Gov. Default: Not When But How

We peasants have the wrong idea about government default. It doesn't necessarily mean that the government flat out defaults on its debt. Most governments are smarter than that. Nor does default necessarily mean hyperinflation. Most governments aren't Weimar Germany or modern Zimbabwe.

The best way to think about default is this. Governments make promises all the time; politicians make promises to get elected. But once elected politicians must choose which promises to keep. The result is that governments default on their promises all the time. But this time is different. This time it is going to be worse. Here how Arnuad Mares puts the argument:

In other words, some or all of its stakeholders must suffer a loss: either taxpayers (through a higher tax burden), or beneficiaries of public services (through lower expenditure) or bond holders (through some form of default).

When you put the argument like that, you realize that governments are defaulting on promises all the time. Usually, they default on taxpayers. Sometimes they default on the voters that get government benefits. Occasionally they screw the bondholders. And they are doing stuff like that all the time. You think that they never default on the bondholders in advanced countries like the US? Think again.

Examples include: the revocation of gold clauses in bond contracts by the Roosevelt administration in 1934; the experience by then Chancellor of the Exchequer Hugh Dalton of issuing perpetual debt at an artificially low yield of 2.5% in the UK in 1946-47; and post-war inflationary episodes, notably in France (post both world wars), in the UK and in the US (post World War II).

The basic skill of politics is to default in the least damaging way--for the ruling class, of course. Today's situation is interesting because the government is clearly coming up against the limits of taxation. Meanwhile they are trying stealth default on Medicare promises through the reduction in Medicare Advantage benefits. And they are inflating the dollar, which screws the bondholders.

The question is: what's an asset holder to do? Dodge the IRS? Don't get completely dependent on government benefits? Keep out of dollar-denominated assets?

The problem with a defensive strategy like that is that in the long run we are all dead. You could reduce your tax exposure, but that takes money in lawyers and tax accountants. You could stay robustly independent, but why pass up the free money? You could stay out of bonds and bank accounts, but that means getting into riskier equities and "real values."

Most likely, the government will squeeze through with some tax increases, some spending cuts, and some inflation.

But with the highly competent Obama administration, you never know.

A Separation between Economy and State

Everyone seems to agree that the separation between church and state is a good thing. You don't want ministers legislating morality, and you don't want a "theocracy." When the political and the religious collapses into one, especially in the modern era of secular religions, you get tyranny and terror.

But what about separating economy and state? For some reason there is a lot less enthusiasm for that.

But why? The record on government meddling in the economy is dismal. Since time immemorial governments have abused their power to regulate currency, visiting untold miseries on their people. And governments have often thought that they had a much better idea of how to run a business than the business owners themselves. Has there ever been a case when a government has actually picked a winner?

At the US founding, people were divided about whether to encourage an agricultural economy or a manufacturing economy, the famous divide between Jefferson the landowner, and Hamilton the businessman, lawyer, administrator, and central banker. In the event their posturing was meaningless. The economy flowed and swelled into thousands of channels, more or less ignoring the government when it could. The federal government did have a lot of influence, of course, mainly by screwing up the credit system again and again.

Of course, nobody is suggesting that the economy should be completely separate from government. Business needs settled and predictable law about thousands of things, and it needs government force, on occasion, to enforce contracts that have gone bad, and wind up the affairs of bankrupts.

We stand at a moment that is particulary propitious for a change in the relationship between the economy and the state. We have had a particularly nasty banking and credit crisis mostly caused by government meddling in the market for housing credit. Government has encouraged, over the last century, reckless lending and borrowing for home mortgages. That is to say, the government has encouraged homeowners to get mortgages loans very close to the value of their homes. As we have seen, that sort of thing creates a systemic risk. When millions of homeowners can't pay their mortgages and/or have mortgages underwater, it raises questions about the solvency of major financial institutions, from banks to government-sponsored enterprises like Fannie and Freddie.

There are, obviously, bound to be occasions when the financial system will fail. I am thinking of nuclear war devastation and an asteroid collision. But it is unacceptable to have a financial system that fails in peacetime. When that happens there is only one answer. The system was set up to fail.

We know why the system failed. It was corrupted and weakened by a thousand different government interventions where the government warped the economic system to achieve political ends, and reserved the power to intervene in routine economic relationships for political gain.

