfully perpetuated an inefficient private health care system that rations health care by ability to pay rather than by need for care.  And, it is trying hard to destroy Social Security and Medicare. Yet, it has been able to convince the Tea Party that the solution is to further reduce taxes and limit the government’s power to protect the people.

What is needed is to bring government back to its original mission of promoting the general welfare, and not that of business and banking. There is a reason that taxes on the highest incomes were high and regulations were strong during the most prosperous period in the country’s history. Over the last several decades regulations have been decimated and taxes on high incomes and capital have been reduced dramatically, to the point where we are again experiencing an age of robber barons while aggregate demand atrophies and wages stagnate. Unless the people in organizations like the Tea Party realize they are working against their own interests, there is little hope of correcting the problem.

An Alternative to Unemployment Payments

Fundamentally, economies thrive when everyone is engaged in productive work in the most efficient way. As disturbing forces arise to create unemployment, the most prevalent solution has been to pay unemployment benefits to workers until they can find employment. There has been no other course, since there has been no facility to employ them beyond the private sector. This is where it might pay to make a fundamental change in national policy.

The government is always engaged in funding projects to improve national infrastructure and defenses. These projects could be structured so that the pace of activities can be adjusted relatively quickly to accommodate the increase or decrease in employment needs. If a segment of the private sector is temporarily slumping, public projects could be accelerated to employ people facing layoffs in the slumping sector. Obviously, there will be mismatches in qualifications and mobility problems, but keeping people productively employed may be better than paying them to do nothing and then having to encourage them to seek other employment or forcing them off the unemployment rolls when they’ve been out of work for some time and their skills have deteriorated.

The Basic Conflict Between Balanced Budgets vs Incurring National Debt or Printing Money

Putting an economy largely in the hands of a central government or unregulated private enterprise have been shown to have different, but comparably troublesome, problems. Central government control destroys initiative and retards the accumulation of private capital that is necessary for growth.  Unregulated private enterprise concentrates wealth in the hands of a few and destroys opportunity for the broad mass of citizens. Both government and private enterprise are authoritarian in nature and take measures to advantage themselves, if checks and balances or regulations are not in place to control them.

Historically, management of economies has become complicated, particularly by the introduction of fiat currencies, making national economies issuing fiat currencies very different from local and personal economies which don’t have that power. The latter must operate under budgets which balance incomes with expenditures, while the former can simply borrow or print money with only devaluation of its currency as the controlling factor. Unless this difference is recognized, there is always a battle between forces that want to treat national economics like local or personal economics and the forces that want to use the national power to borrow or print money to counter instability. Over the years, the forces that want to balance income and expenditures have prevailed except in times of great crisis.

This is the crux of the problem we face. We have two choices, either demand austerity measures or tax increases in times of recession, in a attempt to rebalance budgets, or use the federal government’s power to borrow or print money to prop up the slumping economy.  The first hurdle we must get over is that these are real alternatives. One or the other is not the only course. And, depending on the circumstances, one or the other may be the more advantageous. We must not let preconceptions or past policies prejudice one alternative or the other.

If it can be shown that national budgets have become wasteful or bloated, programs have become obsolete, or lobbying pressures have caused expenditures to become excessive, austerity programs can be very useful. If taxes have become excessive or unbalanced among different segments of society, changes may be required. But if the country faces a crisis of instability due to natural sources or accumulated risks, austerity measures or tax policy changes may not be the best answer. When faced with reduced demand, government stimulation of demand to replace lost private demand may be a better alternative.

If the national government borrows to increase demand as a result of a reduction in private demand, it is subject to its ability to borrow and at what rate. If rates become sufficiently high it may become advantageous to simply print money and pay the price in a devalued currency. These are real alternatives that must be weighed. If a country is disadvantaged in its trade relations with the rest of the world because of the value of its currency it may be more advantageous to print money. If the rest of the world is awash with capital and borrowing can be done at a low rate it may be advantageous to borrow.

Until we can agree as a nation that we have these alternatives we will be unable to reach the best solution when confronted with recession or other forms of instability.

CompuVision is the Future

The migration of television channels like MSNBC to the internet illustrates why television will ultimately give way to CompuVision, the fusion of television and the internet. If you compare the interactive format from MSNBC on the internet above to the the linear television format, the latter pales by comparison. In the internet format you pick the shows you want see, then pick the segments that interest you, and finally click an icon to watch the segment in full screen format. You are interrupted by a commercial only when you are switching to another segment and to display ads only when you are selecting shows and segments, not when you're engrossed in watching the segment. It makes so much more sense than watching a whole show, or multiple shows, only a small portion of which you have an interest.

There will come a time when the display market will stand alone and the CompuVision unit you buy will be a combination of the current set top box/DVR and a full blown computer with a wireless keyboard, mouse, and a remote control that will look more like an iPod with touch screen input. This unit will interface with the appropriate modem/router on the input side and the large screen display unit on the output side. Peripherals such as scanners and printers will be wireless and communicate with the CompuVision unit through the router. If sufficiently fast wireless communication can be developed, the display unit could also have built-in wireless. This would completely eliminate cables. Media like DVDs could be eliminated completely with all media being streamed or downloaded over the internet. I hope I'm still around when this happens.

How to see a stock market bubble

This chart will tell you how to detect a bubble in the stock market. It's available at: http://www.bullandbearwise.com/SPEarningsChart.asp
As you see, the real S & P P/E went sky high during the housing bubble. Now it's down to where it was on September 30, 2007. It's still not down to historic norms, so the current bubble is still not completely deflated. If it starts going up again, it's time to get out of the market.
This chart is not be be confused with the annualized P/E chart for the S & P. That one uses old data over the previous year to come up with the P/E so it is late on predicting both the start and end of a bubble.

Time for a transaction tax on derivative trades

A one percent transaction tax on derivatives trade would pay for the entire US budget. If congress wasn't being paid off by these same big banks there would be no federal budget deficit.

JPMorgan, Bank of America Corp., Goldman Sachs, Morgan Stanley and Citigroup Inc. executed 96 percent of the $293 trillion in over-the-counter derivatives trades made by the top 25 U.S. bank-holding companies and their customers as of Sept. 30, according to the Office of the Comptroller of the Currency.

