Here’s a prediction: The next major development shift in technology, particularly consumer technology, will be artificial intelligence (AI). More specifically, AI seamlessly integrated into most consumer electronics gadgets, such as personal computers, mobile devices, game consoles, and even household appliances. The key to such technology is to capitalize on human learning and a collective memory that form human thought and “personality.”
|“The only way of discovering the limits of the possible is to venture a little way past them into the impossible.”
–Arthur C. Clarke, Hazards of Prophecy: The Failure of Imagination, in Profiles of the Future (1962)
“Our imagination is stretched to the utmost, not, as in fiction, to imagine things which are not really there, but just to comprehend those things which are there.”
–Richard P. Feynman (1965)
What does it take to realize consumer-friendly AI technology? The answer varies, depending on the functionality, as one might expect. AI systems that implement machine learning, planning, information extraction, decision making, and image, speech and language processing/recognition in various architectures (including distributed processing such as neural networking algorithms) that execute specific intelligent tasks have been around for years, but even those systems have not permeated the consumer technology world as much as some of us would have imagined. Robotics, perhaps the most identified AI application, has given us the Roomba (autonomous vacuum cleaner). Siri, a virtual personal assistant developed by SRI Intl/DARPA and a recent Apple software adaptation that runs on the latest iPhones, might be what many consider among the first serious steps in the consumer AI direction, but it has many limitations (more on that later in this series). Thusly, the dream of the “AI Companion” is probably a bit farther off in realization.
|For Parts II-IV of this series, plus other reviews and primers, Readers can visit a separate, dedicated site on Artificial Intelligence and Artificial Cognitive Systems HERE.|
Imagine an artificial system that intelligently learns from your actions, your other human conversations, responding to your half-certain queries with relevant answers or suggestions, fluidly providing companion-like responses and conversations, or solving problems you’ve only begun to formulate. Imagine also that such a system appears to have complex perception and thought, including a fluid understanding of a conversation or of your well-being, a sense of humor and a gift of metaphor, or a creative approach to a hard problem. Those of us immersed in the science fiction world have for years read about such constructs, dreaming about the maturity of AI technology as a range from a seamless intelligent learning system for the casual user to an interactive system that can pass a Turing Test, and that is indistinguishable from another thinking, breathing human (what I term the “AI Companion”).
Why haven’t we made much progress on bringing the wonders of AI (cognitive systems included) to the masses? What are the limitations and can we define them? Is there some grand challenge that we all ought to identify with?
Significant discoveries and technical advances are being made in neuroscience, biomedical engineering and neuroprosthetics that will enable us to understand at a fundamental level how the brain processes sensory information (neural encoding), stores and recalls knowledge (memory and learning), handles highly abstract concepts and thought, and enables complex motor control. My prediction is that these advances will have the most impact on AI.
More specifically, I predict that understanding the fundamentals of neuroplasticity and synaptic plasticity (the brain’s ability to structurally – anatomically and functionally – change as a result of programming and learning, from cellular changes to cortical remapping) will be key, and that such self-replication and self-reconfiguration features will be required for novel technologies implementing more general AI and “cognitive systems.”
In the shorter term, the consumer might expect that current technologies, such as application specific integrated circuits (ASICs), reconfigurable computing architectures like field programmable gate arrays (FPGAs), and even more specialized neuromorphic chips, along with neocortically-inspired algorithms, may suffice to provide limited “AI on a chip” tasks, akin to the goal-directed intelligence of intelligent agents, expanded natural language and speech capabilities, and neuroprosthetics (brain-machine interfaces included).
The goal of this essay and associated reviews is to concisely communicate the latest advances in AI, how they might translate to the human consumer world, and what they portend for the future in terms of the development of an “AI Companion” that is both intelligent and can think. Let me first review a bit of AI histrionics.
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1. Are Penrose and Kurzweil both crazy?
Roger Penrose in his book “The Emperor’s New Mind,” argues that machines can never sport human intelligence and pass a true Turing Test, due to their algorithmically deterministic nature. He conjectures that human consciousness is “not ‘accidentally’ conjured up by a complicated computation,” that an algorithmically based system of logic is insufficient to simulate human intelligence, and that human thought may even be a physical paradox indescribable by “present conventional space-time descriptions.” Penrose stands at odds with AI proponents who believe that human intelligence and cognitive ability can be reproduced through algorithmic simulation on a ‘sufficient’ computing architecture.
Contrast Penrose with Ray Kurzweil, author of “The age of spiritual machines: when computers exceed human intelligence.” Kurzweil provides a convincing debate against Penrose’s thesis, in that if human intelligence and thought (consciousness) is formed on the basis of quantum decoherence from an inherently undisturbed evolution of quantum coherences that comprise human brain function, that there is no physical or technological barrier to reproducing such a ‘system’ on a machine. However, basic quantum computing itself appears to be a grand challenge .
Are Penrose and Kurzweil both making AI into an eccentric endeavor that the average human consumer might never experience?
2. Strong AI vs. Weak AI
It is useful to distinguish between two forms of AI challenges: strong AI and weak AI. Strong AI is AI that displays human intelligence and can pass a Turing Test. Such an AI system can perform any intellectual task of a human and can display human thought. The key here though is human thought – consciousness, understanding, feeling, self-awareness and sentience. Philosopher John Searle popularized the strong AI hypothesis when he proposed the “Chinese Room Argument,” which states that an AI program cannot give a computer a “mind” or “understanding”, regardless of how intelligently it may make it behave. Searle asked the question: does the machine truly “understand” (“think”), or is it merely simulating the ability to understand (which would not be classified as equivalent to human thought)? Weak AI, sometimes termed “applied AI,” is AI that accomplishes specific problem solving or reasoning tasks that do not encompass the full range of human cognitive abilities, namely the literal display of human thought. As the reader might guess, many current and past AI programs and projects fit the weak AI strain, including expert systems and personal AI assistants. The Holy Grail and grand challenge of a cognitive strong AI system remains elusive.
Searle might appear to be just another pessimist, like Penrose, but he really isn’t – he never stated that a strong AI system with human consciousness cannot be designed and built – he simply added more rigors to the challenge. However, one (namely, I) might ask the following question: if an AI system can simulate human thought and pass a Turing Test, then who cares?
3. Minsky brings sanity to the problem, with a dose of skepticism
Marvin Minsky, a well-known strong AI proponent and researcher, framed the AI challenge succinctly in a short essay almost two decades ago . In particular, Minsky outlines that a versatile AI will need a common sense knowledge base and multiple methods to reason and communicate. Rather than placing the AI challenge in the stratosphere, Minsky’s “theory matrix” of AI functionality implies that functionality vs. tractability is the metric to work toward, a metric that will improve with the evolution of technologies over time.
On the other hand, Minsky called the Loebner Prize, an annual competition for AI systems passing practical Turing Tests, a publicity stunt, and he may be correct, but the bottom line is that we need some competitive forum for the “strong AI,” or otherwise we will just keep on churning out prototypes like Watson, Eliza and Rosette (the latter two being gifted chatterbot) that cannot think.
4. What is human “thought” and why is it so elusive?
Now that I’ve used the terms “thought” or “think” in addition to “intelligence” in describing what properties an AI might have in the future, I think I should explain why “thought” is so much harder than “intelligence” to capture and implement in the artificial domain. A major part of the answer is that we simply don’t fully understand human thought and cognition, either from the strict human neural architecture point of view, or from the plethora of artificial models that have been constructed for decades by neuroscientists, psychologists and computer scientists (and even philosophers). As Richard Feynman so aptly pointed out: “What I cannot create, I do not understand.” (I might add the term [re]create.)
Human consciousness, which maps into the idea of self-awareness, is a related concept that has the same quality of the unknown as human thought. One might think of human thought as encompassing consciousness, sub-consciousness and intelligence, but also a very relevant property, perception, which has to do with organizing and interpreting sensory information.
As the intellectual debates over “what is consciousness” rage in the ever-present form of popular bestsellers (I list a few of the better ones in ), some in the AI field have asked what the point would be to recreate human thought, particularly consciousness and perceptive qualia (defined as subjective sensations) in an AI, instead making the plea that we focus on taking the salient human intelligence features of the neocortex and using them to construct intelligent machines. Both Marvin Minsky and Jeff Hawkins  have argued this idea persuasively, and they come at it from a functional point-of-view: incorporating capability features that have remained quite challenging to AI designers, such as machine vision and natural speech and language recognition and generation. Hawkins in particular has concentrated on the reductionist idea that thoughts are predictions tied to the massive memory capacity of the neocortex, and when combined with sensory input, are our perceptions. This forms the basis for his memory-prediction framework of intelligence, which has evolved into a more formal hierarchical temporal memory algorithm for how the neocortex processes information: hierarchically and with ubiquitous temporal feedback. (Never mind that humans can be biased predictors, as pointed out by Daniel Kahneman .)
However, I think it is short-sighted to ignore the broader concept of human thought and whether we can incorporate features of it into an AI to enhance its appeal in terms of human utility and value, beyond “human intelligence” or predictive capability. Stated another way, there is a strong possibility that what we call “human intelligence” is inseparable from the broader features of “human thought” that aren’t always classifiable as simple predictions. A few prime examples include our fluid and effortless ability to understand natural speech and language, even the more nuanced features; our ability to make connections between disparate concepts or events, many times through subjective routes; our ability to form and manipulate abstractions; our creative and imaginative capabilities; our sense of humor or metaphor; our ability to effortlessly perform analogical reasoning (form analogies), to name a few.
Indeed, from a neurological perspective, the “binding problem” – how the brain unifies sensory representations with higher-level “invariant representations ” learned and stored in memory to form intelligent perception and thought – is by far an unsolved problem. Unlike Penrose et al., I don’t share the view that the problem is intractable or that it requires yet unknown obscure theories or a new kind of science. I am in the camp that all that is “human thought” might be an emergence of the “critical mass” density of dynamic and plastic synaptic mapping and neuronal activation. The evidence mounts that there is dynamic cross-domain mapping and activation between processed sensory information (sound, vision, tactile…), short and long-term memory stores, speech and language centers, and motor control areas. Collective memory and learning (in addition to memory and predictive capability) are key elements. The goal is to understand and harness this dynamic mapping and activation/collective memory and learning complexity and to apply it to AI.
Sidebar 1: Voices from the Neuroscience Community, Take 1
I will ignore the philosophical discussion of what it would mean to create a “self-aware” AI that could possess qualities of a malevolent nature – my aim is to focus on qualities that enhance, not detract, and it seems to me that an AI that is “aware” of the malevolent side of human thought might itself have value. Morality, empathy, ethics and free will are all a part of human nature, and for an AI to grasp those concepts would be useful.
A final conundrum on this topic is whether a Turing Test is sufficient to gauge human-like qualities of an AI. This would presume that the test includes all ranges of human thought, and negates spurious outcomes. We certainly wouldn’t want an AI that passes but a human that fails – a case where the AI fooled the tester, who poorly designed the test. Philip K. Dick’s literary play on this in “Do Androids Dream of Electric Sheep”  is not forgotten.
5. AI and the “Grand Challenges”
In defining AI systems, I find it helpful to view the scope via an “AI systems requirements” matrix, such as the one shown in Fig. 1. Architecture (models, structure, algorithms), knowledge (representations, acquisition) and interfaces (sensory or action-based) are all integral to any advanced AI.
Of the model systems listed on the left (expert systems, virtual personal assistants, intelligent games, intelligent agents, robotics (autonomous)), I review several state-of-the-art and recent consumer-based implementations in detail, specifically those shown in bold in Fig. 2. Those reviews are discussed below. Machine learning, knowledge representations & acquisition, machine vision and natural language processing (NLP) are four major elements of any potential AI system that will communicate and interact with a human, and I provide primers on these on a separate site area dedicated to AI (Click HERE for link to the AI site and primers).
The items in Fig. 1 that are bold red are AI grand challenges, and are particularly directed toward an “artificial cognitive system” or cognitive architecture implementing human cognitive ability, namely cognitive memory and learning, human-level natural language understanding (NLU), perception and thought.
As a convention, I apply the term “artificial cognitive system (ACS)” if the goal were to produce a strong AI with human cognitive abilities, or simply keep the term “AI” for systems implementing the weaker AI attributes (the majority of the requirements in Fig. 1).
Sidebar 2: Voices from the AI/CSE Community
6. AI reviewed: From the expert/superhuman/humanoid to the consumer/gamer/patient
In Fig. 2, I provide a list of AI model systems, descriptions and recent projects, classified by applied capability; those that are reviewed in detail are shown in bold.
My approach is interdisciplinary and broadened, in that the scope of the projects reviewed transcend traditional computer science/engineering and robotics (where AI has found its home since the beginnings) and extend into the consumer, gamer and biomedical space, as well as computational neuroscience and neuromorphic engineering. My aim is to understand and communicate recent advances in both large-scale and consumer-driven applications, any innovative crosscurrents that would drive large-scale capability down to the consumer level, and major insights or breakthroughs that might lead to a truly cognitive AI.
Each applied area and its associated programs can be found in Parts II-IV of this series, found at these links:
• “The State of AI: Expert Systems, Intelligent Gaming and Databases, Virtual Personal Assistants”
• “The State of AI: Brain Simulations and Neuromorphic Engineering”
• “The State of AI: Intelligent Agents, Robotics and Brain-Machine Interfaces”
These reviews, along with primers and other material, are also accessible on separate site area dedicated to AI (Click HERE for link to the AI site – reviews, primers, surveys, extended material).
All of the programs I review are known in the public domain; there may be proprietary or classified programs that exist, which are of course not covered. I invite readers who want to expand on my reviews and primers to submit letters or whole articles, and I will consider publishing them on the dedicated AI page. My goal is to make the AI theme a continued essay, review/survey and primer effort as technologies advance, including revolutions in our knowledge base of the human neural architecture itself.
7. The epilogue of AI: Artificial Cognitive Systems
What is Project ACS? Project ACS is meant to be a placeholder for a project that leads to the first serious artificial cognitive system (“ACS” – I coined the term above), that when suitably evolved, can pass a Turing Test without fooling the human tester, and may even look and act like a human (android, humanoid), though looks are not the top requirement. What do I mean by “evolved?” Just like humans must learn and grow based on their genetic makeup and environmental factors (phenotype characteristics), so too would an artificial cognitive system. I don’t think the learning and development process can be avoided (this is an important point missed by many designers), and learned machine replication is certainly an open area of research.
Among the major unsolved neuroscience puzzles that are likely to benefit AI and the development of an ACS are (1) the resolution of the neural architecture to such a degree as to produce applicable and practical cognitive model(s) and knowledge representation(s), and (2) the resolution of the “binding problem” discussed above. Resolving these puzzles must go beyond the usual “task dependent” focus, into a more generalized view and framework (hence the categorization of an ACS as a “grand challenge;” by “task dependent” I mean a focus on visual processing or unimodal processing, for example). In the following link, I list a number of key considerations for artificial cognitive systems (representations and architectures), based on the reviews, surveys and expert viewpoints I have presented in this series.
Sidebar 3: Key Considerations for Artificial Cognitive Systems – Representations and Architectures
As for the binding problem, this unsolved controversy has yielded a span of views, from those of V. Ramachandran and others , who find evidence from neurologically impaired patients that binding is indeed a relevant dynamic, to those of M. Nicolelis , who argues that binding may be nonexistent (or not as “discretized” as some interpret), to those of Edelman et al.  who have proposed a plausible model solution to the problem. The binding problem may seem like a philosophical nuance (or nuisance) that has no bearing on the development of an ACS, but I disagree. At the heart of the controversy is whether the processing of sensory information (including predictions about the information being sensed to enable recognition) and “intrinsic thought” follow two separate neural processing pathways. (Examples include the recognition of a face, as opposed to “intrinsically” visualizing that face via thought alone, or the recognition of tonal sequences, as opposed to intrinsically playing a melody via thought, or the cross-modal processing of language involving abstract concepts.) Neuroscience data on this is so far indeterminate, as even recent studies involving invasive measuring techniques on epileptic patients indicate (see Part 4 for a few recent studies).
If the brain does separate these functions only to integrate them at some level of processing, then why, and how, is this accomplished? This question has a potentially major bearing on how the neural architecture is structured, so as to enable speech and language understanding as well as abstract perception and thought. Some have argued that one unified “endogenous” view would make sense from the perspective of the allocation of the brain’s energy resources , a valid approach. No doubt the answer to this puzzle, which involves the real matters of self-awareness and the capabilities and capacities for abstract perception and thought, will require many more neurological studies and data, and will in turn impact the development of viable models and representations. Edelman and his colleagues/students [5,27] assess the role of selectional theories in developing models of the brain (e.g. neural Darwinism), defining testable predictions that would have an impact on the development of an ACS. More recently, the mapping efforts of Sporns et al. (see  and refs. therein) are on a productive track to produce the data and resolution necessary to test such theories and models.
Readers may note that I don’t have any other programs or projects listed in the category of “Cognitive Architectures” in Fig. 2, because as far as we publicly know, humankind has not yet developed such an ACS. In fact, no one has ever won the silver and gold levels of the Loebner Prize, which provides an annual platform for practical Turing Tests (see note, ).
(A visit to the Wiki site ‘comparison of cognitive architectures’ will provide some basis as well – note all the incomplete fields – this is due to lack of progress in this area. Most, if not all, of the projects listed are driven by computer science/pure AI researchers.)
Why is there a lack of significant progress in the area of cognitive architectures and a “Project ACS?”
|“In this age of specialization men who thoroughly know one field are often incompetent to discuss another. The great problems of the relations between one and another aspect of human activity have for this reason been discussed less and less in public.”
–Richard P. Feynman, 1956
My view is that the AI community is still quite cloistered, lacking a wide interdisciplinary approach, and a healthy level of cross-pollination in ideas, discoveries, discussion and debate. Yes, the computer science/engineering community has morphed over the years into branches such as computational neuroscience and neuromorphic engineering, and this migration has been productive, but not completely so. Why? Within those branches we still see silo-ing and tunnel vision, a persistent linkage to the old paradigms of von Neumann computing and semiconductor-based architectures, and still no major contribution to truly cognitive architectures. The grand challenge of neuroplasticity (including combined features such as autonomy, self-replication and self-reconfiguration, and fault tolerance) is not being tackled enough.
(To be fair, there is a recent movement “biologically-inspired cognitive architectures (BICA)” that was spawned in part by a DARPA program of the same name. Though the program got cancelled in 2007 for being too “aggressive,” the movement still lives on in the form of a society of the same name, which organizes annual meetings and publishes progress updates HERE. After viewing some of the online videos of the recent Nov. 2011 meeting, my critical comments still apply, and I recommend that participants in this movement continue to reach out to key peripheral fields that will have a major impact in designing cognitive architectures.)
Fields like cognitive neuroscience (including neurology, psychiatry, psychology), neurobiology and biomedical engineering have made and are making major discoveries including:
• A systemic understanding of the neural architecture:
• Practical progress in neuroprosthetics:
The challenge is for the AI community at-large to tap into these discoveries and advances to draw more insights and ideas toward the goal of developing cognitive architectures or a successful Project ACS. In doing so, I think the task requires breaking out of the silo or tunnel vision and forming a concerted, interdisciplinary effort. The researchers involved in the progress made on neuroprosthetics and BMIs should serve as a useful role model.
Sidebar 4: Voices from the Neuroscience Community, Take 2
Finally, this essay started with a dream: it turns out to be mine. Do humans dream of an “AI Companion?” Yes, they do.
Author’s Note: I should add that after I wrote this essay I came across a relatively recent debate between Ray Kurzweil and Paul Allen, co-founder of Microsoft and benefactor of the Allen Institute for Brain Science . (Click HERE to read the debate text.) I found the debate unproductive. The reason why we have not had significant progress in AI in terms of building a truly cognitive system is because of the prolonged lack of significant interdisciplinary effort between traditional AI and neuroscience and the vast range of disciplines in between, as argued above, as well as a lack of focus toward a common goal. My view is that all sides could and should be motivating one another to follow the same grand challenge, which I have called an “ACS.” What I see as an outsider (and I consider myself one, as I was not born into either field, but have a decent background in scientific research) is that both fields have wasted years debating largely philosophical issues (just visit your local library to view the plethora of books on consciousness and mind/brain deliberations – 30 or some odd years and 100s of tomes, written by AI and neuroscience luminaries alike), without committing to a grand challenge with a consistent, methodical path to get there. Likewise, the Allen/Greaves/Penrose “complexity brake” can be a blindsight hindrance, just as much as Kurzweil’s unfocused, misguided optimism. The singularity might not be near, but the commitment to a grand challenge sure as heck should be. QED
For more information, reviews, primers, surveys and thoughts, please visit separate site area dedicated to AI (Click HERE for link to the AI site). I also welcome constructive and friendly comments, suggestions and dialogue (click on contact link at top).
Disclaimer: The material presented here and on the dedicated AI page(s) are intended for understanding and informative purposes; any intelligent opinions or critical appraisals, separate from facts presented, are wholly those of eidolonspeak.com/individual authors (i.e., me). I encourage readers who find factual errors, or who have alternative intelligent opinions and appraisals, to contact me. Cheers.
References and Endnotes:
 “The Emperor’s New Mind,” Roger Penrose, 1989.
 “The Age of Spiritual Machines: When Computers Exceed Human Intelligence,” Ray Kurzweil, 1999. See also “The Singularity is Near,” 2005.
 “First universal programmable quantum computer unveiled,” Colin Barras, New Scientist, 15 November 2009.
 “Future of AI Technology,” Marvin L. Minsky, 1992.
 “A Brief Tour of Human Consciousness,” V.S. Ramachandran, Pi Press, 2004.
“The Quest for Consciousness, A Neurobiological Approach” C. Koch, Roberts & Co, 2004.
“In Search of Memory, The Emergence of a New Science of Mind, E.R. Kandel, W.W. Norton & Co., 2007.
“A Universe of Consciousness: How Matter Becomes Imagination,” G.M. Edelman and G. Tononi, Perseus Books, 2000.
“Synaptic Self: How Our Brains Become Who We Are,” J. Ledoux, Penguin, 2003.
“From Axons to Identity: Neurological Explorations of the Nature of the Self,” T.E. Feinberg, Norton & Co., 2009.
“The Problem of Consciousness,” F. Crick and C. Koch in “The Scientific American Book of the Brain,” ed. Antonio R. Damasio, 1999.
“Can Machines Be Conscious,” C. Koch and G. Tononi, IEEE Spectrum, June 2008.
(The last reference contains a relatively newer proposal for a Turing Test, based on comparing metrics from an “Integrated Information Theory” of consciousness to empirical/phenomenological test data of real test subjects. In my view, a battery of practical Turing Tests based on a number of viable theories or models is probably a sound approach, not any one test, derived from one theory or model. I also do not share the relatively pessimistic view held by the authors, whom I consider key contributors from the neuroscience community. Koch/Tononi also need to buy into that grand challenge I argue for, the central argument of this essay.)
 “On Intelligence,” Jeff Hawkins, Owl Books, 2004.
 “Thinking, Fast and Slow,” Daniel Kahneman, Farrar, Straus and Giroux, 2011.
 Hawkins in  uses the term “invariant representation” to refer to the brain’s internal high-level stored pattern representation of images, sounds or any sensory information that may be stimulating the central nervous system. He correlates this invariant representation with the stability of neural cell firing high up in the cortical hierarchy, as a response to sensed lower-level fluctuating stimuli, denoting that the cortex has rendered a recognition (prediction) of those stimuli (using the invariant representation), even when the stimuli are “noisy” or include distortions, transformations and fluctuations. Examples include quick and easy facial recognition under blurry or distorted conditions, or the seamless ability to recognize music in any key or a familiar rhythm embedded in a new song. This is a type of auto-associative recognition using invariant representations, but there can also be hetero-associative recognition as well.
Ramachandran in  uses the term “metarepresentation” to mean much the same thing, but also characterizes it as “a second ‘parasitic’ brain – or at least a set of processes – that has evolved in us humans to create a more economical description of the rather more automatic processes that are being carried out in the first brain…bear[ing] an uncanny resemblance to the homunculus that philosophers take so much delight in debunking…I suggest this homunculus is simply the metarepresentation itself, or another brain structure (or a set of novel new functions that involves a distributed network) that emerged later in evolution for creating metarepresentations, and that it is either unique to us humans or considerably more sophisticated than ‘chimpunculus.’ ” Ramachandran goes on to say that that this metarepresentation “serves to emphasize or highlight certain aspects of the first [sensed representation] in order to create tokens that facilitate novel styles of subsequent computation, either for internally juggling symbols (“thought”) or for communicating ideas (“language”)…the parts of the brain tentatively involved in these novel styles of computation include the amygdala (that gauges emotional significance), the angular gyrus and Wernicke’s area clustered around the left temporo-parietal-occipital (TPO) junction (language and semantics centers), and the angular cingulate, involved in ‘intention.’ ” Ramachandran focuses on the significance of the metarepresentation to the emergence of language comprehension/meaning capacity and self-awareness, and defines a few tests on patients with neurological damage to investigate the extent of a “representation of a representation.” One interesting case he cites is the ‘blindsight’ syndrome, in which a patient with visual cortex damage cannot consciously see a spot of light shown to him but is able to use an alternative spared brain pathway to guide his hand unerringly to reach out and touch the spot: “I would argue that this patient has a representation of the representation – and hence no qualia ‘to speak of.’” He also cites a converse case, Anton’s syndrome, a blind patient owing to cortical damage but denies that he is blind: “What he has, perhaps, is a spurious metarepresentation but no primary representation. Such a curious uncoupling or dissociations between sensation and conscious awareness of sensations are only possible because representations and metarepresentations occupy different brain loci and therefore can be damaged (or survive) independently of each other, at least in humans. (A monkey can develop a phantom limb but never Anton’s syndrome or hysterical paralysis.)” The important point is made that “just as we have metarepresentations of sensory representations and percepts, we also have metarepresentations of motor skills and commands…which are mainly mediated by the supramarginal gyrus of the left hemisphere (near the left temple). Damage to this structure causes a disorder called ideomotor apraxia. Sufferers are not paralyzed, but if asked to ‘pretend’ to hammer a nail into a table, they will make a fist and flail at the tabletop. The left supramarginal gyrus is required for conjuring up an internal image – an explicit metarepresentation – of the intention and the complex motor-visual-proprioceptive ‘loop’ required to carry it out. That the representation itself is not in the supramarginal gyrus is shown by the fact that if you actually give a patient a hammer and nail he will often execute the task effortlessly, presumably because with the real hammer and nail as ‘props’ he doesn’t need to conjure up the whole metarepresentation.” Ramachandran also discusses the role of the angular gyrus in the left hemisphere (located at the crossroads between the parietal lobe (touch and proprioception), the temporal lobe (hearing) and the occipital lobe (vision)) in “allowing the convergence of different sense modalities to create abstract, modality-free representations of things around us.” He argues from studies on patients that such cross-modal representations are highly linked to the ability of understanding and grasping metaphor in language – patients with lesions in the angular gyrus are unable to grasp cross-modal metaphors.
That the brain learns and stores “idealized” representations for images, sounds, symbols, language, touch, smell or motor skills/motion that are later used for recognition and other associative tasks (or even the stuff of subconscious dreams) is not new. I do not know who originally came up with the concept, but Crick & Koch in  also discuss a similar “explicit representation,” which they also call a “latent representation.” Koch discusses such representations and their invariant nature at length in his book , along with his general goal of identifying the “neuronal correlates of consciousness.” I consider Hawkins’ general concept of an “invariant representation” to be a powerful one, and his neocortical structure processing model implementing “invariant representation” learning and memory storage for later predictive use with sensory stimuli simple and elegant, but he apparently only applies it to auto-associative recognition tasks. It does appear increasingly evident that for the complex processes of visual awareness the neocortex plays a dominant role, and auto-association perhaps the dominant process for predictive recognition.
While I suspect that the “invariant representation” conceptual power and utility runs quite deep in terms of human thought (conscious or subconscious), memory, recall, recognition, perception, etc., including the hard problems of language understanding and abstraction, for the latter we likely need to apply hetero-associative and cross-modal processing. Ramachandran’s extended view of the structures producing metarepresentations and their interactions appears to go beyond simple neocortical structure processing. Deriving extended structure and processing models that capture the range of associative (and even non-associative) and cross-modal interactions is part of the grand challenge.
 “Do Androids Dream of Electric Sheep,” Philip K. Dick, 1968. This science fiction classic was the inspiration for Ridley Scott’s 1982 sci-fi flick, Blade Runner.
 “Two Views of Brain Function,” M.E. Raichle, Trends Cogn Sci vol. 14, p.180, 2010. This review is accessible HERE.
 “The Human Connectome: A Structural Description of the Human Brain,” O. Sporns, G. Tononi, R. Kötter, PLoS Comput Biol 1(4) p. 245, 2005.
 “Paul Allen: The Singularity Isn’t Near,” P. Allen and M. Greaves, MIT Technology Review, Oct. 2011.
 “Recursive Distributed Representations,” J.B. Pollack, Artificial Intelligence, vol. 46 (1), p.77, Nov. 1990.
 “Implications of Recursive Distributed Representations,” J.B. Pollack, Advances in Neural Information Processing Systems I, 1989.
 “Neural Network Models for Language Acquisition: A Brief Survey,” J. Poveda and A. Vellido, Lecture Notes in Computer Science, vol. 4224, p. 1346, 2006.
 “Learning Multiple Layers of Representation,” G.E. Hinton, Trends in Cognitive Sciences, vol. 11, p.428, 2007.
 “What Kind of Graphical Model is the Brain?” G.E. Hinton, International Joint Conference on Artificial Intelligence, 2005.
 “Energy-Based Models in Document Recognition and Computer Vision,” Y. LeCun et al., Ninth Intl. Conf. on Document Analysis and Recognition, 2007.
 “Learning Deep Architectures for AI,” Y. Bengio, Foundations and Trends in Machine Learning, vol. 2 (1), 2009.
 “Modeling Neural Networks for Artificial Vision,” K. Fukushima, Neural Information Processing, vol. 10, 2006.
 “Temporal binding and neural correlates of sensory awareness,” A.K. Engle and W. Singer, Trends in Cognitive Sciences, vol. 5, 2001.
 O. Sporns, G. Tononi, G.M. Edelman, “Connectivity and complexity: the relationship between neuroanatomy and brain dynamics,” Neural Networks, vol. 13, 2000.
 “A Theory of Cortical Responses,” K. Friston, Phil. Trans. R. Soc. B, vol. 360, 2005.
 “Hierarchical Models in the Brain,” K. Friston, PLoS Computational Biology, vol. 4, 2008.
 “Towards a Mathematical Theory of Cortical Micro-circuits,” D. George and J. Hawkins, PLoS Computational Biology, vol. 5, 2009.
 “Beyond Boundaries: The New Neuroscience of Connecting Brains with Machines - and How it will Change Our Lives,” Miguel Nicolelis, Henry Holt & Co., 2011.
 “Networks of the Brain,” Olaf Sporns, MIT Press, 2011.
Do central banks stabilize or destabilize financial systems? The answer is: “both.”
Perhaps one popular notion is that a central bank, such as the Federal Reserve (the Fed), the Bank of England (BoE), the Bank of Japan (BoJ), the European Central Bank (ECB), etc., is the ‘Big Bank’ that can step in and provide funding in a monetary or liquidity crisis, seeking to relieve selling pressure in markets and to get credit-money to flow again, in essence, to act as a lender of last resort. Another popular notion (and one that is more common historically) is that a central bank exists to finance sovereign national government debt, to issue fiat paper currency, and to set interest rate policy based on any number of perceived macroeconomic factors. Yet another popular notion is that a central bank acts as a cartel monopoly, and because it can print fiat money and set interest rates, it is a central planner possessing exogenous powers to manipulate capital markets.
The thesis of this work is to convince the reader that a central bank, such as our own Federal Reserve, is for all intents and purposes a giant hedge fund, nominally drafted and chartered by the sovereign to keep sovereign borrowing costs low, among other hedging and financing aims, and that it can incur risks of failure.
A hedge fund is defined as “a private investment fund that participates in a range of assets and a variety of investment strategies intended to protect the fund’s investors from downturns in the market while maximizing returns on market upswings.” In rudimentary analogy, the Fed is a private institution chartered by Congress, employing “monetary tools” to finance and manage Treasury assets/liabilities, and exercising hedging strategies to protect the Fed’s “constituents” from capital market downturns (e.g. the “Greenspan or Bernanke put”) while maximizing the growth of the “national wealth.” The monetary tools and hedging strategies include the Fed’s many “asset swap programs” and “open market operations.” A generalized example is the process through which the Fed accumulates Treasury or Agency  debt securities in exchange for some other “asset,” such as fiat money (dollars), or debt securities existing on its balance sheet. In executing this process, the Fed affects the money supply and the interest rate structure of the Treasury yield curve, which in part drives the market for interest rates on other debt securities. The Fed also lends money at a discount to its constituents through its “discount window,” and will lower its Federal Funds target rate to reduce this discount in the event of market turmoil, in effect providing a put option. (A dated table of published Fed programs can be found HERE.)
On the face of it, the hedge fund analogy might provide an inspiring view of the role of a central bank, particularly if one buys into the “national wealth benefactor” belief. In reality, hedge funds can fail, and fund investors can lose everything.
The skeptical reader is probably asking how a central bank can fail, especially if it retains the power to print fiat money and set interest rates and reserve ratios. Let me answer this by saying that a central bank, such as the Fed, is not the exogenous hand of God, but essentially another endogenous player in the financial system. If the Fed were the exogenous hand of God, as some claim, we’d not see the evidence of financial instability that central bank monetary policies create or exacerbate, or at the very least, fail to fix. Those instabilities are twofold: (a) they exist because the financial system can be thrown out of equilibrium, and most neoclassical monetary measures that the Fed and other central banks employ assume an inherently equilibrium system and response; and (b) fiat money is multiply leveraged by the Fed and other central banks in attempts to restore stability and provide relief to markets and constituents, and such compounded leverage is linked to the growth of endogenous credit-money and the increases in risk of financial instability, market dislocations or shocks.
The Fed’s regulation of interest rates, which have included repeated interest rate cuts and sharp reversals (Fig. 1) has coincided significantly with the growth of financial markets, and with the rise of risk, volatility and financial instability. The Fed’s justification for controlling target interest rates is to regulate price inflation when markets heat up and to provide credit ease to markets in a disinflationary turmoil. In practice, this tool has had significant unintended consequences, distorting what the market perceives as price based on supply and demand. The “Greenspan put” came to be the market hedge bailout that provided protection to market bulls, and particularly those selling leveraged derivative contracts as portfolio insurance or as a bet against spiking volatility. With the Fed standing ready to provide liquidity in the form of interest rate cuts, open market operations or discount loans, market constituents were given a green light to take on greater risks than they would if there had been no hedging backstop. The 2008 financial crisis that started as a severe dislocation in the credit and mortgage debt securities markets in 2007 formed a culmination of risk-driven mania induced by easy credit and the implied Greenspan-Bernanke put option hedge.
Since early 2009, after the Fed reduced the target Federal Funds rate to a pinioned range of 0%-0.25%, the Fed has resorted to outright quantitative easing or debt monetization measures in large scale to prop up flailing markets, buying up Treasuries and other debt securities, namely Agency debt obligations and mortgage-backed securities, with fiat dollars. (A list of these large-scale asset purchases can be found HERE.) Money supply metrics have swelled to record levels, as has the consumer price index, a measure of price inflation (Fig. 2).
Most recently (Aug/Sept. 2011), the Fed has announced an indefinite continuance of its zero interest rate policy, and a large-scale “maturity extension program” (a.k.a. “Operation Twist”), whereby shorter-term maturity Treasuries on the Fed’s balance sheet are sold and the proceeds used to buy longer-term maturity Treasuries, with the intention to keep long-term interest rates, and most notably long-term government borrowing costs, low. As of the writing of this essay, the Fed’s published balance sheet (Fig. 3) has swelled to ~$2.9T, with >91% of it (~$2.7T) composed of Treasury and Agency securities. (The Fed’s published, simplified balance sheet can be tracked HERE, with debt securities acquired via open market operations tracked HERE.)
It is important to point out that the Fed doesn’t follow standards of accounting that apply to (most) of the rest of the world. Capital, which it does not hold should its portfolio lose significant value, can simply be declared. It is useful to ask the following question: when the securities (namely Treasuries) that the Fed holds come due, who pays whom? For what? That’s where a program such as Operation Twist comes in – it is a scheme to refinance that debt. Likewise, if the Fed starts to unwind its balance sheet by selling off Treasury and Agency debt securities, who will buy them? The Fed already had a failed auction this summer when it tried to sell mortgage-backed securities it held , and recently it has only stepped up the purchase of Agency MBSs. The Fed increasingly looks like a buyer of last resort, with fiat money multiply leveraged to monetize the debt securities it purchases. In the event that foreign and domestic holders of Treasuries (Fig. 4) decide to sell their holdings, causing an increase of selling pressure and triggering a sharp decline of Treasury prices (and a commensurate sharp increase in interest rates), can the Fed declare enough capital to buy up all that sinking Treasury debt?
The ultimate questions that everyone should be asking are these: How sustainable are the Fed’s various hedging strategies described, can it fail and what are the risks of failure?
The leveraging of the dollar to monetize debt and keep interest rates stable and low has limits – the Fed cannot simply declare capital indefinitely to maintain stability. An instructive analogy is a company that decides to issue too much equity or debt – in doing so it dilutes its capital standing, and loses market value, sometimes sharply. Another analogy is that of a private hedge fund – those that thought they could hedge away risks through complex arbitrage trades, especially involving high leverage and little capital as a cushion, failed spectacularly. A prime example is that of Long Term Capital Management . LTCM was able to move interest rates and ‘invent money’ with its highly leveraged swap book.
If the Fed can fail, who will be its lender of last resort? Who is its regulator?
A solution is to let markets freely determine interest rates and attendant price levels based on supply and demand instead of artificially driven, leading to exogenous seeds and shocks, and ultimately, financial instability. Sound money and a defendable, honest monetary standard that cannot be gamed or cheated remain the alternative to fiat money that can be declared at will, violating the property rights of those who have earned their money and who cannot simply declare capital at will. The Fed (or any similar central bank) as an independent  lender of last resort constrained to these principles would be a far safer entity, at less risk of failure, and less of a danger to capital markets and economies.
Author’s Note: I provide two primers below for the reader interested in understanding some of the concepts referred to in this essay. The first primer is on endogenous money, and the second primer is on chaos theory and how it may apply to financial markets in cases where mainstream neoclassical models break down.
 “Agency” refers to housing-related government-sponsored enterprises (GSEs) Fannie Mae, Freddie Mac and the Federal Home Loan Banks.
 “Failed Fed Auction an Early Warning?” Susanne Lomatch, June 12, 2011.
 “Vintage Greenspan and the Lessons of LTCM,” Susanne Lomatch, August 13, 2011.
 An independent Fed would be decoupled from its government-sponsored charter.
Primer on Endogenous Money
Endogenous money refers to the theory that money comes into existence driven by the requirements of the real economy and financial market participants, and that banking system reserves are enlarged or drained as needed to accommodate the demand for lending at the prevailing interest rates.
One can immediately see from this simple definition why endogenous money is an important concept when we try to gauge the effect of ‘exogenous’ measures enacted by a central bank, such as the Fed, in the form of fiat lowering of target interest rates and injecting fiat money into the money supply or into bank reserves via its various open market operations. Further, one can also envisage the unintended consequences if such exogenous measures lead to geometric growth (or volatility) of endogenous money, and a commensurate rise of risk through the increase of leverage and fractional reserve lending. The geometric and power law growth of the debt securities markets  and derivatives markets  corroborate the growth of endogenous credit-money and the attendant risks that market participants find compelled to hedge.
If history is a guide, the central bank (the Fed) becomes in reality just another endogenous player in the system, as its future actions are dependent on the progression or play-out of the endogenous mechanics of system, including the instabilities that result. In short, the central bank is part of the ‘feedback loop,’ and may impose negative side effects in the attempt to restore stability to an inherently endogenous system. The Fed is known to use neoclassical monetary models to estimate quantity of broad money and to set its monetary policies accordingly, while these models may underestimate the effect of its exogenous measures.
The endogenous money theory is based on three main insights: 
1. ‘Loans create deposits’: at the level of the banking system as a whole, the drawing down of a bank loan by a non-bank necessarily creates new deposits (and the repayment of a bank loan necessarily destroys deposits). So while the total quantity of bank loans and the quantity of deposits may not equal each other in an economy, a deposit is a logical concomitant of a loan – it should not be seen as that which a bank needs to raise prior to extending a loan.
2. Whilst banks can be capital-constrained, a solvent bank is not usually reserve-constrained or funding-constrained: they can usually obtain reserves or funding if required either from the interbank market or from the central bank.
3. Banks will therefore pursue any profitable lending opportunities that they can identify up to the level consistent with their level of capital, treating reserve requirements and funding issues as matters to be addressed ex post – or rather, at an aggregate level.
These insights imply that the quantity of broad money in an economy is determined endogenously within an economy: in other words, the quantity of deposits held by the non-bank sector ‘flexes’ up or down according to the aggregate preferences of non-banks. Significantly, the theory states that if the non-bank sector’s deposit holdings are augmented by a policy-driven exogenous shock (such as quantitative easing), the sector should be expected to find ways to ‘shed’ most or all of the excess deposit balances by making payments to banks (comprising repayments of bank loans, or purchases of securities).
This account runs entirely counter to the mainstream economic theory of money creation, which states that the quantity of broad money is a function of (a) the quantity of “high-powered money” or “government money” (notes, coins and bank reserves), and (b) the money multiplier. Endogenous money concludes that the money multiplier as a concept has no bearing on how lending and bank reserves interact in practice.
 “Global Debt Watch,” Susanne Lomatch, September 15, 2011. See also detailed data for U.S. debt markets HERE.
 “Global Derivatives Watch: Netting, Collateral and Capital Cushions Matter,” Susanne Lomatch, September 15, 2011.
 The italicized portion was adapted from a Wikipedia entry for Endogenous Money.
Primer on Chaos Theory vs. Neoclassical Models in Quantitative Finance
This primer is a very brief introduction to how chaos theories may apply to financial systems and markets when standard neoclassical models (based on normal random probability distributions and the assumption of equilibrium behavior) break down.
In a financial crisis, instabilities become manifested in the form of outcomes that would occur with incredibly miniscule probabilities when standard equilibrium theories are applied that assume a normal Gaussian probability distribution. This fact has emerged from the numerous historical examples we have on record, e.g. the 1987 Black Monday stock market crash, which exhibited price changes that would have occurred with a normally distributed probability of 10^(-160) [1,2], or the 10-sigma (10 standard deviation) failure of Long Term Capital Management (discussed in the essay text above) , or most recently, the 2008 financial crisis, which began with a massive dislocation and seizure in the credit markets in August 2007 when the LIBOR-OIS spread jumped a whopping 17x its usual standard deviation (17-sigma) . As  asks, “The close calls of 1987 and 1998 had made quantitative risk models that had emerged from rational market finance look bad. Would they have looked much, much worse if the Fed hadn’t bailed markets out? On the other hand, if the Fed can be relied upon to save the world’s financial markets whenever they threatened to freeze up, what was the problem?”
While markets do at times exhibit a normal random walk whereby price movements can be predicted with models assuming a normal distribution, there are times of turmoil when those models break down spectacularly, and market hedgers or policy estimators that use these models to make complex trades (e.g. with derivatives or a leveraged arbitrage) or to enact monetary measures (e.g. fiat interest rate cuts or fiat money injections) may find failure or unintended consequences a real possibility.
Two assumptions of neoclassical models are independence between events and linearity. When events develop an interdependence (e.g., future events depend on past outcomes) and nonlinearity enters as a dynamic, unpredictable outcomes can occur, sometimes involving great volatility and erratic behavior.
Chaos theory concerns the study of systems where a small input can lead to a disproportionate (nonlinear) response. Stated another way, small occurrences significantly affect the outcomes of seemingly unrelated events. Though “standard” chaos theory applies to deterministic systems, it is where seemingly random systems become chaotic that is of great interest, and has possible application to understanding the behavior of markets, financial systems, and the deleterious effects of participants, including central banks. As quoted from a pioneer of chaos theory, fractal mathematics and their application to finance: “We need to understand, in much closer fidelity to reality, how different kinds of prices move, how risk is measured, and how money is made and lost. Without that knowledge, we are doomed to crashes, again and again .”
 “Recovering Probability Distributions from Equity Prices,” J.C. Jackwerth and M. Rubenstein, Journal of Finance, Dec 1996.
 “The Myth of the Rational Market,” J. Fox, HarperCollins Publishers, 2009.
 “Fooled by Randomness,” N. N. Taleb, Random House, 2004.
 “Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis,” J.B. Taylor, Hoover Institution Press, Stanford University, 2009. See also “A Black Swan in the Money Market,” J.B. Taylor and J.C. Williams, Hoover Institution and FRBSF, April 2008.