Of course, businesses play their part in this racket. They importune for subsidies and privileges on the grounds of national defense or energy security, or local economic benefit. Usually, they are merely trying to raise the bar against new entrants into their business.

Obviously we can't change everything overnight. The government has got into the micro-management of business over decades, and a reckless change would be foolish. But here are some principles that could guide us in separating the economy from the state.

1. Privatize the credit system. The government has utterly failed to manage the monetary and credit system safely. In fact it has used it, again and again, for political gain.
2. More equity, less debt. Two hundred years ago we needed banks because there wasn't a big market in debt and equity securities. Today equity is easy, and it could be cheap.
3. No government businesses. They are inefficient and they compete unfairly.
4. No administrative regulation. In the recent meltdown the SEC failed, the Fed failed, the regulators of Fannie and Freddie failed. So what's the point?
5. No more subsidies. Subsidies just encourage corruption, and waste resources.

Well, that's a start. The fact is that government is terrible at supervising business, and business ought to keep its hands out of bribing politicians. If they can do that, then we will all benefit, for it is the wealth created by business that provides revenue for government and it is the regime of peace provided by government and the performance of promises supported by law that allows business to thrive.

Surely that's something we can all agree on.

America's Unchanging Two Party System

According to the political scientists, the United States has enjoyed five party systems, ending up in today's Republican/Democratic Party division.

But really, it's always been the same.

There has always been a middle-class commercial party and there has always been a populist power-to-the-people party.

The Federalist/Whig/Republican Party has always believed in an America where if you study hard and work hard you can make a decent standard of living for yourself.

The Anti-federalist/Democratic-Republican/Democratic Party has always believed that you need a politician to fight for the people against the powerful.

For the rich and powerful, there has always been a temptation to lead the populist party. Thus Thomas Jefferson, slave-owning landowner, affected a man-of-the-people image when he arrived in Washington DC to become president in 1801. Ditto Franklin Delano Roosevelt, scion of Dutch padroons. Ditto the Kennedy clan, rich kids of a successful Wall Street speculator.

When they first emerged onto the political stage the Progressive movement of educated youth ran against the powerful city machines and their patronage politics. It was the genius of the liberals of the 1930s to convert the elite Progressivism of the turn of the 20th century into a vanguard cadre to lead the down-scale big city machines and give their crude patronage/clientage politics a patina of good government.

President Obama and his liberal allies in Congress have scorched off that patina in an acid bath, and the great middle class in America now sees the Democratic Party as an unalloyed patronage party, to which you belong if you think that the only way to get ahead is as the rank-and-file in some political army.

The defeat of Mayor Fenty last week is a sign that maybe the white gentry liberals, the heirs of the elite Progressives of 100 years ago, are reaching their limit in the patronage/entitlement/identity/jobs-for-the-boys politics of today's Democratic Party.

The Tea Party, on the other hand, is a pure expression of middle-class commerical politics. Worried about debt and ruinous spending, it is forcing the Republican Party away from a mushy capitulation to patronage politics and back to his origin, the robust politics of the commercial industrial state conceived by Mr. Federalist, Alexander Hamilton, in the early 1790s.

How will it all turn out? My judgement is that the key to the future is middle class women. The feminist movement turned women to the left, and got them to believe in patronage politics for a while. But I think that middle-class women are not voting their interest when they vote for patronage, identity, feminist politics. Women stand or fall by the families they build and the children they raise to adulthood. Welfare state patronage politics plays merry hell with all that, and women are not stupid. They are trusting, and they believed the feminists when they told them that they needed to stand for women's rights. But women are not stupid. They know what their children need in a global competitive economy, and it is not the patronage politics of the Democratic Party.

All this is to say that the two party system lives and you ain't seen nothing yet!

Will the Dems Split?

Like Aunt Em, I have waited all my life for the Democratic Party to split. Now, finally, Michael Barone has reported on a possible split between gentry liberals and public-sector unions. But because I am a realist, I can't get too excited about it.

Actually, what he reports is not a split but the public-sector unions beating the pants off the gentry liberals in places like Washington DC. In the mayoral primary last week the tony liberal areas voted for reform Mayor Adrian Fenty. Too bad. Fenty was defeated in the Democratic primary by Council President Vincent Gray. Fenty has been working to reform the schools and the city government, but that cuts no ice with teacher unions and government employee unions. They don't care about lousy schools and overmanned, inefficient city services. They just care about their jobs, their paychecks, and their pensions.