A Note About Leverage and Credit Default Swaps

Leverage is only possible if there are funds available at low interest rates, compared to what money managers think they can get somewhere else, usually involving some high risk speculation scheme. This is so only because there is too much capital available compared to the need for capital. If there were productive uses for the funds at reasonable rates why would holders of the funds being willing to lend them out at low rates to money managers who want to lever up some speculative scheme?

Our financial problems today are largely a result of money managers using leverage to increase yield at great risk, and then buying phony insurance in the form of credit default swaps (CDS) to guarantee their risky investments. Unlike real insurance, CDS don't require any reserves to pay off if the investments go bad. Also, they don't require that the purchaser own the asset being insured. So an outfit like Goldman Sachs can buy a CDS on some collateralized asset they don't own, and then proceed to drive the price of that asset down so that they can collect on the CDS.

Talk about Ponzi schemes, this one doesn't even require convincing investors to give you their money.

How Wealth and Income Inequality Causes Unstable Credit and Asset Price Bubbles

Income and wealth inequality is the root cause of financial instability. Capital, and the need for capital must be balanced for an economy to function stably.  

If the accumulation of capital exceeds the need for capital to fund growth, the taxes on wealth and capital gains must be increased, and that on consumption and consumer income decreased .

If consumer demand, and the attendant capital needs, outpace capital accumulation, the reverse is required. Taxes then should be shifted from capital gains to consumption and consumer income.

Over the past several decades capital accumulation has outpaced the demand for capital, largely due to reductions in top bracket tax rates and stagnation of middle class incomes. The discussion that follows shows what happens when this occurs.

Enterprises need capital to expand and take advantage of new opportunities. This allows economies to grow to accommodate increases in population and the attendant need for new jobs.

If too little capital is accumulated, growth will be curtailed. If  the effect is severe enough, sufficient growth will not be achieved to accommodate population increases and the need for additional jobs, and the standard of living will fall. 

If too much capital is accumulated, rates of return on capital drop.  As rates of return drop,  capitalists seek ways to improve them through the use of leverage or through the use of techniques to increase the demand for credit. 

If leverage is used ,  risk increases, necessitating even larger rates of return. This leads to a potentially unstable situation. So there is a limit to the amount of leverage that can be used.

As the limits of leverage are reached, investment banks and hedge funds will look for ways to stimulate demand for credit. This can be done by relaxing the standards for issuing credit, and compensating by using techniques to hide risk.

By collateralizing debt and issuing insurance on debt capitalists can be made to feel more comfortable with less secure investments. Debt issued with relaxed credit standards can be mixed with more secure debt making it harder for rating agencies to correctly assess risks. If regulation does not keep up with these measures, or decreases, the value of the collateralized assets and insurance instruments will be jeopardized.

Excess capital can also result in additional risky speculation. When returns on productive investments are low and approaching inflation levels, capitalists will be willing to take larger risks in short term speculation on valuable assets and commodities, caused prices to rise. In turn, the rise in prices creates an upward momentum in asset prices that attracts even more speculation. Such price bubbles tend to be self sustaining as more and more capitalists are willing to take advantage of the upward momentum in prices, until eventually that trend cannot be sustained and the bubbles burst.

All of these measures are driven by the need to increase returns on capital, when there is just too much capital for the real investment needs of the country. This is the situation that has developed over the last few decades largely because returns have been going more and more to capitalists while workers wages have stagnated. With stagnating wages, the demand for goods and services has not kept up with the accumulation of capital.

The stagnation of wages has been caused largely by shrinkage in the manufacturing sector, causing consumers to seek returns in the financial sector and to tap available credit to sustain consumption. This is evidenced by the excessive growth of the financial sector. At the same time, high income and capital gains tax rates have been reduced, accelerating the income and wealth gap between capitalists and middle class consumers.

Unless taxes are shifted to wealth and capital gains from consumption and consumer incomes, this increasing spread in income and wealth will continue to cause instability and the kind of financial crises we are now experiencing.

The Free Market Myth

You hear a lot of noise from conservatives about how the free market is the be all and end all of all things good. This is far from the case when government is in bed with private industry. Here are a few cases where the free market isn't free.

1) Cell Phone Service
Every day in almost every newspaper in the country there are full page ads from cell phone companies offering essentially the same type of service with the exception that the instrument that you can use is in the exclusive domain of one company. Cell phone users are paying for all this advertising and hardware exclusivity. The price of cell phone service is outrageous compared to internet phone service. Had the government invested in the infrastructure for high speed internet service in cities and along interstate highways, mobile telephone service would have been nearly free everywhere, as it is on the internet now.

2) Cable TV
Here again we have multiple companies charging high prices for nearly identical services, where you have little choice in what is available for purchase. Services are bundled for the convenience of the supplier and investor, instead of the consumer. If you're interested in only HBO you can't get it without subscribing to a whole raft of channels you don't want. HBO now has HBO Go which allows streaming of content on the internet, but it's not available unless you pay around $100 a month for HBO and a bunch of junk you don't need from a cable company.

3) Commercial Television
We are still locked into an outdated system where programming is interrupted by commercials. Now commercial channels don't even allow you to watch the program without pasting animated advertising at the bottom of the screen during the program. If you prefer to watch the same program uninterrupted and are willing to pay for it, it's not available.

Where is the free market that is supposed to be the best way to satisfy consumer needs? It's a myth. What is sold is determined by what is best for the companies selling it. This happens because politicians are owned by corporations. Ala carte cable TV services aren't available because cable companies write the laws that control cable TV. And, cell phone companies write the laws that control mobile phone service. And, commercial TV companies write the laws for commercial TV.

Recently there have been articles in the news about building high speed internet infrastructure. Cities are looking at 100 Mbps, Google at 1000 Mbps. This is ten to one hundred times the fastest service available now. It will enable phone, data, and TV in HD over the internet. It is the future, but will it come to pass. It is unlikely, because it would deny commercial TV, cable TV and cell phone companies the profits they now make due to laws written for them.

What we have now is not capitalism. It's state capitalism. They used to call it fascism. And, people seem to be the proverbial frog in the heating water, accepting more and more intrusion into the decisions they should be making as consumers.

