Market Says Ho Hum on Tax Package

The "framework" for a tax deal struck between President Obama and Republican leaders yesterday seems to satisfy neither the Democratic base nor the Republican base. So it probably represents the best deal that either side can hope for on December 6, 2010 in a lame-duck Congress.

The most telling reaction, of course, is from the stock market. On the buy-on-rumor, sell-on-news theory, we can assume that the market, that rose strongly last week and today is flat, thinks the package is so-so.

That is not good news for President Obama, who needs a pretty strong economy starting early in 2011 to get a decent economy in 2012 for reelection.

Of course, the tax package, which more or less extends the Bush tax cuts, doesn't do anything about the real big drag on the economy, which is ObamaCare.

The stage is now set for the political argument of the next two years. Should the economy be based on the privilege-and-subsidy state of the liberals, on the belief that ordinary people cannot get a fair shake without a heavy government leaning on the exchange relationships of employer and employee, producer and consumer? Or should it be based on a level playing field of low tax rates and low spending, on the assumption that capitalism is basically a win-win proposition where service and trustworthiness is repaid in a decent return on labor, on capital, on the consumer dollar, and on the investment of trust in the system?

This is the Great War that has raged since 1848, when the educated youth upped and declared that the whole thing stank. They declared that the bourgeois were exploiters and that students and workers were victims. Special interventions were needed to save the workers from a fate worse than death, and the educated youth were the only chaps with the moral standing to do it.

Now, more than ever, it is time to really evaluate what the century and a half of economic interventions has really delivered and what it can hope to deliver in the future. Or is big government just big government whether it is run by absolute monarchs or absolute politicians?

Now more than ever, it is time for the lovers of liberty to strain every brain cell and every sinew to persuade the American people first, that the liberal world view is wrong and second, that its politicization of everything is cruel, corrupt, unjust, wasteful, and deluded.

End the Fed?

Why do we have a central bank, asks Gerald O'Driscoll of the Cato Institute? It's not actually necessary for a modern financial system. The US didn't have a true central bank until 1913. Canada didn't have one at the beginning of the Great Depression, and its banks sailed through the crisis without failure (But the Canadians legislated one in 1935).

The simple answer is that a central bank is really convenient for the government. It helps to get the government out of a jam and it helps the government to market its debt.

In wartime, a central bank is invaluable, because it helps the government commandeer the nation's resources for the struggle. And in a financial crisis it can act as lender of last resort to help financial institutions facing liquidity problems, i.e., a run on the bank.

After the Bank of England got started in the 1690s, it became evident that there was another benefit of a central bank, provided it was combined with sensible government fiscal policies. Government debt became highly regarded collateral, and rock-solid debt is the foundation of a well-functioning financial system. That was the basis of Alexander Hamilton's successful launch of the US National Debt in the first Washington administration.

The problem is that the government abuses the advantages of a central bank. The ease of floating debt creates a temptation to float more of it. Then the day comes when market actors wonder just how solid the government's debt is. Then they start to demand higher interest rates. Then the government gets into a sovereign debt crisis. Then the government defaults on its debt. Given this vicious cycle, maybe it is best to get rid of the central bank and get rid of the temptation for bad behavior.

The thing about debt comes down to the old saw about banks. The bank will only lend money if you don't need it. When you are in trouble, the bank will demand outrageous guarantees and collateral.

Well, of course. Credit works when everyone knows you are good for it. That means that you keep your debt levels low enough that you can always meet your obligations, even in the middle of a financial crisis. Financial crises, large and small, occur when debtors get in a jam. The solution to financial crises is for every actor to keep debt and equity properly balanced and keep risk capital and working capital clearly separate.

(That's easy to say, of course. In real life, consumers and businesses make mistakes and they put off doing something about it. Then, all of a sudden, it's too late, you are underwater, and you are facing bankruptcy.)

OK, so what should we do about the Fed? In my view we need to limit the Fed to the one job that central banks do well, and that is acting as the government's banker.

But it is time to move away from the temptations. Lender of last resort? Maybe, but the financial system should not rely on that. Printing money? Maybe, but we have seen that central banks can't be trusted to maintain the value of money. There has to be a better way, and I suspect we will see another way develop with the new ETFs for gold and other commodities.