Does this mean trouble for the Democrats? Barone:

Gentry liberals and public employee unions were allies in the Obama campaign in 2008. But now they're in a civil war, in city and state politics.

Civil war? Really? I suspect that there is less here than meets the eye. Gentry liberals may not be unionized and they may like the idea of helping kids and fixing up municipal services, but not if it means breaking a sweat.

Gentry liberals occupy the sweet spot in the big-government universe. They are the managers, the directors, the principals, the government lawyers, the journalists. Their boat is floated by the sea of rank-and-file employees that deliver the votes.

Expect to see gentry liberals wringing their hands about welfare and family breakdown, about underperforming schools and inefficient municipal services. But don't expect them to vote to cut their cushy jobs in the higher reaches of the education blob or the university or the regulatory maze.

But the gentry liberals will be perfectly happy to let their union thugs take all the incoming rounds from the Tea Party and others. While they stay above it all.

I'd say that the chaps who ought to be thinking about splitting are the educated youth. They should realize that they are screwed, and better forget about their idealistic careers in government. But it may take them a while.

Here's Extremism For You

Well, so Christine O'Donnell is an extremist. That is what our Democratic friends want voters to believe. I guess that's what you get when you run seminars on the women in Lord of the Rings.

But if you chaps want extremism how about this?

In the United States there's a party that champions a program to force every worker to pay a tax amounting to 15 percent of their wages. At the end of 40 years the government pays the worker a "benefit" every month, as the mood takes it, until the worker dies. The money belongs to the government. All told, these government pension programs costs $1 trillion per year. And the government pension programs will all go broke in the next 30 years. Of course, if you'd paid 15 percent of your wages into a bank account, you could have lived off the interest and passed the principal on to your children. How extreme is that?

Here's another example of the extremism that we just take for granted.

The government forces every senior citizen to belong to a government health care program which yields a crazy quilt of benefits and puts the government in between seniors and their doctors. Combined with other government health care programs, it costs about $1.1 trillion a year, and there is no money to pay the benefits in the out years. Based on current taxation levels, we are short something like $30 trillion to pay the benefits promised by the government to seniors over the next generation. Of course, seniors could decide to look after their own health care, since seniors, in general, are the richest Americans. That means something at a time when young people are hurting badly in the Great Recession, and, when they have jobs, pay the taxes for all this and have children to raise and mortgages to pay. How extreme is that?

We have extremist education too.

The government forces every parent to send their children to a government child-custodial facility from age 7 to 16. It costs about $1.0 trillion a year. After the government has held these children in custody for ten years here is the result. On adult literacy, about 15 percent of Americans are "below basic," which is a polite word for functionally illiterate. About 50 percent of kids entering college require remedial courses. How extreme is that?

Here's another extreme situation.

The government forces everyone to pay for their vast establishment of programs for the relief of the poor. The result is a vast underclass, the utter collapse of the family among low-income Americans, and a stealth gray area of people on disability pensions. But this program is cheap. It only costs about $0.75 trillion a year.

For a generation at least, conservative Americans have been agitating to reform these programs, to reduce their reckless overpromising, and to reform their administrative failures. But a certain party, filled with extremists, has demonized every attempt at reform.

Who cares, you might say? Conservative Americans are prudent, careful people who will survive when the balloon goes up and the government defaults on its promises. Why should we care?

Well, the truth is we do care. We don't want the clients of the Democratic Party to wake up one day and find that the party's over and that, as they say in Eastern Europe, they'll be reduced to eating the paint off the walls. We want the folks on government programs to live decent, dignified lives.

We just believe that you can't have dignity when your life depends on some politician bringing home the bacon. There's a word for that kind of society. Feudal.

Republicans Eating Their Own?

This week we are back to the old meme: Republicans eating their own.

How come this only happens to Republicans, the usual suspects whine?

The answer is that the Republican Party is a different animal from the Democratic Party. And as I look around the blogosphere this morning I see that everyone agrees with me. Roger Kimball gets it, almost:

That’s the thing that scares people about the tea party. It operates outside the jurisdiction set down by the other parties, be they Democratic or Republican. All those sources of patronage, wells of political preferment, reservoirs of prestige, perquisites, and power: That’s what politics as usual is about. It has built up an impressive institutional structure.

That's OK as far as it goes. But here is commenter ZenPundit on a ChicagoBoyz blog about NPR's difficulty in understanding the Tea Party.