Signs of a Declining Empire

Sometimes it appears that the country is stuck in a quagmire from which it cannot remove itself. We are a divided country along partisan lines. The Republican Party is controlled by the right wing, moderates having almost completely disappeared. The Democratic Party is controlled by the coalition developed during the Clinton administration which is in bed with commercial and banking interests, not unlike the GOP of old. Neither party can muster a controlling majority and candidates who would bring about real change cannot get elected. Obama is the classic example of a candidate that can get elected. He is charismatic, a good orator, and continuously triangulates in an attempt to please everyone. Unfortunately, that means perpetuating the stasis with which we are confronted. This stasis has led to several disheartening consequences.

1) We have become a nation of consumers, not producers, dependent on foreign countries for most of our consumer goods. Trade decisions are heavily influenced by international corporations that profit from favorable trade agreements. The economy is heavily influenced by a Federal Reserve Bank that does the bidding of Wall Street at the expense of average people. Trickle down is the modus operandi, and promoting the general welfare is on the back burner. Laws to limit speculation and prevent excesses are undone. Speculative bubbles are left to burst with catastrophic consequences.

2) We no longer can pass any real reform legislation, due to our inability to overturn the filibuster rule in the Senate. With the country nearly equally divided, with few prospects of sixty percent majority, legislation is watered down to where it is just nibbling at the margins of real reform. Major decisions boil down to catering to a few Senators from small states who are riding the political fence.

3) There is no will in either party to confront the dangers of the military industrial complex. The Republican Party never met a war it didn’t like and the Democrats are scared to death of being labeled weak on defense. We have supported a client state, Israel, in the Middle East that has resulted in our not being able to be an unbiased arbiter of thorny issues there.

4) We have left the prosecuting of military adventures around the world to a small group of volunteer service people, largely from the poorer segment of society, while the children of the rich and powerful are safe at home to pursue their personal ambitions. This has led to a lack of appreciation of the horrors of war and the terrible after effects on the participants in combat.

5) Foreign policy, heavily affected by multiple foreign wars and threats of war, has been been delegated to the military command structure to a large extent. What the generals want they get, so as not to anger the Republican right wing and make the Democrats appear weak. The money for war and the number and length of wars is increasing dramatically. Congress seems incapable of limiting war spending of any kind, while scrutinizing every penny spent to promote the general welfare.

Unfortunately, there are few signs that anything will change for the better in the future. We seem resigned to letting the system drift downward, like lemmings going over a cliff. There is no great outrage toward the intractability of our problems. The old don’t seem to be concerned about the state of affairs they are leaving their children and grandchildren. And, the young seem content to wile away their time in the fantasy of video games and reality television, rather than in preparing themselves to tackle the problems ahead of them. It’s all very disheartening.

Our UnRepresentive Democracy

Some aspects of our constitution have constricted us in adapting to changing circumstances over time. Other western countries with parliamentary systems have been able to adopt programs such as universal health care, while we have been unable to do so because our system allows a minority to block major legislation. This is primarily due to how our Senate operates.

Consider the chart below which shows how many people are represented by each senator from the several states. The average number of constituents represented by a senator, that is, the total population less Washington DC, divided by 100, is about 3 million people. In contrast, Wyoming senators each represent only 266,334 people while California senators represent 18,378,333 people each.

To compound the problem people in overrepresented states are more Republican. From the House representation which is nearly one person, one vote, there are 59.1% Democrats and 40.9% Republicans in the country. The overrepresented small states have 46% Republican senators vs. 54% Democrats, while the underrepresented large states have only 35.3% Republicans and 64.7% Democrats.

To compound the problem even further it only requires 40 senators to stop key legislation due to the filibuster rule. This enables lobbyists to concentrate their time and money on 40 people to block any legislation. And, if a Republican president is in office there is no hope of overriding a veto. This phenomena enabled Bush to get almost anything he wanted while the Republicans had a slim majority in congress, whereas the Democratic legislation can be easily blocked even with Democratic majorities in both houses. Since small conservative states are overrepresented in the Senate, it is nearly impossible to get a majority necessary to prevent legislation from being blocked.

A recent poll showed that the country supports the Obama health care program by a sizeable majority.

From Reuters:

“A Times/CBS poll found 85 percent of respondents wanted major healthcare reforms and most would be willing to pay higher taxes to ensure everyone had health insurance. An estimated 46 million Americans currently have no coverage. Seventy-two percent of those questioned said they backed a government-administered insurance plan similar to Medicare for those under 65 that would compete for customers with the private sector. Twenty percent said they were opposed.”

Yet the latter program has been taken off the table by a small state senator from Montana, Max Baucus because he said it’s a non-starter in the Senate.

A similar situation exists in the effort to reregulate banks. The powerful banking lobby can easily round up 40 senators to block the effort, in spite of the fact that the majority of Americans want it done.

A few words in support of our government

Our government has made the decision that there will be no more Lehman's. That's probably a decision forced upon them by the specter of a complete collapse of the financial system if a big bank like Citi were to go under. Furthermore, our government has concluded that it can't convince Congress to provide the funds to bail out the banks without some help from private sources. But, private funds sit on the sidelines, too afraid to invest in the toxic waste.

The government has given the banks bailouts at little or no interest to beef up their balance sheets. And, since the government has driven down interest rates to near zero, the banks are also getting deposits from private sources at near zero rates. The government has noticed noticed that the banks have developed a strong revenue stream from these sources of funds, due to the huge spreads between the cost of funds and the rates they can charge on new, healthy loans. Both Warren Buffet and John Hempton have provided evidence for this.

These revenue streams will enable the banks to write down their toxic loans against income, if they withhold dividends. The government can apply pressure to ensure this gets done. As the loans are written down they can be sold off to private buyers, who, in turn, can renegotiate the terms with the distressed borrowers and make a reasonable profit on the deal.

But private buyers are wary that the downside risk is too great to be buying up the toxic loans, even at a discount. To reduce the downside risk and bring buyers into the market, the government is willing put a floor under the losses on prospective buyers of problem loans and are willing to make low interest loans to the buyers to leverage the investment and increase their return. This all is part of the Geithner plan.