 “The (Mis)Behavior of Markets: A Fractal View of Financial Turbulence,” B. Mandelbrot and R.L. Hudson, Perseus Books, 2008.
Early American colonists fought a war of independence against the British economic tyranny espoused by King George III, his Parliament, and the Bank of England (BoE).
The BoE, a “private” institution established in 1694, was set up to supply money to rebuild the British Navy after the battle of Beachy Head, as the Crown and its Parliament had run dry of public funds. Incorporated into the BoE Royal Charter from the start, the bank assumed special privileges for converting a portion of the sovereign debt into shares of “The Governor and Company of the BoE,” including the issuance of £1.2M in BoE banknotes with only a fraction backed by gold. Such fractional reserve banking had become all the rage in Amsterdam and Stockholm, financing brisk economic activity on the European continent and beyond – and the British figured that they too could help drive their own revolution in financing public credit and tradable government debt: facilitating the swap of short-term debt (unfunded deficits) with long-term debt (funded or tax revenue-secured loans) , and inventing a central bank with monopoly powers to dominate and propel that market. The leap of faith was to believe that such long-term debt would retain stable value, given the ever-growing deficits and national debts that exceeded tax revenues and gold reserves. Within two years, as bank gold reserves shrunk to less than 5% of outstanding banknotes, there was a run on the BoE, with investors demanding gold specie payments for their banknotes. The BoE had sustained its first insolvency, but with sovereign backing, had power to suspend redemption of banknotes until the bank was recapitalized by an injection of gold from shareholders [2,3]. A resumption of specie payments and fractional reserve banknote issuance continued with the BoE’s charter extension in 1697.
Charter renewals for the BoE over the next century were motivated by the need for increased fiscal and wartime financing following spikes in sovereign deficits, and with each renewal, the value of the BoE’s monopoly franchise as a banking enterprise increased [1-4]. In 1697, the BoE garnered partial monopoly central banking and government-backed note-issuance status, and its shares were declared personal property not subject to profit taxation. In 1708 the BoE provided new funding to the sovereign, in part to bankroll the War of Spanish Succession, in exchange for monopoly of joint-stock banking and joint-stock note issuance. In 1742 the BoE provided an interest-free loan to the sovereign in the wake of the War of the Austrian Succession, in exchange for its monopoly on paper currency, or the issuance of circulating non-interest bearing promissory notes. Such cheap loans continued in exchange for reaffirmation of monopoly banking charter extensions in 1764 and 1781, to cover deficits from the Seven Years’ War and the American Revolutionary War.
Notably, two other government-sponsored corporate entities, the South Sea Company and the East India Company, provided substantial national debt financing to the British sovereign during the same periods as the BoE, in exchange for monopoly regional business and trade privileges. The South Sea Company in particular was incorporated on the basis of a national debt-for-equity swap in the wake of the War of the Spanish Succession (1711), whereby holders of £10M in short-term government debt would swap with equity in the new company, which would receive a steady revenue stream from interest payments on a perpetual £10M loan back to the government. The sovereign would then place a tariff on imports from South America, where the South Sea Company conducted its trade business, in part to pay such interest obligations. Over the next nine years, the South Sea Company took on a number of similar sovereign debt-for-equity swaps that sought to convert high interest debt into lower interest long-term debt, in 1720 amassing over 75% of the total national debts on record, £38M/£50M . The combined trade monopoly and swap revenue boost from the sovereign made the South Sea Company the momentum growth stock of its day, and as soon as the last and largest sovereign debt-for-equity swap deal (£30M) was announced, shares were bid up in hyperbolic fashion [6,10], fueled by an incentive for an inflated stock price to induce government annuity holders to convert their debt-to-equity, plus a credit expansion that was promoted by the sovereign, the markets, and the Sword Blade Bank, the in-house private bank of the South Sea Company.
Ironically, the BoE made a counterbid for the South Sea swap deal to Parliament, but the sitting Chancellor to the Exchequer Aislabie (and many in Parliament) stood to profit from the South Sea deal, which was ultimately approved. The rapid rise of the stock benefitted from speculative mania and a credit expansion – many shares were traded on margin or leveraged. Ultimately the stock soared 900% and then crashed 90%, a casualty of a liquidity squeeze when sellers run for the exits. The Sword Blade Bank was rendered insolvent. Many famous investors lost money, including King George I, Sir Isaac Newton (£20M) and the next-in-line Chancellor of the Exchequer, Robert Walpole . The BoE, essentially a competitor of the Sword Blade Bank/South Sea Company, sustained a simultaneous bank run, but with the help of the sovereign, was once again empowered to suspend specie payments [2,3].
The South Sea Company went into a government receivership managed by Walpole, with the stock holdings and assets split between the BoE, the Treasury, a sinking fund, and the East India Company. The sovereign that could have easily allowed shares to float to zero in effect bailed out government debt holders, who were now South Sea stockholders. Walpole gained notoriety for restoring confidence in the capital markets for tradable government debt (public credit), and in elevating the power and reputation of the BoE in the process, but there remained no long-term will to control the national debt or credit expansions that would lead to other speculative bubbles and panics that threatened economic stability. Walpole’s influence as effectively the Treasury Secy and central bank chairman wrapped in one would span the next two decades, and earn him the historical reputation as “the true ruler of England, despicable as he was in many respects” . Walpole would seemingly forever cement the advantages to a growing long-term national debt and a monopoly central bank to manage it. Almost half a century later, Alexander Hamilton, America’s first Treasury Secy, would study and admire  Walpole for his “legendary turnaround” role in managing the South Sea financial crisis and promoting the status of the BoE, and especially his reputation as “the true ruler of England.”
Over the course of 1694-1764, British sovereign national debt to the BoE and other privileged corporate entities and investors exceeded £130M, and the sovereign was thusly so strapped that interest on the debt could not be paid. It was in 1763-65 that King George III, Parliament’s George Grenville and the BoE turned their sights toward the American colonists, searching for tax revenue to control the exploding national debt and seeking to ban Colonial Script, American colonial paper money that staged a competitive threat to the BoE’s monopoly on paper currency. The Currency Act of 1764 (in conjunction with the BoE charter extension of 1764) made it illegal for colonies to print their own money as legal tender for public and private debts, and the infamous Stamp Act of 1765 sought direct tax revenue in the form of valid British currency only, not Colonial Script. From 1763-1773, though the Stamp Act was repealed and the Currency Act amended to allow colonial money issuance for public (but not private) debt, failure to resolve the issues of “taxation without representation” and “subversion of American rights” led to a Declaration of Rights and Grievances of the First Continental Congress and the Revolutionary War.
In 1797 the BoE’s gold reserves had been so depleted from the War and from international traders increasingly demanding gold specie payments in exchange that the British sovereign yet again sanctioned the BoE from paying out gold until 1821, requiring it to issue banknotes (IOUs, essentially) instead. Banknote holders protested at the steps of the “Old Lady of Threadneedle Street,” and price inflation spiked, vacillating wildly between 1797 and 1821 [Fig 1]. Though the concurrent industrial revolution fueled real growth in the British economy, the national debt would continue to increase (to £844M in 1821) from several prolonged wars (including the Napoleonic) and continued international expansion.
Britain’s leverage of public and private credit helped propel it to superpower status, but contributed to significant inflationary and deflationary economic cycles in the early nineteenth century [Fig 1]. Several financial crises and prolonged recessions led to an erosion of confidence in the BoE, subsidiary banks and finance. The Bank Charter Act of 1844 reaffirmed again the monopoly status of BoE banknote issuance, but only if they were 100% backed by gold – marking the influence of the British Currency School [9,10] to officially establish a gold standard to combat price inflation. The British Treasury retained the power to suspend the gold standard in the case of a financial crisis, which it did at various points in the mid-1800s and again at the outbreak of WWI. In the 1844 Act, demand deposits were exempted from the 100% reserve requirements – the Currency School argued that unlike banknotes, demand deposits were not money  – thusly, fractional reserve banking remained a fixture of the British banking system. It didn’t take long before a significant credit expansion by the BoE and subsidiary banks fueled a speculative bubble that caused a yet another drain on gold specie reserves, triggering a suspension of the gold standard (1847) and a flight to recapitalization. Britain would continue to struggle into the twentieth century with such leverage cycles, exacerbating its ability to sustain its economic expansionist growth model built on public and private credit.
If this brief history of the BoE rings a bit with the history of America’s Federal Reserve Bank (The Fed), it is no coincidence. Though many colonists and founders were intent to escape the British economic leviathan, complete with ever-growing sovereign debts, a hungry taxation bureaucracy, and a monopoly central banking system to reinforce and propel the machine, there existed very influential landed aristocrats that “had been staunch Patriots, but Patriotism did not mean the same thing to manor lords as it did to the population at large…they resented and resisted George III for meddling in their affairs and joined in revolution against him in much the spirit of the feudal barons who had exacted Magna Carta from King John at Runnymede” . Robert Morris, ‘financier of the Revolution,’ was certainly one of them, and Alexander Hamilton his protégé. Morris would move to establish a monopoly national bank similar to the BoE in 1781, before a peace treaty with Britain was finalized. The “Bank of North America” was in fact the first fractional reserve commercial bank in the U.S., and quickly adopted a pyramid of expanding money and credit on top of a reserve of specie . The inflation of its banknotes on the market was a major contributing factor to its demise as a national central bank in 1783, but it would retain private regional commercial banking status in Philadelphia for many years.
Though Morris fell from political favor, Hamilton would carry on his “nationalist vision of a strong central government, the power of the central government to tax, a massive public debt fastened permanently upon taxpayers”  and finally, a central bank to reinforce and propel the machine. Hamilton spent many years building the case for strengthening the taxing power of Congress, which the 1781 Articles of Confederation refused to allow the federal government [8,11,12]. It is no surprise that Hamilton’s first public position was as Receiver of Continental Taxes for New York, appointed by Morris in 1781 . As a major contributor to the Constitutional Convention in 1787, and the ratification process via his writings in the Federalist Papers, Hamilton was able to secure remarkably few restrictions on the new federal government’s power to tax, borrow and spend in the Constitution. In particular, Article I, Section 8, Clause 2 states that “Congress shall have the Power…to borrow Money on the credit of the United States” – with no conditions specified. Hamilton would use such clause, along with his “necessary and proper” clause rider, to later promote his Constitutional argument for a national central bank.
Morris endorsed Hamilton as Treasury Secy to George Washington, when a newly elected President Washington asked Morris what should be done about financing public debts . The “First Bank of the United States,” proposed to Congress by Secy Hamilton in 1790, was chartered to provide central government financing, a centralized currency, and fractional reserve lending, national and foreign. This First Bank of the U.S. was a “private” company with shareholders and a limited charter as the sole federal bank, similar to that of the BoE. Government debt financing and a resolution to the issue of a fiat paper currency were central motivators, given the devalued status of Continental currency, Revolutionary War bonds, and post-Continental note certificates. Continentals were fiat money from the start, and when colonial governments issued too many notes or bills, and failed to retire them out of circulation through taxation or bond issuance, inflation surfaced (“not worth a Continental”) [11-13].
The net federal and state debts from the War and the post-Continental period were estimated by Hamilton at almost $80M and held by domestic and foreign creditors (foreign debt ~ $11M; Continental and post-Continental debts ~ $40M; state debts ~ $25M; annual interest ~ $4M) [8,12,13]. Hamilton urged Congress to assume and consolidate the debts into a single national debt in 1790, to be redeemed and refinanced into new bond issuances with a lower average interest rate and six ways to subscribe . Much of the existing debt was trading at far below par (some for as little as 10% face value), acquired on the secondary market by wealthy investors, and such speculators stood to profit handsomely from the proposed redemption package. Hamilton’s debt redemption scheme had been recycled from an earlier scheme proposed by Robert Morris, as a basis for establishing the Bank of N.A. Of the scheme, Morris was quoted as saying that the windfall to the public debt speculators at the expense of taxpayers would cause wealth to flow “into the hands which could render it most productive” .
Alert readers may be asking themselves why Hamilton chose to make debt holders of such depreciated paper “whole” by offering to redeem at values closer to par, as the new government could have either redeemed at current market value, or even allowed such paper to depreciate out of existence on the secondary market, especially the domestic state and post-Continental note certificates that made up the majority of the legacy debt. Some in Congress supported only the servicing and repayment of the foreign debt and the honor of Continental fiat currency, as three of the thirteen states had largely retired their state debts .
In essence, Hamilton pulled a Walpole, seeking opportunity and power in leveraging public credit to raise even more funds, to be administered and further leveraged by a federal central bank with monopoly powers to issue public debt securities and fiat currency. Hamilton knew that such a system was unsustainable without an adequate stream of federal tax revenue to secure the debt, in keeping with the British taxation model. Spain in the 17th-18th century, and France in the 18th-19th century, lost any imperial advantage that they may have had against Britain, in part due to their inability to adopt a financial system of public credit with proper funding and servicing. Historians acknowledge Britain’s relatively “efficient” tax system (in terms of tax collected and not pocketed or evaded) as no small contributor.
Hamilton was not only motivated toward funding the existing and growing national debt, but equally if not more in increasing the money supply and liquid capital for investment. Gold and silver specie were in relatively scarce quantity in circulation compared to the size of the public debt (one estimate is 20x in 1783 ), and the track record for banknote issuance pyramided on top of specie reserve had serially resulted in inflationary tendencies. Yet Hamilton’s answer to establishing public credit through a national central bank was to transform public debt into a form of money itself, by casting the debt into public securities and paper fiat currency: “To this provision…will procure to every class of the community some important advantages…It is a well-known fact that in countries in which the national debt is properly funded, and an object of established confidence, it answers most of the purposes of money. Transfers of stock or public debt are there equivalent to payments in specie; or in other words, stock, in the principal transactions of business, passes current as specie.” . British economic historians would recognize securitized funding for public debt as common practice in eighteenth century England, part of its “financial revolution” , and a powerful source for its expansionist foreign policy. Modern monetary theorists would relate Hamilton’s public credit system to the “monetization of the debt,” a process regularly practiced by our Federal Reserve through open market operations (asset swap programs). Under Hamilton’s securitized system, principal payments on the debt would be unpaid in favor of regular interest payments, under the “full faith and credit of the United States.”
In reading Hamilton’s First Report on Public Credit , it is evident that he struggled with two problems surrounding his proposed public credit system, which remain unresolved to this day. The first is the issue of the unfunded state: “…by being well funded, [the public debt] has acquired an adequate and stable value. Till then, it has a rather contrary tendency. The fluctuation and insecurity incident to it in an unfunded state, render it a mere commodity, and a precarious one…one serious inconvenience of an unfunded debt is that it contributes to the scarcity of money” . Hamilton undoubtedly viewed liquefying the national debt as a way to “build the national wealth” – a funded debt allowed Britain to borrow large sums of money to finance wars and growth via the issuance of long-term bonds and annuities, and such a system maintained relative stability as long as Britain could push off repayment of principal, employ tax smoothing, or enforce tax collection by any means possible, including war. When the latter didn’t work, the flight of gold specie would lead to financial crises and economic recessions or depressions.
Hamilton’s second problem was with speculation and speculators, and the potential undue they might have toward a public credit model of “adequate and stable value” as well as their contribution to “a pernicious drain of our cash from the channels of productive industry” and “the present depreciated state of…property” . His text indicates that he really had limited grasp of the economic instabilities from an over-extension of credit, the dynamics of inflation and deflation following such credit-money expansions, and likely even the laws of supply and demand. He discusses asset price deflation (a modern term, not his) in rather circular terms, blaming speculators and insisting that a cure for such evils was a monetization of the public debt: “The decrease in the value of lands ought, in a great measure, to be attributed to the scarcity of money; consequently whatever produces an augmentation of the moneyed capital of the country must have a proportional effect in raising that value. The beneficial tendency of a funded debt in this respect has been manifested by the most decisive experience in Great Britain.” Moreover, Hamilton endorsed the concept of “easy money,” the same easy money that leads to credit expansions and speculative bubbles : “The interest of money will be lowered…for this is always in a ratio to the quantity of money, and to the quickness of circulation. This circumstance will enable both the public and individuals to borrow on easier and cheaper terms” .
Few Americans (and others, no doubt) are probably aware that debt monetization (quantitative easing, essentially) and cheap money were prominently endorsed in Hamilton’s early Report and not as devices invented later by the Federal Reserve. Hamilton’s proposal for a sinking fund in the Report was expressly to be used to purchase government issued securities on the market to drive their value closer to par , in effect, to give the appearance of retiring the debt cheaply, but in actuality being an asset swap program (fiat dollars for securities) that manipulates the market to fix and stabilize the price of such securities. The more securities trading below par (due to the bearish speculations that Hamilton expressed such dislike toward) the greater need for such a device, which we today call the Fed’s “open market operations.” Like the Constitution, Hamilton’s reports put no limits on the government’s ability to borrow and to print money, and ultimately, to spend. Though price inflation had been a persistent problem prior to, and during, the period in which Hamilton wrote his Report (see [Fig. 2] below), he made no serious mention of such dynamic in connection with his proposed monetization scheme. Price inflation measures at that time included food and commodities and inflation existed precisely because of too much depreciated paper currency and too little specie (especially gold) to back it up .
Hamilton’s national central bank bill proposal accompanied the establishment of a currency mint, and import duty and excise taxes to secure long-term national debt financing . All of the proposals met with significant opposition, yet they all passed First Congressional muster in 1791. At issue was the centralized federal nature of the bank, currency mint, and excise taxes, power shifted away from private banks and mints and state excise taxes. Jefferson and Madison argued that the bank violated traditional property rights and monopoly laws and that Congress did not have the Constitutional authority to incorporate a bank or any other government-sponsored entity . The excise taxes proposed on domestic whiskey were to service the restructured $80M debt held by note and bondholders and in Hamilton’s words, “to discourage the excessive use of those Spirits, and promote Agriculture, as to provide for the support of the Public Credit.” After passage, the Whiskey Act led to a rather prolonged Whiskey Rebellion, a first test of the federal government’s power to enforce domestic tax collection. The debate between Hamilton, Jefferson and Madison over the establishment of a central national bank was extensive , and the deadlock only eventually broken by a reluctant referee, Washington. Congress approved the bank charter shortly after the Whiskey Act, and set a precedent for the central federal bank model that would ultimately become the Federal Reserve.
The First Bank’s charter was not renewed in 1811, facing strong continued opposition from Jefferson and members of Congress. Hamilton’s political influence had ended with his loss of life in a duel in 1804. The will to pay down the national debt completely began to build and was finally consummated by Andrew Jackson, a hard money entrepreneur and a common sense speculator with a penchant for limited government.
Unfortunately, free banking  and hard money would not ever completely take hold in America. The U.S. started with a fragile bimetallic (gold and silver) standard with the 1792 Coinage Act, but that standard would suffer from Gresham’s Law, driving gold out of the country and inflating silver stock . The lack of stability of a hard money standard would aggravate the success of free banking, and numerous episodes of mass credit expansions would lead to various manias, panics and crashes throughout the nineteenth century and early twentieth. (The late nineteenth century would be graced by one William Jennings Bryan, who would repeatedly call for mass printing of greenbacks, fiat currency issued during and after the Civil War.) Any chance free banking would ever have ended in 1913 with the establishment of the Federal Reserve Act and the Federal Reserve banking system. John Morgan and Andrew Mellon would come to replace Robert Morris and Alexander Hamilton as the champions for America’s version of the Banking School and national monopoly cartel banking.
Epilogue – The Debt, The Fiat Money and The Bank
The life of the national debt would grow with the monopoly powers of the central bank. Figures 2 & 3 represent that signature life for America, but the trends have been similar for many other sovereign nations. Figure 2 shows similar trends to [Fig. 1] (for the U.K.), that a rise in national spending (and debt) correlate with inflationary spikes, and inflationary spikes and upward inflationary trends can happen during periods when the money supply growth explodes, as succinctly depicted in [Fig. 3]. Though the national debt shown in [Fig. 3] is in nominal terms (not adjusted for inflation), the corresponding price index indicates that the real growth is high; the current nominal national debt at some $15T doesn’t even take into account unfunded liabilities, such as social entitlements (estimated at over $100T) and the cost of state defaults, should they occur and should there be a political will (and there likely will) for the Fed to step in with another asset buying program.
National sovereign debt, the oblivion spending by the national central government, and the monetary debasement of fiat currency via central bank debt monetization (asset swaps or any other monetary liquidity injection tool) have “grown the national wealth” as measured by GDP, but they have all come to represent a form of economic tyranny as well. At issue is the same issue that drove many of the original thinkers and founders – Locke, Smith, Paine, Jefferson and others – who were concerned about property rights and the role of government to protect those rights. State-sponsored monetary debasement is an old crime, one practiced in ancient Rome and in medieval China with limited success. Today that practice goes on in sophisticated form, with precarious implications. At a minimum, the property rights of creditors (and savers) are continually debased, at the expense of debtors, who gain under inflationary conditions.
Though the colonists and founders escaped George III and Parliament, they did not secure the escape of the pecuniary system that has morphed into a realm of modern monetary madness.
Dear Readers: Stay tuned for the next essay “Federal Reserve Capital Management,” which explores whether the Fed is just a giant hedge fund.
 “The Financial Revolution in England: A Study of the Development of Public Credit 1688-1756,” P.G.M. Dickson, Macmillan Press, 1967.
 “History of the Bank of England,” A.M. Andreadés and H.S. Foxwell, 1909.
 “The Mystery of Banking,” 2nd Ed, M.N. Rothbard, Mises Institute, 2008.
 “Paying for Privilege: The Political Economy of the Bank of England Charters, 1694-1844,” J.L. Broz and R. S. Grossman, August 2003.
 “The South Sea Bubble: Memoirs of Extraordinary Popular Delusions and the Madness of Crowds,” C. MacKay, 1841.
 “Devil Take the Hindmost: A History of Financial Speculation,” E. Chancellor, FSG Press, 1999, p.58-95.
 Walpole was a staunch supporter of the BoE in Parliament, representing the BoE’s bid against the South Sea Company for the debt swap deal. Dickson  is ambiguous about whether Walpole lost money on the South Sea Bubble – he makes it clear that he held £2K stock from the April 1720 issuance, so he obviously engaged in the mania along with others, but Dickson claims he held his stock for final clearing until 1723, which was well after Walpole’s/BoE’s receivership plan was enacted, in which many stock (debt) holders benefitted from the bailout/backstop/put terms implied; i.e., the stock wasn’t allowed to simply float to zero, or the original debt holders left with worthless claims after loaning the gov’t money in exchange for the original annuities and other issuances. Therefore to make the claim that he lost money is not a stretch. He gained notoriety for restoring faith in public credit, but let’s not forget the self-serving aspects: he bailed himself and others out in the process, and strengthened his BoE patronage.
 “Alexander Hamilton: A Biography,” F. McDonald, W.W. Norton, 1979. This is an exceptionally well-researched, even-handed biography of Hamilton.
 “Currency and Banking Reform in 19th-Century Britain,” M. McCaffrey, Ludwig von Mises Institute, September 2010.
 “Manias, Panics and Crashes,” 5th ed, C.P. Kindleberger and R.Z. Aliber, J. Wiley, 2005.
 “A History of Money and Banking in the United States” M.N. Rothbard, Mises Institute, 2002.
 “Hamilton’s Blessing: The Extraordinary Life and Times of Our National Debt,” J.S. Gordon, Walker & Co., 1997. This is an extended essay on the history of the U.S. national debt, taxation, and the economics and politics of both since the 1780s. Though Mr. Gordon is most unfortunately pro-central bank, anti-free bank and anti-Jeffersonian, his candid essay provides many insights into why the U.S. exists today bearing significant looming problems with sovereign debt and a failed system of taxation. Mr. Gordon is thankfully anti-Keynesian.
 “One Nation Under Debt: Hamilton, Jefferson, and the History of What We Owe,” R.E. Wright, McGraw-Hill, 2008.
 “First Report on Public Credit,” Alexander Hamilton, January 1790. The First Report contains several important quotes by Hamilton on a monetized system of public credit, an accounting of the foreign and domestic federal debts, the proposal to restructure existing debt, and a proposal to establish a distilled spirits excise tax, the first domestic federal tax. “Second Report on Public Credit,” Alexander Hamilton, December 1790. The Second Report contains a revised proposal for a domestic distilled spirits excise tax to fund the debts, which included an accounting of state debts; the Congress had voted down the first proposal. “Report on a National Bank,” Alexander Hamilton, December 1790. This report contains Hamilton’s proposal for the establishment of a national central bank. “Report on Establishment of a Mint,” Alexander Hamilton, January 1791. This report contains Hamilton’s proposal for a mint, which was later approved by Congress via the Coinage Act of 1792. Note to the reader: if the LOC links above to Hamilton’s reports do not work, his papers are collected HERE on Google books.
 Hamilton’s defense of the Constitutionality of a national bank can be found HERE; his intent to model the bank and a centralized financial system after the BoE should come as no surprise, given that he was a student and admirer of Robert Walpole, the First Lord of the Treasury of Great Britain 1721-1742, and the Walpolean financial system . Jefferson’s defense can be found HERE, with notable quotes out of the text: “…the existing banks will, without a doubt, enter into arrangements for lending their agency, and the more favorable, as there will be a competition among them for it; whereas the bill delivers us up bound to the national bank, who are free to refuse all arrangement, but on their own terms, and the public not free, on such refusal, to employ any other bank…It may be said that a bank whose bills would have a currency all over the States, would be more convenient than one whose currency is limited to a single State. So it would be still more convenient that there should be a bank, whose bills should have a currency all over the world. But it does not follow from this superior conveniency, that there exists anywhere a power to establish such a bank; or that the world may not go on very well without it…Can it be thought that the Constitution intended that for a shade or two of convenience, more or less, Congress should be authorized to break down the most ancient and fundamental laws of the several States; such as those against Mortmain, the laws of Alienage, the rules of descent, the acts of distribution, the laws of escheat and forfeiture, the laws of monopoly?”
 See, for example, “Aurophobia: Or, Free Banking on What Standard?” in “Economic Controversies,” M.N. Rothbard, Mises Institute, 2011.
Notes to Figures:
[Fig. 1] Data sources: U.K. National debt/GDP; Historical UK Consumer Price Inflation, 1750-2009 – “Consumer Price Inflation Since 1750,” J. O’Donoghue, L. Goulding, G. Allen, 2004; Note that price inflation is the YoY change in the U.K. Retail Price Index (RPI) with numbers reported after 1947 HERE.
[Fig. 2] Data sources: U.S. National Debt/GDP; Price Inflation is the YoY change in the Consumer Price Index (CPI) reported by the BLS before 1983. (The CPI reported 1983 and after by the BLS was modified to minimize food and commodities. The pre-1983 CPI is still calculated by several sources, most notably John Williams’ Shadow Gov’t Statistics (SGS), which is the source of the data shown.)
[Fig. 3] Data sources: National debt and CPI (SGS) data from the same sources as Fig. 2; M3 money supply is taken from both Federal Reserve data up to 2006 (when the Fed discontinued providing it) and external sources (NowandFutures.com) which still calculate it based on the same formula.]]>
Commodity prices have risen dramatically over the last year, especially in basic agricultural commodities (grains, soy, cotton), certain industrial metals (copper, palladium, rare earth) and lumber. Concise evidence of this rise is seen in the CRB Index, a price index of 19 commodities, including many of those cited; this index has risen 26.3% over the last year, and 31.2% just since late August. Not coincidentally, on August 27, 2010, Federal Reserve Chairman Ben Bernanke gave a speech announcing that a new round of targeted monetary quantitative easing measures were needed and to be expected in the coming months, even though the Fed’s Permanent Open Market Operations (POMO) had begun churning up a few weeks earlier. And thus began a six-month surge in commodity prices, taking the major stock indexes higher for the ride (see Figs 1-6 below).
Since August 2010, we’ve seen repeated news reports of rapidly increasing inflation measures in China and many Emerging Market (EM) countries (Fig 7). For example:
· China: CPI increased 283% from July ’09 trough of -1.8% to Nov ’10 recent peak of 5.1%, and is running 12% yr/yr food inflation;
· Vietnam: CPI 12.2% Jan 2011, 13.1% yr/yr food inflation;
· Egypt: CPI 10.4% Dec 2010, 18.5% yr/yr food inflation (global high);
· India: CPI 9.7% Dec 2010, 17.1% yr/yr food inflation;
· Russia: CPI 8.8% Dec 2010, 12.8% yr/yr food inflation;
· Indonesia: CPI 7.0% Jan 2011, 16% yr/yr food inflation;
· Brazil: CPI 5.9% Dec 2010, 10.4% yr/yr food inflation.
This inflation has led to demonstrations in China, as well as price fixing plans by the Chinese government, and riots in other emerging or frontier market countries, including Tunisia and Egypt of late. Many pundits, including Mr. Bernanke himself, have concluded that the commodity inflation is based on strong raw demand, and not a monetary phenomenon. These “Commodity Malthusians” as I like to call them, cite that there is simply a growing demand for too few goods, and that those goods have a hard resource limit, much like the original Malthus argument that population growth would exceed earth’s ability to sustain with its resources (“The power of population is indefinitely greater than the power in the earth to produce subsistence for man“). However, the Commodity Malthusians have not made their argument, and the evidence suggests that both monetary and trade policies have aggravated the rise in both core and commodity inflation globally.
So how do I know the last statement to hold weight? A straightforward explanation is that the U.S. has been exporting U.S. dollars for decades to other economies, buying foreign goods for consumption – the nominal cumulative total U.S. trade deficit is over $39T from 1985-2010. Furthermore, many commodities are priced and market-driven in those dollar terms. Certainly for China this is true: our trade deficit with China is near an all-time low ($252.4B in 2010, nominal cumulative $2.25T since 1995), China maintains a large holding of U.S. Treasury debt ($895.6B), and the Chinese Yuan/Renminbi is pegged to the dollar (Fig 8). The U.S. maintains a trade deficit with many high inflation EM countries, such as Vietnam, Indonesia and Egypt, in addition to all four of the BRICs. Some have made the overly simplistic counter-argument that since many of the EMs have a sovereign currency not pegged to the dollar, that the price increases are demand driven in these fast growing economies, especially in cases where the local currency has strengthened against the dollar. What this argument fails to factor is that commodities are all too often bought and sold with dollars, not the local currencies, and that many of these same EMs are importing a plethora of dollars from international export trade of their goods and/or from the investment dollar flow into the country from foreign interests. The flood of dollars into China and other countries has led to too many dollars chasing commodities and goods with a weakening of purchasing power – the classic definition of inflation (“always and everywhere a monetary phenomenon,” as Dr. Friedman warned).
Much has been made about the Fed’s “pump-priming” of the economy with cheap money (target interest rates at historical lows) and its repeated use of POMO and other securities purchasing programs since September 2008. Along with the November 2010 announcement of $600B in quantitative easing (“QE2”), the Fed will have added over $1T in monetary liquidity to the markets since March 2009, and over $2T since September 2008 (Fig 9). Money supply measures continue to increase, at least those that are still published by the Fed (Fig 10). Where is all the money flowing? Some made its way into member bank reserves, to shore up the massive losses from the housing/mortgage and credit market crisis. But a good amount has funneled into the commodities futures and stock markets, and the timing of the injections with those market surges is evident. This isn’t a new phenomenon; markets have surged following dovish Fed monetary policy at every turn, giving rise to the S&L bubble of the ‘80s, the Nasdaq bubble of the ‘90s, as well as the early stages of the housing and commodity bubbles after the millennium, with inspiration sourced to former Fed chair Alan Greenspan. The “Greenspan Put” has morphed into the “Bernanke Put” – a play on the options term that implies a tradable floor on asset prices, as the Fed pump-primes (price fixes) to save the day with its inflation bias. The effect this has had is to continually weaken the purchasing power of the U.S. dollar, and ultimately will mean a pernicious global tax on those holding dollars and buying commodities priced in those dollars.
The CRB Index over a 25-year period (Fig 1) is most revealing of the dynamics discussed in the last paragraph, focusing on the rise and fall of the index with dollar weakening and strengthening. Some may say there is an anomaly with the significant strengthening of the U.S. dollar from ’98-’02, but not so; this dollar strengthening was a result of a short squeeze from a crowded short trade on the dollar, even though the money supply was increasing and interest rates were kept at a relative low, and so with such qualified strength there remained a floor in commodity prices. When Greenspan opened the floodgates on interest rates to the downside in 2002, commodity prices exploded, unabated until the height of the housing/credit market bubble, followed by the rise again after Fed liquidity injections from March 2009 onward.
What has me so worried about the Commodity Malthusians is that their ever-increasing demand-driven arguments sound an awful lot like the hollow arguments made during the housing boom – that demand (and prices) could continue to increase indefinitely. Even more worrisome is their lack of recognition of demand substitution for many commodities. Though they claim many commodities will increasingly have inelastic demand, the fact is that there are viable substitutions that will change the dynamics on that inelasticity, making the demand more elastic over time . Of course, this won’t matter if the price levels are driven by global monetary inflation – not just from the dollar but also from other currencies that are continuously devalued via inflation-biased monetary policies. As Keynes said, in the long run we are all dead.
My guess is that this situation will end one of two ways. One, global markets will shift to recognize a new reserve currency (or a basket of currencies), and that commodities will increasingly be priced and market-driven in that measure. The bright side, and a true challenge, is if that measure follows some standard, and maintains relative stability over the course of time. The other possible outcome is that the U.S. will fix the Fed’s money printing transgressions before the stagflationary drain drags us all down too much. Commensurately, we need to address global debt and trade imbalance issues, with the U.S. held to a higher standard than continuously rolling over ever-increasing debt and unfunded liabilities that have no chance of being repaid, and that are obscured by the Fed’s “asset swap programs.” Whom are we fooling? There is no such thing as a perpetual motion machine. Those put options can expire worthless.
“Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” –Ben Bernanke, National Economists Club, Nov. 2002
 Commodity substitutions can be made for many of the inflated commodities discussed. Above a certain price, it is more economical to substitute aluminum for copper in at least 20% of the applications of copper. Many rare earth metals that are deemed crucial for electronics and other specialty applications have non-rare earth metal replacements: one example is neodymium, a rare earth magnetic material that can be replaced with nanostructured iron alloys. Additionally, while it has been reported that the rare earths have supply constraints due to a Chinese embargo (China mines some 90% of the world’s supply), China does not have the largest deposits, and rare earth elements are relatively abundant in the earth’s crust. Agricultural commodities have many substitutions, and consumers regularly change their preferences based on supply and demand to compensate – crops can vary widely with weather, but crop utilization and capacity can also be altered. Lumber can be substituted with other building materials, such as composites. Inelasticity is a perception that changes with time and technology innovations – and can take rapid swings in the commodities futures markets with it. To the bullish speculators buying into the “commodities supercycle”: caveat emptor, and don’t forget to hedge.
 Official reports of core inflation (CPI) in the U.S. by the BLS have been consistently low over the last two years. Other independent statistical measures of CPI suggest that the actual core rate is much higher, 5-6%, closer to current inflation reported in Brazil. Food inflation is also reportedly low, but independent year-over-year measures are anywhere from 5-15%.
 Currency devaluation is sometimes referred to as monetary debasement. The history of monetary debasement has been discussed by economist Murray Rothbard in “What has government done to our money.”
Notes to Figs 1-10: The reader is encouraged to look at the following charts: The CRB Index, first over a 25-yr period with the U.S. dollar index $DXY (Fig 1), and then over the last year, correlated with equity metal miner proxies for copper and rare earth metals (Figs 2,3) and the Dow Jones Coal Index (Fig 4). The six-month relative futures contract performance of various commodities, many of which make up the CRB Index, is also notable (Fig 5), with almost 100% rise in the futures prices of cotton, 70% in corn, 60% in palladium. Major stock indexes over the last year (Fig 6). Food prices and EM inflation (Fig 7). The U.S. and Chinese global trade balances, core inflation rate in China, the CRB Index with the U.S. dollar index, and Fed money supply measures (Fig 8). The Federal Reserve reported balance sheet showing liquidity injections and asset purchase programs (Fig 9). Money supply measures M1, M2 and M3 (Fig 10). Note that M3 has been considered the broadest measure of the money supply, and is defined as M2+large time deposits, institutional money market funds, short-term repurchase agreements and other larger liquid assets. M3 is no longer reported by the Fed, though their explanation for such discontinuance leaves one wondering why. M3 since 2006 has been estimated by various sources.]]>
Free market capitalism is under assault. Framed as the culprit for the global financial crisis by the popular media, politicians and ideological opportunists alike, who expediently blame the United States for igniting the crisis. The irony is that we haven’t had true free market capitalism in the U.S. for a very long time. Plagued with recurring financial panics, recessions and downright depressions, the real culprit is the federal government management of money and credit that is quite antithetical to free markets.
Article I, Section 8 of the U.S. Constitution clearly gives Congress the enumerated right “To coin money, regulate the value thereof…” But in 1913, Congress decided to outsource monetary management to the Federal Reserve Banking System. And it did so for purely political reasons [1-4]: to charter an ‘independent’ body with the power to print paper money when the needs of government or special interests arose. More to the point: to finance government debt and perpetuate government spending habits; to rescue banks that become illiquid and insolvent due to risk mismanagement and/or instabilities in a fractional reserve banking system; and most insidiously, to inject inflation into the economy when prices fall below a certain point (price controls). None of these actions belong to free market measures in a capitalist society.
The stark reality is that the U.S. abandoned free market principles when it adopted fiat currency manipulation strategies and promoted a fractional reserve banking system that lends out many more dollars than exist in real deposits. A fiat currency (e.g., U.S. Dollar, Euro, Sterling, Yen) by itself is not the problem; it is the abusive government regulation of the value of the fiat currency that is anti-free market. Purposefully driving interest rates to zero instead of allowing for market determination of rates is anti-free market manipulation. Likewise, lending money created from thin air instead of from a rational measure of deposits undermines the supply and demand of resources that are natural to a free market and distorts healthy business cycles, not to mention the high risk of high leverage if loans default. The U.S. did not invent this brand of money and credit misregulation – it was adopted from millennia of central banking history in Britain and Europe [1,5,6]. The U.S. has become perhaps uniquely addicted to the easy money and credit binges promoted by our central bank, the Fed – especially since demand for Treasurys by foreign creditors (i.e., China and Japan) is limited. Runaway government spending, off-balance sheet entitlement liabilities and easy credit promises made to voters have throttled this modus operandi. And the crony capitalism of government welfare (bailouts, “subsides”) to large corporations and financial institutions has only made the addiction worse.
Consider the following basic examples to further illustrate. In a free market, interest rates are set by the supply and demand of the market, not artificially by a central bank. “When the Fed lowers rates artificially, they no longer reflect the true state of consumer demand and economic conditions in general. People have not actually increased their savings or indicated a desire to lower their present consumption. These artificially low interest rates mislead investors. They make investment decisions suddenly appear profitable that under normal conditions would be correctly assessed as unprofitable. From the point of view of the economy as a whole, irrational investment decisions are made and investment activity is distorted” . Artificially low rates are used to “stimulate” the consumer driven economy and interest rate sensitive investments, but the damage is borne in a misallocation of resources and a distortion of healthy free market driven business cycles. Consumers save less and consume more resources, and businesses that choose to invest will not only find resources limited and even more expensive as time progresses, but lending supply limited unless banks relax their reserve requirements. Modern fractional reserve banking answers this problem: banks lend from checkable demand deposits as well as timed deposits (such as CDs). Money that is lent can be multiplied by lending out on a basis of fractional reserves – for every dollar in checkable deposits, a dollar lent is deposited in checking and loaned again, up to the legal reserve limit. In a loose monetary environment, credit expansion means greater risk, as we have seen just recently in the credit boom of the last decade. In the worst case, artificially low rates and the artificial growth in lending supply (credit expansion though the creation of money in fractional banking) end in a business recession or depression: businesses cannot complete all of the invested projects due to the scarcity and/or inflationary expense of specific resources, and consumers cannot continue to spend what they don’t have. Natural supply and demand of the business cycle is disrupted.
As  succinctly points out, “The interest rate coordinates production across time.” And as far as the growth in the money supply caused by the artificial credit expansion, the effect on the fiat currency is profound: it further drives up prices of specific resources. When the system becomes unstable, banks run into liquidity and/or insolvency problems. And the central bank (the Fed) exists to reliquify banks that hit the instability curve. “Although interbank clearing mechanisms and continuous public supervision would tend to limit credit expansion in a fractional-reserve free-banking system, they would be unable to prevent it completely, and bank crises and economic recessions would inevitably arise. There is no doubt that crises and recessions provide politicians and technocrats with an ideal opportunity to orchestrate central bank intervention…Until traditional legal principles are reestablished, along with a 100-percent reserve requirement in banking, it will be practically inconceivable for the central bank to disappear” . In short, the free market and healthy business cycles are held hostage by the Fed.
The interplay between the savings rate, interest rates and lending, as they affect business cycles and consumer spending habits, are central to Austrian business cycle theory, founded by Ludwig von Mises. The Austrian economics school , led by Mises, his student Friedrich Hayek, and a range of economics scholars including Murray Rothbard and Henry Hazlitt, propose a different route to promote a free market economy – one based on a commodity-backed currency or standard that cannot be easily manipulated, banking and credit institutions that do not rely on an unstable fractional reserve practice for lending, and the lack of a need for a central bank that intervenes in markets with planning and control to undermine them.
As Mises noted in his seminal “Theory of Money and Credit:” “There is need to realize the fact that the present state of the world and especially the present state of monetary affairs are the necessary consequences of the application of the doctrines that have got hold of the minds of our contemporaries. The great inflations of our age are not acts of God. They are man-made or, to say it bluntly, government-made. They are off-shoots of doctrines that ascribe to governments the magic power of creating wealth out of nothing and of making people happy by raising the ‘national income’” .
Hayek in his Nobel lecture on unemployment, aggregate demand and inflation: “The very measures which the dominant ‘macroeconomic’ theory has recommended as a remedy for unemployment, namely the increase of aggregate demand, have become a cause of a very extensive misallocation of resources which is likely to make later large-scale unemployment inevitable. The continuous injection of additional amounts of money at points of the economic system where it creates temporary demand which must cease when the increase of the quantity of money stops or slows down, together with the expectation of a continuing rise of prices, draws labour and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate – or perhaps even only so long as it continues to accelerate at a given rate” .
Rothbard in his “Case Against the Fed:” “The Federal Reserve System is accountable to no one; it has no budget; it is subject to no audit; and no Congressional committee knows of, or can truly supervise, its operations. The Federal Reserve, virtually in total control of the nation’s vital monetary system, is accountable to nobody—and this strange situation, if acknowledged at all, is invariably trumpeted as a virtue” .
Hazlitt on inflation, government spending and monetary management: “It is next to impossible to avoid inflation with a heavy [government] deficit. That deficit is almost certain to be financed by inflationary means – i.e., by directly or indirectly printing more money. Huge government expenditures are not in themselves inflationary – provided they are made wholly out of tax receipts, or out of borrowing paid for wholly out of real savings. But the difficulties in either of these methods of payment, once expenditures have passed a certain point, are so great there is almost inevitably a resort to the printing press.”…“’Monetary management’ in practice is merely a high-sounding euphemism for continuous currency debasement. It consists of constant lying in order to support constant swindling. Instead of automatic currencies based on gold, people are forced to take managed currencies based on guile. Instead of precious metals they hold paper promises whose value falls with every bureaucratic whim. And they are suavely assured that only hopelessly antiquated minds dream of returning to truth and honestly and solvency and gold” .
Robbins on conditions of recovery from “The Great Depression:” “The policies which have been pursued by the Central Banks in the attempt to counter deflation have resulted in the creation of a basis for credit expansion much more considerable than that existing at the commence of the slump. If business prospects were to brighten and confidence were to be restored, it would probably be incumbent on the authorities actually to contract this basis if things were not to get out of hand. To carry through such a policy of business stabilization and at the same time to attempt to get back to the price-level of 1926 are not compatible undertakings” .
We need not forever succumb to the mentality “We are all Keynesians now.” Keynesian monetary and fiscal policies – from artificially low interest rates and central bank bias toward inflation to high government deficits – have been utilized in one form or another over the last hundred years or so, with few exceptions. Mises may have had the last great word on Keynes though: “None of the arguments that economics advances against the inflationist or expansionist doctrine is likely to impress demagogues. For the demagogue does not bother about the remoter consequences of his policies. He chooses inflation and credit expansion although he knows that the boom they create is short-lived and must inevitably end in a slump. He may even boast of his neglect of the long-run effects. In the long run, he repeats, we are all dead; it is only the short run that counts” .
The bottom line is that it would be a tragedy if we forever abandon free markets, trust in money and banking, and ultimately, genuine economic liberty and prosperity. Let us all become Misesians.
References and Endnotes:
 “The Fed,” Martin Mayer (The Free Press, 2001).
 “The Case Against the Fed,” Murray N. Rothbard, (Ludwig von Mises Institute, 1994, 2007). This is available in epub format for download from the LvM Institute at mises.org.