The one thing we must stop is the failed policy of goosing the economy with the central bank and easy money. That is pure inflation, and that is wrong. Economies that need goosing are economies that have been distorted by bad government programs. Getting the central bank to paper over the government's failed subsidies and privileges doesn't solve anything.

Trust in the Slum

Suppose we accept that in the rarified air of high commerce that the economy runs on trust.

But what about life at the bottom? What is it like in the mean streets of the western inner city What about commerce in the slums of the third-world city? There, surely, you will find naked capitalism, where the rich get richer, the strong survive, and the poor go to the wall.

The poor don't write, but researchers do, and we have recent research on life on the mean streets of the underclass city. According to Hernando De Soto, commerce in the informal economy of Lima, Peru, is all about gaining the trust of the consumer. According to Sudhir Alladi Venkatesh, life on the South Side of Chicago, where President Obama used to community-organize, people struggle along with a remarkably entrepreneurial will. And in the third-world slums of Hyderabad and Africa, enterprising education entrepreneurs run schools that outperform the government schools. When there are any.

Hernando De Soto described the informal economy of Lima, Peru, in The Other Path twenty years ago. He tells the story of the Andean peasants moving to Lima in the teeth of bumbling opposition from the political system and the formal business sector.

The peasants needed property rights, to build houses, to earn a living, and the political system, oriented towards the exchange of favors, did not understand. The politicians and the bureaucrats made it almost impossible, mainly by suffocating bureaucracy, for migrants to live and work in the city legally. What could the migrants do?

One way that peasants could earn a living was by selling goods as a street vendor.

Street vending is illegal, but the peasants did it anyway. In 1986 when De Soto conducted a census of street vending in Lima, he found over 91,000 vendors. Street vendors start as "itinerant" vendors, with no fixed location. Vendors soon establish a fixed route every day so they can establish a reputation for reliability and earn the trust of their customers and credit from suppliers. But, of course, itinerant vending with a limited supply of goods cannot earn as much as vending from a fixed location on the street, so successful vendor soon finds a place to set up a barrow or a stall illegally on the sidewalk. If it's a good pitch, he is soon joined by other vendors. This competition is beneficial, because it helps create a critical mass: "vendors realize that the safety, cleanliness, quality, and variety of goods available" affect the volume of customers and the power of numbers helps to defend them against the government and competing interests. Eventually the successful street vendors combine to build a "minimarket" and then move off the street into permanent markets that they have combined to build and operate. Denied access to the institutions that are supposed to reward trust and reliability, the newcomers to the city must create their own culture of trust without the assistance of the formal legal system. The process is clear. These rural peasants combine to win formal property rights out of a society that hardly knows they exist, and resists their attempts to earn a living from the burgeoning city.

Informal trading is not the only off-the-books activity in Lima. New housing is typically built by "invasions" of state-owned land on the periphery of the city. Mass transit is furnished by informal bus companies that operate in a curious no-mans-land between legality and illegality. And there is a vast economy of small-scale manufacturing that operates outside the law in order to hide from expensive labor laws and business regulations.

The story in The Other Path is clear. The immigrants to the city want to establish property rights for themselves. But they find that they must deal with a political system for which power and the exchange of favors is the only true reality. So they must fight for the right to acquire property rights in their housing and their employment.

That's a sober thought for Tea Party Americans as we struggle with the favor factory of the modern administrative state. How do we convert this corrupt culture of compulsion and its divisive political warfare into a culture of social cooperation, a world where people can abandon the trenches of political attrition and work together to serve each other and benefit society with their wealth-creating skills? How do you reform a political system so that there is less politics?

Warren, Tell 'em It Ain't So!

So now we know why Warren Buffet is such a goo-goo about the estate tax, and why he thinks it's such a good idea to keep it.

Any guesses?

It turns out, according to Jonathan Strong, that the life insurance industry, one of the strongest lobbies in Washington, DC, is against the repeal of the estate tax.

Now, why in the world would the life insurance industry care about the estate tax? Their job is life insurance, not railing about inequality and family dynasties, right?