So the question arises, why should the government do this? The government is essentially using taxpayer resources to bail out the system? True, but if the system will collapse if it's not done, what is the alternative?

There are a couple remaining question to be answered. First, where is all this bailout money coming from. And, second, can the taxpayers be made whole, or at least partially compensated. To answer the first question, we must ask what private investors are doing with their money if they are not spending it to stimulate the economy or investing in, or lending to, businesses, including banks. Mostly, they are buying treasuries at little or no interest. So, if the investors won't spend or invest, and are giving the money to the government, all the government has to do is spend and invest it for them, which is what they are doing by bailing the banks and funding the stimulus. What better use could the government put this money toward than saving the country from the calamity that could arise if the system crashed?

Now, is there a way to make the taxpayers whole, or at least partially compensate them? If the government really wants to compensate the taxpayers who did not contribute to the problem they first have to identify who these taxpayers are, as opposed to the ones that contributed to the problem. This shouldn't be that hard. If we look at who profited from the bubbles, it was clearly the investor class, particularly high income investors and speculators, and the financial and insurance sectors that were so busy profiting that they overlooked the fact that what they were doing was putting the whole country in jeopardy. Some investors have already suffered from losses on their investments, but others have still prospered more than they suffered.

Obama has already taken steps to try to correct the problem. He has proposed raises taxes on the high income investor class, and taxing profits from investments at higher rates than currently are in effect. This is not soaking the rich. It's just taxing them to pay for the trouble they've caused with their hedge funds and derivative investments that have nearly driven the country into a second depression. This is one way of partially compensating low income people who have not profited from the bubbles over the last couple decades, who have seen their paychecks stagnate, and now are losing their jobs. They have suffered enough. And, their children and grandchildren don't need to be saddled with debt that more properly belongs to those who have profited from the growth in the financial sector over the last several decades.

Further measures may need to be taken. A financial transactions tax may need to be implemented after the crisis to make taxpayers whole. The whole financial and insurance industry may need to be restructured to prevent the development of businesses that are to big to fail. Laws to reign in greed and irrational exuberance seem not to have worked, so it may be time for the government to take a more active role in the financial and insurance industries which have caused this crisis. When finance grows from 19% of GDP to 30% in a couple decades it saps the talent from other industries that actually produce goods and services that are necessary to the economy. It's time to reign in these industries to a more reasonable size relative to the rest of the economy.

How the government is bailing out banks at your expense

Banks have made bad loans and are leveraged to the hilt so investors will no longer lend them money or invest in them. The fair thing to do when banks are in this condition would be to take them over and reorganize them to put the losses they have accrued in the hands of the shareholders and creditors where they belong. But, the banks have tied themselves in a Gordian knot by insuring loans with phony insurance called credit default swaps. So the government is afraid that reoganizing them could result in a cascade of bank failures that could jeopardize the whole financial system. So, instead, it has chosen to flood the financial system with free money from taxpayers by lowering interest rates to near zero and lending money to every bank that has a problem.

With rates low, banks can get nearly free money from depositors and they can borrow from the government without limit, as long as the congress is willing to appropriate the funds. These funds are used to make new loans at very attractive spreads. These interest earnings have gone way up over the last several months. The government looks at this and says, Hey! These banks are really making money. All that's needed is for us to keep pouring money into the system and keep interest rates low until they get well. As the income flows in, banks can improve their balance sheets and gradually write off their bad debts instead of paying dividends. What the government doesn't seem to care about is that banks are able to do this because the government has driven deposit rates down to near zero and is running up debt at the expense of taxpayers. In this way the same people who caused the problem are benefiting from the government solution.

Since the government probably can't supply enough money for the whole bailout, because taxpayers won't allow congress to appropriate the necessary funds, the government has devised a clever way to get private investors to participate in the bailout. As banks write down their bad loans, they can sell them off to private investors, who in turn can buy them at a price which allows them to renegotiate the loans and make a nice profit. Some private hedge funds are already doing this. But most are still sitting on the sidelines, spooked by the possibility that they will get burned by the bad loans. To sweeten the deal enough to get private investors cash into the game, government has decided to lend these private investors money to leverage the deal, thus increasing their returns. And, on top of that, it will guarantee the loans from downside risk, another gift from the taxpayers to the capitalists.

An interesting point illustrated here is that it's not necessary to be a recipient of bailout funds to profit from bailout deluge. If banks don't have too many bad investments they can use the windfall profits afforded them by the government dictated low deposit rates to get well and claim they did it without a government bailout. But, this is hardly the case, and I'm sure they're not going to volunteer to help pay off the national debt the government has run up to afford them the windfall profits.

It's all one big oligarchy. Once the taxpayers have paid a big price to buy time for the banks to work off their bad investments, the people at the Fed and Treasury can go back to the banks where they used to work and get fat salaries and bonuses for saving the banks with taxpayer money. And, we and our descendants will be left to pay off the federal debt they have run up.

What will the stimulus bill accomplish?

The financial crisis does not yield easily to stimulus because it's primary cause is an overhang of debt built up over several decades. How this occurred is explained in a previous post on this blog, My Short Explanation of the Financial Crisis. Consumers are no longer spending on discretionary purchases and businesses are not investing because demand is declining. As the government pumps money into the system to replace that previously supplied by consumers and businesses, only that which is given to consumers that are just getting by will be spent to sustain demand. Consumers that are meeting their basic needs will use the money to pay off debt or save it. Businesses that are burdened with debt will use it to pay off debt, which may be due to bad investing or a result of the crisis. Those that are not will pay it out in dividends or bonuses, since opportunities for expansion are limited due to reduced demand for their products. The primary useful effect of the stimulus will be to keep workers in productive jobs rather than just pay them to be unproductive. In this sense it is not really a stimulus program, but a program to reduce the severity of the consequences of the crisis and shorten the recovery time, as the debt overhang is worked off. To not have any government spending could worsen the consequences and possibly lead to a deflationary spiral that could lead to a depression.