 “Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse,” Thomas E. Woods Jr. (Eagle/Regnery Publishing, 2009). An excellent book with straightforward explanations of concepts that ought to be second nature in a free market. A must read for the high school and college students that will shape our future economies.
 “End the Fed,” Ron Paul (Grand Central Publishing, 2009).
 “The Evolution of Central Banks,” Charles Goodhart (MIT Press, 1988). As Goodhart contends, a central bank is a necessary development out of a conversion from commodity-backed money to fiat money and fractional banking.
 “Money, Bank Credit, and Economic Cycles,” Jesús Huerta de Soto (Ludwig von Mises Institute, 2006). Noted italicized quote is from p.638. This is a highly recommended work on the legal and ethical aspects of fractional reserve banking, including history of legal challenges to this system, which extend back over millennia.
 The Mises Institute, started in 1982 by Austrian School scholars, exists today as an education and research organization focused on promoting Austrian economics theory, as well as classical liberalism (which shares many concepts with modern conservatism). Classic works by von Mises, Hayek, Rothbard and others are freely available to read online at http://www.mises.org.
 “Theory of Money and Credit,” Ludwig von Mises (Yale University Press, 1953). Quotes are from the preface to the new edition, 1952. In this seminal work, Mises discusses the value of money, the business of banking under fiat money, interest rate policy and production, credit and economic crises, and finally, a treatise on the return to sound money (monetary reconstruction). Contrary to popular opinion among economists, the re-adoption of a commodity standard can be straightforward and with high-merit. Mises further outlines a re-adoption prescription in . Woods concisely reviews the myths and merits of a commodity standard on p.130-134 in .
 “The Pretence of Knowledge,” Friedrich August von Hayek (Economics Nobel Lecture, 1974).
 “The Inflation Crisis, and How to Resolve It,” Henry Hazlitt (Arlington House Publishers, 1978). Noted italicized quotes are from p.39 and p.32. A classic book on the myths and fallacies surrounding inflation, and straight talk on how to confront the inflation compulsion. Hazlitt appears to have been a staunch supporter of an international gold standard, which he passionately, if not controversially, comments upon (p.37): “It is precisely the merits of the international gold standard which the world’s money managers and bureaucrats decry. They do not want to be prevented from inflating whatever they see fit to inflate. They do not want their domestic economy and prices to be tied into the world economy and world prices. They want to be free to manipulate their own domestic price level. They want to pursue purely nationalistic policies (at the expense or imagined expense of other countries), and their pretenses to “internationalism” are a pious fraud.” Hazlitt echoes similar arguments made by Hayek in his book “Denationalization of Money” (Institute of Economic Affairs, 1990).
 “The Great Depression,” Lionel Robbins (Books for Libraries Press, 1934). Noted italicized quote is from p.164. This is an amazing book, written during the Great Depression by a keen observer from the London School of Economics. Robbins clearly began to understand and elucidate (particularly in Chapter III) the boom-bust cycles created by money and credit expansion, and the devastating effect it can have on capital formation, business planning and expectations. It is both a mystery and a tragedy that such an early text on the subject matter was not taken more seriously by other contemporary economists and economic policy makers.]]>
Many articles and tomes have been written this year about the 2008 Financial Crisis, but few have approached the subject with an analytic-based story as compelling as John Taylor’s . As we celebrate the one-year anniversary of that rocky week in September 2008, marked by major bailouts, bankruptcies and mergers of distressed financial institutions, massive Federal Reserve injections of money into the banking system, and a major economic and market contraction, we ask ourselves: how could it have been prevented? According to Taylor: by acknowledging as early as the Fall of 2007 that the root of the problem was counterparty risk dislocations and not liquidity problems, and by not shocking the system with excessive monetary easing or government intervention.
|“We should base our policy evaluations and conclusions on empirical analyses, not on ideological, personal, political, or partisan grounds.” -John B. Taylor|
Taylor focuses on specific interest rate spreads  to diagnose that the early problem (Summer 2007) was with the risk associated with bank balance sheets, causing banks and other institutions to contract their lending, including inter-bank lending, resulting in skyrocketing adjustable rate mortgage (ARM) and consumer interest rates, which in turn acutely affected the broader economy. His analysis also documented that had the Federal Reserve followed an “automatic policy rule” for setting interest rates in the early part of this decade (particularly 2002-2004, a period of excessive easing), that a housing bubble would likely not have developed, that a more gradual rise and fall in housing starts would have been realized, and that mortgage delinquencies would not have been as severe.
Importantly, Taylor’s analysis shows that there was a global correlation between interest rate spreads; i.e., that the spreads denominated in dollar-euro-sterling tracked each other quite nicely, indicating that the balance sheet risk issues were widespread among U.S., European and British banks, but not as coupled with Japanese banks. Similarly, many central banks in the U.S. and Europe (OECD countries) appear from the data to have ignored the use of a sound automatic policy rule for setting interest rates, placing rates artificially too low from 2002-5. This set a global environment for sharply rising housing investment as a percent of gross domestic product (GDP), amid a historically low global savings as a percent of world GDP.
Central bank liquidity programs (the Fed’s Term Auction Facility) and federal government Keynesian-style stimulus infusions (the 2008 U.S. tax rebates) had little effect in bringing down elevated interest rate spreads in 2008, according to Taylor’s analyses. Had those solutions been replaced by a targeted solution aimed at bank balance sheet issues, which evidently appear to have been driving the risk premium in the spreads, we might have seen a very different outcome. As Taylor notes, other measures of counterparty risk, such as credit default swap (CDS) premiums and the spread between interest rates on unsecured and secured lending in the inter-bank market became elevated and correlated in time with short-term mortgage/consumer-related rate spreads . Transparency into bank balance sheets was needed early.
To his character, Taylor generally refrains from talking about specific personalities involved in the policy decisions that led to, and prolonged, the crisis. Instead, he offers solid suggestions for policy reform, which include the global adoption and maintenance of principles (such as an automatic rule) for setting interest rates, diagnosed rationale for government intervention, and a predictable framework for government assistance to distressed financial institutions.
Clearly Taylor was not a casual observer during the crisis. After trying to convince colleagues early (Summer/Fall 2007) of the nature of the problem, he was repeatedly ignored. One might wonder upon the alternate history had he been Chair of the Fed.
References and Endnotes
 “Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis,” John B. Taylor (2009 Hoover Institution Press, Stanford University).
 The fundamental metric used in Taylor’s analysis is the 3-month “Libor-OIS Spread,” or the difference between the London Inter-Bank Offer Rate with a 3-month maturity and the Overnight Index Swap with the same maturity. Most ARMs and consumer interest rates in the U.S., Europe and Britain are tied to 3-month Libor, while the OIS is a market measure of federal funds rate expectations. As Taylor points out, factoring out interest rate expectations allows for further analysis of the dependence of the spread on risk and liquidity, two other important measures. The Libor-OIS Spread jumped a whopping 17x its usual standard deviation in August 2007, and remained relatively elevated until jumping another 100x in October 2008. Taylor has termed this phenomenon as a “Black Swan in the Money Market.”]]>
If you need a break from the acute spike in political correctness that now permeates popular American media, politics and culture, then I highly recommend the comedic works of Mel Brooks.
Many have probably seen his best-known and highest ranked film, “Blazing Saddles,” but fewer know that he co-created and wrote many episodes of the popular 1960s TV series “Get Smart,” a tongue-and-cheek satire of the secret agent genre. Brooks once said in an interview, “It’s an insane combination of James Bond and Mel Brooks comedy,” with the lead character Maxwell Smart (played by the brilliant Don Adams) reminiscent of another comedic genre of its own, the blundering Inspector Clouseau of Pink Panther fame.
The setup is this: when you get absolutely fed up with all that petty bickering and posturing and you’re convinced that just about everyone has lost sight of what it means to be free, pop in one of those Get Smart DVDs and kick back. Though I watched quite a few of these in rerun when I was a kid growing up in the 70s, I don’t notice it in reruns anymore. I also wasn’t old enough to recognize the sheer brilliance of Brooks, co-creator Buck Henry, and the many script writers so inspired: Get Smart is essentially Rocky and Bullwinkle, another favorite but of the cartoon genre. Agent 99 with her high-pitched, wide-eyed innocent-but-headstrong Rocky lines, and Agent 86 with his inflated-but-endearing smart aleck Bullwinkle wisecracks. “Missed it by that much,” “Would you believe…,” “That’s the second biggest…,” “Sorry about the crack about…,” “…and loving it” never get old.
Max is continually thwarted by the likes of Kaos agent Conrad Siegfried, a redolent Boris Badenov. Batman scoring music with Star Trek choreography brings more smiles.
Brooks and Henry had trouble getting the show accepted by network television executives, looking for another also-ran in television sit-com. But Brooks persevered, with his gutsy conviction “I was sick of looking at all those nice sensible situation comedies. They were such distortions of life.”
“Blazing Saddles” (c. 1974) is perhaps a required tonic for those too-many too-serious politicians running roughshod over all good people out there these days. Looking to change the country and the world all in one day? Sit down and watch “Blazing Saddles” and give it a rest. Satire never had it so good, and Mr. Brooks leaves all those self-righteous/lefteous “community service” folks in the dust with his witty message. Warner Brothers reportedly screened the film and made Brooks take out all the politically incorrect elements, but Brooks defiantly put them back in the final cut. All of us want to ride off into the sunset with Bart, who had that Western can-do sensibility, and that optimism of a free spirit.]]>
Everyone is now aware of the U.S. housing bubble and what it has done to our economy. Spurred by several factors, including the availability of cheap money and credit, lax lending standards, Wall Street sell-side analysts and credit rating agencies, and a decades-old government policy of encouraging commercial banks and savings associations to provide mortgages to low-income buyers who might otherwise not qualify to buy a home. What the housing bubble suffered from interminably was a lack of discipline: recognizing that housing prices could not increase forever and that valuation for the assets (pricing) was far out of whack with intrinsic value. Add to that the fact that many buyers simply did not understand the impact of adjustable-rate mortgage resets at higher rates. And let us not forget the bottomless pit that such government-sponsored entities (GSEs) as Fannie Mae and Freddie Mac represented, backing and buying all of those mortgage loans that were based on buyers that couldn’t pay even if the prices weren’t as inflated as they actually were.
We now find ourselves in the same situation with government. Consider this: have we ever known a government, be it federal-state-local, that has scaled back in scope and spending? As of this writing, the federal deficit is at an all-time high (>$1.2 Trillion) and many state and local governments are straining under their own debt. Are we in danger of a catastrophic event, such as government debt default? Whom would we blame, our legislators or ourselves or both?
Inaction usually comes at a high price, such as with the housing bubble, whereby all responsible parties ignored all the warning signs – as far back as 2004-5, mind you, and perhaps even earlier in the case of subprime mortgages. When the signs became quite obvious in early 2006, with the sharp decline in the market price of subprime mortgages and securitized packages of such mortgages (collateralized debt obligations, or CDOs), few at the Treasury and Federal Reserve stood up and proclaimed a problem. Meanwhile, during 2007 the shorts were making money on the fall of ABX (an index of subprime CDOs), and rightly so. The rest is history, as they say – complete and replete with government bailouts and an economic correction that has put us in greater danger of – even more government.
Not all bubbles need to end this way – certainly not our government bubble. Can you imagine a similar situation with what we have now: a federal government that seeks to make promises to every living constituent, to secure their sought-after vote and ensure continued authority and control? State governments that are given federal stimulus and grant money and put on the hook to keep the run-rate going even with a risk of default? Local governments that continue to spend and raise property and sales taxes, even in an economic slowdown? Sound familiar?
What we need is a clarion call. One that shouts for a major reversal of the growth and scope of government at all levels, but particularly the federal level. Do we really need career Congressmen and Senators that live their life spending increasingly more of our money for increasingly less value delivered? Is the majority not unlike shady mortgage lenders that sign up buyers (voters) by making promises with someone else’s money?
Surely this is not the scenario the Constitutional Framers had intended. The Constitution is clear regarding the role of the federal government in providing security for country and citizens, as well as protection of certain inalienable rights – but not much else. There is little accounting for the growth of monetary control (through the Federal Reserve), endless and many times toxic regulation (through various federal agencies), and the rise of public entitlement programs (social security, Medicare, nationalized health care), all of which threaten to reduce our freedoms and devalue our currency and assets, not to mention put our government at high risk for default.
Though we have had prosperous growth in the past, with an ever-rising gross domestic product (GDP) that approaches $14 Trillion on a nominal basis and $11 Trillion on a real basis, the growth of one component of GDP – government expenditures (G) – is almost twice that of another component of GDP – private investment (I). We now have a government that believes that increasing G to throttle the largest element of GDP, consumer spending (C), is sustainable and will lead to solid jobs and long-term prosperity. Government, and not the private sector, is increasingly perceived by partisans as the generator for everything from economic growth to social justice, providing for the span of what any citizen might need or want – per government specification. There is little care given to the fact that an increasing G crowds out I, and that individual freedoms are siphoned away. The rubric is a mounting campaign to discredit and destroy free markets, individual freedoms and choices, and the charity of the prosperous private sector.
Partisanship has not been the answer but the problem in the growth of government. Both national parties have supported big government largesse and spending for decades. The issue is not always individual party members – a few are dedicated and principled, championing fiscal discipline. The dilemma arises when such individual legislators are at odds with the ‘party line,’ which can be anything but principled – a means to the end of maintaining party control, to heck with fiscal discipline and limited government. The current American political system rewards the growth of governing power, no matter which party is in power – and government spending is the prime route to increasing that power.
The direction for those looking for less government, fiscal discipline and free markets will likely not be found in playing by the rules of the current American political process. Our nation was founded on the revolutionary notion that self-governing individual states would unite against a British parliament and monarchy, rejecting the authority of the parliament to govern them without representation. Yet today we can make the strong argument that elected representation in the House and Senate has become akin to a parliamentary process, whereby representation of constituents has been replaced by cloistered partisan politics and the inflationary government spending that fetches evermore power. Career partisan politicians are the antithesis of ‘less government.’ The Framers never intended that such beasts would become the rule – a rule that has meant a dramatic distortion of the spirit of the revolution, the Declaration of Independence and the Constitution. A return to the Constitutional concept of a ‘citizen-legislator’ is a crucial step. Instead of sending career partisans to seal our fate, the alternative is to send citizens that know their term is limited and will return to their district and chosen profession.
The growth of government has been synonymous with the elevation of social issues onto the national stage. As a corollary, the trend toward less government is met with the sensibility of a reduction of social issues in politics – Americans are more concerned about fiscal/trade and security issues and look at social issues as something that ought not to be on the federal legislative agenda but left to individuals and local governments. Many may argue that redress of inequalities of inalienable rights are a valid concern on a national political level – and this is supported by the Constitution – but the distortion of this redress to mean everything from entitlements to welfare to corporate bailouts has grown far out of control. The solution is to promote personal responsibility, accountability and social charity, all of which preserve the human notion of individual freedoms and choices that defined us as a great nation from the beginning and throughout our historic civil struggles.
James Madison, the principal author of the Constitution and the Federalist Papers, clearly regarded partisanship power as a detriment in Federalist 10 and viewed States’ rights as a check against unbridled federal control over the Union in assuring the inclusion of the 10th Amendment to the Constitution. However, a careful reading of Federalist 10 tells us that Madison did not believe we would ever arrive at the circumstance we now find ourselves in: that partisan power could corrupt and assert the type of federalist control that his present-day Anti-Federalists warned about. Madison’s laudable optimism in a strong Union republic was clear at the time: “A rage for paper money, for an abolition of debts, for an equal division of property, or for any other improper or wicked project, will be less apt to pervade the whole body of the Union than a particular member of it; in the same proportion as such a malady is more likely to taint a particular county or district, than an entire State.”
Those who debate or doubt Madison’s implicit support of the 10th Amendment need only read the following from Federalist 45: “The powers delegated by the proposed Constitution to the federal government are few and defined. Those which are to remain in the State governments are numerous and indefinite. The former will be exercised principally on external objects, as war, peace, negotiation, and foreign commerce; with which last the power of taxation will, for the most part, be connected. The powers reserved to the several States will extend to all the objects which, in the ordinary course of affairs, concern the lives, liberties, and properties of the people, and the internal order, improvement, and prosperity of the State.”
Of crucial importance is the fact that originally, state legislatures were to appoint Senators, to ensure representation of state legislatures, and as a reinforcement of the 10th Amendment. As Madison declared in Federalist 45: “The Senate will be elected absolutely and exclusively by the State legislatures. Even the House of Representatives, though drawn immediately from the people, will be chosen very much under the influence of that class of men, whose influence over the people obtains for themselves an election into the State legislatures. Thus, each of the principal branches of the federal government will owe its existence more or less to the favor of the State governments, and must consequently feel a dependence, which is much more likely to beget a disposition too obsequious than too overbearing towards them. On the other side, the component parts of the State governments will in no instance be indebted for their appointment to the direct agency of the federal government, and very little, if at all, to the local influence of its members.” This original intent was thwarted by the addition of the 17th Amendment, ratified by states in 1913, which dictates that Senators not be appointed by legislatures but by popular election. It was because of “partisanship and strife” that state legislatures fell under the pressure to ratify the 17th Amendment, having failed to appoint Senate representatives in many cases.
A path to less government clearly rests on the enforcement of the 10th Amendment and a move away from polarized partisan politics. The latter would be aided by a repeal of the 17th Amendment, which can be accomplished via the process set forth in Article V. Federal courts, including the Supreme Court, have repeatedly assaulted state and local governments for relying on the 10th Amendment to fight against the application of federal mandates and regulations, or essentially most of the impositions on states by an out-of-control federal government in scope and spending. This issue must also be addressed, as it signifies a serial usurp of states’ rights via federal power, sanctioned by federal courts that have no Constitutional authority to make law.
Furthermore, federal courts have continually misrepresented the Commerce Clause in Article I, particularly “to regulate commerce…among several states…,” or interstate commerce to mean that Congress has unlimited authority to impose unchecked regulatory power over commerce everywhere domestically, period. Madison enumerated the limits of this clause very clearly in Federalist 42: “A very material object of this power was the relief of the States which import and export through other States, from the improper contributions levied on them by the latter. Were these at liberty to regulate the trade between State and State, it must be foreseen that ways would be found out to load the articles of import and export, during the passage through their jurisdiction, with duties which would fall on the makers of the latter and the consumers of the former.”
A call to action for ‘less government’ could mean a good old-fashioned revolution. In his first inaugural address, Abraham Lincoln advised us: “This country, with its institutions, belongs to the people who inhabit it. Whenever they shall grow weary of the existing government, they can exercise their Constitutional right of amending it or their revolutionary right to dismember it or overthrow it.” These sobering words weigh heavily on those looking for a “lawful, peaceful, bloodless revolution to restore our Constitutional republic.” Grass roots efforts to push for the enforcement of the 10th Amendment and Constitutional mettle, and a concerted action to vote out all career partisan politicians are but a beginning.
This is a first in a series of articles planned on the growth of government, our political system and guidance provided by the Constitution and the Federalist Papers.
This article is dedicated to Publius and modern-day descendants. Keep up the good fight.
My commentary ‘calling’ started with enthusiastic and unsolicited posts on the Wall Street Journal (WSJ) online site, in response to articles published on various topics. Starting in May 2008 with capital markets – the role of the Federal Reserve, the impact of government regulation and intervention, the power of special interests, etc. Foreign policy and national security (inextricably linked), and targeted issues in the national debate, such as health care, ‘climate change’ and education, also captured my attention and comment.
I have since given up adding free online content to the WSJ site, and wish to publish this body of commentary somewhere (where better than here?), with the intent for it to provide further usefulness in the public domain. My apologies on the lengthiness – I have since learned that I should have been writing for my own site all along! Cheers to all of you who contribute free online content – it is a risky endeavor in terms of the returns.
Posts on Capital Markets: Capitalism and Free Markets
Posts on National Security and Foreign Policy
Posts on Health Care, Education, ‘Climate Change’ and Other Assorted Issues
Posts on Capital Markets: Capitalism and Free Markets
Let’s Try Market-Oriented Market Reform, 5/31/08:
About the only useful step Congress could/should make from Mr. Ely’s list is to modify corporate tax policy – specifically to bring the level of capital gains taxation for corporations (which include financial institutions) to the same level as individual capital gains tax rates (15%). This disparity alone discourages equity capital investments that companies would have otherwise made, and would likely raise revenue for the Treasury to boot. The market itself, without Congressional meddling, should handle all other reforms. In fact, interest rate policy should also be more market based (independent of the Fed).
A Brave New World for Financial Regulation, 6/19/08:
More regulation by the Fed or the SEC will not solve the problem. Investment banks by their very nature must be allowed to fail, as they will continually look to inventing innovative new products and strategies to take advantage of the efficient (or inefficient) markets. Risk comes with reward and failure. It is part of a free market system. To neuter it with heavy-leaden regulation will render the market anything but free – think socialism. Yes, investment bank fiduciaries should self-police themselves by balancing leverage and reserves to cover losses and margin calls, and investors should actually read prospectuses. What ever happened to accountability? Know your statistics and invest money you can lose. Don’t cast blame for risk taking and loss. Let failure run its course to clean out the system – others will swiftly step in to fill the void.
Information Age: Inherently Risky Business, 6/16/08:
This touches on the features of a market with inefficiencies. Though there are uncertainties we find difficult to quantify, game theory and other strategic approaches (some not so formalistic but intuitive) can help to identify them. Investors and traders should always keep in mind that there are unknowns, and only bet to lose what they can manage.
Toward a Transparent Financial System, 6/27/08:
I would add that price and volume speak for themselves and is information already readily available to everyone. My interpretation of Mr. Pandit’s piece is that the Fed should regulate all dependents equally, commercial or investment bank. But aye, there’s the rub – do we socialize risk and provide safety nets backed up by Uncle Sam for risky investments or do we let the free market work, with the successful investors surviving and unsuccessful investors failing? Commercial banks are heavily regulated because depositors expect that a portion of their money will be available if there is a failure (and there is a premium paid for that – FDIC). If more regulation means socializing risk, then we can do without it.
Paulson’s Fannie Test, 7/15/08:
One wonders whether Mr. Paulson cares more about shoring up the system to protect brokerage houses and hedge funds than he does to maintain a fiduciary role over the U.S. taxpayer balance sheet, and to promote a sound dollar. If Bear had been allowed to fail without backstops to protect bondholders we would have come to this Fannie/Freddie issue sooner. They too should be allowed to fail, and both stockholders and bondholders should take the hit, just like we all do when other investments fail. An RTC-like entity can handle the receivership of F/F’s portfolio from there. Let’s stop this nonsense about “systemic risk” management and let the free markets work as they should. Stop socializing risk Mr. Paulson, there is no blank check from the U.S. taxpayer, and please apologize to Adam Smith and Milton Friedman, who I am sure are both rolling over their graves simultaneously.
This was published as a Letter to the Editor in the Journal on 7/22/08.
What Price Would You Put on a Short Seller’s Head, WSJ Blog, 7/15/08:
The Uptick Rule and stricter enforcement of the borrowing rules were in force during the Tech Bubble – and that didn’t stop the rampant short selling. Sometimes I wonder why people have such short memories of market history…Don’t blame the short sellers. If you want to protect your shares, spend money on stock certs and only invest money long that you can ride out or lose. Short sellers are speculators – they provide liquidity to the market.
Why No Outrage? 7/19/09:
I disagree with James Grant – people are outraged with Fed and Treasury policies and actions – perhaps it is not as noticeable when the mainstream media is so fixated on popular culture, not to mention the high probability that the mainstream probably doesn’t even know anything about how interest rates are set, or about capital markets in general. I’ve gotten so outraged since the Bear bailout I’ve made it a point to start contributing to the WSJ forum pages – and I’m grateful that I have the opportunity to do so. If anything, the WSJ provides the best coverage of the issues surrounding the Fed and Treasury, but I think they could be even tougher in their opinion stances and investigative pieces. Having worked my whole life to become financially independent, fiscally responsible and debt-free, it is rather abhorrent that I must take the hit in not being very well compensated when I lend my money – the Fed and Treasury have seen fit to devalue the dollar with the policies of recent years, and providing bailouts for obscure bondholders I’m sure doesn’t help either. I wish I could have that kind of guarantee, but then again, I’m proud of my accomplishments in managing my money without such socialized backstops from a near oligarchy of a government.
How to Shake Off the Mortgage Mess, 7/30/08:
Asset liquidation is the key strategy here – lower the price enough and buyers will likely show up with cash in hand. The recent CDO sales by Merrill and others at cents on the dollar indicate that this is what is needed, but on a greater scale. There are buyers out there for the foreclosure backlog, but the price on the open market has to be allowed to come down – not subsidized by the U.S. taxpayer.
Hank Paulson’s Fannie Gamble, 8/1/08:
Bush has lost all credibility after he chose to support HR 3221 – Housing Pork and Fannie/Freddie Bailout ExtraOrdinaire. My embarrassment reaches far to Boise – where our own senators voted to support him and that. We really need someone in there soon who vetoes all earmark legislation headed for the WH. Massive budget deficits and a weak currency are not good for a sovereign populace and those supporting such should lose his/her job…our system should be rewarding those showing fiscal responsibility.
We’ll Protect Taxpayers From More Bailouts, 9/9/08:
The authors ought to go further and take a look at steps to “protect” our financial markets from government/special interest manipulation – and move them ever closer to freer markets. Fannie/Freddie should have been put into receivership, and assets sold, with bondholders losing out as much as equity/preferred holders. The U.S. taxpayer should not be on the line for this failure. The current Treasury’s best customers should not have undue influence on the functioning of financial markets in order to tilt the system toward their favor. What we need is a good old-fashioned Boston Tea Party style response to the Fannie/Freddie Bailout. Where and when will that come? The Treasury and Fed have not shown the value of “systemic risk management,” which looks to be a form of nonsense that we will look back on with more critical disdain in years to come. Let the Fed and Treasury get out of the way of the functioning of free markets. Inflated assets should be allowed to deflate, and interest rates should not be kept artificially so low for so long.
Resurrect the Resolution Trust Corp., 9/17/08:
The only viable option is #4. A new RTC can take distressed/illiquid assets into receivership and sell them to interested buyers. The original firms would be disassembled. After the AIG bailout today, the government is that much closer to running out of money to backstop failed/mismanaged institutions. AIG’s insurance customers can find other companies to offer them comparable policies. Retirement annuity customers have some protection of their assets and can move them elsewhere. Why is the government getting involved in backstopping a poorly managed institution? It was known to many of us some 4 months ago that this company had made some bad bets and that management was reluctant to take the necessary steps to forestall the inevitable. Bailing AIG out is not the role of the federal government. Even seasoned investors weren’t willing to touch AIG prior to a formal bankruptcy. So why should the U.S. taxpayer?
Loosen Deposit Insurance Rules to Prevent a Bank Run, 9/17/08:
I disagree with Mr. Lindsey. Why should financial institutions be held to a different accounting standard (not “Mark-to-Market”) than their customers (who are always Marked-to-Market)? Let’s face it. Many financial institutions made some bad bets on structured financial products in an environment of cheap money and lax lending standards. They ignored conservative reserve requirements and capital ratios. Individual investors who have done the same have historically lost out after making such mistakes. Financial institutions should be no different.
Letter to Senator Mike Crapo, 9/17/08:
Dear Senator Crapo,
I urge you not to vote for any legislation that puts taxpayer money on the line for bailing out failing/failed financial institutions that have made bad bets on highly leveraged investments with a high risk of failure. The U.S. taxpayer balance sheet is not infinite, and major bailouts devised in a shortsighted time span would only serve to further dilute and devalue the dollar, increase inflation and ultimately downgrade the debt rating of the U.S itself. The canards by the administration that this is a major crisis are overblown and highly reactionary – and have obviously served to tilt the system in favor of saving institutions of interest to Secy Paulson, as well as others in the Federal Reserve system. This is the kind of manipulation of financial markets that should be investigated. If an RTC-like entity is resurrected, it should follow the original function of the first RTC – to take bad assets into receivership with no monetary outlays to buy them, find a buyer, and ensure that the institution that originally held them is dismantled in an orderly fashion. The $700B+ being discussed is not acceptable to fiscal conservatives like myself. Again, I urge you as a member of the banking committee to consider some of these issues and support fiscally conservative principles that many Idahoans believe in – let’s not bail out failed financial institutions. Let’s support institutions and individuals that make the right financial decisions and follow sound risk management.
Susanne Lomatch, Ph.D
Let’s Get the Bank Rescue Right, 9/24/08:
This shows the problem when there are no fiscal conservatives with high positions and loud enough voices. But many Americans embrace such conservatism, and do not want to support a taxpayer-forced bailout of any kind. They also do not want to see failed institutions survive or yield a windfall of any kind, after showing incredibly poor financial judgment and lack of dexterity in risk management. The left and the administration have agendas, and meanwhile the rest of us see a clear solution. The original RTC concept is appealing, one with the authority to take distressed/illiquid assets into receivership without any monetary outlays to buy bad assets, find buyers (without restriction on a time period), and dismantle the failed financial institutions in an orderly fashion. No fanfare, no parachutes for failed management. I’m convinced the market would embrace such a decisive plan, and we’d preserve American capitalism to boot. What are we waiting for? Anything short of this would not yield satisfactory results long term, as people lose confidence in a system where the game is rigged and losers don’t lose.
How to Restore Trust in Wall Street, 9/25/08:
Mr. Levitt is spot-on here. After hearing so many dissenting voices against FV/M-to-M accounting, we get a staunch supporter with some clout. The dissenters (and I still cannot believe how many there are – and who they are) have a very weak argument for why financial institutions shouldn’t follow these principles. Here’s the doosie I’ve heard recently: “It’s the right set of rules, but not for this market.” True maybe, but not a reason to re-tilt the playing field. When the going gets tough, the tough should get going – if I have to follow these rules, so should financial institutions.
Is Commercial Real Estate Next? 9/27/08:
Mr. DeBoer is like Mr. Bernanke – both have a narrowly trained lens on what they think was the cause of the Great Depression, and it shapes their thinking, or in the case of Mr. DeBoer, their raison d’etre as it applies to an argument for a bailout. There were many factors at play that caused/prolonged the Great Depression, a horribly failed trade policy being primarily among them. Fortunately we don’t currently have such a skewed trade policy, and the commercial real estate market may benefit in getting a cash infusion from foreign investors.
Mark to Mayhem? 10/1/08:
It is correct that “a mere accounting rule can’t alter the underlying economics of a <you fill in the blank> business.” Mark-to-market simply makes a business more transparent, as opposed to having a business hide their poorly performing or essentially worthless assets in off-balance sheet entities. Shifting the rules to mark-to-maturity won’t change reality if some of those assets will be worthless before maturity, no matter what we do. Why don’t we stop talking about accounting rules and start talking about real incentives, such as cutting the capital gains tax for individuals and businesses? This is a no-brainer: when investors and businesses know that they will make more money if they commit capital to new investments in all capital markets (including real estate) they will do so. And thanks to Mr. Laffer we have some evidence that the Treasury will certainly make money on that deal. Businesses pay the same capital gains tax rate as they do corporate tax – many CEOs have commented on how their investment dollars would be unleashed if there were a simple change to lower the capital gains rate from the high corporate rate to the same rate that individuals pay. Stop complaining about how mark-to-market makes no sense and start giving a real incentive to unleash capital.
Volcker: We Have the Tools to Manage the Crisis, 10/10/08
The Great Depression was made worse because of Smoot-Hawley (steep tariffs on foreign traded goods) and price supports on (mainly farm) goods, as well as wages. Mr. Obama has espoused anti-free-trade rhetoric, and he is predisposed to price fixing. Mr. Volcker has been rightly disappointed with Republican leadership. But why he doesn’t even mention the most obvious and easy solution to this mess is beyond me: cut or suspend the capital gains tax on individuals and corporations. This is highly stimulative and will unleash new capital. And it will make money for the Treasury. And it won’t cost the taxpayer a dime.
Washington is Killing Silicon Valley, 12/22/09:
I agree with Mr. Malone, that the options expensing issue is tricky for small start-ups, where their valuation is difficult and where expensing may not make sense. However, if options are not expensed, then they should at least be disclosed in a very transparent way so that the market (including retail investors) can easily factor that in, i.e., that the stock price accurately reflects the density of options grants. Something for FASB to work on, or for SV to lobby for.
The Weekend That Wall Street Died, 12/29/08:
There should have been no gov’t bailout of Bear or AIG or C. If the management of these companies cannot prevent a market meltdown, then the natural course is to declare bankruptcy in one form or another, reorg or liquidation. The U.S. Taxpayer should not “bear” the undue burden of poor risk management or liquidity positions of any public company. There will always be competition to take the place of the loss. Such is the nature of true capital markets. Wall Street is not dead.
Six Lessons for Investors, 1/8/09:
Mr. Bogle has some good advice, but most of it is an advertisement for his Vanguard family of mutual funds. He leaves off some other valuable advice that was largely overlooked by financial experts and the press in recent years: keep a portion of your portfolio in cash and cash equivalents (and no, not those obviously risky auction rate securities!), and pay down your mortgage(s). I cannot believe how many experts told people to get huge mortgages and ignore paying them down because of the missed opportunity costs of the stock market. Luckily, I was not one of those heeding that advice. Keeping cash on the sidelines also works well for those of us who want to buy bargains as the markets continue to vacillate.
Freedom Is Still the Winning Formula, 1/13/09:
It is perplexing why New Zealand is ranked #5 on the ’2009 Index of Freedom’ list.
I just returned from a long stay in New Zealand, and I thought it was one of the more socialist countries I’d been to in recent years. There is wage and price fixing by the (now former Labour) government, which has caused much consternation among all of the small business owners I spoke with. Good service is almost non-existent, partly due to the wage fixing, and also due to a high GST (VAT) with almost no custom for tipping. Therefore there is little incentive for businesses to promote good service, and customers are forced to not expect it. As a visitor, it was very difficult to get over-the-counter drugs or supplies that we take for granted in the U.S. OTC drugs and supplies are regulated and must be sold in designated pharmacies, often at double or triple the cost one would pay for those goods here, and available at every supermarket. New Zealand also has many residual blue laws.
Perhaps the ranking is based on projected results: in November, New Zealanders threw out the multi-decade reign of the Labour Left in favor of a right of center National party, and just three days after our own election. Seems like the populace had had enough of that social experiment and may now indeed choose capitalism as a worthy dance partner.
Geithner Delay Slows Assembly of Crisis Team, 1/24/09:
Geithner’s confirmation should be blocked for as long as possible, long enough for the supposed “crisis” to work itself out on its own, without any government meddling or spending. In the mean time, there are plenty of qualified blue dog dems that could be Treasury secy. Best to pick one that believes in protecting the taxpayer and limited government, and is not a crook. (Wishful thinking but not impossible.)
Geithner’s China Bash, 1/24/09:
China’s just-issued response is perfect: “We thought in the face of the financial crisis, there would be a spirit of self-criticism beneficial to finding ways of resolving the issue and overcoming the crisis,” [Central Bank Deputy Gov. Su Ning] said, adding that it was imperative to avoid any excuses to encourage trade protectionism.
Geithner clearly inserted the wobbly criticism aimed at China to avoid further discretion of his own shortcomings at the NY Fed: $29B to BSC, $125B+ to AIG, and many $B to other associates to protect counterparty trades. Where is the focus on that by the WSJ? There are indeed many more qualified candidates for Treasury Secy – we deserve no less.
AIG in Talks for U.S. to Backstop Assets, 1/31/09:
The basic fact is that AIG made catastrophic bets in the CDO/CDS market and did not have the risk management to cover the losses. Should an entity like that continue to receive taxpayer money to operate? No. If they cannot sell assets to cover their debts or raise capital then their business should go to their competitors.
An AIG Unit’s Quest to Juice Profit, 2/5/09:
“The securities-lending portfolio had shrunk to roughly $70 billion by September 2008, when AIG’s problems reached a critical point. Credit-rating services downgraded AIG’s ratings, allowing trading partners on credit derivatives sold by its financial-products unit to demand billions more in collateral from the firm.”
In effect AIG was a House of Cards with little or no effective risk management. The $B profit target should have been a red flag to scrutinize, along with the possible impact on leveraged CDS trades if there was a liquidity crunch.
There are plenty of insurance companies out there that have managed the financial arms of their businesses without imploding. Instead of continuing to prop up AIG with taxpayer money (in effect rewarding their failure in risk management), the gov’t should get out of the way and let AIG sink or swim so that the marketplace can maintain fair competition.
Let’s Start Brand New Banks, 2/6/09:
“…all of the current proposals for increasing lending require more government involvement…”
Isn’t this the problem? Surely there are plenty of solutions that don’t involve the government. Why are they not being considered? Also, banks should not be expected to lend out of their capital reserve accounts. Banks lend mainly from deposits. Finally, as bad banks fail (if they are allowed to do so), profitable private banks will take their business competitively.
U.S. Weighs Fed Program to Loosen Lending, 2/7/09:
Is this article a sarcastic joke? The Fed should not allow hedge funds to use the U.S. Treasury for its leveraged carry trades. This is a ridiculous and hypocritical after what has already happened in the financial sector. So the next bailout will be to hedge funds who ate up too much cheap money from TALF and made too many bad bets? I can see making it easier for real businesses (particularly small businesses) that actually produce valuable goods and services to get loans if they need them and have sound plans. Where’s the emphasis on that?
Energy Secretary Says Stimulus Money to Be Used Quickly, 2/8/09:
The density and power of lawyers will likely grow during this administration, so Steven Chu should get ready for a fight with the prevailing winds and reconcile the fact that “politics is harder than physics.” A lot of things won’t make sense to him, and he unfortunately might eventually be told to sit down and accept it. I hope he doesn’t.
Greed Is Good, 2/8/09:
Mr. Smith’s piece only provides further motivation for many financial sector companies to revert back to private companies or partnerships. Then they can do anything they want. As public-sector companies, I think many of them have found it has turned out not to be a panacea. They have had to contend with shareholders and Sarbanes-Oxley (whatever good that has ever done, probably none) and more public scrutiny. Shareholder revolt is getting stronger every year, and Carl Icahn has some good arguments for changes in corporate law. So Mr. Smith: quit complaining, and convince your colleagues it’s better to exist as private entities rather than public ones. Capitalism is good. There’s a price (and should be) for access to taxpayer money.
How Government Created the Financial Crisis, 2/9/09:
“What was the rationale for intervening with Bear Stearns, then not with Lehman, and then again with AIG? What would guide the operations of the TARP?”
Very good questions. The answers appear insidious, driven by special interests, but we’d all like to be proven wrong. What is needed is a candid commentary on this very subject from Hank Paulson, preferably on these pages.
This concise analysis is just one of many excellents from John Taylor – one of which was published in 1996 by the Kansas City Fed: “How Should Monetary Policy Respond to Shocks While Maintaining Long-Run Price Stability?” This is available on the web.
It is a shame that Prof. Taylor is not given more consideration by the current monetarists at the Fed. It appears he’s understood the cycles, causes and effects far longer than most and to ignore this knowledge and not put it to work is nonsensical.
Solve the Toxic Asset Problem, 2/9/09:
“…it is of paramount importance that governments inside and outside the EU also show a clear commitment and strategy to reducing budget deficits and rolling back public debts as soon as the recovery is firmly on track. I certainly intend to help them devise an exit strategy…”
Many of us would love for Mr. Almunia to come to the U.S. and fight on our behalf to limit the out of control gov’t spending here. Most of the expenditures in the latest “stimulus” bill are long-term payments, not short-term stimulus. So the fight needs to start now. Maybe he can also help with our gov’t-sponsored Ponzi scheme problem – social security and Medicare.
Railing Against the Rich: A Great American Tradition, 2/9/09:
Prof. Brinkley doesn’t discuss populist anger and resentment toward government. Perhaps that wasn’t a huge factor back in the 30s, but it is now, and in fact, it is under-estimated and growing.
Bank Bailout Plan Revamped, 2/9/09:
“Executives at J.P. Morgan Chase & Co. have been cool to the idea of selling assets into a “bad bank” structure. They believe it may be wiser to hold on to sour assets that have already been written down, in the hope the bank can recoup losses when markets revive.”
Is JPM just coming around to this wisdom now that the Treasury/Fed is considering letting hedge funds bid almost nothing for these assets to make double digit returns? Maybe others will follow suit and we won’t need any further action. There’s lots of money out there already for loans and investments, it appears to be consistently gamed by government involvement.
The Unmentionable Bank Solution, 2/11/09:
Many have now been crying for the end of mark-to-market as a solution but this will make things worse in the medium-long term. The markets may rally on the idea, but it is essentially what Japan chose to do during its long downturn and it did not help. There is no substitute for letting completely insolvent entities fail, and allowing new investment to go elsewhere. The sooner we get to this and move on the better. There’s capital already waiting out there to be put to work.
Obama to Shift Focus to Budget Deficit, 2/14/09:
Deficit control would have been to never pass the ‘stimulus.’ Most of the stimulus is not short-term spending but spread over 5 or more years and a rehashed deal of it is adding more to welfare payments.
This is a political setup to start raising taxes. It has nothing to do with a sincere effort to reduce spending and make government more efficient, and to attack our Ponzi scheme problem (social security and Medicare).
1930s Lessons: Brother, Can You Spare a Stock? 2/15/09:
Personal Credit Institutions (35% gain, ’30-’33)…this will likely also be profitable in the next few years — the assumption is that these are existing institutions without toxic assets biting into their cash flow, or new businesses that will pop up (and they will — look for new private banks and credit unions).
Would have liked to have seen a comparison with 73′-75′ or ’80-’82, which we still have yet to rival. We are still not in a depression, but it looks ever increasingly likely the media wants us to be!
Synchronized Boom, Synchronized Bust, 2/18/09:
Begs the question: is it time to seriously consider removing the power of manipulating interest rates and the money supply from the Federal Reserve and then turning them over to market forces? Radical, heretical, uncivilized…yes, I hear the shouts but the debate should ensue.
Business World: How Democracy Ruined the Bailout, 2/18/09:
Mr. Jenkins makes the mistake of assuming the decisions, if they were left up to the Fed, would not be politicized. He is wrong. Academicians often make decisions that are politically motivated and they crave power just like mere mortals.
There’s Virtue in Geithner’s Vague Bank Plan, 2/18/09:
“Bailout 2.0 lacks details, but it is clear it won’t propose more bank freebies.”
I’d like to know how the authors are convinced of this given Geithner’s track record with AIG and others. I’d like to think receivership and the sale of completely insolvent banks and their assets will happen quickly and smoothly but I’m guessing it will be more complicated than that. I understand the issue people have with selling the impaired CDO/MBS assets on the bank books at fire sale prices. If that is the case, then perhaps a portion (and I mean a portion, not all) of the non-performing/illiquid assets can be held in a trust until those assets recover. In any case, a high-yield market for these assets needs to be developed. In the mean time, while we wait for a resolution the markets continue to reduce the shareholder value of the suspects on their own.
Is the Administration Winging It?, 2/19/09:
I equate Mr. Rove’s pieces with those of Thomas Frank’s. Neither are effective or credible messages from conservatives or liberals. Maybe the Journal should consider new messengers.
U.S. Steelmakers Seek More Tariffs to Fight Imports, 2/20/09:
The other WSJ headline today: “Obama, in Canada, Warns Against Protectionism.” I’m sure the Canadians are rolling their eyes as the top steel exporter to the U.S., now effectively shut out of 25% of the market by stimulus bill fiat. Credibility gap indeed.
‘Nationalize’ the Banks, 2/20/09:
Mr. Roubini gives a bit of revisionist history in this interview. Temporary nationalization of banks and liquidation of the good and bad assets did not start with the Swedes in the early 90s. The Resolution Trust Corporation (RTC) led by Bill Seidman (former FDIC head) in the late 80s employed this strategy to clean up insolvent S&Ls. Bill doesn’t seem to get enough credit these days for his work. The positive of the approach is that the government committed no capital to buy assets – the RTC simply acted as a receiver to facilitate the restructuring and resale of the good and bad assets, including spinning off the banks to new owners and management. The reasons why this approach is unpopular now include: (1) the insolvent banks are larger and the senior management has much more lobbying power to preserve their enclaves; (2) there is a backlash against selling bad assets at fire sale prices. Neither of these reasons should stand in the way of employing this process as a solution, which worked in the past and can be made to work for larger banks. Once again, if fire sale prices for distressed assets is the issue, then put a portion of them in a trust as a partnership with the bad bank bondholders and creditors and let the assets recover. Receivership is the solution over of conservatorship (which is akin to perpetual nationalization and elicits continual cash infusions from the Treasury to keep these poorly run institutions afloat). We don’t need more AIGs, FNMs, or FREs. Insolvent banks and companies need to be allowed to fail so that free market capital can be better spent on stronger and more competitive banks and companies or newly formed ventures.
Inflation Signs Will Likely Be a Mirage, 2/20/09:
I will add that demand does not have to increase to produce inflation – if the offer of goods and services become limited and the gov’t keeps on printing money then prices can rise.