First, a majority of the Left are still in the “community organizer”, Alinskyist, protest theater, organizational front group, grievance-victim-social-justice paradigm adhered to and honed since the 1930’s by the Marxists, Social Democrats, organized labor and the New Left. They want a centralized nanny-state themed to race and gender issues and approach politics with a vanguard mindset where talking points are issued by the leaders and everyone must stay in lockstep.

We need to understand that the Republican Party, though it certainly deals in "wells of political preferment, reservoirs of prestige, perquisites, and power," only does it to a limited extent. It offers jobs to people who work in the federal government when Republicans are in power. Otherwise Republicans go about their daily life in the private sector. That makes the Republicans much more loosey-goosey.

But the Democrats are different. The whole point of the Democratic Party chaps is to organize a patronage system for themselves and their clients fed by government revenues. If you are a Democrat you probably earn your living in the education establishment, or a health/welfare bureaucrat or client, an NGO activist, or a government program benefits recipient. Your whole life is organized around the continuance of that government salary or benefits. Obviously, Democrats cannot relax for a moment. They must stay organized in their citadels of government largesse, ready to repel insurgents at any moment. Because if the Republicans ever took that money away...

The Democratic machine presents an awful power to the world. It has to. For anyone that breaks ranks, well, there's always the ancient threat: That's a nice little teaching job you got there. Pity if anything should happen to it.

But we should take our inspiration from that other formidable political machine, the Soviet Union. It specialized in frightfulness, right up until the day that it collapsed, as the Marxists like to say, of its internal contradictions.

The problem with the Democratic Party is that it has promised itself and its supporters loot and plunder that cannot possibly be delivered. Sooner or later the whole thing is going to collapse, because it will just run out of money.

When people worry about the lack of unity in the Republican Party, they have a point. But in the long term, this lack of unity is a strength. The really scary thing is the rictus of smiling unity in the Democratic Party. The day that smile breaks will be a day to behold.

Today GOP Elite Freaks. In November...

Hey, GOP establishment, I feel your pain. All the nice plans you made to get to 51 in the Senate look like they are compromised by the primary victory of Christine O'Donnell.

And I agree, she seems like a piece of work. Reminds me of another chap, name of Bill Clinton. A little bit of trouble keeping the story straight.

Glenn Beck had the mot du jour. Today, the Republican establishment is freaking, he said on his radio show. But that is just the beginning. Wait till the MSM starts freaking. Wait till the Democrat establishment starts freaking.

Naturally, establishment Republicans are worried that the defeat of RINO Republicans means that Democrats will elect people in Republican districts and the result will be that there will be no Republicans in the Northeast.

Maybe. That is certainly the lesson of the last ten years. Democrats have been able, time and time again, to brand social conservatives as way out radicals. But that was then. This is now.

The Preserve RINO strategy is a defensive strategy. It is a holding operation, trying to accommodate the natural domination of Democrats in the Northeast.

But the point of the Tea Party movement is to change the status quo. It is to energize natural conservatives and to begin the process of persuading moderates and independents that a Republican Party of common-sense conservatism is their kind of party. That's what a movement does. It moves the country.

When you start to do that, you leave behind the nice comfortable assumptions of the old order. You enter a revolutionary phase, where Americans are open to persuasion, where voters are up for grabs.

So the question becomes, should you use the strategy of the Allied World War I generals, and advance in lockstep, a step at a time? Or should you adopt the strategy of the German General Staff, that subordinate commanders down to the squad level should always be ready to exploit opportunities?

My feeling is that we are in new territory. My feeling is that the 50-50 nation of the past ten years is history. (Yeah. Remember 50-50 nation? Seems like ancient history!) My feeling is that we don't want to be fighting the last war.

And let's get back to the Germans again. In the Franco-Prussian War, General von Moltke had a real problem with over-enthusiastic unit commanders getting their units into trouble. But these tactical reverses didn't matter because Moltke had his armies in the right place at the right time. The French with their Chassepot rifles might win a local victory, but next day they would have to retreat.

That's where we are today. American politics is changing, and nobody knows where it is going, and where we will end up. It isn't going to be safe, and the old gang is going to have to give up its power.

In my view the Democrats will have a much bigger problem with that. But right now they are too busy laughing as the tsunami bursts over the GOP establishment. But don't worry. The tsunami is heading right their way. They are just too stupid to realize it.