The key to how the stimulus should be used relates to who should be helped and who should not. Banks and investors that invested unwisely should suffer the losses. Right now this segment is sitting on the sidelines with their money in treasuries making little or nothing. They are not investing, because demand is dying and investing would be unproductive. But, they have reaped large rewards over the last several decades through leveraging, which caused the crisis, and should now be willing to now take their losses. Reducing capital gains and dividend taxes, especially retroactively, would just be a windfall for banks and other large investors that have reaped the gains, but now want to socialize the losses. Income tax rebates for wealthy investors will not stimulate the economy. They will be used to pay down debt from leveraging bad investments. Consumers are already paying the consequences for their spending euphoria over the last several decades. They are not being bailed out. And they will continue to suffer the consequences, for as long as the recovery takes.

So, is the stimulus package configured right? To the extent that tax cuts are going to investors who made bad decisions, it's not. To the extent that the cuts are going to people just getting by, it is stimulative. There appears to be an argument over specific spending projects in the package and how quickly the money is spent. Since the primary effect of the program will not be to stimulate the economy, but to reduce the severity of the consequences while debt is being worked off, any programs that keep people employed productively are worthwhile. If the money is spent so quickly that it becomes inefficient and wasteful, it will be counterproductive. If is spent so slowly that people are not employed productively, it will be inefficient, cause more pain, and lengthen the recovery period. Since it will take considerable time to work off the debt, the most important consideration is to keep the spending at a pace that keeps people employed productively without waste or undue hardship.

My Short Explanation of the Financial Crisis

Over the last several decades the finance industry has grown to be the largest contributor to GDP. Yet it's difficult to discern what they have been producing, other than bubbles and crises. In the process they have internationalized capitalism. During the same time corporations and the people who own and run them have prospered handsomely while the average workers situation has deteriorated.

This has resulted in huge capital accumulation around the world, way more that can be productively put to use funding real opportunities. With the help of the Fed and the government, providing easy money and reduced regulation, asset values continued to rise, seemingly in perpetuity. This was an opportune situation for the application of leverage to magnify profits. Profits were rolling in at unforeseen rates. With too much capital, and to few places to apply it, banks found it necessary to fund poorer and poorer investments, lest their huge profits be truncated. But, poorer investments necessarily implied higher risk so a method had to be found to hide risk. Into the breach jumped the investment banks, rating agencies, and insurance companies. Securitizing debt obligations was the answer. Pool the risky assets, slice and dice them into tranches of various levels of risk and sell them to all those investors looking for a place to put their unused capital. But, how to rate such assets, no one knew. Rating companies, also wallowing in huge profits and fearing loss of them, threw up their hands. They had no models to do it. So what to do? Rate them highly and continue to make huge profits or rate them realistically and let their competitors reap the huge profits. The decision was easy.

But, buyers of the new assets were asking questions. How risky were they, really. They found it hard to believe that slicing and dicing bad assets could end up with a highly rated asset. Into the breach jumped the wiz kids at the investment banks and insurance companies once again. Guarantee them! Write some insurance guaranteeing the asset. Viola! Credit default swaps. Not only were these magic instruments not covered by insurance regulations, but they could be traded on their own, opening up more opportunities for profit. The investors bought the swaps to guarantee the overrated assets and the profit bonanza continued on.

With all these new assets and guarantees all that was needed was more risky assets to finance. Ah, alas the government had sanctioned expanding home ownership, the new ownership society. Just get rid of all the rules for qualifying home buyers, the problem would be solved and the profits would continue to roll in. No one dared question the infinite wisdom of the finance industry. After all, the industry had soaked up most of the talent from Ivy League schools in the last several decades. And the real estate and construction industries were more than willing to accommodate the new bonanza.

But, ooops! The payments came due, the ARMs (Adjustable rate mortgages) were no longer hugging home buyers, they were strangling them. And securitizing debt had been expanded to auto loans, credit card debt and almost any other kind of debt. The jig was up. Time to pay the piper. The asset value climb was over. Time to get real. The banks found themselves having to come up with additional reserves to cover the falling value of the assets on their books. And they had to pay off the leverage loans. And their investments in swaps were tanking. The couldn't refinance their commercial paper. What would they do? Other banks wouldn't lend to them. After all, they were having their own problems.

Time to play the trump card. Who's running Treasury, one of our own, Henry Paulson, he'll save us. Sure enough, he seems to be doing just that, using the well worn Bush technique of scaring the hell out of Congress to get them to write a blank check, as was done in the Iraq war. Alas, they fell for it again, and here we are, once again, kneeling at the feet of the money changers that couldn't find anywhere to invest their heaps of cash skimmed off the top of every transaction that makes up that holy of holies, the GDP.

The Underlying Problems of the Financial Crisis

This financial crisis is not caused by a shortage of capital. The world is awash in capital. Why else would capitalists be making bad investments? When all the good investments are funded the only ones left are the bad ones, or using the money to speculate in financial markets. Now these banks and hedge funds with all the money are pulling their capital out of productive uses and putting it in government securities at little or no interest because they are afraid they will lose it. In short, they are hoarding, instead of investing. The government giving these same banks more money will not fix the problem. Why wouldn't the banks just take the cash and pay it out in dividends and executive bonuses, buy more government bonds, or use it to de-leverage bad investments? The most direct way for the government to solve the crisis would be to take the money they're getting and invest it in productive companies that need the cash to operate or expand, or divert it to infrastructure projects and research that employ people who will spend the money they earn, thus creating demand. To give the money to people who have demonstrated that they won't invest it in productive enterprises is rewarding them for bad behavior. When the private financial system fails, it's an opportunity to show that the federal system works, not a time to be weak kneed and just throw good money after bad and send the bill to the taxpayers of the future.

The genesis of this whole problem is the world wide financial pyramid that allows corporations to divert most of their profits to executives and stockholders, while squeezing labor costs to the bone. They spend huge sums lobbying for special treatment and tax loopholes. This is the whole reason that corporations exist. Over the last several decades wages have stagnated while capital has been accumulating. People have even been encouraged to borrow against what few assets they have to spend more on products and services, allowing corporations to divert even more to executives and stockholders. Why should they do otherwise? Only the government has the power to balance the creation of capital against the welfare of the general public, through regulation and taxes. Call it class warfare, or whatever you want. That's what happening. There is no need for government to pay people to do nothing. Our infrastructure is falling apart, research on new technolgies is suffering, and demand is falling because consumers have exhausted their credit, prices for goods and services continue to rise, while paychecks stagnate. The government needs to play a positive role in countering the excess accumulation of capital at the expense of the standard of living of average citizens.