U.S. Eyes Large Stake in Citi, 2/23/09:
Citi deserves receivership and the RTC treatment, not capital injections from the U.S. govt. If you feel the same call your legislator and express your views. We should all have a say in whether the U.S. government takes an investment stake in C.
We don’t need a repeat of the same painful, failed mistakes Japan made for a decade. As I recall the economy rebounded and capitalism thrived after the S&L crisis was resolved with the RTC. To all of you out there holding Citi preferreds: FNM preferreds issued in May ’08 at $25 have paid NO dividends and sold Friday at 95 cents. Know the risks.
Obama Wants to Move the Center Left, 2/24/09:
Mr. Miller’s piece was filled with empty praise for a “visionary centrist.” Can he not read that the majority sentiment and the determination in this country is that that we restore real growth, and the way we do that is not through penalizing producers but by incentivizing them to unlock their capital and spend (invest) it? Promoting an atmosphere where producers and would-be producers (and that can include anyone, from any strata or ethnicity) have the optimal chance at doing what they do best: create, build and grow new ideas, concepts, products, services, etc. To the center-left, government is increasingly seen as the answer to growth and a required involvement in every aspect of life and commerce, when in fact constitutionally government’s primary function is national security and protecting the inalienable rights of its citizens. Man, how the latter has been distorted by the left.
Bernanke Helps Stocks Snap Back, 2/24/09:
Bernanke stated in his testimony that we are not making the same mistakes that Japan did for over a decade, citing that we have more transparency. While he seems to have answers for all the questions thrown at him, this one doesn’t stick. Throwing more government capital at banks with unrealized losses is exactly what Japan did, and he won’t admit we are doing the same. Let’s stop the march to more AIGs, FNMs, and FREs.
TARP Fraud Could Cost Taxpayers Billions, Watchdog Warns, 2/24/09:
The solution to this is to not make the Treasury a piggy bank for the insolvents. Obama et al., wake up. If a guideline is needed for putting the large insolvents (like C) into receivership then get on with it. I’m tired of hearing about how valuable the intangible assets (franchise value, etc.) are when the orgs in question have significantly more downside exposure to their toxic assets. If the intangible assets are so valuable they will do just fine in the hands of new owners.
Obama Seeks to Snap Gloom, 2/25/09:
We are not (yet) in the deepest recession since WWII. Still competing with 73-75 and 80-82. Bad gov’t political propaganda and journalism run amuck. Higher taxes, more welfare programs, bad monetary and fiscal policy, bad bank bailouts and nationalized health care will lead to the worst recession since WWII, however.
Obama Unbridled, 2/25/09:
“This time, CEOs won’t be able to use taxpayer money to pad their paychecks or buy fancy drapes or disappear on a private jet.”
Mr. Obama conveniently forgets that Nancy Pelosi has done all three of these in recent history. If he is so concerned about taxpayer money then he should apply the rule universally, to Congress no less.
Officials Unveil Details of Stress Tests, 2/25/09:
The “stress test” is meaningless because it is de facto designed to pass everyone. The fact that these banks have the open checkbook of the U.S. Treasury and Fed make this whole exercise a sham.
Curse of the Zombie Banks Haunts Fed, 2/26/09:
“Central bank intervention…”
The price fixing by the Fed is bad policy and like loose monetary policy will lead to unintended consequences: increased risk exposure and higher debt. When will we learn?
Stressing Over Bank Tests, 2/26/09:
The stress tests are meaningless if everyone is going to get gov’t $ no matter what, and that no hard decisions are going to be made to clear the system and get our markets functioning again.
Japanese Yen Is Less of a Shelter, 2/26/09:
This is good news. Japan had little room to weaken the Yen with monetary policy without substantial risk. The currency markets are doing it for them.
Support Japan’s Entrepreneurs, 2/26/09:
Japan has one of the lowest foreign direct investment (FDI) ratings of major industrialized nations. Also, Japan has the highest corporate tax rates. Growth will be hampered until these two metrics are changed. They are gov’t policy issues.
Obama Budget Pushes Sweeping Change, 2/26/09:
Consider the classics – they don’t get repeated often enough:
—”The problem with socialism is that you eventually run out of other people’s money.” -M. Thatcher
—”Our whole civilization rests on the fact that men have always succeeded in beating off the attack of the re-distributors. But the idea of re-distribution enjoys great popularity still, even in industrial countries. If we wish to save the world from barbarism we have to conquer Socialism, but we cannot thrust it carelessly aside.” -L. von Mises
—”Man is not free unless government is limited…As government expands, liberty contracts.” -R. Reagan
—”From the saintly and single-minded idealist to the fanatic is often but a step.” -F. Hayek
—”A society that puts equality… ahead of freedom will end up with neither equality nor freedom.” -M. Friedman
How Geithner Can Price Troubled Bank Assets, 2/26/09:
Private investors must step up to the plate to drive a market for the toxic assets and they cannot do this if the government is in the middle with an open checkbook to the banks. That is not a free market. The banking crisis will not subside unless the government gets out of the way of manipulating our capital markets and returns to its more limited role as a regulator.
President Takes Aim at Foreign Profits, 2/26/09:
Multinationals have worked around our high corporate taxes and now they will be chased down even further. Expect multinational stocks to be under pressure, especially those that haven’t already taken a large hit. Corporate taxes ought to be reduced instead, and everyone should consider the impact this tax policy will have on their investments. The administration has no clue how to use tax policy to promote real growth. Everyone pays corporate taxes. This move will only encourage companies to further seek off-shore shelters of some kind, which could be avoided in part by just lowering the corporate tax rates.
Don’t Be Fooled by Faux Bulls, 2/27/09:
It is important for investors to keep cash on the sidelines to put some money to work when good stocks and ETFs hit lows. But in a bear market they have to be disciplined to sell those on rallies and then buy them back if they still remain buys. This is one strategy to replacing lost returns. Simply put: investors need a tinge of a trading mentality.
Rating Agencies Endorse Revised AIG Bailout, 3/1/09:
The credit rating agencies have absolutely no independent credibility after this move, if they ever had any left just before. How far will the government go to meddling in our markets, picking winners and losers by how much lobbying power is involved on both sides, and in fact, increasing tremendously the risk of investing in every asset class for all of us? Everyone should keep in mind that the original bailout of AIG last Sept. by the NY Fed happened because of AIG’s CDS derivative connects to other powerful entities, namely Goldman Sachs. GS stood to lose billions if AIG collapsed and, well, we all know how deep the tentacles of GS reached within the Treasury and Fed, and still do.
This is corruption on a massive scale and it only hurts the healthy companies that played by the rules, had adequate risk management and should be thriving in the absence of AIG and other failures. Finally, as a corporate governance issue the current board should have been replaced months ago, but now they are essentially wards of the government and perhaps consider themselves protected in their role. Every one of them should be ashamed of their performance, or lack of performance, in allowing AIG to incur fatal risks and driving shareholder value to zero.
Japan Mulls Using FX Reserves for Loan, 3/1/09:
A good move for Japan assuming they can control the risks and make smart investments. An alternative to drawing down their reserves too much is for them to make it more attractive for FDI in Japan through incentives and tax policy.
AIG to Receive Additional $30 Billion in Federal Assistance, 3/1/09:
AIG is responsible for poor risk management and financial leverage of their CDS contract issuances and GS and others are responsible for being on the other side of those contracts, regardless of the amount of regulation. If I go to Vegas and bet all my money on black should I get bailed out by the government and taxpayers? Should Vegas be outlawed? No to both. Know the risks and the consequences, accept and learn from them, and move on. We will all come to learn that the government cannot legislate responsibility.
Information Age: Too Risky for Venture Capitalists, 3/2/09:
Tax policy can be used very effectively to change economic behavior and stimulate real growth. The demagoguery by the current administration is quite destructive and without merit. Moving the capital gains rates up will drive VCs to invest in other countries that have eliminated their cap gains rates, simply put. Even Bill Clinton realized this.
U.S. Extends AIG Bailout by up to $30 Billion, 3/2/09:
Correct me if I’m mistaken, GS already received a large CDS payout from the original $85B loan. GS was involved in the discussions leading to the original bailout of AIG by the NY Fed. The WSJ needs to address these rumors, either dispel them or verify them. The market needs transparency.
“Why doesn’t the treasury lay out for us what this “systematic risk” is?”
Because we would find the arguments weak compared to the real reason for the bailouts: to protect special interests. None of us are protected – the markets continue to tank, and will until we get truly credible transparency.
Bush/Paulson are gone, and yes, their management of the situation was tragic; the current Obama/Geithner/Bernanke team is proving no better. All of you who think Bernanke is a brilliant guy should read this:
Koreans Take Pay Cuts to Stop Layoffs, 3/3/09:
Koreans culturally are quite conservative and we could learn a great deal from them. They have always had an export-dominated and have overcome great pressure in the past, like the ’97 Asian currency crisis. They will pull through this better than people give them credit for. Watch and learn.
‘Bad Bank’ Funding Plan Starts to Get Fleshed Out, 3/3/09:
This plan sounds like it will be loaded with contingencies and regulations. Would the savvy managers/investors want to get involved when there are better risk/reward profiles out there and no ominous strings? Face it: banks cannot overcharge for their distressed assets, and a set of essentially leveraged closed-end funds with high risk/measly reward doesn’t sound all that attractive. Why can’t the banks get together without the gov’t and start an auction market for their distressed assets? (Yes, and don’t tell me that this won’t work – I think there are many out there that would bid on the assets if the ask was right and the market liquidity would build over time.)
AIG’s Black Box, 3/3/09:
Rumors abound that $30B was paid out to GS to settle CDS contracts from the original $85B gov’t loan and that GS was involved in the discussions leading to the original bailout of AIG by the NY Fed. Can’t this be dispelled or verified? The next step from there would be to determine if Fed and/or Treasury officials were lobbied by AIG counterparties to produce the bailout loan. I see a great deal of wrong with this picture. The market deserves the transparency, one way or the other. The government should get out of meddling in our markets, picking winners and losers by how much lobbying power is involved on both sides, and in fact, increasing tremendously the risk of investing in every asset class for all of us. It only hurts the healthy companies that played by the rules, had adequate risk management and should be thriving in the absence of AIG and other failures.
Fed Moves to Free Up Credit for Consumers, 3/3/09:
This sounded good when it was targeted to short-term commercial paper, which is needed by most businesses.
Now it (TALF) has evolved into a leveraged lending program targeted to “AAA rated” ABS’s. Most economists I’ve seen comment on this don’t support it, they say it will only perpetuate what hasn’t worked in the past – and doesn’t address the real problem of existing distressed ABSs on bank balance sheets. One even went so far as to say that it is equivalent to “heads speculators win, tails taxpayers lose.” The leverage outlay is 5 cents limit for speculators and 95 cents for the Fed (uh, taxpayer). And we all know how reliable AAA-rated ABS’s are, historically – so extrapolate. The best idea I heard was that said new lending should not be new ABS issues but just plain-old bank lending, just like the old days. Simple is better, and when the gov’t isn’t involved, all the better. And I still think banks should get together and form a JV market to sell all those “bad” ABSs on their balance sheets. And I still don’t want to hear “it won’t work.”
U.S. Pushes for Crackdown on Tax Havens, 3/4/09:
“The proposal also would treat foreign corporations managed and controlled in the U.S. as domestic corporations for income tax purposes.”
This will drive away such foreign corporations – and the jobs and domestic economic growth they create.
Bernanke Expresses Frustration Over AIG Rescue, 3/4/09:
Me thinks he doth protest too much…But seriously – he should continue to get a challenge from Lacker and others. And we’d like to see him replaced by John Taylor.
The Truth About Korea, 3/5/09:
From my research on Korea’s economy over the last 30 years it is very clear that the continued conservative policies from the BoK and the gov’t will contribute to their ability to pull out of this downturn faster than most.
Steve Forbes: Obama Repeats Bush’s Worst Market Mistakes, 3/6/09:
As a set of counterpoints to Mr. Forbes’ comments on short selling:
(1) The average CBOE volatility and its SD were quite high historically from late 1997 to early 2003. Stocks, especially technology stocks, were rampantly shorted after the tech bubble burst in 2000, and the Uptick Rule was in full force during that period. Most of us lost money. Because of the volatility, short sellers also didn’t do so hot. Fundamentals were bad, not just in tech stocks. There were no large gov’t bailouts of failing tech firms – and indeed there should not have been. The markets recovered strongly in 2003.
(2) Volatility did pick up in mid-2007, but it is coincidental with the removal of the Uptick Rule. Fundamentals were getting worse, and in fact turned into a perfect storm from mid-2007 to mid-2008 due to the leverage bubble. The government intervention in early-mid 2008 of backstopping BSC with Fed guarantees and putting FRE and FNM into conservatorship didn’t help.
(3) The SEC orders against short selling (not just naked short selling, but all short selling) on financial institutions in July and again in Sept did not prevent a market meltdown. Indeed, many think the resultant increased volatility and bid-ask spreads impacted liquidity. Repeated Fed/Treasury rescue of AIG and other financial firms has not helped.
When the fundamentals are quite bad it seems convenient to blame short selling. I also think there are similar arguments for mark-to-market. In football when the team is losing the game due to bad strategy and plays the referee doesn’t change the rules to suit the losers. Having the referee pick winners and losers is also a lousy precedent for instilling confidence in the game.
Top U.S., European Banks Got $50 Billion in AIG Aid, 3/6/09:
The issue now is whether counterparties influenced the NY Fed to make the $85B loan so that they could get paid. This has not been reported, one way or the other.
Hank Greenberg noted that $30B was paid to GS in other sources, see http://industry.bnet.com/financial-services/1000250/hank-greenberg-investigate-the-goldman-cabal/ and http://rothkopf.foreignpolicy.com/posts/2009/01/30/a_conversation_with_hank_greenberg_dont_scapegoat_china_he_warns_and_watch_for_gold.
From the WSJ article, not all payments to counterparties have been reported yet. Immediate full disclosure is warranted, as AIG likely remitted the payments after they received the original gov’t bailouts – bailouts that now dwarf anything any other company has ever gotten in history (some $160B+?). Yes, we need to keep the pressure on regardless of which parties were/are involved. This stinks.
How to Twitter, 3/8/09:
I can see the value of Twitter and other social networking platforms for advertising.
But ask yourself – how long is this fad going to last?
Dow 5000? A Bearish Bet That Looks Quite Possible, 3/8/09:
We do need a major capitulation (very high volume to the downside) before a marked rally. Much of the trading lately has been shorting and covering on limited volumes, with net selling on higher volume on some days. I’ve been looking now at the ’96 lows on a technical basis, which are a supported outcome from the fundamentals as well. Keep cash on the side and be ready if we approach those lows. Stock price forecasting may be bogus, but watching how the market is trading and setting your strategies isn’t.
J. Cramer did another bottom-up analysis and he came up with Dow 5350. This is coincidentally the ’96 low. The scenarios he used were worst case in his mind, and I believe he’s not a complete nihilist. GM in bankruptcy, JPM to 5, AA to 2, etc. The other lows from ’96 are not as dire a drop from here, that being the S&P (~8.3%) and the Russell (~11.7%). But the Nasdaq would drop by ~18% like the Dow if we were going back to its ’96 low of 1053. If we do retrace back to 5350, I would think given the S&P weighting of financials and other weak sectors that it would drop by 18% as well. Since tech fundamentals may be perceived as better, an 18% drop on the Nasdaq may be overly pessimistic. Hedge fund redemptions and margin calls continue. Shorting weak names continues. One would think the put buying would accelerate as we go lower, driving up the implied volatilities and making the payouts greater.
Debt to Bank On? Or Is It Time to Think the Unthinkable Again?, 3/8/09:
Changing accounting rules will not change perceptions. Banks and financial institutions have the ability (and have had the ability all along) to do better PR on what is on their balance sheets. The reason they haven’t does not translate fully to the excuse of not being able to value the assets. The assets can be marked to model and reported.
“But 18 months into the crisis, and with little sign that the banking system is stabilizing, investors are again starting to price in radical outcomes.”
Can’t say I blame investors on this one. Gov’t intervention has not made the situation better, it has only increased risk.
O, Canada: Banks Look Healthier, 3/8/09:
Canadian banks could buy up some of our failing banks and take the gov’t risk factor off our hands in the process. Citi is a good candidate right off. But unfortunately the US gov’t might block such actions on a protectionist move. Cut off your nose…
Bearish Big Investors Catch Gold Bug, 3/8/09:
Gold is a short-term investment to be traded and used as a hedge, not to be held for very long periods. Of course this is based on history given inflation-adjusted prices for gold. From the 30s until now gold returned a CAGR of only a few % (or less). Just something to keep in mind. Wouldn’t bet my whole portfolio on it!
Treasury Plans Small-Business Aid, 3/10/09:
More $ to SBA loans for qualified candidates is laudable, but I agree with one of the other comments…just cut corporate and capital gains tax rates and watch growth explode. We all pay corporate taxes and small businesses do indeed incur cap gains taxes.
Dow Surges 5.8%, 3/10/09:
Anyone who lived through the tech bubble and shorted then knows the Uptick Rule is a red herring.
Lawmakers Weigh Need for Second Stimulus to Spur Job Growth, 3/10/09:
Just cut the corporate and capital gains tax rates! Quit the demagoguery over business tax policy. Businesses will start to invest and earn more, and hiring will rise.
SEC May Reconsider ‘Uptick Rule’, 3/10/09:
We had an Uptick Rule during the tech bubble crash, along with significant volatility. Plus years of studies showing it is really irrelevant. Supporters are banking on the fact that this will lead to different market behavior, but if it does, it will be based on perception and short-lived. Short selling enables liquidity in the markets. It is not a safe way to make money, it is risky. Studies show that it can be more profitable to buy short-term put options, depending on whether volatility is in your favor. If we were to really put more disincentive into short selling then the way to do that is by imposing higher borrowing fees. Heck, I’d like to get a cut of those fees! But I don’t want the gov’t legislating that. The brokerages make money off short sellers and set the borrowing terms. I think the liquidity provided by short selling does allow for buying opportunities to everyone.
Fed Considers Its Next Actions, 3/11/09:
“Options Include Purchasing Treasurys, Fannie-Freddie Debt…”
There’s an analogy for this, but I’d rather not go there in words.
Alan Greenspan: The Fed Didn’t Cause the Housing Bubble, 3/11/09:
Mr. Greenspan rests his arguments to be excused from blame for the housing bubble on the decoupling of long-term fixed mortgage rates to the Fed-funds rate. But during the period in question the preferred mortgage products were adjustable rate mortgages (ARMs), which were much more closely correlated with the Fed-funds rate, and were sold in droves by the mortgage industry because of the historically low Fed-funds rate.
So Mr. Greenspan is wrong – monetary policy does have unintended consequences if left too easy for too long, affecting asset price stability. His weak defense of this issue leads all of us to again question the wisdom of the power we have placed in the Federal Reserve system.
Freddie Reports $23.9 Billion Loss, 3/11/09:
The gov’t had its chance in July to break FRE up and sell off the parts, with many at the urging. Instead, we got stuck with poor hedging strategies and more debt. I suggest it’s not too late – no $30B injection, just take any losses and sell off the assets. The gov’t should get out of the mortgage business.
The Next Big Bailout Decision: Insurers, 3/12/09:
No gov’t lifeline please, we all have a vote on that (or should). If all of the insurers capital requirements are being affected by an accounting rule (which I doubt) then give them temporary reprieve, otherwise encourage them to do better PR on what is on their books and to sell more debt (which they will be successful doing if the PR job was believable).
The Obama Rosetta Stone, 3/12/09:
Figure No. 9 is just a graph showing how everyone benefited during economic growth and decline periods since 1980. Art Laffer should get the Nobel Prize for his seminal work, whereas Piketty and Saez should get convicted of a hate crime.
Planning for the Next Blaze Even Before This One Is Put Out, 3/12/09:
“Who shall be saved, and who shall be allowed to die?”
The gov’t should not pick winners and losers in the capital markets. The gov’t should stay out of it. Economic (and social) engineering by our gov’t is most pernicious and insidious.
Cuomo, Frank Seek to Link Executive Pay, Performance, 3/13/09:
This story will put a damper in the recent market performance! Here comes the massive exodus to private hedge funds and a drive back to private partnerships for new and existing firms…
“A person close to Mr. Cuomo said change is needed but the intent isn’t to micromanage or interfere with the private sector.”
Wen Voices Concern Over China’s U.S. Treasuries, 3/13/09:
I’ll provide a few translations:
“We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets. I do in fact have some worries,” Mr. Wen said in response to a question. He called on the U.S. to “maintain its credibility, honor its commitments and guarantee the safety of Chinese assets.”
–Translation: we reserve the right to reduce our exposure; in fact it is likely we will do so.
“He said that while China’s first priority is to protect its own interests, it will “at the same time also take international financial stability into consideration, because the two are inter-related.”
–Translation: There are other opptys out there other than the U.S. and we will start to consider them in a serious way.
“No country can pressure us to appreciate or depreciate” the currency, he said.”
–Translation: Don’t tread on me.
Bottom line: I respect China and they have a great oppty to not make the same horrible mistakes that we have over the last 46 years, but to adopt the policies that have worked (like all the pro-growth policies, such as friendly business tax policies).
Obama Talks With CEOs, 3/13/09:
If Mr. Obama would kindly step aside and yield his job to Mr. Parsons…!
“Mr. Obama made it clear he wants the business community’s cooperation to secure his agenda of expanding the federal role in education, overhauling health care and transforming the energy sector.”
Yeah, and to heck with the business community and its future.
Obama Outlines Plan to Curb Earmarks, 3/13/09:
“We can’t have Congress bogged down at this critical juncture in our economic recovery,” Mr. Obama said. “But I also view this as a departure point for more far-reaching change.”
–Translation: Pelosi runs the country and I can’t stop her. I can only add more of the spending *I* want to do for my *agenda*.
Venture Capitalists Chart a New Course, 3/13/09:
Get rid of Sarbanes-Oxley for start-ups. And yes, Sarbanes-Oxley needs to be rewritten substantially – it did nothing for the latest Enron era in the financials.
This is a great time for bargains, but due diligence is still required!
European Leaders Push Back on Obama’s Calls for Aid, 3/13/09:
France also has lower corporate tax rates than the U.S….just thought I’d point that one out.
Summers: Timing of Turnaround Is Unclear, 3/13/09:
As are any solid pro-growth economic plans coming from the Treasury, White House or Congress.
Is Rand Relevant?, 3/14/09:
To me, Ayn Rand’s work translates to a message of freedom of self-determination without the infringement of egalitarianism. This is quite consistent with our founding fathers’ intents. It is also a principle worth fighting for.
This was published as a Letter to the Editor on 3/17/09.
With Deflation Possibly Near, This Economist Is All Abuzz, 3/15/09:
Deflation is a temporary phenomenon.
Dollar Cost Averaging Through the Downturn, 3/15/09:
The trick is to take profits in your portfolio when there are substantial gains. It always amazes me how many just watch the gains accumulate and don’t at least take half or a portion of the profits off the table, keeping cash for averaging during/after declines. There will always be cycles in the market. Strict buy and hold doesn’t cut it anymore – some active management is prudent. But if you cannot bring yourself to do any management then DCA and diversification are minimal requirements.
AIG Faces Growing Wrath Over Payouts, 3/15/09:
AIG and others will continue to commit the equivalent of economic blackmail against the U.S. gov’t as long as they continue to receive payments and reprieves. So who is worse: AIG or the federal government?
Bernanke Defends Recovery Efforts in Rare TV Interview, 3/16/09:
On AIG: “I understand why the American people are angry. It’s absolutely unfair that taxpayer dollars are going to prop up a company that made these terrible bets.”
Ben: Me thinks thee doth protest too much. You in effect authorized the original NY Fed bailout and subsequent Fed injections. You could have at any time stood up and said “no” but you caved in to special interests, all within the veiled excuse of ‘systemic risks.’ By not allowing for failures (and by indeed continuing to prop up failures) you are imposing price fixing measures.
Bear Stearns: The Fed’s Original ‘Systemic Risk’ Sin, 3/16/09:
Many of us listened to the April 2008 testimony of Bernanke and Geithner, with disbelief of the answers and rationale that were offered in the name of ‘systemic risk’ and the Fed backstop guarantees of Bear assets that to this day are still not transparent to the public. Special interests were involved, and were a motivating factor for the decisions made by the Fed and Treasury. The moves by the Fed to save Bear set a precedent. It sent us on the slippery slope that indeed enabled the bailout of AIG (once again, motivated by counterparty special interests) and the short shrift of Lehman (where the special interest link was weaker). Special interests still reign supreme and until this changes we will suffer the consequences of lack of confidence in our capital markets and a much less efficient system for everyone involved.
Wallison: Congress Is the Real Systemic Risk, 3/16/09:
GSEs and failed GSEs that go into conservatorship in perpetuity should be wiped from the possibility of existence. They crowd out private sector businesses and set a low standard for performance. The government has a responsibility to provide national security to its citizens, not mortgages and insurance products.
The Real AIG Outrage, 3/17/09:
The counterparties are not the problem – they do indeed deserve settlement on the contracts they purchased, under normal circumstances. If I buy a policy or unregulated CDS contract from an outfit that goes bankrupt and can’t pay the settlement, that is a risk I take. The risk failures at AIG should have been passed through to counterparties in a failure settlement (bankruptcy), and not made fully whole via a massive gov’t bailout. All of us want to go back to Sept 17 or thereabouts and shake some sense into Mr. Geithner.
Fed to Buy Treasurys, Expand Balance Sheet, 3/18/09:
The Fed is easing its way into a corner. This move signals that there are not enough buyers of Treasurys to sop up all the stimulus spending and toxic assets. How many more rounds of this? Now we’re in a self-perpetuated Treasury bubble. So much for “free market.” Short the dollar and buy oil.
Fed’s Gamble: Buying Long Bonds, 3/18/09:
The government is paying off one credit card by borrowing from another. They are taxing the savers to bail out the borrowers. Taxation without representation, to be exact.
Short-term: Ride the reflation trade by buying stocks, shorting the dollar and buying oil and other hard assets. Use trailing stops!
Long-term: Fight for a free market. It’s currently held hostage by the Fed. Don’t convince yourself that you can’t fight the Fed.
Secretary of the Fed, 3/20/09:
We put too much power in the hands of the Fed, whether they are independent or not. Interest rates are best set by the markets, not by a committee that is influenced by politics and deluded into thinking that Fed-style economic engineering is in everyone’s ‘best interests.’ It is this kind of market-interventionism that continually creates asset price instabilities.
U.S. Sets Plan for Toxic Assets, 3/20/09:
I agree with the assessment that the private sector has been warded away from anything smacking of a gov’t-private deal, where the ‘private’ will be at risk for being private. As hard as it may be at this time for the markets, the best thing to happen is for the private sector to walk away until the gov’t isn’t involved at all. The implications would be harsh, but they would be temporary as time scales go. It is better we all take the hit now than live under a regime where we all answer to Congress! In the mean time, the toxic assets will recover enough.
Downpayment Insurance Could Stabilize Home Prices, 3/21/09:
The idea of downpayment insurance is appealing, but only if the gov’t isn’t involved. If we’ve learned anything at this point from the abuses of the Community Reinvestment Act and the costly failures of the two major housing GSEs, FRE and FNM, the gov’t should *not* be instrumental in providing mortgage products or insurance. Perhaps former executives of FNM see it differently, since they derived their well being from a GSE, and perhaps look to gov’t to be the solution for everything. But that’s not how the responsible in the private sector see it – we believe that gov’t is here to provide national defense, and that’s about it. Not everyone is entitled to a house – it is a privilege, not a right. Not everyone is entitled to insurance either. All of us must work for these possessions. Allow the markets to self-correct without continual price fixing mechanisms that have little traction and only dig us deeper into a collective debt hole. Buyers will see value when demand starts to outtake supply, and prices will start to recover. If the insurance industry sees value (read: potential profit) in offering downpayment insurance after they’ve run the actuarial numbers, then they will get into the business sans gov’t involvement, as it should be. And remember how we all got here: gov’t-enabled cheap money fueling highly leveraged mortgage products, spurred on by inapt gov’t policy.
Now Is No Time to Give Up on Markets, 3/21/09:
Gary Becker is a voice of reason and a shot of optimism. Business tax policy is an important tool for stimulating growth, yet it is demagogued to death by the sitting Congress and Administration. Cut the corporate and capital gains taxes and we will see private capital unleashed from its coffers, with real growth and jobs to follow. Everyone pays corporate taxes – a fact that eludes most liberal economists when they turn only to the idea of neo-Keynesian spending. Prof. Becker rightly points out that much of the recent ‘stimulus’ spending is not short-term targeted stimulus, it is long-term discretionary or entitlement spending, with a strong political connection. The idea that market forces will prevail in the end is reassuring, and an even better outcome is that they are ‘free,’ i.e., without the constant disruption of countervailing gov’t forces.
Retailers Propose Initiative To Temper Labor Demands, 3/23/09:
Walmart is taking a different tack – they are paying bonuses and profit sharing and fighting this type of legislation as gov’t interventionism, which it is by its very nature. Businesses that do well reward their employees, but the gov’t shouldn’t dictate the terms! Howard Schultz and John Mackey are in over their heads here – legislating their corporate policies to fit everyone will likely come back to haunt them.
Geithner: My Plan for Bad Bank Assets, 3/23/09:
Dear Mr. Geithner: Repeated government intervention caused the problems that we now deal with: government-enabled cheap money fueling highly leveraged mortgage products, spurred on by inapt government policy. Government is not the answer, and to imply that our economy will not recover without yet more government involvement is simply not correct. Banks are already starting to make a profit from the yield curve, and like many of us, they have assets on their books with values that will recover in time, as the economy recovers. Indeed there is no need to rescue banks and financial institutions that will survive this crisis, and those that will not survive even with the current cash flows generated from a munificent yield curve should fail, with their assets sold to settle creditor positions. The taxpayer should not be a put option for financial institutions that under any other circumstances would (and should) fail. Instead of putting up more taxpayer money for a now vague problem where there is an additional punitive risk of association, many of us urge the Treasury to support corporate tax rate cuts, which would unleash capital and spur growth for everyone.
Financial Stocks: Will Good News Follow the Bad?, 3/23/09:
Banks are benefiting big time from the yield curve – this was the bullish news. Banks don’t need more massive bailouts – and we don’t need to prop up the banks that would fail even with the yield curve munificence.
As It Starts Programs, Fed Weighs How to Stop Them, 3/23/09:
Interest rates should be determined by market forces, not the FOMC, a committee that is influenced by politics and deluded into thinking that Fed-style economic engineering is in everyone’s ‘best interests.’ It is this kind of market-interventionism that continually creates asset price instabilities.
China Takes Aim at Dollar, 3/24/09:
There was a WSJ op-ed last week from a conservative economist on gold-backed Treasurys. This may be a concept whose time has come.
While I don’t trust the Fed, I *certainly* don’t trust the IMF – letting them dictate the terms for and control a reserve currency (and its supply) is not the answer. The dollar is slowly losing reserve status just as the pound did early last century – what will replace it? Hopefully not IMF funny money.
Hernando de Soto: Toxic Assets Were Hidden Assets, 3/25/09:
Mr. De Soto wants us all to believe that there is an evil “shadow economy” that should be exorcised from existence, that it is filled with toxic assets and the players who traded them. I reject the view that those “toxic” assets are not governed by property law, and that derivatives – even naked ones – are not recognizable and enforceable contracts.
Instead of his prescription of a government crackdown on the free market and all its principles, why doesn’t he simply state we need more disclosure and transparency? That is what is ostensibly missing here, nothing more.
Volcker: China Chose to Buy Dollars, 3/25/09:
“We’re in a government-dependent financial system; I never thought I would live to see the day… We’ve got to fight to get away from that.”
Does he truly believe this given the fact that he’s strongly supported a liberal socialist government to power?!
On Wall Street, Talk of Trust and Civil War, 3/25/09:
“Mr. Soros sought a thorough overhaul of regulation of the markets. “The idea that the markets are self-correcting has been proven false. … The market, rather than reflecting the underlying reality, is always distorting it.”
This guy is bi-polar. We all know he made his money from bear-raids in multiple markets. I have high respect for capitalism and the money he’s made, but extreme disrespect for his dishonesty. Mr. Soros, perhaps you’d like to take free market opptys away from the rest of us so you can have it all to yourself? Faust indeed.
Geithner’s Gaffe Briefly Hits Dollar, 3/25/09:
Unreported: George Soros made money off the comment, after denouncing that markets are not efficient. Tim got the gaffe from George. (Disclaimer: this is a joke not a rumor.)
Have We Seen the Last of the Bear Raids?, 3/26/09:
Did Mr. Kessler forget that we had a housing bubble and that banks and other financial institutions were highly leveraged, not to mention many homeowners? This was cause for shorting the ABX and then moving on to other inflated indexes, driving the value of CDOs down. The rest is history, namely any exploitation of the CDS market to attain further gain. But I agree with Mr. Kessler’s tone: that traders saw asymmetries in the market and exploited them – in many cases fairly. And this enabled a quicker exposure of market weaknesses than we may otherwise have gotten. In my mind this is an example of how efficient the market is, and we would do well to respect that fact.
Treasury Maps New Era of Regulation, 3/27/09:
PPIP is a scam, a put option provided by the taxpayer. The gov’t should get out of its adopted role as a financial market maker/enabler. That is not the function of gov’t.
The sad thing is that the arb chasers will look for any weakness in this plan and we will find out about it ex post facto – via market reactions. And I would welcome that event, because I think it will prove the gov’t cannot control one of the most important inventions in modern history.
Bankers, Obama in Uneasy Truce, 3/28/09:
I suspect the tone of the meeting was not as cordial as was reported – namely, “cooperative” could be interpreted many ways.
Economy Raises Tentative Hopes a Trough Is Finally in Sight, 3/28/09:
The rate of decline has slowed, but we may move sideways in the trough (compared to levels of late last year) for many months. I don’t see the catalyst that will kickstart the economy out of a sideways trough. This means meager growth if any after the large GDP declines in Q4/Q1. The parallel here is Japan in the 90s. This scenario doesn’t mean that the market can’t trade +/- 20% around a trading range. To get above 1050 on the S&P will require a catalyst, IMHO. And there are many analysts who are bearish long-term (who are otherwise bullish analysts) because of the amount of Fed quantitative easing and the massive gov’t spending. This combination has never worked when coupled with unfocused and irresponsible fiscal policy. So I buy that there will be a retest of the lows sometime this year or next. Best to trade the market, but I realize everyone cannot do this, so DCA plus diversification are fine prescriptions.
GM’s Wagoner Will Step Down, 3/29/09:
GM stakeholders (debt holders and shareholders) should have driven this change, not the White House. This is yet another example of how we’re headed in the wrong direction in the business community. Shareholder/debt holder rights activists like Carl Icahn were on the right track, but haven’t gone far enough on stakeholder reforms, and are standing idly by without saying anything while this mess happens. So now we have the White House and Congress stepping in to make decisions for publicly-traded companies. Gov’t should get out of the picture and let the company stakeholders and management deal with this issue. Several airlines have gone through and emerged from bankruptcy, some more successfully than others. GM should be no exception.
U.S. Bailouts So Far Total $2.98 Trillion, Official Says, 3/31/09:
It’s a sad situation when the voter pool out there is so ignorant of the state of our unfunded liabilities. Explains how we can get a Bernie Madoff, GWB and a BHO. It seems like the best one can do in these times is conduct your life and business so that it minimizes gov’t exposure. Hard to do. As for gov’t bailouts, it is an intrusion on our capital markets and a subversion of the bankruptcy code. It started last year with the BSC bailout, thanks to Paulson-Geithner-Bernanke, and has grown in geometric proportions since.
Credit-Card Bill Narrowly Advances in Senate, 3/31/09:
This bill will motivate credit card companies to eliminate higher risk accounts. It may also motivate those same companies to eliminate rebates and perks for very low risk customers, and perhaps even start charging them fees.
Treasury’s Very Private Asset Fund, 3/31/09:
“The purpose is to create new buyers for these toxic securities, a process that, in Treasury’s own words, will lead to better “price discovery.”"
How can there be efficient price discovery with the gov’t as a market maker for these assets? PPIP is a put option provided by the taxpayer. The gov’t should get out of its adopted role as a financial market maker/enabler, picking dealers and buyers. That is not the function of gov’t.
The sad thing is that the arbitrage chasers will look for any weakness in this plan and we will find out about it ex post facto – via market reactions.
Move to Ease ‘Mark’ Rule May Subvert Treasury Plan, 4/1/09:
Mark-to-market becomes an advantage when the markets improve – so banks are hesitant about adopting changes unless that advantage is preserved. So the changes will likely be surgical on the downside. Remember – rules are meant to be broken.
Lawmakers Have Long Rewarded Their Aides With Bonuses, 4/1/09:
Congress fashions itself these days as a neo-Rome. May it meet the same fate as the old.
Spend It in Vegas or Die Paying Taxes, 4/2/09:
The points made in this article on estate tax could well apply to almost any other area of the tax code. Art notes that “all the costs associated with these tax shelters and tax avoidance schemes are pure wastes for the country as a whole and exist solely to circumvent the estate tax…a number of studies suggest that the costs of sheltering estates from the tax man actually are about as high as the total tax revenues collected from the estate tax.” The former is certainly true for many wealthy taxpayers who do the same to minimize their individual, partnership, or sub-Chapter S income tax paid, while the application of the latter is probably not as dramatic.
Some additional important points to be made:
-As the tax rate is lowered the cost-benefit equation for sheltering vs. paying the tax changes;
-Tax shelters are a heavily advertised and lobbied industry, employing droves of tax attorneys and accountants.
Therefore if we’d really like to make the tax code fair to everyone we’d lower all rates and close all loopholes.
The Socialist Solution to the Crisis, 4/2/09:
Mr. Rasmussen, like many of his ilk, thinks he can subvert American Capitalism and our Constitution with his socialist/Marxist agenda. We will not allow them to succeed. We care too much about individual freedoms and choices, and shun the tyranny of those who wish to control society, by imposing social and economic engineering to limit freedoms and choices.
India’s Faulty Exceptionalism, 4/2/09:
I’ve read in various places that while there are no formal banking relationships with many average and low-income Indians, there are networks of micro-lenders that have had success in supporting small-time entrepreneurs. India is a service-oriented economy and has had the advantage of an influx of service-oriented jobs shifted from other economies that suffer from high corporate taxes and regulations. Our loss is their gain.
Free-Marketeers Should Welcome Some Regulation, 4/3/09:
“But this crisis was primarily caused by managements and individuals throughout the financial system who exercised extremely poor judgment. The private sector, not the public sector, is where the biggest mistakes were made.”
Mr. Singer, I’d wager that the majority of free-market capitalists believe that the government was, and still is, a substantial fraction of the source that has made the outcome of this “crisis” worse than it otherwise would have been had we not been inflicted with gov’t intervention. Artificial interest rates, gov’t price fixing, and subversion of bankruptcy and property rights laws are all examples. In a free market, poorly performing institutions fail (no matter how large), investors and debt holders of those institutions lose their some or all of their investments, assets are sold at market value, and remaining creditors get what’s left. This may seem harsh to you, but it is a self-healing mechanism for the market and an optimum way for participants to learn to set and adjust risks. The fact that you do not support this route means that you do not trust free markets and may even have other motives. We don’t need more regulation that limits free-market functions, we need more disclosure and transparency. If that isn’t available to an ‘optimum’ level, then market participants should factor that into their risk models. If they don’t, then there are consequences that have a learning cycle. Responsibility, like morality, cannot be legislated or regulated. The free-marketers want to preserve freedoms and choices, not severely limit them to suit other special interests. Stick to improving information disclosure and transparency on a voluntary basis and avoid more gov’t imposed rules that have unintended consequences.
Hedge Fund Paid Summers $5.2 Million in Past Year, 4/3/09:
“…the influence of lobbyists is curbed…”
How many people buy this? I don’t believe lobbying power and influence has changed one iota. It existed in the Paulson Treasury and extends to the Geithner/Summers Treasury. It existed in the Bush White House and extends to the Obama/Axelrod White House.
From Bubble to Depression? 4/6/09:
“How can one crash that wipes out $10 trillion in assets cause no damage to the financial system and another that causes $3 trillion in losses devastate the financial system?”
The conclusions on monetary policy, lending standards, real estate market speculation, and the largest growth of Fed liquidity to the market in recent history are spot on. What this analysis does not factor into the outcomes is the role of government intervention and fiscal policy. After the tech bubble burst the government did not extend a hand to failing companies like Enron and Worldcom and a whole host of smaller firms that failed. Investors took their lumps, learned their lesson and moved on. Assets were sold at fire sale prices to investors like Warren Buffet. The economy sprang back in part due to the lack of price fixing (i.e., a floor) on distressed tech bubble assets and the capital gains and income tax rate cuts in 2003. In the housing bubble case, government intervention crossed the line. The Fed extended a significant portion of its balance sheet to guarantee the distressed assets of an investment bank, Bear Stearns, instead of allowing it to fail, and the assets sold off at market prices. Fed backstops were extended to the GSEs, FNM and FRE and then yet again for AIG. Except gov’t cronyism didn’t save Lehman, just the opposite.
Firms Move to Fight Overseas-Profit Tax, 4/6/09:
“They also say it contributes to the inefficiency of the U.S. tax system, making it more difficult to raise the money the government needs.”
Any excuse to feed the monster. Protectionism will not protect the American standard of living, we rely on global trade and the investments by multinationals overseas are not always to seek cheap labor but to improve the goods we do buy from our trading partners. Multinationals also seek to avoid unionized labor, which raises prices for everyone. Keep in mind that Japan and South Korea have major manufacturing facilities here for this purpose. Finally, entropy and the 2nd law do not imply complete disorder – entropy is the amount of order, disorder, and/or chaos in a thermodynamic system and is governed by statistical probability distributions. We would likely not all equilibrate to the standards of living of those residing in present-day Mexico or China. The most likely outcome would be that the average standard of living would rise – how much – TBD.
In Defense of Derivatives and How to Regulate Them, 4/7/09:
The misinformation on derivatives (which extend from ordinary stock options to credit default swaps) is replete in the popular media. Though the author did not mention it, there is also controversy over naked derivatives, namely naked CDSs, where investors or traders have no commensurate insurable interest. Options are traded all the time without having to own the underlying stock, so a regulation requiring an insurable interest on a traded CDS ought to be carefully reconsidered. The author covers well what is really required: improvements in disclosure and a functioning clearinghouse, and that those who voluntarily opt-out are a red flag for risk management models.
Tech Giants Help Clients Tap Stimulus Funds, 4/7/09:
“International Business Machines Corp. developed a software program specifically designed to help companies keep track of how they’re spending stimulus funds. IBM is also positioning its consultants as experts who can help companies measure the results achieved through stimulus funds, which many of the grants require.”
IBM used to be on the leading edge of technology innovation but has shrugged that lately as it repositions itself as a gov’t contractor. I can understand the role of defense contractors, but not IBM’s role.
SEC Floats 5 Potential Short Curbs, 4/8/09:
“One method that would stop this (and the bear runs on stocks that this feeds) is to require that a stock be borrowed and held in the sellers account PRIOR to the short sale.”
I agree with this measure. While the uptick rule will likely make little difference this hassle would. Also: how about giving a fee cut to all stock holders whose shares are lent to short sellers? I’d appreciate that…and even pay it if I want to short a stock.
The NYSE has had program trading curbs (“circuit breakers”) in effect ever since the ’87 crash. For a good long time until Nov. 2, 2007 the curbs went into effect whenever the NYSE Composite Index moved 190 points or more from its previous close, and remained in place for the rest of the trading day or until the gain or loss had decreased to 90 or fewer points. This curb permitted program sales to be executed only on upticks and program buys on downticks. This curb was eliminated Nov 2007 due to “ineffectiveness in curbing market volatility” which I buy. The NYSE still has these curbs, they just kick in at a wider range: At the start of each quarter, the NYSE sets three circuit breaker levels at levels of 10% (1-hr and 1/2-hr halts, depending on trading time), 20%, (2-hr and 1-hr halts) and 30% (market closes) of the average closing price of the DJIA for the month preceding the start of the quarter, rounded to the nearest 50-point interval. As of the first quarter of 2009, these levels are 850 points, 1,700 points, and 2,600 points. OK, now that you know that…to add more rules or breakers — I agree EMPHATICALLY that it would be a detriment. We should be promoting more voluntary disclosure and transparency and focus on that, not more rules that have unintended consequences.
Is Silicon Valley a Systemic Risk?, 4/9/09:
It appears the present government will not stop their mission to control and dominate every aspect of business conducted in this country by private citizens. This has become a matter of a separation of Business and State, much like Church and State, and unless the issue is put forth in those stark terms the headwinds will not mitigate until those who misuse their power and misunderstand Constitutional authority are thrown out of public office. With the exception of Axelrod, none of the characters mentioned has ever started and/or run an entrepreneurial venture or business. As such, their only claim is to control others who do. We live in a dangerous time, with now repeated government threats to American Capitalism, innovation, and our business culture by those who don’t subscribe to or understand their principles. American innovation starts and flourishes under a culture of freedom to privately fund promising ideas that may lead to marketable solutions and a good return on investment. That funding will be in jeopardy if there are government controls and intervention – an menacing thought. We ought to be moving further toward private funding of technological innovation, applied R&D, and even pure R&D. Sincere thanks to James Freeman for a commendable piece on the threats we face from our own government.