International trade has exacerbated the problem. Having goods made offshore, where labor is cheaper makes for higher profits and greater opportunity for diverting more to capital, less to labor. Profits of offshore enterprises mount and what do they do with these profits? They invest them in US government securities, fund US consumer debt, or bid up the price of assets around the world, creating the bubbles we've seen. Petroleum exporting countries pile up huge cash reserves looking for a place to make more money. The answer is to put this excess capital in the hands of consumers that will spend it instead of hoard it. This can only be done through progressive taxation, direct government investment in enterprises that produce useful goods, or government funding of infrastructure or long term projects for which there are long gains. Corporations will only invest for the short term. Their stock is valued on current or short term profits, not long term success. That's why they show little interest in future technologies and keep building gas guzzlers until oil prices skyrocket. The conservative distrust of government has been a primary reason why we are in this fix, since government is the only solution to correcting it. If this financial crisis doesn't demonstrate this, I don't know what will.

Capitalists vs. Businessmen

I think it's time to clarify the distinction between capitalists and businessmen. We sometimes consider them one and the same. Capital is life blood of business. If businesses want to innovate or expand, capital is almost always needed beyond that which the people running the business can provide. So they turn to capitalists to provide it.

Capital is accumulated when individuals or businesses earn more than they need for day to day operations or consumption. So, they look for a place to put it where they can access it later, or where they can earn a return on it by lending it to someone else. Banks used to be businesses that fulfilled this role. They take deposits from people or businesses, pay them a return for the use of their money, and lend it out to others who can use it to innovate, expand or acquire infrastructure like homes, land, buildings, transportation, machinery, etc. Such assets have value to those who acquire them and value to the society in improving our standard of living.

So what is a capitalist? Anyone who accumulates wealth beyond their needs and lends it to others. This can take the form of bank deposits, stock or bond purchases, or personal loans. In this sense, a capitalist can be an individual, a small business, or a mega-conglomerate.

So what is businessman? Anyone who starts or acquires an enterprise which provides goods or services to others for a profit.

So what is the distinction? If a capitalist operates a bank, brokerage, or other business strictly as a service to others for a profit, they are a businessman. But, if what the capitalist is doing no longer becomes a service to others but an impediment to needs of others to innovate, expand, or acquire infrastructure to facilitate their operations, they are no longer a businessman, but only a pure capitalist.

The distinction is easily seen by considering what is happening in our financial markets now. Our financial system, when run efficiently, provides the necessary capital to allow the smooth functioning and funding of our productive enterprises. The stock market and banks provide the capital for companies like GE and Home Depot to innovate or expand their operations, and to provide the necessary cash flow for day to day operations. This is often called liquidity. To maintain liquidity, banks have to provide reserves to allow withdrawals by depositors, and they must take care to assess risk properly and limit leverage so they don't get caught in a bind if asset values start to fluctuate wildly. They must take care not to get trapped in viscous cycles by assuming conditions will continue to progress as they have in the past. In short, they must be always vigilant that they are there to provide a valued service and not to take advantage of their position to enrich themselves at the expense of the economy they are serving.

Deviating from these principles is what caused the current economic crisis. Businessmen in the finance industry abandoned their role as businessmen and became pure capitalists. Seeing their competition use leverage and derivatives to increase profits at the expense of risk, they had a choice to make, continue being conservative and providing a business service for a reasonable profit, or jump on the band wagon and do what their competitors were doing to make better returns. This happened at all levels of the economy. Even though the average Joe or Jane didn't come up with any fancy derivatives to increase their return, they were more than willing to use leverage and credit, engage in speculative transactions like flipping assets for a profit, and invest in stocks for no other reason than that they were going up, with little consideration of the value of the underlying investment. They added to their stock of credit cards and borrowed on their homes to increase consumption, paying little attention to what would happen when they had to pay off these debts. Banks stopped being businessman and reverted to pure capitalism, sending out credit cards to people without due consideration of their ability to pay. Instead they just assumed a percentage were going to go bad. As is now apparent, this kind of behavior is what has led to the many bubbles that have formed, and that have now caused our credit markets to freeze up.

So what are bubbles? A bubble forms when asset prices are bid up due to the expectation that a current trend will continue, ignoring the underlying asset value. It's essentially a switch from fundamental investing to speculation. Individuals can get by with a whole lot of speculation for a while, then go broke and start over. But, when the whole financial industry engages in the process we get what we have now, a credit crises, where everyone loses confidence in the people and businesses they do business with in a normally functioning market environment.

What has happened over several decades is the finance industry has syphoned off a sizeable portion of the GDP to enrich those in the industry at the expense of productive businesses who need their capital and services to grow and innovate. We are at a point now where capitalists would rather put their money in treasuries at near zero rates of return, than invest in businesses which need the capital to function and grow. During the housing bubble buildup capitalists, large and small, made abnormal profits by encouraging people to buy houses with little or nothing down, low or zero interest rates initially, and other incentives to unsophisted buyers. The real estate industry and the housing industry went along because it was very profitable. But, anyone could have seen that at some point homes would become too expensive to sustain the rate of sales and the bubble would deflate, which it did. That in itself wouldn't have caused the crisis we are now in, if large financial institutions had not shifted from being businesmen to pure capitalists, chasing profits without regard to risk.

Now we find ourselves in a situation where the capitalists money is sitting on the sidelines in treasury instruments earning little or no return, while businesses and individuals are starved for the lifeblood they need to function efficiently. We should realize that every dollar that goes into a fat salary of an executive is a dollar that could be used by some innovator or businessman to improve the standard of living for all. Every dollar that is tied up in a bank not being used, or is being paid to a congressman to write a loophole for a capitalist is not being used to improve our standard of living. Every dollar that goes to buying the sixth or seventh home, the yacht or private jet for someone who successfully gamed the financial system is not going to improve the standard of living for all in our society. The redistribution that is taking place is not from the rich to the poor, it's from all of us to people in the finance sytem who are gaming the system by being pure opportunistic capitalists instead of business people who provide capital to our productive businesses for innovation and growth.

So how does the government fit into all this? First, is important to recognize, as we have seen historically, that the business environment is not stable without some form of regulation. This can take many forms. Non-government agencies like the Fed are charged with containing inflation and maintaining stable employment and growth by adjusting the money supply and providing credit as needed. But, they are not charged with containing speculation or regulating the business environment, particularly preventing bubbles from developing. They don't have the tools. And government oversight is hindered by the campaign financing and lobbying activity that influences government officials. The revolving door of individuals moving from industry to goverment and back also contributes to a lack of objectivity in regulating business. This must change if we are to secure anything resembling long term stability and an efficient system.

When we have a crisis like the one we have now where the government is receiving funds from capitalists for essentially safe keeping at little or no interest, they must use this money to provide relief to the people and businesses that would normally be receiving it to innovate or expand their businesses or to individuals that can use it to get out of a bind and continue productive employment and purchasing. Instead, they are using it to relieve the pressure on a non-productive finance industry that was instrumental in causing the problem in the first place. This money should go to directly to aid the people and businesses that are productive, to improve infrastructure, and to increase demand for useful goods and services in a declining economy.

The bottom line is that we must come up with incentives for people, businesses and government to keep its eye on how money passing through the economy is being used. Where it is not being put to productive use, government regulations and tax policy should be adjusted to see that it is. The government is charged with promoting the general welfare and this a fundamental role of government.

Progressive Taxation and the Myth of Redistribution

The problem with conservatives using of the cliche' "redistribution" in response to any question on progressive taxation, is that it assumes that the income going to corporations and wealthy people is earned in the first place. Corporations are chartered by the government and given special consideration, avoiding some forms of liability, to accumulate capital for investment. Corporate charters do not address any aspect of fairness in determining how corporate income will be distributed. Corporations sole reason for existence is to maximize return to shareholders and minimize the cost of the factors of production, including labor, whereas the Constitution charges government with promoting the general welfare. So there is a conflict in the goals of these two institutions. Wealthy people and corporate executives are much more dependent on income from capital than from wages. So benefits accruing to corporations also tend to accrue more to the wealthy than to average wage earners.

In assessing what income is actually earned, all factors must be considered, not just who receives income under current law. Clearly corporations and their largely wealthy benefactors would not prosper to the extent they do if they didn't operate in a country with an established system of laws and infrastructure bequeathed to them by past generations. So it is not clear that just because someone earns an income that it should be attributed only to their own efforts. Some credit must be given to the system they operate under and the contributions of others in generating their income. This is particularly true of corporate income, where executives get to decide where the income goes, without much interference from outside sources. Under conditions of labor surplus this results in most of the income being diverted to owners of capital. Under labor shortages, more would be claimed by labor. But, under our current system, where illegal immigration and outsourcing operates largely unfettered, labor is at a major disadvantage in maintaining it's interest without government assistance.

Aggravating this conflict of interest is the fact that wealthy people and corporations have more influence on government through lobbying and campaign financing, whereas average wage earners have a much reduced voice in how laws are made. This allows the wealthy to create tax loopholes which favor their interests at the expense of the average wage earner.

The solution to this conflict could come from two different directions. First, corporate law could be changed to charge corporations with some measure of promoting the welfare of their workers, not only the welfare of their shareholders and executives. The other way, which is currently used, is progressive taxation. It will be difficult to make major changes in this arrangement, so, at least for now, we must be content with using progressive taxation to promote the general welfare. So the next time you hear a conservative claim income redistribution in response to a question of on progressive taxation, point out to them that it is only a means to compensate for the unfair claims on income, due to the advantages given to corporations and the wealthy by our corporate charters and lobbying laws.

Advice to My Grandchildren

After living in Sun City Summerlin, Nevada and witnessing world events over the past decade, and the long campaigns over the last year, I've come to the conclusion that the best advice I can give to my grandchildren is to settle in an area with as much diversity as possible. That includes diversity in race, culture, education, lifestyle, income, wealth, and environment.

It seems to me that most problems are created when a majority of people share the same outlook. They come to believe that because they are in the majority their way of thinking and doing things must be the right way, and that people who don't fit the mold must be wrong headed or inferior in some way.

This seems to be true whether it's a country, a small town, a university, a corporation, a club, a religion, or any other organization where like minded people come together. Only if no group predominates do people actually come to think for themselves rather than follow convention to avoid being ostracized, or get in a rut simply because it's the course of least resistance.

I think I first came to realize this by living in a community where people come from all parts of the country. But, even here the people share a common characteristic, age, which seems to be a basis for many of their thoughts and actions. This is mitigated by having close association with family of widely varying age. Living in a city which is a broad mix of people of different backgrounds and wealth was another broadening experience. And, probably, living alone has been an influence on my thinking, not having someone who shares most of my values to reinforce the rightness of my thinking. All of these things have given me a much more open attitude towards life and people.

Seeing how a government controlled by one political party operated was another eye opener. Witnessing how countries dominated by one religion operated was another factor. Observing how the West, the dominant countries of the world over the last century, faced the challenge of new world powers like China, India and Russia was another factor.

And, finally, seeing how the country became polarized to the point of ignoring reality and important issues, to seek belonging to political tribes bound mainly by like identity, was the final factor in my coming to this conclusion. The extreme reactions to a candidate of black/white heritage and to two different women making their first foray into national politics illustrated the point.

It is my hope, that as time moves on, we will come to realize that the right way of thinking and doing things can only be discovered by taking into account the wide variety of ways people live their lives across the world. Only then, can we draw conclusions about the best way to live our lives.

The Reality and Consequences of Asymmetric Warfare

Much has been written about the metaphor and the reality of “The War on Terror”. Unfortunately, not many lessons have been learned.