Volcker Assumes Smaller-Than-Expected Role With Obama, 4/11/09:
It is probably best that Volcker not be associated that closely with this agenda.
The Path of Kohn: Crisis Changes a Fed Vet, 4/12/09:
“Every talking point of the last 30 years about the dangers of exposing the Federal Reserve to credit risk or lending to nonbanking institutions has [Mr. Kohn's] fingerprints on it….”
And his decision (with others) to deviate from this had led to disastrous consequences. This guy has no conviction. The Fed needs to lose the power it has with politically motivated economic engineering of our economy.
Everyone Should Pay Income Taxes, 4/13/09:
Mr. Fleischer loses me when he spikes “a certain amount of income redistribution in a capitalistic society is healthy, but this goes too far.”
This statement is wholly equivalent to “A certain amount of theft is moral.” Neither justifies a basis for the tax code we currently have or might have in the future. Close all loopholes (from top to bottom) and lower all rates to a flat tax rate. Get the government out of health care and retirement programs that have morphed into Ponzi schemes with unfunded liabilities.
Business World: GM Is Becoming a Royal Debacle, 4/22/09:
I’ll add to this one: “A monarch, when good, is entitled to the consideration which we accord to a pirate who keeps Sunday School between crimes; when bad, he is entitled to none at all.”–Mark Twain
Good Government and the Animal Spirits, 4/23/09:
The government need not be the referee of Capitalist games – as the authors point out, there are well-oiled private sector infrastructures that operate quite well, “such as trade associations and exchanges.” I’d like to hold up the options and futures markets and exchanges as prime examples of complex markets that, as far as I am aware, do not have the gov’t as a referee in the form that I think is being proffered by the authors. I also take strong exception to equating Capitalism with basic animal instincts. Capitalism allows all of us to realize our full potential, should we wish to exercise that right. It demands a critical mind as well as a challenging spirit. As often stated, government intervention and regulation penalize honest, law abiding players, no matter how good and “athletic” they are at their game – which is what I think the authors and their like are concerned about. For the politically appointed referee to handicap the best players to level the game to suit his needs – sounds like an infringement of freedom.
Bank Officials to Hear Results of Stress Tests, 4/24/09:
Analysis based on TCE has just been published at http://seekingalpha.com/article/132969-bank-stress-tests-tangible-common-equity-a-critical-metric. I think the results are not surprising. The question is what the gov’t will ask the 5 “red” banks to do, if anything. The real question is whether there are banks in the 19 that have exceptionally low or negative TCE.
I’ve always thought these tests were meaningless; the FDIC has been doing stringent ratings for years. Waste of taxpayer money and Geithner/Bernanke grandstanding, with a possible gov’t ulterior motive.
World Bank Report Card, 4/25/09:
With the U.S. subjecting viable U.S. commercial banks to stress tests I think it only right that the Treasury review the U.S. funding of the World Bank. The U.S. has the largest voting share (with Britain) on the board, yet how effective has the U.S. gov’t been in dealing with the fraud? Not very effective. Hmmm.
Some Lobbyists Try to Skirt Stimulus Ban, 4/28/09:
This lobby ban is a sham – it reduces transparency. Registered lobbyists just recruit unregistered interested parties to represent them and it goes unrecorded.
Buffett: Simple Answer to Moody’s Question, 5/2/09:
Not everyone made the same mistake on housing — those shorting the ABX in 2006/7 have the profits to show for it, as do those who sold their properties in 2005/6 after seeing a nonlinear run-up in prices. The fact that Buffett’s common sense didn’t kick in on this one sooner is perplexing. His excuse that he didn’t want to “rock the boat” (or a better analogy would be that he didn’t want to shout “Iceburg!”) takes away from his credibility.
Odds-On Imperfection: Monte Carlo Simulation in Finance, 5/3/09:
Invoking some of the techniques of chaos theory might be useful. Some of the instabilities referred to by others (e.g., government intervention) are largely non-random, and could be characterized as chaotic. As is known in chaos theory, random events can be amplified in a nonlinear chaotic system, leading to serious distortions. The problem with using Monte Carlo simulations is that many of them are based on sampling probability distributions that are constructed upon a Markov process or chain – where the desired distribution is the equilibrium distribution.
Declarations: ‘Shrink to Win’ Isn’t Much of a Strategy for the GOP, 5/3/09:
Peggy Noonan ranks right up there with Maureen Dowd – except Maureen is at least honest about which side she’s on and why. Another post a few months back suggested that Peggy consider writing romance novels. It would be refreshing for the WSJ to consider replacing Noonan and Karl Rove as political columnists that pretend to be torch-bearers for conservatives. They have both had their significant hand in giving victory to the liberal left, and in their fabric don’t understand that losing fiscal control was the single largest failure of the GOP, followed closely by Beltway corruption. They also don’t understand the power of what could be – and the WSJ could capitalize on that by recruiting some fresh talent that writes about libertarian issues – “freedom, less government, fiscal control.”
The Next Housing Bust, 5/4/09:
The calamity here is that the voices during the debate to raise the conforming loan limit in late 2007/early 2008 to $700K+ were not loud and influential enough. While we ought not to have the FHA program at all – it is a form of welfare to both buyers who cannot realistically afford a home and to the industry facets that have housing inventory to sell – raising the limit put a gasp in the breath of many onlookers wondering when and how the fairy tale would end. $50-100 Billion seems like a low figure, and I am sure it will be “rationalized” away in view of all the other bailouts that have eclipsed it. The real issue is that the FHA and its conforming limits were promoted and passed by both sides of the aisle – absolving neither side of culpability in the housing mess. And to think – just a mere 9-10 years ago many of us were required to put down 20% and pay relatively high interest rates to buy a home.
New York Fed Chairman’s Ties to Goldman Raise Questions, 5/4/09:
This is a clear conflict of interest, given the current role of the Federal Reserve. It is not really a “private independent bank.” It is a funding arm of the US Treasury, and has regulatory functions. The probability that the NY Fed chairman had access to material inside information on GS is high, and if he traded on this information he should face insider trading charges. There is a bill circulating Congress, HR 1207, Federal Reserve Transparency Act of 2009 (which calls for Fed audits): http://thomas.loc.gov/home/gpoxmlc111/h1207_ih.xml.
We Can’t Subsidize the Banks Forever, 5/5/09:
The gov’t can’t subsidize banks forever, but nationalization is not an option either. Receivership and restructuring has worked – the important issue is to uphold property rights and contract laws in the process. As we now know, size of the institution is not the problem – it has become a demagogue.
Capitalism In Crisis, 5/7/09:
Mr. Posner’s piece reminds me of just how far the Chicago school has fallen from the influence of Milton Friedman.
With inane statements like: “a capitalist economy, while immensely dynamic and productive, is not inherently stable,” and
“…businessmen seek to maximize profits within a framework established by government….” and
“…we may need more regulation of banking to reduce its inherent riskiness. But now is not the time for that: There is no danger of a renewed housing or credit bubble in the immediate future. The essential task now is to recover from the depression…”
we get interspersed a tangled mess of commentary that contains no concrete plan for returning to capitalism and free markets; on the contrary, we are left with the impression that the author prescribes more government, more regulation, less freedom.
Mr. Posner: Ye have little faith in capitalism. Allow market forces to function to the fullest extent possible, without the non-random chaotic effects of government intervention and control, and observe what happens.
Stressed for Success? 5/8/09:
…”relax,” said the Geit man,
We are programmed to receive.
You can checkout any time you like,
But you can never leave…
The bad banks have survived because of a steep yield curve, a gift from the Fed. Historically low interest rates will have an inflationary effect, and the Fed refusing to release projections of interest rates that (may or may not) have been factored into the stress models is indeed disquieting. Hedge yourself! This could be heaven or this could be hell.
The Friedman Flap, 5/11/09:
“This structure was designed under the Federal Reserve Act of 1913 to help insulate the Fed from political pressure, and it has worked well.”
Really? I suggest the WSJ editorial board re-read the sordid history of the Fed, particularly the shenanigans of the NY Fed, in the years just prior to the 1929 market crash. Add to that many other Fed histrionics throughout the years, plus this recent incident, coupled with Geithner’s transgressions of the last few years as NY Fed President in favoring special interests. The Fed is not a private independent bank, it is a cartel and a funding arm of the U.S. Treasury. Our markets will not truly be free until the Fed is eliminated. In the mean time, both the House and Senate have called for Fed audits, more transparency and disclosure, which is a step in the right direction until the political will exists to eliminate this institution.
Tax Increases Could Kill the Recovery, 5/13/09:
Not mentioned in this article is the historical fact that no matter what the marginal tax rates have been, government tax revenue has been pegged at around 19.5% of GDP (“Hauser’s Law”). This means that raising marginal tax rates is highly specious and misleading reasoning for increasing tax revenue, and contrary to what Mr. Orszag and others would have us believe. What is needed is an increase in GDP – as total government tax revenues are proportional to the GDP, as data over the last 40 years suggest. Raising marginal rates (corporate, individual) will impede the GDP, as will consumption taxes like cap-and-trade or a VAT.
The New Tudors, 5/13/09:
-King: So what do my court fools have for me today?
-Rahm: Sire, I have visited the Treasury and have made sure that they understand our latest economic insurgency plan.
-Orszag: Yes, Sire, your wealth and prosperity redistribution visions are in play; full equality will be achieved and the proletariat compensated to support your divine destiny.
-Axelrod: I have updated TOTUS with my latest speeches and have reprogrammed your hypnotic marketing chip with enhancements to recruit new followers.
GM to Import China-Built Cars to U.S., 5/13/09:
-Gettelfinger: The King must be arrested for Treason if these imports are approved. He led us to believe he was on our side!
-Faust: He is on the side of everyone and no one, my son. You cannot arrest the one who offers you a bargain.
-Auto Buyer: Wow, great deal on the price, but I hope this Chinese-built car doesn’t have the same problems as that Chinese drywall…
Information Age: Derivatives and the Wisdom of Crowds, 5/18/09:
Some may argue that putting derivative trades through a concentrated set of clearinghouses standardizes trading and streamlines the aggregation of information. So I see an advantage there. Risk pricing has been a real issue, and one can also argue that if trades don’t go through a standard exchange then there may be risk dislocations. In any case, this article raises some very important questions deserving further debate. Should we crowd out the little guys with trading platforms in favor of large trading monoliths? In the equity world we still have OTC and large exchanges, but one disadvantage of the OTC is thin trading and price dislocations.
Why Beijing Wants a Strong Dollar, 5/28/09:
Zach: It is wishful thinking that the U.S. and China will coalesce in economic simpatico – I too subscribe to this wish as a possible outcome. But one is not being truthful to oneself if one does not admit another possibility: that China will divest itself in U.S. debt as it sees practical to do so as other opportunities arise for its reserves. Any seasoned trader would do the same.
VATs Mean Big Government, 6/4/09:
A VAT in addition to income taxes would mean a reduction in GDP, pure and simple. Less discretionary income will be spent and business will be reduced. The electorate must get their act together and vote out all politicians supporting this, if it is instituted in addition to income taxes. The only way a VAT would be acceptable is having it replace the income tax system we have (completely).
SEC Deluged by Support for Uptick Rule’s Return, 6/10/09:
The uptick rule reinstatement will do little to remove volatility during a declining market – in fact, there will be little effect on market dynamics. A study of market data over a 10-year period, during which the uptick rule was mostly in effect, shows that from ’97-’03 market volatility was elevated and, as we all know, there were significant market declines, particularly in the Nasdaq. I personally knew traders who shorted the Nas and tech stocks daily from ’00-’03 and made a great deal of money – legally – during this period. If the uptick goes back into effect, traders will simply modify their methods back to what they were before 2007 and program trading algorithms tweaked back to what they were before 2007. Naked short selling has not been substantiated – but I suspect it is a problem – particularly because the SEC cannot, it seems, accurately account for “fails-to-deliver” rates and how they occur (willfully or system glitch). If the SEC wants to truly make a change with a real effect on short selling it would require that short sellers receive a borrowed security in their account before selling it short (meaning it might take a few days to settle or clear). An additional onerous regulation would be to require that short sellers pay a higher fee for borrowing a security to sell short and having part or all of that fee increase go to those who actually own the security. Both of these remedies are controversial. But not requiring security loan settlements leaves the door open for system manipulation that can affect the market in adverse ways.
Laffer: Get Ready for Inflation and Higher Interest Rates, 6/10/09:
The Fed actions in September 2008 were driven by a panic reaction to the Reserve Primary money market fund breaking the $1 threshold (because of its exposure to Lehman) and a perceived threat of a run on the banks (likely exacerbated by Paulson’s frenzied reactions from the Treasury). As we all now know this action did little to prevent a seizure of the credit markets and a commensurate decline in the broad securities markets from October onward. What might have happened had the Fed done nothing and the markets allowed to correct without this intervention? Bernanke would answer that we would have fallen into a deeper depression and that injecting the system with a massive amount of money was the only solution. This is unsubstantiated. And Art Laffer makes an excellent case that at this point a retraction of that monetary base must occur to avoid the consequence of all that money flooding into the broader system – monetary expansion and inflation. What is Bernanke’s plan? We all ought to be demanding an answer. The rumors are not quieting – that the Fed will be buying more Treasuries. But none of this will be solved until the government develops fiscal control and restraint – a reversal of the trend toward a doubling of the gross gov’t debt as a %GDP.
Volcker: Moral Hazard and the Crisis, 6/16/09:
This effort by Mr. Volcker is laudable but doesn’t go far enough. Hedge funds have not been a threat during this “crisis” and ought not be subjected to increased government regulation. But I would also argue that other financial institutions that are not depository institutions ought not to be constrained further either. If they incur significant risks and fail, let them fail. Depository institutions are different, but only to the extent of their liabilities to insured depositors through FDIC. Beyond that, there is risk. As many of us out here now know, if we’d let some of the financial institutions that were propped up by massive Fed liquidity around September 2008 fail, we’d be much better off. No more price fixing and taxpayer put options please.
Consumer Agency to Seek Wide Reach, 6/16/09:
Several suggestions for names:
“Agency for Consumer Price Controls”
“Wage and Price Control Board”
“Bureau of Redundant Regulation”
“Government Financial Products Division” …
This sounds like massive government intervention into capital markets, under the rubric of “consumer protection” (a.k.a. nanny state). Ben, people learn from failures, but if you don’t let them fail, they won’t learn.
Too Big to Fail, or Succeed, 6/18/09:
Lehman’s losses started accelerating the week that Fannie/Freddie were forced into conservatorship – the data is very clear on this one. That same week, AIG also faltered. After 7 days, Lehman declared bankruptcy and AIG got an $85B NY Fed bailout (special interests duly served). The impact of the Fannie/Freddie forced conservatorship cannot be understated. The correct course would have been to leave them alone, and let them fail if they could not survive as a going concern. The government ought not to be in the business of buying mortgages or setting a market for mortgages. The proof that this GSE system was rotten need not go any further than the clarity of how much money GSE insiders looted from the company (Franklin Raines, Democrat and former CEO, made upwards of $100M+ during his tenure). Systemic risk has been a wedge used against free market capitalism. It is understandable to enable standards and regulations for depositor-based institutions up to the limit of protecting insured FDIC depositors, but beyond that, intervention and regulation starts to hurt those that take risks looking for a reward, and who for the most part do indeed understand the risks. Investors need to read their prospectuses.
How to Get The Fed Out Of Its ‘Box’, 6/22/09:
Addressing the long-term off-balance-sheet debt (from entitlements) is a key issue, but so is a sincere effort to reduce near-term gov’t spending, and to cut corporate and investment tax rates. Eliminating the employer health tax subsidy is great – but why not go all the way: eliminate all govt’t tax subsidies and deductions and simplify the tax code. As for the Fed: The likely course, given Bernanke’s leadership, is more Treasury purchases, quantitative easing, debt monetization…unless we get a radically new plan — which indeed ought to include the Fed not manipulating the market.
A Triple-A Punt, 6/22/09:
Credit rating agencies have the same problem now that tech stock analysts had earlier this decade. The assumption that housing prices would increase indefinitely was fundamentally flawed, as was not seeing the early cracks in the mortgage CDO and credit-CDS markets. The solution for the industry is not giving these firms exclusivity in judging the credit-worthiness of assets and businesses – the due diligence ought to be spread around and verified independently. And information flow is key to managing risk.
Bernanke at the Creation, 6/23/09:
Bernanke overshot the deflation issue with the massive increase in the Fed balance sheet starting in Sept. 2008, and it looks like he has no plan to retreat. Price fixing and artificial price floors don’t work. No more market manipulation by the Fed: Times have changed since the early 30′s and the market ought not to be a depression-era experiment.
The Cap and Tax Fiction, 6/25/09:
“The resource cost does not indicate the potential decrease in gross domestic product (GDP) that could result from the cap.”
And there will be a reduction in GDP – the CBO was/is likely avoiding publishing the results that they already have on this. The solution is to avoid cap and trade and develop a “race to the moon” strategy of nuclear energy technologies. France has a 30-year edge on us here – and we ought to finally recognize that and put a serious effort toward a competitive nuclear energy complex that essentially delivers the same result as a cap and trade, but without a hit to the GDP.
Congress Must Pay for What It Spends, 6/25/09:
The test of Paygo or other Balanced Budget initiatives is sustainability, which neither side of the aisle has been able to accomplish. There must be a sustained reduction of spending and a refrain from raising tax rates. We already have the 2nd highest corporate tax rates – and we are moving toward meeting Japan on gov’t debt as a %GDP.
Wary Banks Hobble Toxic-Asset Plan, 6/29/09:
It’s called a carry trade, courtesy of the Fed/Treasury and the Taxpayer.
This defines why a bank like Citi ought to have failed and been broken up, Sept-Q4 2008.
Too Bernanke To Fail?, 7/1/09:
Bernanke is an avowed believer in price fixing and price floors. He has defined ‘systemic risk’, which is used as a wedge against healthy market cycles. This is the danger that his leadership has presented to us in the last few years. Either eliminate the Fed or put in someone who understands the value of a more benign Fed and price dynamics, such as John Taylor.
Asian Officials Push Back Against Savings Glut Theory, 7/6/09:
“The rise and subsequent collapse of U.S. house prices, he said, “has nothing to do with the difference in savings rates between the U.S. and China.”
And the data supports this conclusion.
The 0% Tax Rate Solution, 7/14/09:
Flat (>0%) income tax on everyone, jettison the tax code and cut corporate and investment tax rates to a flat rate. Trim gov’t spending to balance. The data on tax revenue for the last 50 years tell the story though on direction. Follow the data.
The Bernanke Market, 7/15/09:
Cut corporate and investment tax rates. Cut gov’t spending. Look at the data and what we’ve done after every recession (including the ’73-’75 recession, which has some similar characteristics in terms of the behavior of the real GDP). The O-dogma against business-and-investor tax friendly policies will stifle growth. Mr. Bernanke is a price fixer and has engineered a yield curve to benefit financials (and commodities!). Indeed, what is his plan beyond that? It ought to be warning Congress and Treasury that private investment is key to GDP and job growth (hence business and investor tax rate cuts) and that gov’t must trim spending (and not just spending growth). Get to it, Mr. Bernanke.
A Tale of Two Bailouts, 7/15/09:
Simple solution going forward: firms that cannot survive, fail. All of us independent investors/traders out here know the risks and take the hits. So should we all.
Economists Warn Fed Independence at Risk, 7/15/09:
Fed manipulation of interest rates and the money supply can be replaced with an automatic rule or a programmable calculator. The Fed has been steeped in politics and in reality has never been independent of the Treasury for the duration of its existence, since 1914. Astute students of monetary history will look back at the Treasury from 1900-1914 (including the 1907 bank panic, which will give one a dose of deja vu) and conclude that the Treasury gave birth to the Fed, but that the Fed still has that umbilical cord attached. And as to who rules who – sometimes that baby controls the parent, sometimes the parent controls that baby. Cutting the cord will be symbolic and lead to less of a solution than getting the Fed removed from micromanaging/engineering monetary policy, which has not led to long-term price stability. Let the capital markets decide.
Let Private Equity Help the Banks, 7/16/09:
The question is whether depository institutions ought to be able to take on significant risk – defined as beyond that which might allow them to cover FDIC losses should the risk bets go bad. Some readers have suggested putting these institutions into higher risk pools – i.e., they pay more into the insurance system to take on the higher risks. Makes sense.
Signs of Capitalist Life, 7/17/09:
Much of the market action this week had to do with a weakening dollar (chart DXY).
China’s Bubbling Consensus, 7/18/09:
Any speculation as to when/what levels the bubble will burst? Tied to our own W or WW or WWW or W^n recovery? Going forward it will be a war of currencies and commodities.
Bernanke: The Fed’s Exit Strategy, 7/21/09:
Mr. Bernanke puts forth several variants for reducing the Fed balance sheet and tightening the money supply, all of which will need to happen if the VoM increases and inflation becomes obvious. He has his work cut out for him, and would be prudent to enlist other monetarists, such as John Taylor. The problem: if we do not have an immediate recovery and another large bank fails, i.e., one of the current zombies. This time, let it fail – don’t keep increasing the Fed balance sheet to save it. No more price floors. Let the markets cycle without more artificial injections of money.
Bernanke’s Assurances, 7/22/09:
On Bernanke’s replacement: Larry Summers is not a fait accompli. Summers has tremendous liabilities; it is a matter of informing the voting public, the media and Congressional members of all of those liabilities and what they might portend. Mr. Summers is interested in power and control, not in genuine efforts to promote policies that would mean widespread business and job growth, continued GDP growth. His performance in his present position is evidence of that. Summers has no definable track record on monetary policy – only a desire to hold the title of Fed chairman. Not a strong qualification. Finally—-his resignation from Harvard over accusing women of “the different availability of aptitude at the high end” ought to remove him from consideration of any public policy position, ever.
Treating Financial Consumers as Consenting Adults, 7/23/09:
I’ve been critical of Mr. Posner in the past for not being true to the Friedman school, but he’s hit one out of the park on this piece.
“Behavioral economists are right to point to the limitations of human cognition. But if they have the same cognitive limitations as consumers, should they be designing systems of consumer protection?”
Seems as if Friedman said it himself. All of these so-called designers are interested in one thing: control. We already have credit card agreements and investor prospectuses: the problem is that the consumer does not read them and takes on risks they know are higher than they can afford. There is such a concept as personal responsibility. We need to emphasize that (and basic personal finance) instead of destroying what remains of our markets.
The Fed Can Lead on Financial Supervision, 7/26/09:
The authors have appeared to use their initial voice in this article for relocating ‘systemic risk’ regulation with the Fed as a vehicle to disparage all of the Fed’s critics. To claim that the Fed/FOMC is not, or has never been, influenced by politics in its decision making for engineering the Fed funds interest rate and the money supply is ludicrous. To claim that the Fed is independent of the Treasury is absurd; in fact, the Treasury gave birth to the Fed, and has had a long and intermingled history with the Fed. The Federal Reserve initiates monetary policy, affecting all aspects of business and life in this country. There is no reason why such an institution ought to be exempt from audits. Denying such audits is equivalent to admitting possible wrongdoing and/or perpetuating an unchecked level of power. The real solution is the free market: let the markets dictate interest rates and the money supply and eliminate the FOMC.
U.S. Issues New Rules on Short-Selling, 7/28/09:
The only way to cut down on naked shorting (willful or otherwise) is to require a hard preborrow. Too bad if the settlement takes time before the trade can commence. Fines for “fails-to-deliver” ought to also be considered, but the issue there is reliability of the data. When even the SEC cannot digest industry ‘fails-to-deliver’ data to make sound policy, you know something is wrong. The way I understand it, such data is unreliable, as it is unclear on whether cases are willful or system glitches, and the SEC has yet to publish hard numbers on their analyses of this.
The Politics of ‘Speculation’, 7/29/09
We need more speculators (read: traders and investors), not less.
We also need greater price transparency, which we would obtain by industry improvement of all market systems (trading systems, electronic and otherwise – meaning make them more efficient and reliable). Such improvements might also help curb ‘unintentional’ naked shorting. A few new jobs created there. More participants and market efficiencies are a positive for capital markets. In the unfortunate event that the CFTC further limits and regulates trading on futures contracts, trading ETNs are an alternative for traders, which move on price action. The SPR exists for emergencies, such as a massive supply disruption internationally or domestically – it does not exist as a tool to manipulate oil prices when market prices extend high. Clinton may have used the SPR for such a purpose, but it was wrong. Obviously the SPR ought to stockpile at low prices when possible. The link between oil prices and dollar volatility is a constant debate, with respect to assigning causality…in particular, consistent unidirectional causality.
The Customer Is Right, 7/29/09:
The Chinese and Russians have also been talking for months on a serious push to make IMF special drawing rights (SDRs), which is defined on a basket of currencies, the dominant reserve currency. So while we are warned by our creditors on the issues with the US dollar, there is a distinct possibility that it will be replaced for many international transactions.
Can the Fed Identify Bubbles Before They Happen?, 7/30/09:
Here’s some sample evidence as to how well the Fed has done in preventing bubbles:
“Indeed, recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward.” — February 2004, Alan Greenspan
“If I am confirmed to this position, my first priority will be to maintain consistency and continuity with the policies established during the Greenspan years.” 2006, Ben Bernanke
Solution: Eliminate the FOMC and let the market drive interest rates and the money supply.
Poised for a Rebound, 8/1/09:
This piece underestimates the influence of a steep yield curve and artificially low interest rates. I wouldn’t be popping the champagne for real Adam Smith-style growth just yet. I understand the optimism and I am an optimist – but I also believe caution and strategy are essential. We face continued assault from a Congress and White House that threatens shackles and limited options for businesses and individuals. Thriving private investment, a cornerstone for GDP growth and widespread prosperity (jobs), is not going to happen so long as the assault on capital and freedoms from this government continues.
What’s Behind High-Frequency Trading, 8/1/09:
Yeah, but that ‘unsuspecting buyer’ actually fell for it and paid the extra $ by entering a market order. He’s at the mercy of the market, so to speak, whether it’s the case you outlined or any other market dynamic. Market orders are the worst way to trade, and this is pretty old news. No one seems to have a problem with currency exchanges at airports that gouge travelers but they have a problem with HFT and flash. And how about all those banks that are offering us artificially low interest rates for our money? How’s that one? Quite frankly I’m getting tired of the whining over these strategies. These firms pay for special access and tools, and any day trader can pay for special access and tools – the latter are not as sophisticated, but so what – they still allow independent traders to get an edge. I agree front-running ought to be illegal, but it is not clear to me that all flash trading is front-running. The SEC ought to definitively look at the evidence and make a determination with industry on how to remove any elements that smack of front-running, leaving the other advantages for the markets intact. ‘Risk free trading’ is a foreign concept to me. There is always risk in the act of trading, and there always has been, and probably always will be. As a trader, I don’t always get the price I want – but when I don’t, I certainly don’t settle for whatever price is available. Every trader has benefited from arbitrage at some point. And trading thin illiquid markets can be quite irritating, but patience sometimes is warranted there (yeah, funny, esp. when talking about HFT).
Bernanke’s Exit Dilemma, 8/4/09:
The Fed will have to raise target rates at some point, and that will slow the reflation trade we are seeing now. When it chooses to do that and by how much are key. Bernanke ought to enlist the help of other monetarists that have studied this issue well, in terms of how to avoid significant price shocks. To not do so is short-sighted and shows even more of the political bias we simply do not need in the Fed.
People will not get used to sharply higher taxes and inflation – they will vote the bastards out. The problem then is we repeat the cycle without legislators who have read the constitution, know monetary history, have fiscal control, have seen firsthand how businesses function, and so on. We’d better all be preparing to solve the latter.
The problem we have here is our own: Government largesse and a Federal Reserve that conducts monetary policy to support that. The solution is to break this mold: less government, less spending, monetary policy that is market and/or rule-driven, and a Fed that simply is a lender of last resort, without the ability to create money to bail out special interests.
There are many similarities of the past 2 years to the 1907 Panic – a good read of this is Friedman’s passage on it in Monetary History 1867-1960. The Fed has had immutable power since its birth, which by the way was made possible as a result of the Treasury – the parent. The Treasury held many a Fed role before 1913, with the same cast of characters. Secy Shaw smacks of Paulson and Bernanke all rolled into one. History repeated itself in 1929 – with a powerful NY Fed and all of the classic mistakes we have seen repeated yet again. There is just simply too much power and politics in the Fed – this must change.
Teeing Up the Middle Class, 8/4/09:
And to hear these words again:
“Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.” Ronald Reagan
“When the people find they can vote themselves money, that will herald the end of the republic.” Benjamin Franklin
We all know what we need to do. Vote for less government and keep more of our money.
Goldman Had 46 $100 Million Days in Second Quarter, 8/5/09:
GS is benefiting from a steep yield curve and artificially low interest rates. And yes, they benefited from that $20B from Geithner last year, not to mention other counterparty bailouts (BSC, et al.) that indirectly helped them. I applaud their trading prowess – the issue is any illegitimate influence they exert to be in favored positions. The Fed needs to be neutered.
In China, Land Prices Fan Bubble Fears, 8/5/09:
One wonders if China will succumb to the same fate as Japan in the late 80s. There have been many articles on this lately:
Shanghai has overtaken Japan as the world’s second largest stock market, and China’s GDP is set to eclipse Japan’s very shortly. One can argue that this inflation in land and stock market prices can go on for awhile given China’s vastly larger population, but not all of that population participates in this growth yet.
It’s Time to Legislate a Spending Cap, 8/7/09:
Spending caps are sensible, but every time Congress has agreed to one it has either been repealed or violated. Mr. Moore does not offer any real solution to this dilemma.
What does one do when dealing with incorrigible, irresponsible parties? Vote them all out.
And an absolute yes to removing the Federal Reserve from the very monetary policy control that keeps the spending party going.
Posts on National Security and Foreign Policy
Russia Can Be Part of the Answer on Iran [in which Senator Schumer urges the U.S. to give up missile defense in Eastern Europe (and most probably Japan) to quell the Russians and Chinese…], 6/1/08:
Mr. Schumer has forgotten (or never understood) how Reagan won the Cold War.
Bush Owes His Successor a Tough Finish on Foreign Policy, 9/6/08:
John Bolton rightly keeps the pressure on the Bush administration to finish with a strong strategic position, particularly w.r.t. North Korea, where mistakes have been made. But he neglects to mention enough the strategic value of the NATO missile defense system in Poland, an accomplishment that will protect our allies. Ms. Rice deserves credit for the latter.
Bill Targets How U.S. Buys Weapons, 2/25/09:
Fixed price contracts will mean more no-bids from the industry. Cost-overruns are not always the fault of the defense contractor – the gov’t many times has unreasonable demands that lead to cost creep. Changes to only fixed price bids will mean more due diligence and less competitive bids. I’m not saying the system shouldn’t change, but the gov’t buyer side needs reform too.
Obama Aims to Reduce Reliance on Defense Contractors, 2/28/09:
When I was a program manager for a major defense contractor I hired many subcontractors, some of which were sole-source. This was unavoidable, as the subcontractors were experts in their field and there were no other sources to provide the studies/products my team needed. To have those studies/products replicated in house would have either not been possible or would have cost 10x+. For the govt to apply a blanket rule against contractors when federal $ are involved is asinine. Yes, there should always be due diligence on the program manager’s part to ensure fair bids and get the best value. Many of us did just that. The new “rules” had better not be as Orwellian as they sound – standardize some guidelines if needed, but if they already exist and it is a matter of more wasteful oversight then it has other motives. We all agree no-competitive-bid contracts for cronies is wrong but don’t hamper the system so much so that money is wasted even when people are following guidelines.
Iran Has Fissile Material To Make Nuclear Bomb, 3/1/09:
“The Obama administration has signaled it might slow down the U.S.’s development of a missile shield in Europe if Moscow were to provide greater assistance in international efforts to curb Tehran’s nuclear ambitions.”
There were never any good reasons for Russia to be against the missile shield or for Tehran’s ambitions, indeed they should stand with us no matter what. Call them on their bluff and concentrate on the real threats.
U.S. Willing to Roll Back Missile-Defense Plans in Europe, 3/3/09:
This is bad strategy. Once again, the U.S. should focus on the real threat (Iran) and stop trying to get an official quid pro quo from Russia (which won’t work). Even if we bluff each other into it, it would be a waste of time. The missile defense system is an asset for the free world.
Obama Orders Overhaul of Government Contracts, 3/4/09:
“We will stop outsourcing services that should be performed by the government and open up the contracting process to small businesses,”
The increase in small business participation sounds good but I am highly skeptical. There are already incentives in place for hiring small businesses as contractors. Need more quantitative details here!
“We will end unnecessary no-bid and cost-plus contracts that run up a bill…”
The majority of the time the party who is responsible for running up the bill is the gov’t! In my years as a program manager on the contractor side, I’ve seen the gov’t continually move the specs around and impose change orders. This drives costs up, period. So contractors are not the singular pariahs here. They have so many restrictions on them that to mandate fixed price on all contracts going forward will only ensure a reduction in those bidding or high bids to cover the higher risks. The gov’t procurement side needs overhaul itself, but not just a new set of cronies and poor performers to replace the old.
Beware of Doing Deals With Putin, 3/4/09:
This is bad strategy. The U.S. should focus on the real threat (Iran) and stop trying to get an official quid pro quo from Russia (which won’t work). Even if we bluff each other into it, it would be a waste of time. The missile defense system is an asset for the free world.
Cheney Says Obama Moves Raise Terrorism Risks, 3/15/09:
The fact that we did not have a bombing after 911 in this country is due in no small part to Cheney. You may (like me) be quite disgusted with the Bush/Cheney economic failures, of which there are many. Both of them (admittedly) ignored sound economic policy and management, allowing Hank Paulson to run the show in 2008 when he needed to be replaced in Fall 2007 for doing nothing. So while they had the country’s best interests in mind by fighting foreign terrorist threats, they lost sight of another piece of the national security puzzle: economic terrorism.
Obama Video Message Reaches Out to Iranians, 3/19/09:
Carter-esque indeed. Except now there are nuclear weapons involved. And trust but verify has no meaning. Peace, love and joy from…the 70s. Will it work this time?
Pain Iran Can Believe In, 3/25/09:
I would add that the current administration must continue to “follow the money trail” as suggested by John Bolton, in trying to map out how Iran is financing both an internal and external weapons race in the Middle East, and to methodically close down all illicit financial and related trading links. This is a necessary ongoing process for the U.S. and allies to effectively contain Iran.
Iran, Syria Got Indirect U.S. Nuclear Aid, 3/31/09:
More solid evidence for the elimination of the UN and the IAEA, or at the very least the elimination of U.S. involvement in or funding to these agencies.
Oil-Rich Arab State Pushes Nuclear Bid With U.S. Help, 4/2/09:
We’ve continually given the UAE all kinds of military and civilian technology, and perhaps incredulously, military technology that was even ahead of our own in some niche areas. This relationship extends back to the Clinton admin, and perhaps even farther back than that. Good policy? UAE has been very pro-American, so there’s something to be said for that given their surrounding neighborhood. Risky? You bet.
Pentagon Pushes Weapon Cuts, 4/6/09:
The WSJ really needs to edit their pieces (or maybe they are truly misinformed):
“…new funding for low-tech weapons such as the unmanned drones being used to hunt insurgents…”
These are anything but low-tech weapons. UAVs, their sensor, weapons and guidance systems are among the high-techest of any of our military systems.
“Mr. Gates’s proposed 2010 Defense Department budget signals a major departure from business as usual at the Pentagon, with a heavy emphasis on overhauling a procurement process that he and congressional leaders have decried as being too heavily influenced by powerful contractors.”
This I simply don’t buy. Not much will change. Gov’t contractors are already highly regulated. It’s the gov’t side that has to change to make any difference. The F22 cuts are a mistake. All this investment only to then cut a program. We must support the concept of air dominance if we are to protect the U.S. We don’t make the F15 anymore so what will replace it in the future…? Micromanagement. And finally the biggest mistake – massive (20%) cuts to missile defense *because* liberals just don’t like the concept. No real reason, other than it’s taboo because Reagan promoted it. Just like corporate tax rate cuts. Can never have those either. Despite the fact everyone pays them. And everyone would be protected with a functional missile defense system. But can’t have either, period. Regardless of the waste of the years of investments and a faltering business economy to boot. Must shift all focus onto socialist cronyism. And, well heck, Obama has his own fortified bomb shelter, so what does he care?
“The Pentagon chief said his plan represents “one of those rare chances to match virtue to necessity; to critically and ruthlessly separate appetites from real requirements,” and that politics played no role in his analysis.”
Yeah, right. Which would you rather have, a gun or a helmet? Which would you rather supply your troops with, food or ammunition? You’d supply both. You’d have a military well equipped and not second-guess what you need for a conflict. True, programs need review for performance and focus, but they are all designed to keep our military modern and ready for unfortunate events. I’m willing to pay for that protection given the real threats we face. Moral high ground must be backed up with a willingness to defend your moral position, otherwise your morality will have an expiration date. (The term ‘Dead Right’ comes to mind.) Missile defense and a nuclear arsenal are prudent measures in the world we live in, period.
Henninger: Obama Among the Dictators, 4/23/09:
Some sobering words to add to this Op-Ed:
“The pacifist is as surely a traitor to his country and to humanity as is the most brutal wrongdoer” – Theodore Roosevelt
“Every dictator is an enemy of freedom, an opponent of law” – Demosthenes
“Between capitalist and communist society there lies the period of the revolutionary transformation of the one into the other. Corresponding to this is also a political transition period in which the state can be nothing but the revolutionary dictatorship of the proletariat.” – Karl Marx
Obama will be judged on the decisions he makes going forward – appearing as a sympathizer of ideological views completely counter to our Constitutional character and spirit, parroting other angry heads of state and targeting that anger toward his own country will earn him a swift trip out of office.
Torture and the ‘Truth Commission’, 4/28/09:
There is little doubt that the Obama Administration will use ‘techniques’ in their intelligence gathering; they just won’t document it, and the measures may be more severe than those used previously. The fact is that the Bush Administration did document their actions and sought legal counsel, in the honesty of following Constitutional precedents in other wars, and with the intent to not exceed constitutional bounds.
Don’t Forget About Foreign Aid, 5/5/09:
There was a reference that appeared in the Journal some months back: “Why Foreign Aid is Hurting Africa” – link: http://online.wsj.com/article/SB123758895999200083.html. This piece offered the alternative view, which is from an economist and aid worker. As the author states, “the strategy of development finance emphasizes the important role of entrepreneurship and markets over a staid aid-system of development that preaches hand-outs.” South Africa and Botswana have developed their economies – it’s only a matter of time for many others.
The Nuclear Realists, 5/13/09:
A modern nuclear arsenal and a strong missile defense system are indispensable investments toward ensuring we maintain peace and freedom. There are obvious dangers in allowing our nuclear capabilities to deteriorate, such as from weapons safety perspective. Proliferation will happen no matter what, so yes, reality dictates that we prepare for all of the possible scenarios.
Putin’s Ninth Year in Power, 5/15/09:
Not to get on Mr. Kasparov’s case too much, but after a string of articles with the same theme (Putin as the “arch-enemy”) one wonders what a nation under Mr. Kasparov’s leadership might look like. Perhaps he could enlighten us in future articles? I think that might be more productive. What I do know is that within the first month of the Obama administration, Mr. Putin warned the U.S. to eschew socialism, as he learned that “excessive intervention in economic activity and blind faith in the state’s omnipotence” and that “Nor should we turn a blind eye to the fact that the spirit of free enterprise, including the principle of personal responsibility of businesspeople, investors, and shareholders for their decisions, is being eroded in the last few months. There is no reason to believe that we can achieve better results by shifting responsibility onto the state.” Mr. Putin is spot-on with his words and timing here, even if it is rhetoric.
North Korea Advertises Its Nukes, 5/26/09:
One has to ask the question: How does North Korea manage to evolve its nuclear program in view of all the sanctions and outside monitoring of its transactions? Possible answer: China. Instability in the region surrounding Japan and South Korea is a strategy that China might advance. A bonus is observing how the U.S. reacts to such instability. As a pro-China advocate, I’d like to think otherwise, but the reality of possibilities dictates.
How to Reduce Nuclear Threat, 5/27/09:
The authors appear to avoid any significant discussion on missile defense – which is an effective, practical deterrent. It is unrealistic to assume that world states will eliminate their stockpiles, no matter what Obama’s position on the matter might be. Vulnerable nuclear materials have already fallen into the wrong hands – and action has been selectively taken. Intelligence and tracking of inventory ought to continue to be at the forefront, along with a strategically distributed missile defense network and the continued modernization our own stockpile (for safety and security). Reducing or eliminating our stockpile as an “example” will only be viewed as a weakness, whereas a strong missile defense will be viewed as a strength and a deterrent.
The Test Ban Treaty Would Help North Korea, 5/29/09:
The U.S. ought never to sign a CTB treaty concerning North Korea or any other nation, for that matter. North Korea proved yet again yesterday that it would not observe any agreement it has made with anyone – the latest case being the 1953 armistice agreement ending the Korean War. The U.S. and its allies need to remain committed to the development and deployment of an effective missile defense network. This remains the key deterrent to problematic rogue states (aside from strategic military strikes).
The Axis of Evil, Again, 6/2/09:
Japan will develop nuclear warheads, and within a short period of time. The only alternative for them is the deployment of a missile defense shield.
U.S. and Russia Push Arms-Control Talks Forward, 6/2/09:
And look how effective concessions by the Clinton admin with NK worked out on nuclear disarmament…Abandoning defensive counter-measures (e.g. missile defense, etc.) is insanity.
Putinism’s Piranha Stage, 6/9/09:
Putin is surely not dumb enough to kill what gave him enormous poll ratings – the illusion of cleaning up a corrupt Russia from the brink of mafia control. So portraying Deripaska as party to that threat is in his favor. Putin has played his cards well outside of Russia – for example, by giving a speech at Davos in January that more or less accuses the U.S. of falling into a socialist trap and over-printing its supply of money to cover. So while he may indeed be a piranha, and one of the last left, he might have enough food to get him through a few more stages. And it’s not clear yet to some of us that he is completely evil.
Obama, the Neocons and Iran, 6/26/09:
In one of his recent speeches on Iran, Obama invoked the word “justice,” a term administration officials said would have more resonance in the Muslim world than “freedom.” It is this type of thinking that will work against us. A consistent message of what the U.S. is all about – individual freedom, religious freedom, a right to self-determination – is a speech that few Americans would disagree with.
Our Decaying Nuclear Deterrent, 6/29/09:
The missile defense system in Eastern Europe ought to be off the table in any negotiation discussion. It is such a network that is needed as a deterrent and to protect allies. In reality, it protects Russia as well. Obama et al. would do best to consider a thrust of missile defense into negotiations as an attempt to use it as a political football and resist – focus on eliminating the old nuclear arsenal for a modernized one and avoid signing/ratifying a “nonproliferation treaty” with anyone, as it will not work in practice. A missile defense network ought to be a high priority given the threats we face.
Wasteful Defense Spending Is a Clear and Present Danger, 7/18/09:
The author has some well-reasoned and sensible solutions to containing wasteful spending in the defense arena, especially the first two points listed: (1) Procurement management side reform – esp. accountability; (2) Limiting change/engineering orders. Having worked in the defense sector, I can say (2) is a big deal to cost creep. I would also add that in some circumstances I’ve seen a better outcome when the military (in the case I’m thinking the AF) runs a program from cradle-to-grave with only a few subcontracts, with better outcomes in terms of delivering an innovative and deployable product – but these were smaller programs – so in limited cases point (3) is apropos. I do know there are clear exceptions to what the author stated: (a) It is career suicide to admit your program is failing/has failed – somehow this has to be addressed with incentives to pick the best capability/value rather than sticking with the initial decision; (b) defense companies often spend their own money developing prototypes in the process of bidding for government contracts. The current administration apparently wants to cut defense spending, jettisoning valuable programs (missile defense, F22 air superiority/dominance) that would ensure the continued freedoms enjoyed by us and our allies, while apportioning little cost control to entitlement programs and other discretionary spending (Congress). The Constitution is clear about providing for national security.
The Right and Wrong Stuff, 7/21/09:
Buzz Aldrin is pushing for a manned mission to Mars, as well as a base on Phobos. Good goal. Funding several parallel efforts of new propulsion systems, co-operative with private investment, is a good goal. Treaties on colonizing space and working out mining rights need to be addressed. Some of us out here are optimists, by the way.
Grounding the F-22, 7/22/09:
Big mistake. We need the air superiority the F-22s provide to keep up with adversaries. Same goes for missile defense. Dead right is not a defendable position.
There Is a Military Option on Iran, 8/7/09:
With all due respect to the General, there is a reason why “there has been a lack of serious public discussion of the military tools available to us.”
We simply don’t discuss what is possible and not possible in too distinct a term. To do so would allow for the development of countermeasures.
Posts on Health Care, Education, ‘Climate Change’ and Other Assorted Issues
What’s at Stake in the Medicare Showdown, 6/24/08:
Defined contribution must be a serious consideration for not only Medicare, but also employer-paid insurance. The fact that most people don’t pay for their own health insurance masks the hyperbolic medical costs that make our food and fuel inflation today look paltry. If people are directly involved in paying for insurance they would scrutinize the costs and there would actually be a free market and more liquidity.
Google, IBM Promote Online Health Records, 2/5/09:
Electronic health records are somewhat of a farce in the health care debate. Security and privacy issues are severely under-rated. Health cost savings is severely over-rated. Who wins and who loses? The pharmaceutical and biomedical companies win if they can buy the data. The patient loses if their data is sold to the highest bidder without their consent or profit, or if security breaches occur and privacy is compromised. HIPAA privacy rules do not cover the government or other specified parties. Technological and medical innovation is important, but the patient needs to be in the game and profiting too.
We Cannot Delay Health-Care Reform, 2/26/09:
National health care will be yet another entitlement program with an unfunded liability weighing on our sovereign debt rating and burdening future generations. National health care will also limit personal freedom. Everyone agrees that costs are out of control and that the system needs to change, but national health care is not the way to fix the problem; it will only cost more and limit people’s choices.
The alternative should be explored as part of a national debate: (1) employ a methodical process of recognizing and fixing the systemic issues that contribute to the high costs and lack of health insurance availability, reversing those trends; (2) ensure a free market model for health care and insurance to allow for more efficient price discovery within the given universe of supply and demand.
If the viable alternatives are not explored as part of a debate then we know that the motives of this administration and its Congressional supporters are suspect. We deserve a fair debate.
In Science and Technology, Efforts to Lure Women Back, 2/25/09:
Businesses might consider offering more contract jobs, and not just for women technologists who exit the workplace. Many highly skilled and productive independent contractors do not want to work full year or even full time in a regular employee capacity, and will accept the more limited pay and benefits for independence and flexibility. Contract work is one way to fulfill labor needs as opposed to hiring a regular employee, which is often very expensive. There are workarounds to such issues as preserving proprietary firewalls, etc., such as asking contractors to sign NDAs.
Regulators See Big Funding Boost in Plan, 3/1/09:
“In a move that promises a major fight with drug makers, the plan backs development of an FDA plan enabling Americans to buy less expensive medicines abroad, an effort drug makers have protested for years.”
Wait…this is deregulation! And a positive development. Let’s hope it’s not a mirage. Many of us buy drugs from Canada and have been threatened in the last year or more with red FDA stickers saying our drugs could be confiscated next time…recently I’ve seen those disappear.
High Court Eases Way to Liability Lawsuits, 3/4/09:
Which makes me wonder why the drug company appealed to the high court knowing it might lose, and in the end making it much worse for everyone. Their appeal had weaknesses, as does Alito’s dissent (” being covered by federal regulation gave Wyeth immunity from state law”). This ruling will of course drive up those costs even more. Why didn’t Wyeth just appeal the state court ruling asking for it to be dismissed, knowing the patient already settled with the clinic (if indeed that is true)?
As an aside, FDA regs didn’t prevent the problem from occurring, and they add to the significant cost of a drug. So the value of the FDA needs review!
Steele: Why the GOP Can’t Win With Minorities, 3/16/09:
“It [conservatism] seeks the discipline of ordinary people rather than the virtuousness of extraordinary people.”
Conservatism demands rigor, critical thinking, and a tinge of the scientific method, all of which know no race or color or class status. But Dr. Steele should not confuse the GOP with true conservatism – those who follow its principles have been marginalized over the last 8 years and are now disenfranchised, with only a soapbox and a voice – and a smile when just about anyone from any background or ethnicity speaks up and echoes the same principles, as they choose to see the value in them.
The Fine Art of Copyright, 3/16/09:
I strongly side with Mr. Garcia on this one. His photo was published and therefore is protected by copyright laws, although publication is not necessary for copyright law protection. Those laws should apply to derivative work based on the original work. It is clear from the poster rendition that the infringement involved no more than about 15 minutes of digital algorithm application to the original photo in Photoshop or an equivalent program, using posterization, which is a common technique that does contour rendering using color schemes. As a photographer-artist I publish my work on the web with the good faith that others will give me credit if the work is used elsewhere. One way to ensure that is with the use of digital stamps or watermarks, but those can be removed easily. In the end the goal is to get your work out there and seen so the risk of infringement is outweighed by the benefits of distribution. Prosecuting and proving infringement can be expensive and difficult, even though the infringement is blatant, as it is in this case.
U.S. Is Open to Carbon Tariff, 3/18/09:
Energy Secy Chu is an ivory-tower academic who finally got a chance to funnel money to causes he and others have wanted for years. Having a Ph.D in Physics doesn’t make you brilliant. A month ago he said in a press conference that he didn’t know the administration’s position on foreign oil, but that he’d find out. All he was interested in at the time was getting stimulus cash out to pet projects. With this reckless policy, if enacted, we’ll start a trade war with China. Worked real well with Mexico – they were right, Congress doesn’t respect NAFTA. And they don’t respect any other nation and free trade. These tariffs will double the impact of cap/trade.
Democrats Angle for Health-Care Edge, 3/19/09:
Nationalized health care will be another major entitlement we cannot afford, take away individual choice, and ruin our highly innovative medical fields. Medicare is being touted as the model yet…Medicare costs are already growing faster than any other health care expenditures and show no sign of slowing. We need to get the gov’t out of providing for health care.
Stimulus Funds for E-Records Augur Big Windfall for Small Health Firms, 3/24/09:
I have seen no studies suggesting digital medical records (DMR) will lower health care costs, indeed the studies I’ve seen show the DMR costs will increase overall health care costs. This is all a ploy to get everyone into a system to pave way for the nationalized health care entitlement program; just as assigning everyone an SSN got him or her into the social security system. Both are Ponzi schemes. The DMR issue has a long way to go to win people over – the privacy and property rights issues (“who owns my data – can it be sold to the highest bidder”) have not been addressed and absolutely need to be. These issues should be on the forefront of every patient-consumer’s mind. Gov’t expenditures of this kind without a public policy debate are a crime – or should be.
National Health Preview, 3/27/09:
The outcome will be worse than this Op-Ed predicts. The model in the sights is not RomneyCare, it is Medicare, as Barney Frank made clear on Fox News Sunday a few weeks back. Medicare has by far the worst metrics for cost containment – it has the highest growth rates across almost all spending categories, over a 9% CAGR in the aggregate and over 50% CAGR for prescription drug spending. The right move would be in the opposite direction: toward a free market where the consumer buys private insurance that is on the basis catastrophic insurance, and then pays all maintenance costs out-of pocket. The consumer is the best arbiter and scrutinizer of cost control (home economies), what their precise individual/family needs are, and in effect should be the direct payer for most health care costs. The middlemen are an extra cost layer in the data. In 1970 consumers paid 33%+ out-of-pocket costs, now they pay 12%. This needs to be reversed. Finally, tort reform must be addressed – while the direct malpractice insurance costs are one factor, the indirect “defensive medicine” practices to avoid lawsuits are at least an order of magnitude higher.
J. Wayne Leonard: Carbon Cap Dilemma, 3/28/09:
Businessmen like Mr. Leonard are dangerous, for their propensity to stand on either side of an issue and appear weak in their convictions and arguments. Auctions of carbon allowances by the government constitute a market-based approach? Gov’t revenues will be returned to the market? Ideally indeed! One would think his fiduciary duty is to his customers and shareholders, but how does a gov’t sanctioned cap and trade or a straight carbon tax square with that? Utility rates will go up for everyone, blind to what the energy source is. Margins will take a hit.
“Mr. Leonard argues that the best way to square these circles is to channel research dollars into the technology that can retrofit existing coal plants with carbon capture technology.”
Completely agreed. But why not have conviction for this approach over tax and gov’t spend cap-and-trade?
“While Mr. Leonard says — repeatedly — that Entergy has nothing against solar or wind, “Our view is that government shouldn’t be in the business of picking technologies. . . . And we’re moving down a path where we’re mandating renewables instead of a price signal to do it. We’re . . . moving toward a planned economy by mandating a technology.”
Completely agreed. Yet Mr. Leonard still supports cap and trade, and even more directly, a carbon tax. This is not market based; it is gov’t picking technologies…so where does he really stand on the issue? His customers and shareholders deserve an answer.
“The focus,” Mr. Leonard reiterates, “should be on developing the cap-and-trade program: Setting the amount of reductions, where we want to be, setting the price signal that works so that it’s not so high that it shuts down coal plants prematurely, and that’s not so low that it becomes a loophole and people don’t end up doing anything — and all we end up doing is taxing people, and God knows what the government will do with that money.”
Aaahh…I see…so price fixing is still ok, but now Mr. Leonard admits that he’s concerned about what gov’t will do with all that money. Please take a side.
“That is really the tough part,” Mr. Leonard says. “The trade-offs are not simple. . . . With a well-crafted bill, the market will make those choices. Or you can do it with a planned economy, and hope you get it right.”"
Again, Mr. Leonard, please take a side. You either have a centralized planned economy or a market-based economy, and better that the latter is free. “Hoping” to get something right is not a sound way to conduct any business, period.
The GOP’s Alternative Budget and Health Care, 3/31/09:
“The budget moves toward making quality health care affordable and accessible to all Americans … We preserve the existing Medicare program for all those 55 or older; and then, to make the program sustainable and dependable, those 54 and younger will enter a Medicare program reformed to work like the health plan members of Congress and federal employees now enjoy.”
This unfortunately proves that the GOP does not understand the extent of the cost containment issues with Medicare, nor the unfunded liabilities that this program has. The liability for current generation is an estimated $30T alone. We need a reduction of entitlement programs, not “reform” solutions that look oddly similar to those proposed by tax and spend liberals.
Sebelius Backs Public Health-Insurance Option, 4/2/09:
“Ms. Sebelius told the panel that public-insurance plans in states across the country didn’t create the havoc upon insurance markets”
Misinformation. Gov’t insurance plans and mandates on public and private insurance plans raise costs, period. We need a free market for health insurance and the gov’t to get out of the health care industry.
The End of Private Health Insurance, 4/13/09:
The electorate needs to get the government out of health care and throw its support to a completely free market, where buying power is placed back into the hands of the patient-consumer. State/Federal mandates increase insurance costs for patient-consumers, and everyone should question their value. Tort reform must also be part of the solution to bring down the substantial costs due to defensive medicine.
Campus Leftists Don’t Believe in Free Speech, 4/17/09:
Mr. Horowitz concentrates his attention toward college campuses with regard to the problem of one-sided ideological indoctrination of students by academics. The larger problem is that such actions happen in public K-12 schools where students usually are not exposed to a market of outside speakers – only parents are aware of what their children are being taught, if they are even in tune with their child’s curricula.
The problem with academia from top to bottom is that we do not have a free market – teachers and professors get lifetime appointments without continued checks and balances of how well they are performing at their job.
Duncan: School Reform Means Doing What’s Best for Kids, 4/22/09:
“We need solid, unimpeachable information that identifies what’s working and what’s not working in our schools.”
But what exactly will Mr. Duncan do with this information? Centrally planned education won’t work for a country our size – the federal gov’t is too inefficient and ought to get out of education. Throwing more federal money at the education system has shown time and again not to improve education quality. $100s of billions of dollars for data is not a carrot – it is a bloated banquet. I don’t see our education system changing with these incentives, I see it preserved in more money. The Dept. of Education ought to be on the list of gov’t departments to eliminate. What needs to change? The stranglehold that the NEA has over our education system, with underperforming teachers asked to leave the system unless they improve, and the market opened up to gifted, dedicated teachers eagerly waiting to teach children. Parents have become more activist in demanding a better educational environment for their children: the rise of charter schools and home schooling is strong evidence of that. But what Mr. Duncan threatens with his piece (if I read between the lines) is more regulation against freedom of choice in education and a preservation of union control. Scary indeed.
Does Avoiding a 9-to-5 Grind Make You a Target for Layoffs? 4/22/09:
“In tough times, many employers revert to thinking critical jobs can only be done full-time, flat-out and under the boss’s nose…At other companies, however, oddball work setups are considered an advantage in the drive for efficiency…”
Companies need to change their attitude toward where work is done and by what type of employee. Full-time on-site employees are the most expensive, and not always the most efficient. I’d like to see companies consider independent contractors for their hiring needs. Contractors are focused and portable, and cost much less to hire.
Teach for (Some of) America, 4/25/09:
Teach for America is but one example of an initiative that has had clashes with union control of our education system.
Another program that I am familiar with, “Physics First,” now sponsored by Project ARISE (American Renaissance in Science Education) and started in the 90s by Nobel Laureate Leon Lederman, has had continual problems with adaptation by 9-12 public school system. Dr. Lederman put it best recently in an interview (http://www.ait.net/technos/e-zine/interviews/leon_lederman.php):
“I’d like to see more businessmen become active in the management of schools. Look at what we have: We have a school, so you have teachers, and then you have a teachers union; then there’s the principal, and they have their own union. Then you have the teacher training institutions, who determine who gets into their course of study; but not too many kids want to be teachers these days (it doesn’t pay too well), so the teacher training institution lowers its standards to attract customers—and that’s the kind of teachers you have in your schools. Primary teachers get maybe one semester of science or math in college, and all of a sudden they have to teach it, so they approach it with total insecurity, fear, and loathing, and of course, the kids pick up on that. It’s a disaster.”
I cannot find the quote, but I recall Dr. Lederman also talking several years ago about how dismal the outlook was for highly trained physicists and engineers who wanted to become public school science/math teachers – the uphill battle against the union enclave. This needs to change. Gifted/highly trained science and math teachers are sorely needed in our public school system to meet the technological challenges that we face this century.
Drugs: To Legalize or Not, 4/25/09:
Drug legalization is a Libertarian issue, and as such does not fit within either of the two national party platforms. Obama voters thinking they will get reform on drug prohibition had better think again.
National Health Care With 51 Votes, 4/27/09:
A grass roots movement against government-run health care is a solution to actions such as this. In 1993-4, constituents called their Congressmen en masse against “Hillary-Care.” George Mitchell could not then summon the votes necessary to pass any legislation. With Presidential talk of pay-to-play, that alone ought to kill any legislative initiative, if the President were indeed serious. Gov’t-run health care is an unfunded liability, with the gov’t unlikely to achieve efficiencies and the innovation of the private sector.
Obama Urges Major Investment in Scientific Research, 4/27/09:
Gov’t R&D expenditure increases sound great – but most of the money spent is politically motivated, not based on merit.
How to Wake Up Slumbering Minds, 4/28/09:
Teaching young and seemingly unmotivated students to “learn how to learn” is a valuable approach. Many of us endure years of mediocre teaching before we command that skill, so to impart it early in an effective way is an exciting prospect for both young students and the teachers that become effective in doing so. A pedagogical revolution would include this to enable students to more easily embrace abstract thinking and concepts.
The Science and Psychology Behind Overeating, 4/28/09:
While reading I was skeptical of Kessler’s motives until I read the last paragraph, where I think he hit one out of the park:
“In the end it’s not about regulation. Government can play a role. It’s about how we as a country view the product. What was the real success of tobacco? We changed how we viewed the product. It was a critical perceptual shift. That’s the key.”
This is how cultural shifts happen (perception changes from a grass roots growth) and I really respect Kessler for admitting that gov’t over-regulation and intervention aren’t nearly as effective: they have the added detriment of reducing personal freedoms and choices. Public perception of healthy behavior vs. addiction is the real issue.
David Wessel: A Determined President Sees Chance to Fix Health Care, 4/30/09:
“He [Obama] is drawn to what Jews call “tikkun olam” or “perfecting the world.”"
David, do you really believe this? Utopias sound good until you realize that in attaining a utopian scenario someone has to lose their freedom to provide for another. Perfect to one is not perfect to another. Think about the implications of what you are saying here. As a person with some Jewish heritage I take issue with your statement. Capitalism and free markets must prevail: we cannot allow gov’t run health care that dictates what kind of care people can have access to, enables price controls (which never work) and squelches innovation. Cost issues can best be contained by reverting to a free market.
An Affordable Fix for Modernizing Medical Records, 4/30/09:
Make no mistake: The $20 Billion gov’t bribe program for “adoption” of medical records is to pave the first step toward nationalized health care. Think of it as no different from being assigned a social security number. This was but one example of many disingenuous outlays in the “stimulus” that underwent no Congressional debate – and indeed it should have been debated – the cost-benefit is far from obvious. There are many issues with electronic medical records that need to be addressed and haven’t – security and property rights issues among the forefront. I would not want my data sold to the highest bidder without my knowledge, consent, benefit, etc. If these issues are not addressed via public debate then down the line we will see many cases before the high court.
Cancer Patients Deserve Faster Access to Life-Saving Drugs, 5/3/09:
We are left to wonder where Mr. Epstein stands on solutions to the legal implications here, given the track record of unbridled litigation. Even if cancer patients sign a waiver in good faith to risk taking a potentially life-saving drug via off-label use, the threat of litigation may further penalize doctors and drug companies and further depress innovation and access. Our hyperactive and emotional tort system must address reforms before “drastic measures” such as Mr. Epstein’s worthy prescription are adopted “when lives are at stake.”
Potomac Watch: Republicans and ObamaCare, 5/8/09:
Take a look at the Medicare spending data over the last 42 years and decide whether Medicare has “held down costs.” Barney Frank and others have made it clear that the model for nationalized health care will be Medicare. The majority of Republicans gave us Medicare Part D, so where’s their conviction to change? Mr. Coburn ought to start looking seriously at a grass roots approach here. There are many of us who want to see a more competitive free market for health insurance, not the system we have, which is wrought with mandates, price fixing, and unfair subsides. We also want to see the innovations that we have in medicine not get squashed by government control and rationing.
The Science Prize: Innovation or Stealth Advertising? 5/10/09:
This is (or should be) the future of funding for many areas of science, astronomy and technology. Government cannot and should not be the answer. There are many people out there (myself included) that look forward to the oppty to donate their estate or money to solve important problems.
Signing On to an Obama ‘Dream’, 5/12/09:
It appears that Faust is doing a brisk business this year. Having Mr. Orszag decide who gets care and who doesn’t, what the right incentives are and what aren’t – social engineering is fun when you (think) you have the power and control, eh? Government involvement in health care means the following: price fixing, subsides, and mandates, which drive up costs or drive away supply, such as in doctor or procedure supply. Rationing of care is common in other countries with nationalized health care.
EPA Chief Says CO2 Finding May Not ‘Mean Regulation’, 5/13/09:
I encourage a read of “State of Fear” by Michael Crichton (GRHS). Global warming propagandists control many ‘educational’ websites, including Wikipedia and various purportedly neutral and balanced science news sites. On Wikipedia, every time a post is made citing scientific studies or evidence that do not support global warming, biased editors delete the posts and bar further posts. So much for academic freedom and an honest forum for looking at all of the available information. Mr. Crichton, along with those of us who have training in the scientific method and in statistics, understood/understand that this debate is replete with misinformation and scare tactics, and without a sound basis.
Social Security, Medicare Face Insolvency Sooner, 5/13/09:
The Madoff detractors were vocal for years before all the money was gone in that scheme. Let’s not wait that long for Social Security and Medicare folks.
Orszag: Health Costs Are the Real Deficit Threat, 5/15/09:
Mr. Orszag seems to miss some key insights in his piece:
(1) The patient-consumer has little control over costs they don’t see. The trend since 1970 is a 60-70% decrease in the amount of out-of-pocket payments for health care services and supplies. This trend is very obvious in the National Health Expenditure Data (NHED), which I am sure the OMB also uses for their studies and projections;
(2) Medicare has the worst cost control record (vs. Private Health Insurance, Medicaid, DoD/VA coverages) – again, evident from the NHED data;
(3) Defensive medicine practiced by doctors and clinicians in order to avoid tort judgments is estimated to be at least 30% of the costs charged to patients. This is over and above the direct costs resulting from tort judgments, such as from medical malpractice insurance. Unless tort reform is addressed, which IS A MAJOR contributor to costs, we will not see cost control. As the American Assoc. of Trial Lawyers (ATLA) was/is a major contributor to Obama and the Democrats, this may not ever change under a Democrat supermajority;
(4) We spend more per GDP in this country for health care partly because patients are denied certain procedures, medicines and services in other countries. Canada is a prime example: since national health care and its rationing and price fixing is mandated in many provinces, Canadians who are forced to get the procedures and attention they need elsewhere end up unreported in the Canadian health care %GDP expenditure data. Thus the argument that we spend more for the same procedures is a red herring;
(5) The cost benefit of electronic medical records has not been justified and the MAJOR issues of data security and property rights have NOT been addressed. (Would you want your data used without your permission or sold to the highest bidder?) Without such important public debates, medical e-records are simply a way for the Obama admin to force people into a national health care system – just as they were forced into Social Security and Medicare entitlement systems many years ago;
(6) Federal and state mandates on health insurance drive up the costs of insurance, penalizing consumers.
Mr. Orszag, we need to move in the opposite direction: toward a free market where a multitude of options are available to the patient-consumer, where there is price discovery and not price fixing (the patient-consumer decides from the many available options what is the best value vs. price, in the given supply/demand – and not mandated/limited by a central government command/control machine), and a health care environment less fettered by the threats from a hyperactive and emotional tort system.
Laffer and Moore: Soak the Rich, Lose the Rich, 5/18/09:
Throwing more money to schools and public services won’t improve the quality of education and life – these are truly improved through a more cognizant citizenry that puts more effort into realizing quality through keeping and maintaining values and standards that don’t equate to more money. Why not let successful citizens donate or contribute their knowledge and skills to public education and services if it means keeping taxes low or even reducing taxes? Ah, but this is where we get into trouble – many of these institutions are protected from unions, and the last thing those unions want is an upset from successful citizens that may eclipse their performance or deliver needed value.
Canada’s ObamaCare Precedent, 6/9/09:
Rationing – the inevitable dividend of nationalized health care. What the author does not emphasize enough is that the Canadian expenditures for health care (the purported and often quoted 10-11% C-GDP) under-report the level of care eventually paid and delivered to Canadian citizens as a result of rationed health care, and a system where advanced procedures and treatments are simply not available.
Conservatism and the University Curriculum, 6/12/09:
In the U.S., Conservatism is Classic Liberalism. The problem is that we’ve gotten completely turned around. Neo-Liberalism has become a socialist movement, defined by the concepts of egalitarianism, wealth redistribution, social justice and central government planning and control, and seeks to employ social and economic engineering to achieve those ends. Didactically, Neo-Liberals have no problem with the retraction of individual freedoms, as they interfere with socialist goals. It is indeed a travesty that our great educational institutions have wandered toward this Neo-Liberalism, and away from Classic Liberalism, or Conservatism. The individual and preserving individual rights define Classic Liberalism. Truly free market principles and a limited government are concepts that belong to Classic Liberalism. The thought of our nation turning into a socialist country and shunning the very document (the Constitution) that binds us from the Founders is a horrible thought. I have faith that there are many people in this country, even young people, who maintain Classic Liberal/Conservative values, and will pass them on to their children. But I wholeheartedly agree with the author that our educational institutions ought to include the true American history and values in modern curricula and not deprive students of a comprehensive education at the expense of social engineering aims. Thomas Paine in Age of Reason argued reason in the place of revelation. The Age of Reason is not atheistic, but deistic: it promotes natural religion and argues for a creator-God. Conservatives (Classic Liberals) believe in freedom of religion and that forms a significant basis for our nation.
Naturalism Has Been Hijacked, 6/13/09:
First: Mr. Kurzweil might want to have a debate with Roger Penrose, who it appears believes that human sentience cannot be replicated by machine. I’d like to witness that debate. I take neither side at the moment.
Second: Yes, don’t kid yourself. Environmentalists are driven by power and greed. They could indeed be Neo-Luddites.
Third: The word Conservation has gotten co-opted as much as the word Conservative. May we all be Liberated.
Health Reform and Competitiveness, 6/17/09:
Competitiveness means not only cutting corporate and investment tax rates, it means eliminating *all* federal and state mandates on health care, including favored tax subsidies. Many small businesses and partnerships are excluded from those tax subsides, unless they organize under Subchapter S.
Dissecting the Kennedy Health Bill, 6/19/09:
Agreed on most points, but take strong exception to the last: we cannot afford what is “good enough for Congress.” (Translation: we cannot afford Congress.) That has been a major problem all along.
Yes, We Can Expand Access to Higher Ed, 6/21/09:
The authors ought to turn their attention toward primary and secondary education, where indeed the failures are occurring, primarily due to the dominance of the NEA, a very political union whose goals are job security and ever increasing funding over teacher performance. In doing so, perhaps the authors can address the problem of qualified science and math teachers and a more positive unbiased emphasis on science, math and technology disciplines in general.
Is Government Health Care Constitutional?, 6/21/09:
The Constitution does not speak clearly on the right to privacy; in fact, such a right is not succinctly defined therein. Privacy is a societal norm that we’ve come to respect and promote. Electronic medical records have a danger of breaking privacy rules (as well as property rights!). The cost-benefit of such records are currently being debated, but the privacy and property rights issues have not been addressed, nor has the issue that such records are actually a front for a new entitlement system (think social security and the social security number).
Government Health Care and Voters, 6/23/09:
Americans do not want universal coverage. Most of the polls show that. Universal coverage = a new Ponzi scheme, and Americans have caught on to that game. As a small business owner, I am most concerned of all of the state and federal mandates that have increased my costs for the health insurance I pay for, and if you look at the data there is a clear correlation with the increase in those mandates and costs. Universal coverage will increase my costs (as it has done in all other countries that have universal coverage) and limit quality care – I have no illusions otherwise. The answer to this whole mess is to return to a free market, where the consumer sees something closer to the real prices and supply/demand, and pays most of the costs out of pocket.
What would happen if the government ran all the supermarkets and produced all the food goods in it? Let’s get the government out of health care.
A Doctor’s Reflections on Health-Care Reform, 6/23/09:
“I feel strongly that if doctors are reimbursed more for office visits, they will spend more time with patients.”
This is a doctor-dependent choice. Personally, I would drop a doctor with this attitude. And no, I do not advocate that doctors get paid less than a market-going rate.
“This will lead to fewer referrals by primary-care physicians and result in lower health-care expenditures. Currently, harried primary-care physicians don’t have the time to delve into medical problems with a hint of complexity. So patients who could be dealt with if more time was available are referred to specialists or expensive radiology studies.”
This simply speaks to the fact that there is considerable defensive medicine practiced by the establishment. Defensive medicine is a major problem and must be addressed through tort reform, which will reduce unnecessary tests. Finally, the problem is with “reimbursements.” Very few other professions and trades depend on a system of reimbursements for their services – they work on a fee-based system, directly with the client/consumer.
Robert Reich: Why We Need a Public Health-Care Plan, 6/24:
“But such [non-profit] cooperatives would lack the scale and authority to negotiate lower rates with drug companies and other providers, collect wide data on outcomes, or effect major change in the system.”
In effect, the over-arching ability of the gov’t to set prices and control the market. Mr. Reich is unconvincing.
Big Health Firms Underpay Claims, 6/25/09:
“He hopes to insert into the health-care bill language creating some type of independent evaluator that can certify that health claims are evaluated properly.”
There’s a true waste of taxpayer money and a pile onto more gov’t bureaucracy (and higher costs for everyone!).
“Health insurers need to publish their allowable charges for all to see.”
The issue is with transparency and flow of information, as in a functioning market, where prices are known to the consumer. This system of reimbursements through third parties where the consumer is often times not involved needs to be thrown overboard.
The Climate Change Climate Change, 6/26/09:
Re-engaging on the science and attendant statistics has led many to the conclusion that global warming is unsettled, and in fact suspect.
“A group of 54 noted physicists, led by Princeton’s Will Happer, is demanding the American Physical Society revise its position that the science is settled.”
The APS has been considerably political on this issue – very troubling, considering it is a professional society. The mean global temperature now is close to that for 1878; human emission of CO2 to the atmosphere for more than a century had no effect on the mean global temperature. As a result, the theory that human emission of CO2 causes global warming has not been substantiated. The CO2 proportion in the atmosphere is ~ 0.038%. Why do you think the politicos changed their moniker from “global warming” to “climate change?” It’s because the data does not support the movement. To avoid a hit to the GDP, any nation ought to reconsider their position on “climate change.” It already sounds like several have. The U.S. is next.
The Dangers of Fannie Mae Health Care, 6/26/09:
Yes, we’ve already seen the effect of government sponsored entities (GSEs). They are corrupt, wrought with fraud, and end in a government nationalization (‘conservatorship’), requiring massive capital infusions. Let’s please not go down that road. The government ought to be out of the mortgage and the health care markets.
God and Science Don’t Mix, 6/26/09:
Richard Feynman sums it up for me:
“God was invented to explain mystery. God is always invented to explain those things that you do not understand. Now, when you finally discover how something works, you get some laws which you’re taking away from God; you don’t need him anymore. But you need him for the other mysteries. So therefore you leave him to create the universe because we haven’t figured that out yet; you need him for understanding those things which you don’t believe the laws will explain, such as consciousness, or why you only live to a certain length of time—life and death—stuff like that. God is always associated with those things that you do not understand. Therefore I don’t think that the laws can be considered to be like God because they have been figured out.”
Feynman’s work that led to calculations of the anomalous magnetic moment of the electron is a marvel of work in theoretical physics, in it’s agreement with experimental data – but as he surely knew, there remain many mysteries that defy such concertos. The search continues.
Hello to Carbon Trading (but With Smog?), 6/26/09:
Carbon trading is a likely fraudulent exercise. If traders want to trade around such entities put it on Intrade and call it a bet on whether CO2 actually affects the mean global temp. That trade can run for years, be between trading parties and won’t adversely affect consumers and businesses – basically the economy as a whole – the GDP.
The EPA Silences a Climate Skeptic, 7/3/09:
This type of political blacklisting (of Mr. Carlin) and deliberate disregard for a balanced debate of all the available information (academic freedom – sound familiar?) is insidious. The citation of events surrounding Copernican theory (I will add the censorship and dismissal of Galileo) is apropos. Wikipedia and other “fair and balanced” (not) science fact outlets ought be chided.
Given all this, I leave readers with the following links – the first contains reasoned arguments based on peer-reviewed information (you might want to ignore APS’s gratuitous political statement at the beginning of the technical letter):
“AGW,” “global warming” and “climate change” have become a political movement, pure and simple, and many who stand to benefit are those who have invested – follow the money trail.
China Ministry Opposes Carbon-Tariff Policies, 7/5/09:
“This violates basic WTO rules. It only pretends to protect the environment, but really it protects trade.”
China has more common sense than most on this one.
House Health Bill Released, 7/14/09:
“The new public plan would see $2 billion in start-up funding from the federal government and would pay doctors and hospitals rates based on Medicare payment rates for its first three years.”
**Look for health insurance and care costs to rise even further. Cause and effect.
“The surtax and other tax changes would help pay for expanding health-insurance coverage for millions of uninsured Americans. It would do so by providing subsidies and setting up an “exchange” where consumers can shop for private health insurance. The bill would also create a new government-run plan that would compete with private plans.”
**Translation: Nationalized Health Care.
“The Blue Dogs are committed to passing health-care reform,” said Rep. Mike Ross (D., Ark.) “However, reform that does not meet the president’s goal of substantially bringing down costs is not an option.”
**The Blue Dogs can kill this beast if they stick by their guns.
“The bill would require individuals to purchase health insurance and includes penalties for employers who don’t offer affordable health insurance to their workers. Large firms that don’t comply would face a fine equivalent to 8% of payroll.”
**Translation: Nationalized Health Care.
“Besides the surtax on high incomes, the bill includes three tax changes that would affect corporations.”
**Disaster in the making. Tax producers and job growers to fund a massive new entitlement program.
Weighing Price and Value When Picking a College, 7/14/09:
The growth (many times the growth of the CPI) of college costs vs. returns is indeed an issue. Some of us were lucky enough to move out of the house at 17, self-afford college and grad school costs and get a spectacular return on that investment, and we’re talking early GenX, not BB. Clearly it would be great for today’s generation to benefit likewise.
Why are costs so high? Here’s my take: today’s universities find no resistance to containing costs. They spend spend spend, much like the gov’t – and the top reason: a matter of ‘prestige.’ Until parents and society push back against the growth of the costs of higher education, we won’t see a change – but of course, the economics may take care of the problem by then – a decline of enrollments, etc.
Blame the Employers on Illegal Immigration, 7/16/09:
Decrease illegal immigration by enforcing the law. Increase legal immigration by increasing skilled workers or wealthy immigrants who can afford to buy distressed assets (come with money). Also the gov’t selling Visas and Green Cards at a decent profit is a good idea.
Senate Leaders Clash With CBO Head on Health-Care Overhaul, 7/17/09:
A public option that underpays reimbursements (as is now done with Medicare/Medicaid) will shift costs to all other consumers. A federal mandate on employer-based insurance will also raise costs, as has every mandate. Let’s move to a free market folks. The CBO director apparently hasn’t been bought off yet (thank goodness) — he’s right on and even he underestimates the cost increases. Producers and businesses that are taxed to pay for a new health care entitlement (public option) will surely pass on costs to consumers.
Call or write your legislators before these ridiculous bills get passed under the dark of night, and not even read by legislators.
India and Climate Change, 7/18/09:
Mr. Antholis is so pickled in the “climate change” religion, that it is difficult to get any critically reasoned argument from his piece. Attacking population growth in India: the Malthusian crutch.
Second City Ruse – Charter Schools and Public Education, 7/18/09:
The cost of public K-12 education is anything but free. It is based on local, state and federal taxes, with a majority from property taxes. The fact that people might perceive it as “free” is a major problem. Lower taxes, repeal legislative attendance mandates and let parents decide how/where to educate their kids or spend their money.
Celebrity Culture vs. The Right Stuff, 7/21/09:
There are always celebrities and they are most always transient. Those that have value (yes, the Right Stuff) will survive the test of time.
Repealing ERISA, 7/21/09:
The self-insured under ERISA could avoid state mandates and courts but not federal mandates and courts – so there is a downside anyway in terms of being at the whims of Congress and the White House. The fact that Congress would go after every advantage the self-insured might have is not surprising at all. The solution: (1) Fire (vote out) all incumbents in 2010 that support this nonsense and (2) Support the move to a free market in health care.
Sick and Getting Sicker: Small Business Health Insurance, 7/22/09:
Intelligent reform means addressing the cost issues without instituting yet more mandates. What is killing the market for small business owners is the rapid rise in state (and federal) insurance mandates. When a small business buys a policy for its employees, most often that policy includes coverages that not all consumers need but that states mandate on insurance policies. The solution is for small business owners to identify legislators that are passing insurance mandates and re-educate them or vote them out. These mandates can also be repealed. Medicare (and any new public option) will surely continue to shift costs to consumers. The cost shift from Medicare has been estimated to be around $1800/year for the average family. The solution is to avoid any new public option and address the below-market reimbursement system from Medicare. I am a small business owner whose insurance premiums have doubled in the last 3 years. Let’s get the government out of health care and move to a free market!
Obama Needs a Move to the Middle, 7/23/09:
Mr. Boskin is naive, but is genuine in his suggestions. Barack Obama is not Bill Clinton: when Clinton realized that HillaryCare was not popular he moved on – and he showed many more tendencies toward capitalism and free markets, not to mention the merit in reducing the capital gains tax rate. He was also a staunch free trade advocate in comparison. Obama on the other hand has dogmatic and demagogic viewpoints that put him at odds with free capital market principles and tax/regulatory policies that would truly unleash growth in this economy: promoting private investment, which will spur job and GDP growth. He clings to pushing for ObamaCare despite its unpopularity and evident cost impact, instead of advocating a bullet approach of removing the cost drivers without destroying completely a market. To Obama, government is the end all, be all, the answer and the raison d’etre.
Intimidator in Chief: Throttling the CBO, 7/23/09:
Nixon’s tactics against the media and his adversaries also comes to mind.
Obama/Reid/Pelosi do a disservice by chiding the results when they don’t flow their way. If the CBO is a casualty in the near term from all this, then all of the watchdogs outside of Congress need to step up their roles even further. The critical analyses must continue.
GovernmentCare’s Assault on Seniors, 7/23/09:
“Less money and more patients will necessitate rationing.”
It will also increase the cost shifting to all other health consumers. Doctors, hospitals, providers and drug companies will need to pass costs on somehow. If they are not allowed – then we truly have hit nationalized health care and most/all health-sector companies will be told by the government what level of profit they can make (if any).
ObamaCare in Trouble, 7/23/09:
The point of ObamaCare is more government, not cost control. Medicare Part D was a huge GOP mistake and showed that big government ends can also motivate the GOP. Those in Congress with fiscal discipline need to take back control – or those of us out here will do it for them.
Detroit’s Schools Are Going Bankrupt, Too, 7/26/09:
We all pay for public education through local, state and federal taxes, and property taxes primarily, so we all ought to have a vested interest to voice concern about how that money is spent. The solution I’d prefer is to see taxes that go to schools lowered, and let parents decide where/how to educate their children. Eliminate legislative mandates that give precedence to public schools that are fraught with union-controlled malaise, as is evident from this excellent article. Many children get pulled from public schools due to poorly performing teachers, and the tax money collected still goes toward poorly performing public schools and teachers. Let’s change the system.
“Collective bargaining for government employees is not a constitutional right; it is a special privilege, and one that has been abused.” Sums it up.
Blue Dogs: All Bark, No Bite, 7/28:
“There are many men of principle in both parties in America, but there is no party of principle.” -Alexis de Tocqueville
This article strikes home quite closely. My Congressman is a freshman Blue Dog, and voted against both the stimulus and Cap and Tax. But on both it was evident that he waited until he took a definitive reading from the political winds before registering his vote; in particular, on the Cap & Tax bill he waited until the results of the ‘test vote’ were completed the day of the vote, and when it was obvious that 8 Republicans were switching sides to vote he suddenly decided to vote ‘no,’ knowing his vote would not be on the line. He knows quite well the wishes of his constituency, mind you, but if his vote is ever on the line, indeed I have no doubt he will vote the party line. I did not vote for him, but the Republican he replaced evidently miffed off enough voters to swing the election. If he jumps the fence toward Pelosi on a key vote, he will lose in 2010. His constituents are overwhelmingly for fiscal discipline in government.
Name: Walt Minnick, District 1, Idaho. Fair warning, Mr. Minnick.
Fannie Med, 7/30/09:
Yep, this is all we need: another GSE pushing subprime products (in this case, health care products). Get the government out of health care and the mortgage market — forever eliminate all GSEs.
(P.S.–I invite all of you readers out there to read again what happened to Fannie/Freddie, which may be considered causal in the decline last Fall…..http://online.wsj.com/article/SB122079276849707821.html)
Farmers Can Feed the World, 7/31/09:
Dr. Borlaug’s article is inspiring:
“Even here at home, some elements of popular culture romanticize older, inefficient production methods and shun fertilizers and pesticides, arguing that the U.S. should revert to producing only local organic food. People should be able to purchase organic food if they have the will and financial means to do so, but not at the expense of……”
Some recent studies on organic food point to a questionable increase in health benefit: http://www.reuters.com/article/scienceNews/idUSTRE56S3ZJ20090730
Studies ought to continue on the differences; advanced technologies in seed and fertilizer development are key, as is crop management.
From what I’ve read of Dr. Borlaug’s comments on AGW/climate change, he is a skeptic:
“I do believe we are in a period where, no question, the temperatures are going up,” [Borlaug] said. “But is this a part of another one of those (natural) cycles that have brought on glaciers and caused melting of glaciers?”
“How much would we have to cut back to take the increasing carbon dioxide and methane production to a level so that it’s not a driving force?” he asked. “We don’t even know how much.”
And I took his comments on climate change in this current article as somewhat innocuous. Supporting AGW/climate change measures that the neo-Luddites advocate does not appear to be his character, and his statements support that.
I respect Dr. Borlaug for the following statement on environmental lobbyists: “some of the environmental lobbyists of the Western nations are the salt of the earth, but many of them are elitists. They’ve never experienced the physical sensation of hunger. They do their lobbying from comfortable office suites in Washington or Brussels. If they lived just one month amid the misery of the developing world, as I have for fifty years, they’d be crying out for tractors and fertilizer and irrigation canals and be outraged that fashionable elitists back home were trying to deny them these things.”
The Fat of the Land: Taxing the Obese, 8/1/09:
That’s the point of getting government out of people’s lives. Government provides the conduit (‘public trough’) for people to seek distribution from others (taken by government, usually). Cut that conduit, and have the government revert to what its Constitutional mandate is. Using tax policy or other government economic engineering to inhibit behavior is wrong-headed and leads to less freedom, not to mention stunted economic growth. Let personal responsibility and the consequences of excess take their natural toll without government intervention. And as for forced ‘equality’ – I certainly don’t want to live under someone else’s definition of how I ought to live my life. Sounds repressive.
Global Warming and the Poor, 8/4/09:
“First-World environmentalists” are primarily elitists whose real interests involve a payoff in their investments in the AGW/climate change movement.
Laffer: How to Fix the Health-Care ‘Wedge’, 8/5/09:
Laffer is right: The alternative is to promote the consumer-as-direct-payer model, with catastrophic insurance payouts above a certain level. Consumer exposure to direct costs and price transparency will happen with a direct, out-of-pocket payer model. The problem is that we’ve moved away from this model since 1965, with out-of-pocket payments decreasing by over 50%. A market-based model would have us move back in that direction. Tort reform and a repeal of state/federal insurance mandates are key to reducing costs as well.
Blue Dog Blues, 8/7/09:
Folks: Here is the letter I wrote Mr. Minnick (my Congressman) on July 16, 2009:
“Dear Mr. Minnick,
I urge you to vote ‘NO’ on any health bill proposed that includes a public option and/or federally mandated health insurance coverage by employers or individuals.
We need to reduce health care and insurance premium costs, and the way to do that is to address the following points:
(1) Rapidly rising state and federal mandates on health insurance and health practitioners – such mandates raise costs for everyone;
(2) Medicare/Medicaid cost shifting from ‘below-market’ reimbursements;
(3) Tort reform, such as pushing for ‘loser pays,’ limiting damage awards, and waiver of jury trials, all of which will help reduce the causal effects of defensive medicine;
(4) Moving toward a free market for health care, where the patient-consumer pays most costs directly, out-of-pocket, except for catastrophic payouts. Price transparency and customer service are key, as they are in other markets, such as the retail and service sectors.
For more suggestions and analyses, please see http://www.eidolonspeak.com/?p=159.
Susanne Lomatch, Ph.D.
Populist anger ought to be refocused on a bloated, irresponsible government. Voters ought to take charge and ownership and vote out legislators who are driving away business and jobs, squelching widespread prosperity, and siphoning away individual freedoms. And partisan politics ought not matter anymore. For example: Mr. Minnick (the subject of this article) ought to vote consistently in support of the wishes of his district constituents, and not jump the fence to save face with the DNC or Pelosi.]]>
Since March I have received several letters and comments [1-3] from thoughtful readers regarding my piece on health care and insurance costs, urging me to reconsider the impact of two particular issues: federal/state mandates on both health insurance and health practitioners, and the cost shifting that must be taking place from government below-market reimbursement rates to doctors and other service providers.
In my March study, I considered five systemic problems that have led to higher health insurance and care costs, in rank order: medical malpractice tort laws and defensive medicine; the dwindling role of the patient-consumer as the direct payer for health care (out-of-pocket payments hitting a record low); high cost growth of prescription drugs; state/federal mandates; and Medicare/Medicaid fraud. I believe I underestimated the impact of mandates, and did not include the impact of the practice of the Medicare/Medicaid reimbursement of doctors and service providers at below market rates.
Health Insurance and Practitioner Mandates
I was forwarded three important references recently from fellow WSJ readers that address insurance mandates [4-6]. Reference  includes a comprehensive list as of May 2009 on all of the mandates passed in each state, and the projected cost impact. Most are <1%, but some that have been passed by a majority of states are 1-3% impact, and with the additive cost impact of mandate after mandate it becomes clear, as Ref.  quotes: “state health insurance mandates could account for a significant portion of health insurance costs in any given state.” The number of such mandates has doubled from 800 to 1600 in almost a decade. Reference  goes further to estimate impact for Louisiana:
“A recent study found that a single additional state health insurance mandate would result in a 0.4 percent increase in the uninsured population. Given that each state had an average of eleven state health insurance mandates at the time of the study, the study concluded that approximately 4 percent of the population was uninsured due to state health insurance mandates. If we applied the findings of that study to Louisiana today, where we now have forty-three mandates, it implies that up to 17.2 percent of Louisianans, or roughly 759,000, could be priced out of health coverage due to state health insurance mandates.” Also in the BRAC paper: According to LA state statistics, 18.5% are uninsured.