The usual short definition of terror is the intentional killing of innocents. It is quite clear that when someone blows themselves up in a disco and takes innocents with them, an act of terror has be committed. It is less clear when innocents are killed in what is usually called an act of war. The occupation of a country usually results in some form of insurgency if the citizens of that country think an injustice has been done. The acts of the insurgents usually take the form of clandestine attacks from cover or suicide bombings of various forms. Such acts of insurgency are usually countered by a violent response from the occupying force, which almost always has modern weapons at its disposal. Since it is difficult to find insurgents because they attack and then hide, usually among the civilian population, the counterattack usually involves the bombing or destruction of a suspected hideout or other location where the suspects are thought to be. This minimizes the exposure of the occupying force to counterattack. In the process, innocents can and usually are killed or injured. This form of attack by the occupying force is usually justified on the basis of combating the initial attack by the insurgents and the innocent life lost is called “collateral damage”.

The consequences of such actions and reactions are not often perceived in their totality. The occupying force considers justice to be done, in an eye for an eye form of revenge. But, the insurgents view it as a further injustice, in the cause they are fighting in the first instance, the occupation. And the innocent victims view it as a fresh injustice, since they had harmed no one up to that point, and it is usually not their decision where insurgents decide to hide. Such a reaction often moves the innocents and their sympathizers into the camp of the insurgents. In this sense, the effects of the attack and counterattack are counter productive to both parties. The occupying force clamps down harden on the insurgents and the insurgents are motivated to strike out once again. The result is an escalation of violence.

One aspect of such encounters that is not often perceived is that to the insurgents the counterattack is just as much an act of terror and the original incident. It kills innocents when it could have been avoided, except for the revenge sought by the occupying force. So the metaphor, “war on terror” becomes the mantra of both parties, solving nothing. Nothing has been done to examine the grievances of the two parties and seek a solution to the injustices. It becomes simple a matter of who can persist the longest, and in some cases it has been decades.

This is not war in the conventional sense where well equipped enemies battle for territory. It is more akin to crime, like the clan battles of the Hatfields and McCoys, with the exception that one side holds most of the cards, so the other side has to move to less and less conventional methods, which usually results in an escalation of brutality. Add to this, religion or ethnic differences and you have what usually amounts to an insoluble problem.

The effects of such conflicts are different for the occupying, well equipped force and the inadequately equipped insurgency. Simple means of war such as rifles, grenade launchers, and explosives are relatively cheap and available. Modern means such as helicopters, cruise missiles, drones, and the electronics to operate them is very expensive. Add to this the difference in the value placed on individual lives by the warring parties and there is no obvious winner. The modern force spends itself into bankruptcy or destroys the will of the affluent society backing them up while the insurgency, having little to live for anyway (occupation saps the will to succeed) and a nearly endless supply of expendable lives can fight on for decades.

At some point, someone should begin to realize that there are better things to do in life and decide that talking, trading, and backing off is a better alternative. What stands in the way is usually religious zeal to prove that your way is the right way and the other guy is either evil or deranged.

Confusionocracy

There is much confusion these days about democracy, theocracy, philosophy, ideology, politics, and basic human rights. Our current administration has the noble goal of spreading democracy around the world, but considering the state of the world today, what could result is just as likely to be an authoritarian theocracy as a liberal pluralistic democracy like ours, that respects human rights. Given a choice, a deeply religious majority is more likely to vote for a government based on the tenets of their religion than one where interest groups vie for control and share power in a questionably stable way.

Our country was settled by people fleeing countries with a state religion, and persecuting those of other religions. At the time, almost all people were religious, having no scientific basis for explaining naturally occurring phenomena other than religion. Hence, it’s no surprise that this country was founded by people who had at least a rudimentary belief in a higher power that might be controlling things. But, it wasn’t long before people of the same religion were in control of the town meeting hall in Salem and burning witches, illustrating that once a single religion predominates over others, and controls the government, irrational behavior is likely to follow. If that example isn’t convincing enough, we only have to look to the Taliban in Afghanistan and the threat we are facing from extremists of the Islamic faith around the world.

Fortunately, when our country was founded, there were a few cooler heads that prevailed in spite of their religious inclinations. In secret, they came up with a constitution that called for freedom of religion, but restricted government interference in religion, a pretty wise decision by a bunch of not so old aristocratic, land owning white men. They enshrined these famous words in a declaration of independence, “that all Men are created equal, that they are endowed by their Creator with certain unalienable Rights, and that among these are Life Liberty, and the Pursuit of Happiness.” It makes no difference who the Creator was, most of us would all agree that, as individuals, we are entitled to certain inalienable rights which should not be infringed by government or any other voice of the majority. Today we call these human rights, and have enshrined them in our bill of rights and enumerated them in documents agreed to by almost all members of the United Nations.

We are now faced with a resurgence of deeply dedicated religious people. We call them fundamentalists because they believe and adhere to the fundamental teachings of their religion, as given in ancient texts which they consider infallible. These people value their religious beliefs higher than their own lives. When this condition exists, rational behavior based on evidence cannot be expected. There is no a priori respect for inalienable human rights as enshrined in our founding documents.

So we have some decisions to take regarding how we conduct our own affairs, and how we confront others who may threaten our way of life. We cannot confuse religiosity with ideology or political persuasion. We cannot confuse “democracy”, rule by the majority, with a government limited in its powers to curtail human rights. Can we rely on polyarchy, the rule by competing interest groups, to preserve human rights and prevent domination by religious majorities? I’m not very confident we can.

In the end, we may have to accept some measure of authoritarianism to protect human rights from infringement by religious majorities, as is now current policy in Turkey. After centuries of rule by caliphates and sultanates Mustafa Kemal Atatürk enshrined a Security Council of the military to ensure that a secular regime would always be in control, in spite of the fact that Turkey is overwhelming an Islamic country, and once was the seat of power of the Islamic Sultans. This structure is being challenged today by Islamic fundamentalists.

As a goal for our country, aren’t we better off championing human rights and structures to secure them, over democracy. It is impossible to be secure if the ruling authority is guided by irrational precepts of age old dogma, rather than a well founded faith in the goodness of human nature and the inalienable rights of individuals, which has served us well for over 200 years. To this end, we must not only be conscious of how other countries are ruled, but we must take great care to ensure that our own government doesn’t come under similar pressures to what Turkey now faces.