The rapid rise of state insurance mandates and regulations is correlated to increases in insurance premium costs, as Ref.  quotes several studies showing statistically significant links, including the result of the author’s own study. Premiums in states with a greater number of such mandates have been shown to be 20% higher in data to 2004 , and the gap may have widened since, as mandates and regulations are being passed by state legislatures at a brisk rate [4,5], even in states that traditionally have had a low mandate/regulation count.
A few federal mandates on health insurance are summarized in .
Federal/state mandates and regulations on health practitioners also have an impact on health costs. In all but 6 states, there exists a legal requirement for physician involvement in nurse practitioner practices, even though there is a current and projected shortage of general or internal medicine MDs according to JAMA . Compliance costs to health care regulations, such as the federal HIPAA, have also had a measurable effect [8, 9].
Medicare/Medicaid Cost Shifting
Low rate, or “below-market” reimbursements from Medicare and Medicaid to doctors and hospitals are starting to show a measurable effect [10-12].
(I use the term “below market” lightly here, as we really do not have a functioning market in health care in the same sense as in retail, finance, professional services, etc., and this in itself is a major problem.)
Cost shifting from the practice of low government reimbursement rates is likely manifested in higher health costs for all consumers elsewhere, as well as increased private health insurance premiums paid by Medicare Advantage (Part C) consumers. There are several past studies that I was able to easily find [13-16]. Reference  estimates that nearly $90 Billion per year is cost shifted from Medicare to health consumers, translating to approximately $1,800 per year in added costs for an average family. As stated in Ref. : “When providers’ prices rise and neither public nor private payers’ compensation follows suit, consumers pay more. The result is that people lose coverage. This appears to be the ultimate cost shift, and the issue deserves more public and private attention and action than current politics are likely to allow, at least for now.”
The Bottom Line: Actions Needed
(1) For state health insurance mandates, consumers need to take action by identifying the state legislators that are proposing and passing these mandates and either re-educate them or vote them out. The same is true for Congressional legislators and federal mandates. Certainly we ought not to forget that these mandates can be repealed. Consumers might also gain traction by contacting their insurance companies to ask them to provide a statement on how the state mandates have affected rates.
(2) Health compliance and occupational regulations need to be revisited and reviewed as a consumer cost-benefit equation. The shortage of internal medicine MDs can be addressed with a greater substitution of nurse practitioners, but onerous state laws slowing this market-based solution need review and possible repeal. Unfortunately, there may be stiff resistance from physician groups (e.g., the AMA), given the market competition from NPs. Consumers can apply pressure to groups and legislators regarding this issue.
(3) Medicare/Medicaid reimbursement policy needs a comprehensive revision. One solution is to eliminate the reimbursement system entirely, from both Medicare/Medicaid and from private health insurance, except for catastrophic payouts. The current system removes or shields the health consumer from the direct costs of health care services and goods, when in fact the consumer ought to be engaged directly by knowing what the true costs are and paying more of those costs out-of-pocket. Health care ought to be really no different on a market basis than the retail, finance, or professional services markets, where client/consumers engage service providers (doctors, clinicians, practitioners) on a fee-for-service basis, where those fees are known beforehand (published, advertised, negotiated, etc.), and where the consumer can decide for themselves who offers the best value.
(4) Laws that prevent employers or insurance companies from giving consumers incentives for healthy lifestyles need to be reconsidered. Consumers that bear the least risks ought to enjoy the cost-benefit of a low-risk pool, instead of assuming the higher costs from the cost spreading, shifting or leveling that occurs from the high-risk patients.
(5) Large companies have started to consider ‘self-insurance’ for their employee groups, so as to avoid the effects of state insurance company mandates and government program cost shifting. Safeway’s CEO published a recent Op-Ed regarding his company’s success in this regard . I think this trend will only continue, but the danger of mandates and cost shifting still remains as a threat to costs for everyone, especially if legislatures begin to target self-insured groups. Some have suggested that self-insurers might then adopt some form of the 1974 Employment Retirement Income Security Act (ERISA), which exempts self-insurers from state law (mandates, but also tort laws and state courts), but requires them to adhere to federal health insurance mandates .
(6) Consumers need to fight efforts to pass a federal mandate requiring employers and/or individuals to purchase health insurance. Wal-Mart and the SEIU came out July 1, 2009 in support of employer mandates, and this is nothing more than a ploy for Wal-Mart to squeeze competition, as several of its major retail competitors and many small businesses do not offer insurance to their associates. Mandated employer or individual insurance opens the door for even more widespread regulation of the health care industry and political interference in personal health care decisions .
“It is taken for granted that workers should receive their pay partly in kind, in the form of medical care provided by the employer. How come? Why single out medical care? Surely food is no less essential to life than medical care. Why is it not at least as logical for workers to be required to buy their food at the company store as to be required to buy their medical care at the company store?”
– Milton Friedman writes against Hillary Clinton’s health care plan: WSJ, Feb.13, 1993
“What most people really object to when they object to a free market is that it is so hard for them to shape it to their own will. The market gives people what the people want instead of what other people think they ought to want. At the bottom of many criticisms of the market economy is really lack of belief in freedom itself.”
– Milton Friedman, Wall Street Journal, May 18, 1961
 Teri J. wrote: “Somewhere between 1999 and 2001, doctors stopped taking Medicare patients because the government reimbursement was too low. It seems to me that is when healthcare premiums started increasing dramatically. My mother ended up with one doctor group for her selection of a primary care physician. My mom died in June 2004 but her primary care physician said that they took Medicare patients only because the government increased the payments to doctors for retired military personnel as otherwise her coverage would have been a hospital ER.” Teri asked me if I had considered the role that low Medicare reimbursements have had on costs.
 Benjamin R. wrote: “I am a physician previously in private practice now working for the federal gov’t. I am also a fiscal and political conservative and so far have heard nothing in the current administration comments that sounds like anything more than a sound bite for the evening news. Your article was interesting but ignores several key points. First if you look at U.S. vs Western Europe comparing costs and care in care, we are very comparable albeit at much higher costs. If you further look at standards such number of days in hospital post operatively by procedure we are clearly far more efficient than they are – medically. However our costs are not. You accurately define the tort mess for its contribution. There are also compliance costs. Ask any nurse how much time he or she spends taking care of patients vs. charting and the charting consumes half the time and thus the efficiency. But that is only the beginning. In any given nursing station they are more reviewers reading the charts than there are people caring for patients. These are government-mandated policies. I personally have come to favor the German model. It is good and much cheaper. It lets professional be professionals although they are not paid as much and it is safe. Besides lower salaries they lack the massive health administration bureaucracies and there is no med mal issue there.”
 P.D. Norman wrote: “Now here is my observation based on [Kaiser and NHED] information:
“In 2004, the United States spent $1.9 trillion, or 16 percent of its gross domestic product (GDP), on health care. This averages out to about $6,280 for each man, woman, and child. Half of the population spends little or nothing on health care, while 5 percent of the population spends almost half of the total amount.”
The elderly (age 65 and over) made up around 12 percent of the U.S. population in 2004, but they consumed 34 percent of total U.S. personal health care expenses. The average health care expense in 2004 was $14,797 per year per elderly person but only $4,511 per year for working-age people (ages 19-64).
However, in 2004, Medicare paid under $6400 in total medical expenses per beneficiary. If cost was $14,797 and Medicare paid $6400 who paid the rest? HINT: Think cost shifting – medical providers pass the cost, along with other unpaid bills from the uninsured, to those that can afford to pay – private health insurance customers. Average 2004 annual premiums for private health insurance were ~ $16,771.
Now here is my opinion: Unfortunately our current government are taking advantage of the public’s distrust of the free market, and are using private health insurance companies as a scapegoat in attempt to correct a flawed and failing system – Medicare. I pray that the American public wises up before its too late.”
 “Health Insurance Mandates in the States 2009,” Council for Affordable Health Insurance (CAHI), May 2009.
 “The True Effects of Comprehensive Coverage: Examining State Health Insurance Mandates,” Baton Rouge Area Chamber (BRAC) Issue Brief, May 2009.
 “The Effect of State Regulations on Health Insurance Premiums: A Preliminary Analysis,” M. J. New, Heritage Foundation, October 2005.
 “Factors Associated With Medical Students’ Career Choices Regarding Internal Medicine,” Journal of the American Medical Association (JAMA), September 2008. See also “Critical Shortage of Internal Medicine MDs Foreseen,” Reuters, September 2008.
 “Health Care Compliance Act Costs Millions,” Jacksonville Business Journal, October 2002.
 “The High Cost of HIPAA,” August 2005.
 “Low Medicare Reimbursement Rates Hurt Hospitals In Iowa And California,” Medical News Today, June 2009.
 “Low Reimbursement Rates Contributing To Physician Shortage,” Medical News Today, April 2009.
 “When Doctors Opt Out,” M. Siegel, Wall Street Journal, April 17, 2009.
 “Medicare Payment Policy: Does Cost Shifting Matter?” J.S. Lee et al., October 2003.
 “Confronting The Medicare Cost Shift,” Managed Care Magazine, December 2006.
 “Cost-shifting increases family spending by almost $1,800 annually,” A. Zieger, December 2008.
 “Consumers and Employers Paying Almost $90 Billion Due to Under-Payments to Hospitals and Physicians by Medicare and Medicaid,” AHIP, December 10, 2008.
 “How Safeway Is Cutting Health-Care Costs,” S.A. Burd, Wall Street Journal, June 12, 2009. “Mr. Burd Goes to Washington,” K. Strassel, Wall Street Journal, June 19, 2009.
 “Individual Mandates for Health Insurance: Slippery Slope to National Health Care,” M. Tanner, CATO Policy Analysis, April 2006.]]>
There’s a catch-22 with increasing the deficit through unabated government spending and then expecting to pay for such outlays with tax increases. Government tax revenue is proportional to the gross domestic product (GDP), and unless the GDP increases, tax revenues will decline. The catch is that sustained GDP growth depends on a number of factors, including private sector investment and innovation, as well as personal consumption (consumer spending) and net exports. In turn, government spending, tax and regulatory policies affect these factors. The goal of this short study is to discuss these dynamics with available macroeconomic data.
The relationship between the U.S. GDP and government tax revenues was discovered by economist Kurt Hauser . Hauser’s 1993 analysis of federal revenue data showed that total federal revenue since WWII had remained at ~19.5% of GDP – i.e., that tax receipts are independent of marginal tax rates. This result is striking given the fluctuation of marginal rates from 1952 to 2009 – individual federal top marginal rates have declined from ~91% to ~35% and corporate federal top marginal rates have declined from ~52% to ~35%.
In an effort to reproduce Hauser’s conclusion, I looked at GDP and federal government revenue data readily available from the U.S. Bureau of Economic Analysis (BEA) . Figure 1 shows total federal government revenue as a percentage of GDP, plus major contributors to that total. All data is expressed in current U.S. dollars, is quarterly data seasonally adjusted at annual rates, and is part of the latest release from the BEA (June 25, 2009). The long-term average of total federal revenue is ~18.1% as of the latest data, and is indeed remarkably level, particularly when compared to the government revenue vs. GDP signatures of other countries. Note the more than doubling of government social insurance tax revenue vs. GDP over the period – the greatest increase among contributors.
Next in Figure 2, I look at the current (nominal) and chained (‘real’) GDP over the same 1947-2009 period, with markings for business cycle recessions as called and defined by NBER . What is striking is the sharp decline of GDP in the current recession, even in the nominal GDP. Other recessions, even the ’81-’82 recession, appear to have had less effect on the GDP, which recovered remarkably well after a flat period and resumed a respectable growth path upward.
Figure 3 shows a compelling story, one I have yet to see elsewhere. It is the % change in real GDP of quarterly seasonally adjusted data, at an annual rate, with the major contributors. The GDP has four major contributors: personal consumption (which includes consumer spending), private domestic investment, net exports, and government expenditures. In Q1 2009 these contributors were ~72%/12%/-3%/19% of the real GDP respectively. Almost without fail, major declines in the GDP were preceded by large declines in private investment. On the face of it, this seems obvious: if private investors stop funneling money into the economy, business growth contracts, jobs contract and eventually even personal consumption (consumer spending) contracts – the data in Fig. 3 shows that real private domestic investment has had a negative annualized change in 9 of the last 12 quarters, and 2 of the last 3 quarters have seen relatively large declines of personal consumption. The last time we had such pernicious declines in private investment and personal consumption was the ’73-’75 recession. The data is clear that private investment is a leading indicator, and that the GDP is highly correlated to it. And so I ask the question: why is it then that government policy makers don’t recognize this basic fact, and set fiscal (tax-regulate) policies to promote private investment when declines are nigh? Stay with me here, there’s more to the story.
Figure 4 shows federal government expenditures as a percentage of GDP, plus contributors. Note the recent major tick up in both current social transfer payments and capital transfer payments (= the infamous $700M TARP), and an increase in the deficit (net borrowing). Quarterly numbers don’t yet reflect the massive $787B stimulus passed in February ’09. Social transfer payments have nearly tripled from 1947-2009, and do not reflect off-balance-sheet liabilities to Social Security and Medicare entitlements. To complete the picture, I also looked at state-local government revenue (Fig. 5) and expenditure (Fig. 6) data from the BEA. Total state-local receipts include tax receipts and social program transfer payments from the federal government. Note that state-local tax receipts have been remarkably constant as a percentage of GDP since the early ‘70s. When added to total federal receipts in Fig. 1, federal-state-local revenue totals ~ 27-28% GDP.[caption id="attachment_145" align="alignnone" width="150" caption="Figure 6-US State-Local Expenditures vs. GDP"][/caption]
As we live in a global economy, it is highly instructive to compare equivalents of Figs. 1-6 to those of other countries. Figure 7 shows real GDP growth, as annualized % change, of 30 OECD countries . The countries are ranked on the right according to the highest projected real GDP growth for 2010. Numbers to 2008 are actual. Major economic crises are certainly reflected for South Korea (1997 Asian currency crisis) and Iceland (recent government default). All countries are expected to endure significant declines in 2009, but regardless of the global crisis, 9 countries are projected to maintain positive growth. Figure 8 highlights total government tax revenue of OECD countries as a percentage of current (nominal) GDP. For the U.S., this is the addition of the data in Figs. 1 & 5, subtracting federal social transfer payments to the states from Fig. 5. The U.S. appears to be the only OECD economy where total government revenue (dominated for the most part by tax revenue) is relatively constant since WWII! This signature (and it is a signature, as other economies are different) ought to be used to set policy. The rank of countries on the right side denote highest-to-lowest %GDP of tax revenue. Next, I looked at two important metrics, private domestic investment (Fig. 9) and gross government debt (Fig. 10). The rankings on the right side are highest-to-lowest of the annualized change in investment outlays and to gross debt as % GDP, as projected for 2010 by OECD. Note that many of the same countries that are seeing positive and increasing GDP growth (Fig. 7), even through the latest global slowdown, also show growth in private domestic investment. Additionally evident is that those same countries have relatively low gross government debt as a %GDP. On the other end of the spectrum is Japan: a slow grower with a high public debt load and anemic private investment growth – and with the highest marginal tax rates on corporate income. The U.S. is not far behind.[caption id="attachment_147" align="alignnone" width="150" caption="Figure 8-OECD Tax Revenue vs. GDP"][/caption] [caption id="attachment_149" align="alignnone" width="150" caption="Figure 10-OECD Gross Govt Debt vs. GDP"][/caption]
Not to be excluded from this discussion are the “BRIC” countries, Brazil-Russia-China-India. I also include a few others, such as South Africa. For that data, I turned to the IMF database . In Fig. 11a, I show the current (nominal) GDP in US$ for the BRIC, SA, and a selection of OECD countries, as well as a few other up-and-coming economies, such as Singapore, Taiwan, Latvia, Argentina, Israel and Egypt. The ranking on the right side is highest-to-lowest GDP projections by the IMF for 2014. Figs. 11b-c are blow-ups of Fig. 11a so as to show the GDP data for the smaller economies. Clearly there are several standouts: (1) the sheer size of the U.S. GDP (economic output) compared to all others; (2) the rapid increase in output of China’s economy, which is projected to overtake Japan this year; (3) the flat growth of the Japanese economy since the implosion of its stock and real estate markets in the early 90s; (4) the projected rising stars of Russia, India, Brazil and Canada.[caption id="attachment_151" align="alignnone" width="150" caption="Figure 11b-BRIC and OECD Current GDP, Expanded"][/caption]
I then gathered private domestic investment rates as a percentage of GDP from both OECD (on BRIC, SA, and a few OECD countries) and IMF, in Figure 12. The IMF data is actual to 2008 but makes projections to 2010. The rankings on the right are highest-to-lowest as of 2007. The countries with the highest % (China, India, Korea) are not surprisingly those with above-average GDP growth. The countries with the lowest % (the U.S., Germany, U.K.) have slower or projected slower growth – which will in turn affect tax revenues and deficits. Two standouts again: (1) Japan, with declining investment but still a respectable level as of 2008, has not been able to translate that level into significant GDP growth – likely because of its very high public debt load and business-unfriendly tax policies, as well as a low ranking of foreign direct investment (FDI); (2) the U.S., which is projected by IMF to have significantly declining private investment levels, and which likely accounts for their forecast of flat U.S. GDP growth into 2010/11 – yet provides us with a suspension of belief after that – the resumption of high growth from 2011-2014 in Fig. 11a simply cannot happen without the participation of private investment.
So we come back to where we started – that catch-22. We can’t have a resumption of GDP growth without private investment participation, and we can’t increase government revenue without a resumption of GDP growth, and we can’t balance our public books without a decrease in the rate of growth of government spending.
What fiscal policies would support a healthy growth cycle, given the dynamics shown here? Let’s start with cutting corporate and investment tax rates. When you tax less of something you get more of it – tax corporations and investors at lower marginal rates and we’ll see a pickup in private investment. That in turn will increase GDP growth and government revenue. Next in line are regulations (like carbon emission cap-and-trade, or state mandates on health care) that act as a tax on businesses and consumers – stop or remove them wherever possible and the growth effects described will be even greater.
“We need true tax reform that will at least make a start toward restoring for our children the American Dream that wealth is denied to no one, that each individual has the right to fly as high as his strength and ability will take him…But we cannot have such reform while our tax policy is engineered by people who view the tax as a means of achieving changes in our social structure.” –Ronald Reagan
 “You Can’t Soak the Rich,” David Ranson, Wall Street Journal, May 20, 2008.
 “National Economic Accounts,” Bureau of Economic Analysis, U.S. Dept. of Commerce. Site contains extensive data on the GDP, federal and state revenue and expenditures, as well as other metrics.
 “Business Cycle Expansions and Contractions,” National Bureau of Economic Research (NBER).
 “OECD Index of Statistical Variables,” Organization for Economic and Cooperation Development (OECD). See also the OECD and BRIC country statistical profile database here.
 “IMF World Economic Outlook Database,” International Monetary Fund (IMF).]]>
During the week of September 15, 2008, the financial world was rocked with rare events that would precede a near 6-month market decline of historic proportions. One of the largest insurers in the world, American International Group (AIG), and the fourth largest investment bank in the U.S., Lehman Brothers, sold off to sharp lows on large volume, and for the first time in 14 years a money market fund (the Reserve Primary Fund) broke the $1 threshold from losses related to the Lehman collapse. Lehman would declare bankruptcy, while officials at the Treasury Department and Federal Reserve would scramble to rescue the sinking titanic AIG, shore up the money market with Fed liquidity to prevent a run on money funds by investors, and force a merger between the third largest investment bank, Merrill Lynch, and the second largest U.S. consumer bank, Bank of America. Shortly thereafter, Mr. Paulson at Treasury convened an emergency meeting on the Hill with Congressional leaders, insisting that a massive public infusion of capital into U.S. banks was urgently necessary to forestall the purported tsunami effects of systemic risk, culminating into a run on banks. Enter the dragon we’ve all come to idolize: the $700 Million Troubled Asset Relief Program (TARP) was born and summarily delivered to financial institutions in the form of both capital infusions and government preferred equity stakes [1,2].
The broad equity markets didn’t sell off sharply until more than a month later, and the market declines would last until March 9, 2009, when the S&P reached a -43% retreat to 677, the Nasdaq -42% to 1269 and the Dow -40% to 6547.
Meanwhile, our nation has searched for answers to why the financial collapses have occurred, and for reconciliations as well as retributions – and in the process showing the ugliest side of American politics, politicians and government officials that we may have seen in modern history.
But let’s get to the ambit of this article: were the events caused by some sort of economic terrorism, and if so, by whom and for what purpose? Or were the events a fateful result of excessive government intervention and control, akin to non-random chaos that can lead to wild distortions, and amplification of random events, as seen in highly chaotic systems?
The economic or financial terrorism theory has been posited by several in the financial and popular media [3, 4]. For some, the theory goes that traders in collusion commit bear-raid acts that include massive concerted short selling of weak stocks, market indexes, or complex derivatives such as credit default swaps (CDSs) that are underwritten on companies or institutions that have credit risk, all to realize significant profits. For others, the theory goes that individuals or organizations that were possibly hostile to the Bush administration or to the U.S. (or both) saw the opportunity to manipulate our financial markets for personal, political, ideological or imperial gain. The usual suspects have ranged from infamous bear-raiders such as billionaire George Soros and his team of hedge traders to state-sponsored efforts sourced to China, Russia or Saudi Arabia.
The conjecture for Mr. Soros’ involvement in mass-market manipulation is his ideological bent toward international socialism , his disdain toward American foreign policy and economic stature , and his strong support for Barack Obama . Early September was a pivot point for the election, with John McCain leading in the polls by 5 points (49% vs. 44%) according to Gallup. After the Lehman, AIG and Reserve Fund failures, with the markets and our Treasury and Congressional leaders in a frenzied tizzy, that lead began to wither, as the public grew wary and annoyed with the state of disorder and disarray. No doubt Mr. McCain did himself in by throwing his support to TARP and whatever bailouts were necessary to dig out of the proverbial missile struck hole, while Mr. Obama sat back and implicitly voted his usual ‘Present.’ Voters who found themselves supporting Mr. McCain suddenly felt alienated in whatever fiscal conservative sensibilities they might have had. Add to that a message that seemed to resonate: Mr. Obama would cut taxes for 95% of Americans, but that we now know has slim to no truth (and that some of us knew at the time held little credibility). Nonetheless, a swift shift in the polls took hold with Obama gaining a 9-point lead by late September, followed by an electorate in November that either stayed at home or shifted their vote to that marketed veil of ‘Hope and Change.’ Back to Mr. Soros: how could he have influenced the outcome? Some might argue he led the massive short interest in names like Lehman and AIG, and a few others who faltered at the time. His bear-raid fame extends back to the destabilized pound sterling currency market of 1992, which gave way to the steepest losses on “Black Wednesday.” Mr. Soros not only made a killing (over $1 Billion) in shorting the pound, but also reaped whatever political gain he might have sought in British parliamentary changes that reflected his negative positions toward Britain and Margaret Thatcher. Mr. Soros has been convicted of insider trading and has combined the trading prowess of his hedge organizations with his particular intents to extend his philosophical views on social and economic engineering around the world .
Involvement of China in such acts is not completely illogical if one accepts the idea that a destabilization of our financial markets may help their huge portfolio in U.S. Treasuries, which are estimated to be around $1-1.5 Trillion – i.e., that an ebb in the equity and corporate/municipal/mortgage debt markets coincides with a ‘flight to quality’ into Treasuries, driving up prices and the value of Chinese holdings. The flaw in this argument is that a Treasury bubble is not sustainable, and unless the Chinese cash out on the peaks, they risk a sharp decrease in value of their holdings with a Treasury sell-off and a reflation trade back into equities and other assets. We do know that the Chinese decreased their exposure of Treasuries in early 2009 , and at around the same time, Premier Wen Jiabao issued strong statements  regarding Chinese ‘displeasure’ with U.S. policy toward monetary easing (i.e., a weak dollar) and the inevitable threat of inflation, risking the value of their Treasury holdings. China central bank governor Zhou Xiaochuan shortly thereafter suggested  an alternative reserve currency system based on ‘Special Drawing Rights (SDR),’ which is essentially a basket of currencies that the International Monetary Fund (IMF) currently uses to fund various causes and interests worldwide. The speculation of Chinese involvement in U.S. financial market destabilization appears to falter with the obvious observation of robust U.S. dependence on Chinese imports – the Chinese have more to gain from a strong U.S. economy, even if it means contending with dollar weakness and inflation. Therefore the deliberate destabilization argument must be bolstered with an accounting of how China might benefit without an economically strong U.S.
Russia’s self-interest is perhaps centered on the price of commodities including oil, with a benefit when prices remain high. The U.S. and then global market turmoils sent oil prices spiraling from a peak of $147 in July 2008 to below $34 in February 2009 (~77% decline). In late January, Vladimir Putin issued assertive statements at the 2009 World Economic Forum in Davos . Included in his speech were clear warnings to the U.S. regarding the over-reach of government intervention in resolving financial institution and business failures, which some have interpreted as a not-so-subtle prod to avoid the Marxist/socialist cavern that had engulfed the Soviet Union for the better part of a century . Mirroring China, Putin also warned  against too much reliance on the U.S. dollar as a reserve currency – with oil globally denominated in the dollar and considerable currency fluctuation from weak to strong in the last year. Given these facts, it is difficult to believe in a coordinated manipulation of our markets by the Russian government, unless we accept that they were willing to suffer a setback from the global plunge in commodities in order to damage U.S. potency in the global financial arena and tarnish the reserve status of the dollar.
Saudi state-sponsored involvement in market manipulation doesn’t appear to pass muster with breadth of Saudi holdings in U.S. equities and debt. Prince Alwaleed (“Kingdom Holdings”) rode the market down on many core fund investments.
So what are we left with? Let’s start with short sellers and/or our own government.
Short sellers became a target for most of last year, with a flash point occurring just after the rapid Fannie Mae/Freddie Mac stock declines in late June/early July . As an initial strike against short sellers, the Securities and Exchange Commission (SEC) issued an order to ban “naked” short selling on Fannie/Freddie and 17 large banks and financial groups . Naked short selling occurs when shares are sold short by traders without a broker-lender delivery confirmation that the trader has indeed legitimately borrowed the shares. The purported danger of such an act is that more shares can conceivably be sold short than are available for borrowing, adversely affecting share price. SEC motives in instituting the ban were clearly tied to discouraging short selling period, as naked short selling was already illegal and that even the SEC could not substantiate the incidence of naked short selling vs. normal (legal) short selling. But instead of investigating and quantitatively verifying the naked short selling incidences, the SEC issued its ban from July 21 to August 12. As has been pointed out in an excellent analysis , the naked short ban did little to stabilize Fannie/Freddie; after an initial short squeeze, the instability and volatility in the markets continued during the ban period and thereafter. What did the SEC learn from this exercise? Not much. With Fannie/Freddie and all 17 institutions listed in the naked short ban guilty of extreme over-leverage and saddled with housing-related assets declining in value daily, even savvy ordinary investors were dumping their shares to reduce risk. By September 5, Fannie/Freddie had reached the same stock price as at the trough of their sharp July declines before the ban.
And then something happened that could be classified as a market catalyst: the government decided to nationalize Fannie/Freddie, removing their management, seizing assets and eliminating all dividend payments . At the close of the next market day, September 8, Fannie/Freddie stock lost most of their value . Lehman closed down almost 12% lower on the day, and its sharp slide continued the entire week, until it declared bankruptcy. AIG, heavily levered on both collateralized debt obligations (CDOs) containing shriveling mortgage assets and CDSs underwritten on Lehman solvency, was issued a massive $85 Billion bailout by the N.Y. Fed (a.k.a. Tim Geithner) . As it turns out, AIG risk mismanagement was key in its catastrophic failure , and has required almost $200 Billion in Fed and Treasury bailouts, with brisk debate as to whether the government and taxpayer would have been better off if AIG had been allowed to fail along with Lehman.
Blame for the Lehman failure has extended to a combination of naked short selling and rampant street rumors regarding its demise . However, whether or not naked short selling is the guilty factor has not been substantiated. Remember that intentional naked short selling is illegal and prosecutable. And so yet another theory has surfaced that the “fails-to-deliver” status of heavily shorted stocks may have been caused by computer or system overflow glitches. Whatever the source, analysts  have found an unconvincing 30-70% correlation of “fails-to-deliver” with price declines, and while the SEC logged a 57-fold increase in failed trades on September 11, 2008 from the year prior for Lehman alone, that could be a non sequitur given the massive increase in the volume of trades and a systematic level of failed trades. The conclusion here is that the SEC and/or the securities industry has to quantitatively substantiate an incidence of naked short selling, attribute cause and effect, and make systemic changes if indeed there existed either intentional fraud or unintentional system glitches. The same applies to mass collusion of short sellers to enable a cascade effect in a stock’s price decline, another conjecture that remains unproven. If this cannot be accomplished with the data available, then obviously our markets do not have enough transparency and disclosure.
Back to the SEC: did it learn anything from banning naked shorting in July/August 2008? No. In reaction to the panic of the week, the SEC instituted a ban on all short sales of nearly 1000 financial institutions and companies from September 19 – October 8 . Market makers for the options markets were exempted from the ban – allowing investors to continue to buy puts, but the confusion reduced the volume in the options markets by almost 30%, decreased liquidity (increased bid-ask spreads) and increased options premiums . The consensus is nearly unanimous that this ban did little or nothing in stabilizing the markets – the market slide resumed on October 1, a full week before the end of the ban. The likely reason? The credit markets, particularly the commercial paper market, began to seize and consumer credit spreads widened dramatically . With businesses and consumers dependent on credit markets for short-term finance, the threat to the equity markets was a direct correlation.
Terrorism is defined by Merriam-Webster as “the systematic use of terror, especially as a means of coercion.” Terror is defined in a range as “a state of intense fear”…”violent or destructive acts committed by groups in order to intimidate a population or government into granting their demands.”
So did we endure “economic or financial terrorism?”
We’ve looked at the range of sources, with some that seem to fit the definition more than others. Mr. Soros remains a compelling case – but unless hard evidence emerges that implicates a particular incidence the calls remain unsubstantiated conjecture.
We must not ignore the damage that has been caused by the chaotic actions of our own government in contributing to and handling the financial failures. From the Bear-Stearns failure and Fed bailout, to the nationalization of Fannie/Freddie, to the AIG failure and Fed bailout, to the forced government equity stakes in major banks through Treasury’s TARP. Add to that the market interruptions and manipulations caused by the SEC by their own short sale bans. Add to that the lack of a formal clearinghouse structure for CDSs and CDOs – which contributed to the risk pricing of these derivatives (think of the decades-functioning options markets and you’ll get what I mean). Add to that the range of credit rating agencies that made the assumption that housing prices were not inflated and would continue to rise. And let’s not forget the ‘independent’ Federal Reserve that first handed us cheap money and credit, which combined with industry and GSE lax lending standards and fantastic over-leveraging provided a ripe environment for outlier price instabilities and market dislocations. Can we make the argument for economic or financial self-terrorism? You bet.
Though Bush/Cheney deserve considerable credit in their efforts to keep our nation safe and secure through conventional national security measures against violent foreign terrorist threats, the fact is they didn’t place as much emphasis on economic security, and hence ceded considerable ‘leverage’ to the likes of Hank Paulson and others in allowing an extreme form of government intervention in dealing with large institutional failures. Obama, et al. show little difference in their handling of such issues, and have weighted the burden considerably through massive spending, onerous federal regulation and tax policies that are antagonistic to business. It appears that GDP growth will suffer indefinitely – inevitably reducing the influence and prosperity that the U.S. may otherwise have.
Finally – what our venerable capital markets scream for is more transparency and disclosure. Without it, markets are not as efficient and ‘free’ and we may be destined to repeat the same mistakes in the future.
 “U.S. to Buy Stakes in Nation’s Largest Banks,” D. Solomon, et al., Wall Street Journal, October 14, 2008.
 “How TARP Began: An Exclusive Inside View,” R. Newman, U.S. News & World Report, May 14, 2009.
 http://www.thestreet.com/story/10438230/cramer-feels-like-financial-terrorism.html; http://www.thestreet.com/story/10438538/raising-the-specter-of-financial-terrorism.html.
 “The Capitalist Threat,” George Soros, Atlantic Monthly, Volume 279, No. 2, February 1997. Some selected excerpts: “I contend that an open society may also be threatened from the opposite direction — from excessive individualism. Too much competition and too little cooperation can cause intolerable inequities and instability.”…” Wealth does accumulate in the hands of its owners, and if there is no mechanism for redistribution, the inequities can become intolerable.”
 “The Bubble of American Supremacy,” George Soros, The Atlantic, December 2003.
 “A Soros Slush Fund,” M. Malkin, New York Post, August 20, 2008.
 “Insider trading conviction of Soros is upheld – Business – International Herald Tribune.” Also: “He’s Seen The Enemy. It Looks Like Him,” T. L. O’Brien, New York Times, December 6, 1998.
 “China Slows Purchases of U.S. and Other Bonds,” New York Times, April 12, 2009.
 “Wen Voices Concern Over China’s U.S. Treasuries,” Wall Street Journal, March 13, 2009. Some excerpts: “We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets. I do in fact have some worries…[we urge the U.S. to] maintain its credibility, honor its commitments and guarantee the safety of Chinese assets.”
 “China Takes Aim at Dollar,” Wall Street Journal, March 24, 2009.
 “Putin Speaks at Davos” (Speech transcript), Wall Street Journal, January 28, 2009.
 Putin at Davos: “In the 20th century, the Soviet Union made the state’s role absolute. In the long run, this made the Soviet economy totally uncompetitive. This lesson cost us dearly. I am sure nobody wants to see it repeated. Nor should we turn a blind eye to the fact that the spirit of free enterprise, including the principle of personal responsibility of businesspeople, investors and shareholders for their decisions, is being eroded in the last few months. There is no reason to believe that we can achieve better results by shifting responsibility onto the state.”
 Putin at Davos: “Apart from cleaning up our balance sheets, it is high time we got rid of virtual money, exaggerated reports and dubious ratings… Excessive dependence on a single reserve currency is dangerous for the global economy. Consequently, it would be sensible to encourage the objective process of creating several strong reserve currencies in the future.”
 Fannie/Freddie stock declined by nearly 65%/68% respectively from June 30 to July 15, to $7.07/$5.26 per share. By September 8, each stock closed at 0.73c/0.88c per share. Fannie Mae and Freddie Mac are government-sponsored entities (GSEs) that buy and sell mortgages. As of 2008, Fannie/Freddie owned or guaranteed approximately half of the $12 trillion U.S. mortgage market.
 SEC Short Ban Ruling, July 15, 2008.
 “Naked Short Selling Ban,” M. Steinhardt, Seeking Alpha, August 28, 2008.
 “U.S. seizes Fannie and Freddie,” CNNMoney, September 7, 2008.
 “U.S. to Take Over AIG in $85 Billion Bailout; Central Banks Inject Cash as Credit Dries Up,” M. Karnitschnig et al, Wall Street Journal, September 16, 2008.
 “An AIG Unit’s Quest to Juice Profit,” S. Ng and L. Pleven, Wall Street Journal, February 5, 2009.
 “Naked Short Sales Hint Fraud in Bringing Down Lehman,” G. Matsumoto, Bloomberg News, March 19, 2009.
 SEC Short Ban Ruling, September 18, 2008.
 “Short Selling Ban Sends Chills Through Options Market,” Seeking Alpha, October 8, 2008.
 “Uncertainty Over Rescue Intensifies Credit Crisis,” Wall Street Journal, October 3, 2008.]]>
It’s been almost 20 years since Tim Berners-Lee first created the hypertext markup language (HTML) and the hypertext transfer protocol (HTTP) between clients and servers that have become the mainstay structural model of the World Wide Web (WWW) we all use today. Web data – text, graphics, video, audio – are marked via simple hypertext links, and not much more. As such, the power of the web is limited structurally to a static system, where data types are often blind, and more information about them is not exploited in a dynamic link variable. Data context, or a semantic interpretation of the data, is also not exploited. In fact, dynamically linked variables often found in object-oriented programming languages remains elusive to what the web could revolve into – a giant relational database, where the power of data relationships can be leveraged to provide web users with a significant advantage in finding and using just the data they’ve been looking for, and not a mountain of data that is irrelevant or that they don’t need.
The person leading this new charge for a massive change in the web as we know it? Tim Berners-Lee. And yes, there are others, notably those associated with the World Wide Web Consortium (W3C) that Berners-Lee started. The new web paradigm is often referred to as the “Semantic Web,” as it denotes defining information and services on the web semantically, such that web tools can more intelligently interpret or “comprehend” web user requests and so that machines can process web data more efficiently . I prefer to include the term “dynamically linked web data” or DLWD, in conjunction with the Semantic Web, as both together represent a direct moniker of proposed transformations (and beyond).
What are the features of DLWD that would make the Semantic Web (SW) a powerful experience for web users? How would they practically be implemented? We explore those nontrivial issues next.
The power of DLWD is best understood through an example of how a web search for information could yield vastly more meaningful and targeted data or query returns.
In a typical web search based on keywords, we get back all HTML links with text or data files that have some or all of the keywords we specified. The mountain of query returns is many times not productive and can rank in the tens of thousands. However, if the web data (text, graphics, video, audio) we were searching each had an associated link variable, and that variable was populated with information that is also searchable, we’d have a better chance of getting back the data we need. Furthermore, the link variables themselves can be dynamically linked to each other, much like pointer variables in object-oriented programming, rendering a correlation factor among search data, and thereby potentially vastly increasing the value of search query returns.
As an example, let’s say you’re looking for a collection of surveys and reviews for a prescription drug on the web, but you want the query results to be targeted to include only surveys that women of a certain age range have responded to. If you enter keywords “<drug name> women age 40-45” into a typical search engine you might get back 1000 or more returns. On the first page alone you might see links to information that have nothing to do with the drug you listed – the link and associated text just happened to contain the keywords “women age 40-45.” Many of the returns may not be an accurate translation of what you meant by “40-45.” Some at the top of the list may include 40-45 to mean several completely different things, like “40-45”% of something, or pages “40-45” of some periodical. The primary issue is that the context or semantics of our query is not used in a meaningful way because the data links we search have no coded context associated with them and the reader of those data links (the search engine) wouldn’t be able to translate it if they did exist. Enter DLWD and the Semantic Web. In this realm, websites are programmed to tag information entered by users with links that are variables, that in turn are populated with useful, searchable information and may even point to other links (DLWD). How this is done is not trivial – many times the survey data we seek may be from users who wish to remain anonymous and just provide casual feedback on their experience on any number of informal forums, like a chat room. The information entered must be encoded to be machine-processable, into a DLWD variable. The feedback might then be combined with other feedback from an entirely different website in an aggregated form by connecting data links having meaningful relationships (fields of the DLWD variables). A search tool that is designed to read and interpret DLWD would be able to limit the query returns to those with relationships most closely matching what we specify in keyword and context. In our example, if there were age and gender variables associated with the searchable data that also contained the drug keyword then we would be sent back all the DLWD links that contain the gender field “women” and any age field with numbers in the range 40-45. We might still get back spurious results if the search results contained only the numbers 40 and 45, or other fields with a number range “40-45,” so context is still an issue. To solve that problem, there must be a way for the search tool to interpret what we meant by “age 40-45,” that we want ages 40,41,42,43,44, and 45. A human knows what the number range means but a machine might not unless it was told to translate 40-45 to mean 40,41,42,43,44,45. One way to ensure this happens is if there exists a pointer to a translation document that defines 40-45 to mean 40,41,42,43,44,45. This pointer could be part of the DLWD variable. In the lingo of the Semantic Web , this type of pointer document is referred to as an “ontology.” Ontologies can interpret the meaning of a particular data set, and more generally they can provide an extensive taxonomy (definitions of all kinds of data objects and the relationships between them, even across different platforms) and inference rules (an if-then-else relationship between variables). In our example an inference rule that might apply is “if age is associated with a number range 40-45 then return all related links with the age numbers 40,41,42,43,44,45.” The ontology may also interpret the gender field values “women” and “female” as equivalent, so that we get all of those DLWD links in our search query results.
In practice, the implementation of DLWD and the Semantic Web are quite nontrivial. After years of exponential growth of web data that is highly disorganized from a lack of inherent structure or logic, we face an uphill climb to reorganize the web into a system with structure and logic, and yes, maybe even the learning and comprehension ability found in artificial intelligence (AI) systems.
As a first approximation, Berners-Lee and the W3C have come up with a set of standards and specifications  for how data might be encoded, ontologies built and tools constructed.
For data encoding, a resource description framework (RDF) structure is proposed, whereby uniform resource identifiers (URIs), such as typical HTTP uniform resource locator (URL) addresses we all use, contain syntax statements that have or point to content descriptions and also point to other URIs. In a data model form, the syntax is “subject-predicate-object,” where the subject is a resource (e.g. a URI), and the predicate represents features of the resource and also relates the subject to the object. This is referred to as a “triple.” For our example, an RDF encoding might be:
subject URL:http://www.<drug name>.com
predicate URL:http://www.<drug reviews>.com/drugReviews
object URL:http://www.<health blog>.com/women/40-45/#1234
to represent “<drug name> reviewed by women of ages 40-45.” In graphical form, the URIs are nodes that have properties, and are linked to other nodes that have related properties and values. As another example, a website on the sun could contain temperature data that includes links to other websites with solar temperature data. Formal RDF would codify this into a knowledge representation so that it is processable and meaningful. It has a possibility of going beyond traditional relational database models, particularly if ontologies are included and, as I point out, data links are dynamic.
For ontology construction, a web ontology language (OWL) has been developed, which is actually a collection of semantics-based languages, many of which use RDF-style statement structures in the form of eXtensible Markup Language (XML) syntax. XML is a prolific open-standard web development framework. RSS feeds are written in XML, which allows for content to be defined separately from formatting, making it easy to parse and streamlined for use across different platforms and applications. Like the generic ontology described above, a typical OWL ontology includes definitions of data objects and their relationships, plus inference rules. In OWL, data objects are organized into individuals and classes, with general and specific properties, all to exploit the semantic nature of the information. As an example, “women” and “female” are individuals of the class “gender.” Next, there are datatype properties and object properties. The “age” class may have individual members that can be defined by whole numbers between 1 and 150. Object properties relate two classes: the property “demographics” relates instances of class “gender” to instances of class “age.” The property “ageRange” relates “40-45” to “40,41,42,43,44,45.” From these examples, one begins to see the power of an ontology when it is included in the realm of a search query. The challenge with ontologies is maximizing their value so that they are applicable to a wide range of uses, are re-usable, and are merge-capable with other ontologies to further increase value. Ontology mapping is key to the concept of association in intelligent systems. Think of a learning system – we start with one way to learn (one ontology) and then merge that with another way to learn (another ontology) and we end up with a more powerful learning capability (the collection of ontologies). This may be simplified given that learning systems are more complex than a typical ontology, but what is conveyed here is that ontologies are necessary components of a Semantic Web in which learning capability might exist.
Tools have been and continue to be developed to take advantage of the W3C Semantic Web paradigm. One of the more useful tools is a query tool that is optimized for RDF and other semantic data encodings – SPARQL Protocol and RDF Query Language (SPARQL). SPARQL has been compared to relational database query languages like SQL, but has a potential to be much more powerful, with the ability to query data web-wide to find high value returns. For example, the following might be a SPARQL query for the data we sought earlier from the search query keywords “<drug name> women age 40-45:”
PREFIX abc: <http://example.com/exampleOntology#>
SELECT <drug name> women 40-45
abc:<drug name> ?drug
abc:women ?gender ;
abc:female ?gender ;
abc:40-45 ?age ;
abc:ageRange abc:40,41,42,43,44,45 .
The expressions “?drug, ?gender, ?age” are class variables and the expressions “drugReviews, demographics, ageRange” are properties. This query specifies exactly what we want and how each of the keyword terms is related semantically. Of course the problem is that the web data we search may not be marked with RDF syntax with inter-related links. Unless that standard is adopted and followed, SPARQL queries would be less than useful. The point is that by setting up the standards for RDF, OWL, SPARQL, etc. web developers and users are encouraged to follow the standards to enable the Semantic Web and its powerful properties.
So then – how are web users and developers encouraged to adopt and follow these standards? Providing RDF information for data links and linking open data sets (i.e., including RDF statements that link to other URIs so that they can discover related properties) is an ongoing mission for the W3C Semantic Web Education and Outreach (SWEO) Community Project. Linking open data (LOD) datasets on the web have grown from 500 Million RDF syntax triples and 120,000 RDF links between data sources in May 2007 to more than 2 Billion RDF triples and 3 Million RDF links in April 2008 . Many organizations, mainly academic, are deploying link data browsers that feature SPARQL and other SW tools. Popular RDF browsers in current use are Disco and Tabulator. This era in time for the SW is not unlike the early era of web development tools, including those that led to Mosaic, the first widely-used web browser developed by Mark Andreessen and Eric Bina at the NCSA/University of Illinois Urbana-Champaign.
Another important project is “DBpedia” which is essentially a tool to extract structured information from Wikipedia and to make that information available in RDF format for further SW use. As of November 2008, the DBpedia dataset consists of around 274 million RDF triples from extracted Wikipedia information. These dataset triples are further linked with other Open Data datasets – a graphical view of current interlinks can be found here . Links include the CIA World Factbook, FOAF and Project Gutenberg. SPARQL queries of the DBpedia dataset can be entered from here.
With all the organic development going on to implement the SW it is not too early to ask where it could evolve, or revolve (as in revolution), to. RDF is a convenient way to express web data in a semantic or knowledge representation using URIs that are interlinked. But to really grow toward a system that has AI properties, or a seamless intelligent learning system for the casual user, the SW must become more dynamic. One built-in way this would happen is through ontology mapping, where ontologies are strengthened, re-used and linked with other such ontologies to grow a knowledge base, or as I like to put it, a “collective memory.” But to really become powerful, links should be dynamic themselves, or changeable, based on any number of forces: learning models, revised or improved information, new information, environmental effects, etc. Hence the term “DLWD.” How one goes from the SW and RDF in its semi-static form to SW and DLWD is, I think, a grand challenge. It will involve thinking about how to make links truly dynamic but not lead to information loss (a real downside threat). The motivation for this is to more closely match a system like that of the human brain, which is a neural network of synaptic circuits that represent a collective memory that can learn and think (that’s putting it simply!). Synapses have strengths that are dynamic and the brain is a highly interconnected system (ultra high integration density) of these local memory circuits. A single neuron cell can contain several thousand synapses. Though there are cells, layers and regions, the brain has built-in redundancy, another feature to consider for the SW future, and is one prevention of information loss. Cloud computing incorporates dynamically scalable architecture concepts (scale-out databases, autonomic computing, reliability, etc.) that will undoubtedly be important for the growth of the SW and DLWD. Association is an important global component to human learning, and a feature in SW ontologies.
The immediate focus of the SW is to (or ought to be to) provide seamless tools for the casual user (read: the consumer), so that he/she may be able to easily extract intelligent, relevant information and even add to the learning cycle. But for those of us who dream, we’d like to eventually see a web that can pass a Turing Test, and may even be a companion on lonely days.
 “The Semantic Web,” T. Berners-Lee, J. Hendler and O. Lassila, Scientific American, May 17, 2001.
 See W3C Semantic Web Activity and working group links contained therein. This site is updated regularly with standards, specifications, publications, presentations, case studies, and an activity weblog.
 “Linked Data: Principles and State of the Art,” C. Bizer, T. Heath, T. Berners-Lee, April 2008.
 “Interlinking DBpedia with other Data Sets,” DBpedia.org. See also .]]>
The debate over health care is heating up. Total national health expenditures have increased over 9.9% per year from 1961-2007, compared to the average inflation rate of 4.3% over the same period [1,2]. As a percentage of nominal GDP, national health expenditures went from 5.5% in 1962 to 16.2% in 2007. To put this cost growth into perspective, consider that national defense spending was only 4.8% of GDP in 2007 and all U.S. exports were ~12% of GDP. Over certain periods, such as from 1999-2007, health expenditures grew 7.4% per year, compared to an average inflation rate of 2.7%. Private health insurance premiums have risen 9.3% per year from 1999-2007, in response to the care cost growth , almost 3.5 times the inflation rate. Estimates for future total national health expenditures vary, but the expected value of 20.3% of GDP for the year 2018 , which implies a compounded annual growth rate (CAGR) of 6.2% from 2008-2018, is feasible considering historical growth rates and the current cost drivers.
Everyone wants to see changes that will bring down costs and make health care and insurance more affordable. What is at stake here is major: the current administration wants to see health care morph into yet another major entitlement program, with sweeping consequences for our national debt and an inevitable impact on personal freedom and quality of care.
This research essay will argue that there is another choice to nationalized health care (NHC): (1) employ a methodical process of recognizing and fixing the systemic issues that contribute to the high costs and lack of health insurance availability to everyone, reversing those trends; (2) ensure a free market model for health care and insurance to allow for more efficient price discovery within the given universe of supply and demand.
The causes or drivers of health care cost growth are controversial and are not widely available in one place, where coherent patterns and trends can be observed and addressed. A chart of the total national expenditures by private or public funds is shown in Chart 1; the same data set is broken out by primary cost areas in Chart 2 (click links to see charts). Both are from comprehensive data that is publicly available [1,5,6].
Chart 1 – National Health Expenditures
Chart 2 – Primary Health Care Costs
Chart 1 shows that Medicare and Medicaid together grew substantially from 1961-2007, at a compounded rate of almost 15% per year, and in 2007 make up roughly the same percentage of total spending as private health insurance (~35%). From 1999-2007 the annual growth rates of private insurance and Medicaid settled to ~8%, almost three times the average inflation rate, while Medicare grew over 9%. On the other hand, the average number of people over 65 covered by Medicare did not grow substantially, as shown in Table 1. The growth of Medicare and Medicaid slowed in the mid-late 90s due to the Balanced Budget Act of 1997, but as soon as those amendments were lifted and the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 passed, the growth resumed. Over a shorter time period, 2001-2007, Medicare grew by 9.7% and Medicaid and private insurance grew by 6.8% and 7.7% respectively. The recently higher growth rate in Medicare spending stems from the large increase from 2005 to 2006 of 18.6%. The source of this increase can be traced to a whopping 892% jump in Medicare prescription drug spending from the newly enacted Medicare Part D Prescription drug program. Spending went from $4B to almost $40B in one year. But the growth story doesn’t stop there. Medicare prescription drug spending growth grew 43.6% per year from 1985-2005, the years that the metric was tracked before the 2006 jump (54.9% compounded annual rate from 1985-2007 to include the 892% and 19% increases in 2006 and 2007, as shown in Table 2). Compare this to compounded growth rates of 19.5% and 15.6% for prescription drug spending from private insurance and Medicaid respectively, from 1962-2005. Very telling, out-of-pocket payments for prescription drugs grew only 6.9% annually from 1962-2005. In 2006 and 2007 there was a marked decline in growth of prescription drug spending by private insurance and out-of-pocket, to 3.4% and –2.2% respectively – likely because of the shift of payments for seniors to Medicare Part D. What can we deduce from these trends? Prescription drug costs for the elderly (age 65 and over) are clearly a cost driver and is the largest single contributor to the aggregate 11.1% average increase from 1999-2007 shown in Chart 2, which in turn is a cost driver to total spending growth. Out-of-pocket growth is the smallest, indicating the shift away from out-of-pocket cost payments, but also perhaps an indication that there is more cost control when individuals are paying with their own money as opposed to a billed payment from Medicare or a private insurance company. Referring to Table 2, other areas where Medicare cost trends are above the total expenditure growth averages is under Other Professional Services, Home Health Care, Nursing Home Care and Administrative Costs, including the costs of separate private insurance. All four of these areas grew such that the Medicare expenditure within the categories as a whole increased substantially (%category). There are some positive trends in the Medicare data, but they may be illusive: hospital cost growth for Medicare recipients has been cut substantially since 1999: the compounded growth rate from 1966-2007 was 13.1%, and has slowed dramatically to 6.1% from 1999-2007. It may be that the rise in prescription drug usage and better preventative senior care are together keeping seniors out of the hospital, or that hospital billing for drugs after 2005 has simply been shifted to Medicare D – the majority of the drop in hospital care growth was in 2006 and 2007. Also, Home Health Care and Nursing Home Care may have increased as a result of shorter hospital stays. Nevertheless, this has not translated into a control of spending for the Medicare aggregate.
|Table 1: Average Coverages (in Millions of People) |
|Medicare (over 65)||39.3||40.6||0.41%|
|Table 2: Medicare Expenditures ||%Category|
|Physician & Clinical Services||14.0%||7.7%||11.8%||19.7%||20.1%|
|Other Prof. Services||20.3%||10.4%||4.8%||16.8%||22.2%|
|Home Health Care||21.2%||14.3%||26.8%||26.0%||40.4%|
|Nursing Home Care||12.8%||12.6%||3.5%||10.0%||17.7%|
|Admin. & Net Cost Priv. Ins.||13.5%||14.8%||14.3%||10.0%||13.9%|
As mentioned in the previous section on prescription drug costs, out-of-pocket payments by far show the lowest cost growth over a 35-year period. This trend is observed for almost all the other health cost categories where consumers can pay from their own pocketbook, as seen in Table 3. For most cases growth has declined recently, but so has the share of out-of-pocket payments except for a few cases, such as dental services and medical products. The declines in out-of-pocket category expenditures are matched by marked increases in Medicare and private insurance like-category expenditures – indicating a dramatic shift away from having the patient-consumer directly pay the bill. When consumers have to pay the bill directly, costs are more transparent to them than when the bill is paid by another source, such as private insurance or Medicare. Transparency of direct costs to consumers is important, since there are indirect costs added by private insurance or Medicare. These indirect costs can be billing markups or the cost of administration or both. Clearly this is a major systemic driver of cost growth being out-of-control for private insurance and Medicare. Let us do a thought experiment to estimate the impact. If cost growth for all areas in Charts 1 and 2 were contained to the typical growth rate we see with out-of-pocket payments, which conservatively appears to be around 6.8% per annum, we would have had in 2007 (from 1961 levels) a total national expenditure of $606 Billion instead of the actual $2,242 Billion, or 4.4% of nominal GDP vs. 16.2%. This is an extreme example, but everyone should get the idea of extremes. Let’s consider a lesser extreme, a growth of 5% annum from 1985 levels, twenty years after Medicare came online and the year that data first showed separate Medicare payments for prescription drugs. A 5% growth rate is what we see as the per annum value for all out-of-pocket payments from 1999-2007. As a reference, the average inflation rate from 1985-2007 was 3.1%. In this case we get total expenditures in 2007 of $1,285 Billion, or 9.3% of nominal GDP. Clearly we cannot go back and change history, but we can learn from this experiment to shape policy. If consumers have greater transparency to costs and are the direct payer there is likely a better chance of keeping growth under control or even reversing the rate of growth.
|Table 3: Out-of-Pocket Expenditures ||%Category|
|Physician & Clinical Services||6.0%||6.2%||46.2%||11.4%||10.4%|
|Other Prof. Services||8.7%||5.4%||43.5%||27.1%||25.6%|
|Home Health Care||15.5%||-0.7%||9.5%||19.9%||10.1%|
|Nursing Home Care||9.3%||3.2%||52.0%||30.4%||26.9%|
Administrative and net insurance costs, like prescription drug costs, are outpacing the aggregate growth rate, as shown in Chart 2. Referring to Tables 2-6, we see these costs are particularly higher for Medicare, a compounded rate of 14.5% per year from 1999-2007 vs. 9.2% for the Medicare aggregate. These cost increases under Medicaid and private insurance are not nearly as dramatic, but are still above the aggregate spend rates. Clearly this is an area for cost control measures, especially under Medicare. Administrative costs for Medicare (and Medicaid) include claims processing and adjudicating, claims fraud investigation, record keeping and analysis. For Medicare and private insurance there are additional costs for collecting premiums to pay claims. All of these are necessary functions, but the costs to perform them are hitting patient-consumers harder every year, and are growing faster than the health benefits. Efficiencies are needed.
In 2007, Medicaid/SCHIP covered 36.3 Million people, as shown in Table 1. These are average enrollments, with one-time enrollment highs during the year reaching an estimated 53.8 Million , due to part-year enrollments of people dropping in and out of the system. The average enrollment numbers grew almost 5% from 1999 to 2007. The 2007 estimate is that there are ~45 Million uninsured in the U.S. , but this is a controversial number. Some sources cite that there are 15 Million that are insurable but don’t sign up for private insurance and another 15 Million that are self-insured, due to higher incomes and better health . Clearly some of the uninsured dip into the Medicaid/SCHIP net but historically have not stayed there on a sustained basis – the fluctuating enrollment data  confirm this. The expenditure growth rate of Medicaid/SCHIP has been closest to the aggregate from 1999-2007 (Chart 1/Table 4), and this could be due to a relatively good economy during this period. Americans will lose their insurance due to job loss in the recent downturn, and the COBRA program has been extended to mitigate this effect, but with high COBRA premiums many may opt for no insurance. Medicaid/SCHIP has been allocated large increases (over $120 Billion) on federal and state levels in the 2009 $787 Billion Stimulus and SCHIP Expansion Bills. So there is no reason to believe (as government estimates have for 2008-2018 ) that the growth rates for Medicaid/SCHIP will hold to the recent historical CAGR of 7.8% as the programs cover more people and eligibility rules are relaxed. A contraction of growth can only occur if less people are covered and there are program efficiencies enacted. So clearly this points to making health insurance more affordable for those who do not have it, whether they are eligible for Medicaid/SCHIP or not.
|Table 4: Medicaid/SCHIP Expenditures ||%Category|
|Physician & Clinical Services||14.6%||8.9%||4.6%||6.6%||7.4%|
|Other Prof. Services||17.7%||12.6%||5.4%||3.8%||5.9%|
|Home Health Care||25.3%||16.7%||6.8%||18.9%||34.7%|
|Other Personal Care||17.9%||10.4%||13.6%||65.1%||73.6%|
|Nursing Home Care||13.2%||4.4%||37.6%||43.0%||41.7%|
As shown in Table 5, the recent growth rate of private insurance costs runs above the overall health expenditure aggregate (8.1% vs. 7.4%), and this growth is driven by several factors: marked cost increases in hospital care, physician care, prescription drugs and administrative functions. Estimates show the number of people covered by private insurance grew less than 1% annually from 1999-2007 (Table 1), so the intrinsic cost increases in the benefits provided are approx. as high as the annual growth rates suggest in Table 5. To fully address the affordability of health insurance, the cost growth of the benefits must be addressed – and this means looking at the cost drivers with a critical eye. We start to do this in the next section.
|Table 5: Private Insurance Exp. ||%Category|
|Physician & Clinical Services||11.3%||8.0%||30.1%||47.3%||49.4%|
|Other Prof. Services||17.8%||7.0%||5.8%||35.4%||36.5%|
|Home Health Care||18.8%||-4.1%||3.2%||24.7%||9.4%|
|Nursing Home Care||22.4%||2.3%||0.2%||9.0%||7.5%|
|Admin. & Net Cost Priv. Ins.||10.6%||9.5%||51.8%||64.4%||60.8%|
|Table 6: DoD/VA Expenditures ||%Category|
|Physician & Clinical Services||12.0%||14.9%||1.1%||1.2%||2.0%|
|Other Prof. Services||-||-||-||-||-|
|Home Health Care||12.6%||21.7%||1.4%||0.3%||0.8%|
|Other Personal Care||5.7%||4.2%||20.3%||5.8%||4.2%|
|Nursing Home Care||15.8%||8.0%||1.5%||2.0%||2.5%|
From the primary data sets in Charts 1 and 2, Tables 1-6 and the analyses in the previous section, it is important to posit what the underlying systemic issues are that drive the observed cost growth, and back those assertions up with further research data. A list of those underlying systemic cost drivers is assembled in Table 7, along with an estimate of their relative weights in contributing to overall cost growth. The estimates apply to the annual growth in costs as well as the principle costs, but we focus on the growth for exemplary purposes. The medical malpractice estimate is based on my own calculation from the weighted growth rates of hospital and physician costs, adjusted for inflation, and is commensurate with a similar estimate by the CBO based on actual malpractice cost data . These are direct medical malpractice costs as measured by malpractice insurance premiums and the net costs to settle claims. Indirect costs associated with malpractice, such as the marked increase in medical tests, diagnostic services and the prescription of multiple drugs to avoid lawsuits, are not included in this factor, and are likely a substantial additional factor. These costs are sometimes called “defensive medicine” costs . It has been shown in some studies that 93% of physicians in high-liability specialties practice defensive medicine . Consumer non-transparency to costs is the next highest factor. Consumers only pay 12% of their health costs out-of-pocket – it used to be 33% in 1970. Private insurance and Medicare pick up the bill for the vast majority of the costs, for benefits that the consumer has less and less scrutiny over. The impact estimate is based on the weighted growth rate of private insurance and Medicare costs, inflation adjusted, where the customer could have more scrutiny, and is a very conservative estimate, as Medicaid and other cost sources are not included. Prescription drug development is the third factor, estimated from the straight weighted growth rate of prescription drug costs, inflation adjusted. In the NHED data  prescription drug costs include all research and development costs, and the separate cost category “Research” in Chart 2 excludes these costs. Medicare/Medicaid fraud and inefficiencies is based on a percentage of the weighted average of Medicare/Medicaid growth rates, inflation adjusted, and is equivalent to ~$4 Billion in losses per year based on 2007 expenditures. This is above the annual average $1-2 Billion in losses reported by CMS , but those were only for Medicare and do not include fraud that is not prosecuted and settled. The remainder factor is the effect of federal and state mandates on private health insurance companies that require them to structure insurance policies to include certain benefit coverages that are excessive or are not medically necessary, and that drive up the costs of premiums. The factor is based on the weighted growth rate of private insurance costs (premiums), inflation adjusted.
So how do we eliminate or reverse the cost growth drivers delineated in Table 7? In Table 8 a set of systemic solutions is proposed, along with estimated minimum and maximum annual growth savings targets. Tort reform is needed to address both medical malpractice costs and the rising costs of prescription drugs, where liability is included in the development costs. Some critics have complained that tort reform that focuses on limiting or capping damage awards, such as non-economic or punitive damages, does little to reverse the cost growth of malpractice insurance premium costs , but this is unsubstantiated from studies that show the measure does have an effect . Capping damage awards is but one part of a complete solution to tort reform. Adopting tort law from other countries, such as in the British-style tort of “loser pays” and allowing judges to dismiss cases that have a weak basis or that would have a negative impact to all parties, or the German and British practices of limiting lawyer fees and jury cases, are structural reforms that should be seriously considered here in the U.S. . Another factor in tort reform is the reduction of “defensive medicine” practices, which was discussed above – the propensity of doctors and providers to over-prescribe tests, procedures and drug treatments that are not medically necessary but that protect a provider if something should go wrong with the patient. Estimates show this indirect cost can be as much as 30% of the bill from the physician  and is in vast excess of direct malpractice costs. Taking all these measures, the min-max growth rate savings estimates are based on a portion of the factors in Table 7 (min: % of cost factors due to direct medical malpractice and drug development) and an additional portion of the cost principle (max: up to 30% of physician and 5% of hospital costs). The next systemic solution: returning the patient-consumer back to a direct payer of costs, where “home economies” such as cost scrutiny and realism within the scope of the patient’s personal budget can be leveraged to keep costs under control. The minimum cost savings target is based on a portion of the factors in Table 7 that apply, such as factors 2/4/5, and the max target is a truly conservative estimate of what we could shave off the principle costs if we fully applied this systemic solution. The final systemic solution: move to a free market model for our health care coverage, in which Medicare and Medicaid are eliminated in favor of affordable private health insurance coverage for everyone, with few exceptions. To get to a free market model, employers/employees must not be the only ones to enjoy a tax subsidy for their health insurance premiums – this must either be extended to everyone, including small business owners and private partnerships, which are not current beneficiaries of this subsidy, or eliminated altogether. Keeping the tax break would encourage everyone who files a tax return to comply with the shift to this system. Current federal and state mandates that impose restrictions on health insurance plans, like requiring the inclusion of excessive or medically unnecessary benefits, must be eliminated, allowing consumers to choose among product offerings and benefits that meet their personal needs. High-deductible ‘catastrophic’ plans that focus the patient-consumer toward out-of-pocket payments for routine maintenance care and supplies would form the basis of offerings, and would cost the least. For an individual in good health this might amount to under $50/mo depending on age and location, and even less if there is a tax subsidy. The minimum cost savings target is a portion of factors 3 and 5 in Table 7, and the max target is a conservative estimate of what might be shaved off the cost principle, particularly given the elimination of wasteful government health programs in favor of an all-private free market. The bottom line maximum net annual growth target (-12.6%, adjusted for inflation) would apply for the first year and then increase to a steady-state run rate, and that may be as high as the min target cited (5.2%), but certainly that could (and should) be less if we want to contain costs.
What will it take to put the targeted solutions in Table 8 into action? Tort Reform was attempted under the Bush Administration but met significant resistance from the Association of Trial Lawyers of America (ATLA) and other lobby groups. This resistance will only be higher under the Obama Administration, as the ATLA was a significant campaign donor, with an estimated 93% of ATLA donations going to Democratic candidates. The cost of tort cases across the board continues to grow at a substantial pace, over 9% average per annum . Doctors and hospitals will continue to practice ‘defensive medicine’ until tort reform is enacted, so the red herring that malpractice costs are contained is simply not true, as the indirect costs are substantial and underreported. We are left with asserting political pressure on Congress and the Administration to see that these ‘defensive medicine’ costs are the real driver and are the raison d’etre for Tort Reform. Customer As Direct-Payer is a measure that can be adopted without delay – start removing the layers between the provider-biller and the patient-consumer and return to a greater degree of out-of-pocket payments. This will meet political resistance within the ranks of the ‘middlemen,’ both on the government and private side, so a tough stand is required. The Free Market Model will take longer, as it requires the elimination of all government health programs, which are by their very nature inefficient. The political headwinds here are formidable: the plethora of lobby groups that have spent millions to fight for greater Medicare and Medicaid benefits, in effect being part of the cost growth problem, will be out in full force to block such a move to eliminate the programs. They must be reassured that a private insurance system will work better, and that the point is to get the government out of health care. This reassurance will best be met by a free market, where medical services and supplies are adjusted by the laws of competitive supply and demand, with price discovery, not price fixing. Insurance companies would compete vigorously for business directly from the patient-consumer. The government will not pick winners and losers on a political basis; the patient-consumer will choose insurance based on price, value, reputation, etc., just as they prefer to choose their medical practitioners and make choices among available medical supplies and services.
Nationalized health care (NHC) has once again surfaced as a leading contender for health care reform, since the Clinton Health Care Plan was handily defeated in 1994 in a Democratically-controlled Congress. This time NHC finds strong supporters in the Senate  and the House, and is staunchly championed by the Obama Administration. Significant outlays (over $22B) were made in the recent 2009 $787B Stimulus Bill to pave the way for NHC, in the form of payments to physician groups and hospitals to “computerize medical records systems” and for a massive digital medical records (DMR) project. The Administration claims that DMR is required for cost savings in general, but this is wholly unsubstantiated . What DMR does do is seek to put all Americans in a database to further enable NHC, no matter whether NHC is the right way to go or not. On its own merits, DMR is costly and there are lingering issues with privacy and property rights that have yet to be reconciled. What is NHC likely to look like if it is implemented by this Congress and Administration? In the words of Congressman Barney Frank: “A single payer system like Medicare” . Given the out-of-control cost growth rates of Medicare, which we have pointedly highlighted from the NHED data in Table 2 and deconstructed in the first section, this prospect should scare the heck out of everyone. At a 9.2% annual growth rate that shows no possibility of abatement without major reforms, Medicare is clearly not the model to adopt, unless we want to literally bankrupt the Treasury and send the U.S. into default. Perpetuating another massive entitlement that will attain unfunded liabilities should be avoided at all costs. Supporters have championed other NHC models, such as those adopted by Euro-zone countries, Britain and Canada. Their first argument for this is that these countries on average spend less on a % GDP basis than the U.S., the reported 9-10% GDP for Canada, vs. our current 17% GDP, for example. But the 9-10% GDP figure is very misleading because it only encompasses government-reported NHC expenditures, not the additional costs from private care that people seek to make up for the quality and more severe availability shortfalls that are commonly cited in these other NHC systems [22,23]. In Canada, much of the costs for private care and unavailable procedures and tests go unreported, as many provinces have bans on private care. Canadians travel across the border to the U.S. for care that is unavailable on a timely basis, or simply unavailable. Surveys of the Canadian NHC system show that it fails to meet patient-consumer needs . It is true that Canadians are healthier on average and have a greater life expectancy , but this is cultural. Americans on the other hand like the flexibility of current U.S. health care system, with all its flaws, over a single-payer solution . As broadcast at the beginning of this story, everyone agrees that costs must be contained, but moving toward the Canadian model or other NHC models is not the way. Americans defend the high quality of care and the myriad of innovations that our rag-tag system produces, in medical diagnostics, drug development, surgical technology, etc. We must look for a way to maintain such a productive system without the cost inefficiencies, but also without shortages and rationing. We must reconcile that we are not Canada or Britain or Europe: we lead the world in medical breakthroughs and clinical care. The straightforward and targeted solutions presented in the previous section encompass the right direction: Tort Reform, Consumer As Direct-Payer, and a Free Market Model. Let’s not wait to move on reforms in these areas.
 National Health Expenditure Data – Dept. of HHS, 2007. Note that “total national health expenditures” includes both public and private expenditures. Summary data and complete data sets from 1960-2007 are found on this site, as well as projections of expenditures from 2008-2018. Quoted growth rates from this data set are calculated as compounded annual growth rates (CAGRs), not average annual growth rates. This is important, as the fluctuations in the data are quite large and straight averages are misleading. All charts, tables and analyses in this paper from the NHED data set were prepared independently by the author.
 Macroeconomic data from Econstats.com.
 Kaiser/HRET Survey of Employer-Sponsored Health Benefits, 1999–2008. Note that other data on private employer health insurance premiums are available from Table 13 in NHED Tables, and from the Bureau of Labor Statistics (BLS) as part of their Employment Cost Index (ECI) Surveys (BLS .pdf source). The latter two sources give average growth rates of 7.7% and 7.4% respectively from 1999-2007, but both of these sources provide a disclaimer that the data errors may be several %-points, as employer non-response on health insurance components of benefits is substantial in their surveys.
 Data on individual health insurance premiums is very limited, but from two studies (2004 and 2006) done by AHIPresearch.org, an industry supported research group, average national premiums for single and family coverage increased 15.2% and 31.1% respectively from 2004-2006. Coverage benefits under individual plans vs. employer-based plans differ substantially, they are not common – individual plans tend to have higher deductibles and less benefits and the average premiums reflect that: in 2006, AHIP reported average annual premiums of $5799 for family and $2613 for single individual plan coverage, while Kaiser  reported $11480 for family and $4242 for single under employer-sponsored plans.
 Notes on data from  shown in Chart 1: “Out-of-Pocket” includes direct spending by consumers for all health care goods and services, including coinsurance, deductibles, and any amounts not covered by insurance (note private health insurance premiums are included under private insurance, not here). “Private Insurance” includes health insurance premiums paid to insurance companies by individuals, and the net cost of premiums earned and benefits paid out by the insurance companies. “Other Private” includes industrial in-plant, privately funded construction, and non-patient revenues, including philanthropy. “Other Public” includes workers’ compensation, public health activity, Department of Defense, Department of Veterans Affairs, Indian Health Service, State and local hospital subsidies and school health.
 Notes on data from  shown in Chart 2: “Other Services” includes Other Professional Services, Dental Services, Home Health Care, and Other Personal Care. “Medical Products” includes durable and non-durable medical products, such as wheelchairs to hearing aids and non-prescription drugs to sundries. “Admin and Net Cost Private Insurance” includes administrative costs of the government programs and the net cost of insurance premiums received and benefits paid out by insurance companies that translates to insurers’ costs of paying bills, advertising, sales commissions, and other administrative costs; net additions to reserves; rate credits and dividends; premium taxes; and profits or losses. The complete formal definitions of all of these categories can be found at the NHED site . See also  below.
 The data in Table 1 is drawn from a combination of data from the U.S. Census and studies by the Kaiser Family Foundation. “Private/Other Insurance” includes employer-based coverage, other private insurance, and other public insurance, such as Medicare under-65 disabled and military-related coverage. In 2007 the percentage ratios of all coverage vs. the total population were employer insurance (52.7%), other private insurance (4.8%) and other public insurance (2.2%), Medicare over-65 (13.4%), Medicaid/SCHIP (12%), and the uninsured (14.9%).
 Notes on data from  shown in Tables 2-6: “Other Professional Services” includes services provided by private-duty nurses, chiropractors, podiatrists, optometrists, and physical, occupational and speech therapists, among others. “Other Personal Care” includes government expenditures for care not specified by service and Home and Community-based waivers in the Medicaid program.
 2008 Medicaid Actuarial Report, NHED/Dept. of HHS.
 Income, Poverty, and Health Insurance Coverage in the United States: 2007. U.S. Census Bureau. Issued August 2008.
 Understanding the Uninsured Crisis in America, CoverageForAll.com.
 Limiting Tort Liability for Medical Malpractice, CBO Report 2004.
 “Defensive Medicine Among High-Risk Specialist Physicians in a Volatile Malpractice Environment,” D.M. Studdert et al, June 1, 2005, JAMA.
 Myths Debunked: Rising Cost of Medical Malpractice Insurance Is Due to High Jury Awards
 Medical Malpractice: Implications of Rising Premiums on Access to Health Care, GAO Report 2003. “Messing With Malpractice Reform,” Dec. 1, 2008, Wall Street Journal.
 “Malpractice: Do other countries hold the key?” R. Lowes, July 23, 2003, Medical Economics.
 “The Supreme Court and the Tyranny of Lawyers,” L. Gordon Crovitz, March 9, 2009, Wall Street Journal. “Practicing defensive medicine—Not good for patients or physicians,” P. Manner, Jan/Feb 2007 AAOS.
 “U.S. Tort Costs Up Slightly in 2007; Significant Increases Anticipated for 2008,” Nov. 2008, Towers-Perrin Report.
 “We Cannot Delay Health-Care Reform,” T. Kennedy and M. Baucus, Feb. 26, 2009, Wall Street Journal.
 “Obama’s $80 Billion Exaggeration,” J. Groopman and P. Hartzband, March 11, 2009, Wall Street Journal.
 Fox News Sunday Interview, March 15, 2009.
 “The Trouble with Canadian Healthcare,” Brett Skinner, Dec. 6, 2008, The American.
 “Canadians and Health Care,” Nov. 21, 2005, “The Rise of Private Care in Canada,” Apr. 25, 2006, “Adding Fuel to the Doctor Crisis,” Jan 2, 2008, Macleans Magazine.
 “Good Health, For Less,” June 25, 2008, Macleans Magazine.
 “Health ‘Reformers’ Ignore Facts,” S. Pipes, March 6, 2009, Wall Street Journal.
Japan’s economic malaise has been in the news recently – it just reported the largest annualized GDP drop (12.7%) in 34 years in the final quarter of 2008, ranking it as the current leader in economic decline compared to the U.S. and the Eurozone . Full-year GDP is expected to drop over 2.5%. Japan’s exports also declined 13.9% in the same quarter, its largest contraction ever. The slowing U.S. consumer demand is a contributor, as is the recent strength in the Yen, reportedly due to safe-haven buying on the world currency markets. Japan now has the highest debt load among industrialized nations, running at almost 160% GDP. With such a high debt load and falling demand for its exports, the Japanese government is finding it increasingly difficult to maneuver a recovery plan.
South Korea’s sharp decline in growth at the end of 2008 has also been news – an annualized GDP drop of 21% in its final quarter of 2008, the worst since its financial crisis in 1998 . Korea’s growth rate has been brisk in the last decade, so its full-year 2008 GDP rose 2.5%. The late 2008 GDP decline is likely attributable to Korea’s own sharp drop in exports, 11.9% from its third quarter, the largest in three decades. Korean exports account for a much larger share of GDP (~40%, similar to China), compared to that of Japan (~20%). The Won (Korea’s currency) hit a decade low last October, with continuing weakness into 2009. Asian currencies ex-Japan as a whole have declined from shrinking exports all across the region, as well as from a drop in global investor demand for emerging market assets. In contrast to Japan, Korea’s debt load is not nearly as high – ~30% GDP. Though its central bank has just reduced the discount lending rate to a record low of 2%, it has cautiously reserved the right to go even lower, in the face of a sharply weakening Won. Nevertheless, Korea may be in a better position to maneuver a quicker turnaround than Japan, despite its greater dependence on export trade.
So why is Korea in a stronger position for a growth turnaround? Several factors: (1) lack of a stock or real estate bubble history due to its relatively conservative monetary policies, and a history of government fiscal control; (2) economic reforms instituted in its banking and corporate entities after the 1997 financial crisis; (3) moderate-low corporate tax rates to spur business investment and growth; and (4) a staunchly pro free trade agenda with the U.S. and other partners. Let us address each of these in turn.
Korea did not share Japan’s experience of a major housing and stock market bubble, which burst at the end of 1989, and that many argue has impaired Japan’s recovery for almost two decades. The Tokyo Nikkei stock market index, from its peak of 38,957 on December 29, 1989 to 7,750 on February 16, 2009, has lost over 80% of its peak value, and is now testing the low of 7,604 set in 2003. If that low doesn’t hold, one would have to go back to 1982 to test another local low point. Japan’s stock and real estate market bubbles in the 80s were caused by the very loose monetary policies of the Bank of Japan (BoJ), which cut the discount lending interest rate from 9% to 2.5% between 1980-1987 and kept that rate at 2.5% for two years, while increasing the money supply at over 9% per year in the same period. The bubbles were pricked once the BoJ increased rates abruptly to 6% from 1989-90. The cumulative capital losses from the 1990-91 stock and real estate bubble implosion continued to increase every year until a low trough was hit in 2002-3. Though there was a recovery in the Nikkei from 2003-2006, it is now almost back down to its 2003 low. The Japanese government estimates almost $15T in cumulative capital losses from 1990-2003.
In an effort to slow the capital losses and stimulate the economy, the BoJ lowered rates again from 6% in mid-1991 to 1% in mid-1995, and then a further reduction to 0.5% in late 1995, where it remained for almost 5 years. Over this decade long period asset prices continued to fall from their once stratospheric highs despite the aggressive easing. It is highly noteworthy to add that from 1990-2000 the Japanese government debt-to-GDP ratio went from 60% to 120% as a result of massive public spending and a huge influx of government capital to the faltering financial sector. Yet by most measures the Japanese economy remained stagnant, the real GDP growing on average only ~1.3% per year.
Without an asset bubble and deflation to contend with, Korea’s economy grew steadily from 1980-1997, the real GDP increasing at an ~7.6% annual rate during this period. In the 80s and 90s, instead of adopting the loose monetary policy of Japan, the Bank of Korea (BoK) maintained a conservative one, managing its discount rate to avoid price shocks and limiting its money supply growth to rein inflation. The BoK’s inflation-targeting actions have contributed to long-term price stability, in sharp contrast to Japan . Government fiscal policy was also conservative, with budget growth in check: the debt-to-GDP ratio contracted from 22% in 1980 to 16% in 1990, and then was cut almost in half to ~8% in 1996. These conservative monetary and fiscal policies made it possible for Korea to enjoy almost two decades of economic stability and growth.
The takeaway here is that monetary policy, if too loose, as it was in Japan in the 80s, can cultivate massive asset bubbles that lead to rapid and unrecoverable devaluation. Responding to such an event with incessant government spending can lead to sluggish growth, especially if that spending is within an economic system that has no process in place for insolvent and non-performing companies and banks to fail, and a tax and regulatory structure that is unfriendly to business. Korea’s much more conservative approach to monetary and fiscal policies during the 80s and early 90s helped prepare it for future economic shocks, such as the 1997 crisis, despite the fact that at that time it shared with Japan similar structural flaws in its corporate and banking systems, an issue that we turn to detail next.
The Asian Financial Crisis of 1997 triggered by the collapse of the Thai currency had a much larger impact on Korea than Japan. The reasons for this are not completely clear, but it appears Korea’s heightened exposure to currency exchange risk was a major factor. The rapid devaluation of the Won and the dangerously sharp decline in Korea’s foreign exchange reserves threatened government default on its debt. Financial institutions and corporations that were highly leveraged to the Won faced massive devaluation of their assets. The high growth rate in Korea spawned an expansion in leverage and credit, and exposed poorly run institutions, many of them large conglomerates and government run banks, to failure. By the end of 1998 bad debt mounted to almost 30% of the GDP and Korea received a loan from the International Monetary Fund (IMF) to help shore up its reserves. How Korea responded to this crisis is instructive . The Korean government divested itself of failing insolvent banks through auctions. In some cases assets were sold at fire sale prices and the bank received new management and investment (complete privatization), in other cases the government partnered with investors to co-own the bad debt until the underlying assets could recover and be sold to a buyer. There are two important points here – Korea realized that propping up failing institutions was not in their interest, nor did they have the luxury of continuing to support national banks – they chose to receive IMF money or risk debt default. Changes in bank management to private hands with foreign involvement could also be argued as having been a way for Korea to modernize its credit system – a deficiency that also impaired Korea before the crisis hit. Several large conglomerate failures during the crisis also showed a need for reforms to Korea’s policy in supporting government-backed family-controlled multinational monopolies. The salient point is that companies were also allowed to fail and be sold off to other conglomerates and foreign investors. Korea’s tough reforms paid off – without the burden of poorly performing institutions, Korea grew its GDP almost 5.3% annually from 1999-2008. Its most recent downturn from slowing export demand will once again test Korea’s resolve in how they handle the hardship. If they adopt the same conservative no-nonsense approaches as they have in the past it will contribute to restoring growth and stability.
Japan had its own banking crisis following the 1997 Asian shock, but escaped the immediate severity felt by Korea, in large part by being saved by the Yen, a highly developed currency, reducing Japan’s exposure to currency risk. Japan’s crisis stemmed from years of asset bubble deflation amidst a growing leverage environment. Bad debt on banks in Japan mounted to over 25% GDP, a substantial figure considering that Japan’s GDP in 1998 was 11 times that of Korea’s. Many banks (some 180 up to 2002 ) were completely insolvent, and instead of allowing these institutions to fail and cleaning out the bad debt, Japan chose to continually infuse poorly run banks with government money for a period of years, in the hope that they would eventually recover. Impaired banks continued to make loans to financially impaired businesses and individuals, without adequate risk assessment for future non-performing loans, and they were allowed to maintain unrealized losses by government regulation. Some claim these policies contributed to deflationary pressures on underlying assets, becoming part of a deflationary systemic spiral. Regardless, Korea’s swift moves to privatize insolvent banks and resolve its bad debt crisis might have been adopted by Japan, but they weren’t. From 1997-2005 Japan’s GDP grew by only ~1% per year. Modest financial and corporate reforms did finally start to kick in around 2004-5, when banks were required to submit to strict audits and technically insolvent ones were forced into receivership, and changes were made to Japanese bankruptcy laws, making it easier for firms to declare bankruptcy and liquidate their holdings. In 2005 Japan’s economy finally started to improve, in part by the rapid growth in the global economy and a weaker Yen. GDP grew from 2005-2008 at ~2% per year.
Now, with export demand weakening significantly along with the recent safe haven strength of the Yen, Japan is vulnerable unless it takes on significant economic reforms. Monetary easing by injecting money into the economy may help to weaken the Yen, but this is risky, as safe-haven demand for the Yen could unwind sharply. Some have suggested that Japan develop a greater degree of domestic consumption to spur its growth, eschewing its cultural propensity to save. But from its own history in the 90s, it is clear that a recurrent government fiscal spending spree will have little effect on spurring new growth, and Japan already is saddled with a large amount of government debt. Japan might do well to look to Korea’s recent history of economic structural changes for answers: adopt tough reforms on government budgets, pay down government debt, allow more insolvent banks and companies to fail, allow a greater degree of foreign investment in Japanese banks and businesses, and reduce its very high tax rates on businesses. The latter two points cannot be understated enough. Globally, Japan has one of the most protectionist domestic markets for foreign direct investment and it has the highest corporate tax rates. Protectionism of its domestic markets and a business-unfriendly environment only protect Japan from real growth.
Tax policy, particularly corporate tax policy, is one lever available to governments to spur growth and job creation. High corporate taxes encourage businesses to invest overseas or to hide their capital from domestic investment. Everyone pays for corporate taxes when they buy goods and services, so a high corporate tax is just another tax on consumers.
Japan has the highest corporate tax rate in the industrialized world, with a high effective marginal tax rate of ~41%. It has historically had one of the most business-unfriendly tax policies , imposing a significant impact on domestic and foreign investment. The recovery of bubble deflating land prices in the 90s was hampered by the imposition of a high land tax in 1992, discouraging a more liquid market and efficient price discovery, and preventing a release of capital to be allocated elsewhere. Similar effects were felt on stock and non-land asset sales with the imposition of a high capital gains tax rate. Japan maintained a high corporate marginal tax rate of over 50% before 2004, yielding an average tax revenue of 3.5% of GDP from 1998-2004. When tax rates were reduced in 2004 and 2005 to ~40% there was a marked increase (~40%) in corporate tax revenue from 2004-2006, to ~5% GDP. In fact, the reduction of corporate tax rates in countries worldwide has shown a remarkable correlation with increasing tax revenue . Increasing tax revenue from these rate reductions stems from an increase in taxable growth from business investment and reinvestment.
Korea has moderate-low corporate tax rates of 13-25%, depending on company revenue (100M Won cutoff). Corporate tax rates have historically been below the international average among industrialized nations, and Korea has made an effort to reduce them every chance it had from 1983-present, from 20-33% to the current 13-25%. In December 2008, Korea announced that it would lower rates even further, to 11-22% for 2009, increasing the revenue cutoff to 200M Won for the lower rate, and then again to 10-20% by 2011. These commitments are in stark contrast to Japan and the U.S., the two countries with the highest corporate tax rates. Historical evidence is strong that Korea’s business tax policies have made it a friendlier place to invest, and have contributed to its remarkable sustained growth: from 1983-present Korea’s GDP grew ~6.6% per year.
Japan has recently surfaced the idea of cutting corporate tax rates from its high 41% level, but no action has yet been taken.
Korea has unilaterally promoted both export and import growth since the mid-1980s, when policy makers diligently started removing barriers to their domestic markets, opening them to foreign competition and seeing this as a way to boost the international competitiveness of its own industries. Their stated objective continues to be that they will promote an advanced, free and open economy, and they have worked toward numerous multilateral free trade agreements with other countries, including the KORUS free trade agreement signed with the U.S. in 2007, which has yet to be ratified by the U.S. Congress or Korea’s National Assembly. With Korea’s heavy dependence on export and import trade, it is not surprising that their policy makers would want to be free-trade evangelists and cast Korea as a leading voice against global protectionism . However, as we know historically, nations don’t always choose a liberal but prudent trade stand – protectionism of domestic markets has been an impulsive or reflexive reaction in economic downturns, instead of seeing free trade as a way to promote growth and stability. The bottom line here is that Korea itself must reform its trade policy – its weighted average tariff rates (~7%) are much higher than even Japan’s (~1.5%) or the U.S (~1.6%). In particular, Korea has stiff tariff barriers in its agricultural and auto sectors. KORUS would lift tariffs or quotas in these areas, and phase out tariffs on consumer and industrial products over a period of years. As a bonus to Korea, KORUS would further increase foreign direct investment, an advantage Korea has had for years over Japan, given the relative size of the two economies.
While Japan has liberalized its trade policy over the years to reduce tariffs, it has kept other barriers in place that appear to impede its growth – foreign direct investment (FDI) is one of the standouts. Looking at the data, in 2007 Japan received ~$111B in FDI, compared to ~$120B received by Korea. That puts them 24th and 23rd on the CIA World Factbook FDI list. Japan has the 2nd largest economy in the world, and Korea’s rank has fluctuated between 11th-14th. How can this be? An obvious explanation is that Japan’s markets are indeed protected, from FDI. Japan should be ranked in the top 10 but it isn’t. In fact, both Korea and Japan could stand to move their FDI rank up, past countries such as Poland and Denmark.
With the U.S. in recession and ratcheting up on its own debt load, particularly with the recent passage of the $787B economic spending package and an estimate of well over $1T to bail out its insolvent financial institutions, Japan and Korea are noteworthy case studies. In fact, in three decades both together have encountered almost all of the crises that the U.S. has endured in the last decade. The opportunity here is to look at what macroeconomic and fiscal policies worked and what didn’t and then cultivate and apply those that were successful. In the final analysis:
 “Steep Export Slide Pummels Japan,” Wall Street Journal, 2/17/09.
 “South Korea Economy Shrinks 5.6%, Worst in a Decade,” Wall Street Journal, 1/22/09.
 “A Tale of Two Monetary Policies: Korea and Japan,” Thomas F. Cargill, FRBSF Economic Letter, 4/15/05.
 “The Seoul Solution to the Banking Crisis,” Wall Street Journal, 2/12/09.
 “Bank Failures in Mature Economies,” Basel Committee on Banking Supervision, April 2004.
 “Toward Meaningful Tax Reform in Japan,” Alan Reynolds, 4/6/98.
 “How Cutting Corporation Tax Would Boost Revenue,” M. Elliot, et al., 2008.
 “’Buy American’ Is No Hit in Korea,” Wall Street Journal, 2/12/09.
 “Asia Agrees on Expanded $120 Billion Currency Pool,” Bloomberg News, 2/22/09.
 Historical economic data on Japan and South Korea from Econstats.com, Economagic.com, Wikipedia, CIA World Fact Book, OECD, Japanese Cabinet Office.