Wrong. It appears that ten percent of the life insurance industry's revenues come from from people using life insurance to reduce their estate tax exposure. Life insurance proceeds don't count as part of an estate; thus the heirs get the money without paying a cut to Uncle Sam.

And wouldn't you know: Warren Buffet, presumably through Berkshire Hathaway, owns six life-insurance companies.

Really, the stench is getting unbearable. Another famous proponent of the estate tax is Bill Gates, Sr. He is a lawyer, and apparently notable as an estate-planning expert.

Estate planning is a phrase that means: rearranging your assets with an expensive lawyer so you can reduce your estate-tax exposure.

The joke about all this is that these days, unlike in the old days of the landed aristocracy, you don't need to worry about wealthy dynasties. The money accumulated by a successful billionaire entrepreneur usually gets dissipated in the next generation. Sometimes it gets dissipated early by his widow.

The estate tax does have the effect of making it very difficult to pass down a family business to the next generation, or worse, forcing the heirs to sell the business to Warren Buffet at fire-sale prices.

Oh, you didn't know that? Yes, it appears that one of Warren Buffet's specialties is buying family businesses on the cheap. It's a cosy little niche that exists because of the estate tax. Almost any family business worth a few million will have to be sold quickly in order to pay Uncle Sam's estate tax. And when you have to sell the family business quickly, chances are that you are not going to get a good price on it.

It's a universal law. Anything the government gets into ends up as a cesspool of corruption and crony capitalism. Because government is force, and politics is power.

Personally, I'm all in favor of the estate tax. But not at 55 percent. I'd say that an estate tax at a rate of five to ten percent would collect a nice little chunk of change but still keep family businesses going in the family. Alternatively, it would help heirs of a creative turn of mind become famous scientists and artists, as happened so often in the 19th century.

But an estate tax that low would put the noses of Warren Buffet and Bill Gates, Sr. out of joint. Not to mention the life-insurance industry.

He's Out of Ammo; She's Loaded for Bear

If you want to know how much trouble President Obama is in, look no further than his federal pay freeze. It's a gimmick, and it shows that he's out of ammo. The glorious days of 2009 when liberals seemed to be converting liberal shibboleths into government programs at a rate of a billion dollars an hour are over. All he's left with is a symbolic pay freeze and doing a deal on the Bush tax cut extension.

According to Rich Galen, the deal is tax cuts extension for unemployment benefit extension. That is not so good for Democrats because, compassionate though it may be, extending unemployment benefits will delay the return of the unemployed back into the labor force. That will delay the recovery. That will lower the chances for President Obama to get reelected. (On the other hand, the equity markets are up two percent today).

Then there is Sarah Palin. She's got another book out, America by Heart, and she's loaded for bear. I notice in her new book that she has stopped calling herself a commonsense conservative. "Commonsense Conservatism" was the line in her first book, Going Rogue. In the last chapter of her new book she calls for "Commonsense Constitutional Conservatism." Well now. What would that be all about do you think? I will tell you.

Sarah Palin is not the clueless trailer trash that our liberal friends want her to be. Instead she is a skilled elected politician who has done it the hard way, working up from city council to mayor to governor without friends in powerful places. She understands that it no longer enough to be a commonsense conservative. Not after two years of the Tea Party.

Palin understands that the fulcrum of the Tea Party movement is not specific issues but the general demand that we return to the concept of limited government, a government of laws rather than a government of programs.

How do you get limited government? You start with a constitution and a people that believe in it. For the last century, beginning with Progressives like Teddy Roosevelt and Woodrow Wilson, our liberal friends have advanced the idea of a "living constitution" that could be adapted to the times. The real meaning is, of course, that the constitution could be changed on the fly rather than the laborious process of constitutional amendment.

Notice that the "living constitution" theory means that the government can do anything. It reduces government to a pure contest of power. One year the government may change the constitution as the behest of the popular will, another year the government may change the constitution at the behest of the educated elite.

The result is what we have today. It is a government that can't say no, a government that has promised pensions and benefits to the people that can never be delivered and will result in a train wreck at some point. After the train wreck the liberal clients will find that the promises are worth nothing.

But now the people, through the medium of the Tea Party movement, are telling the progressive elite that they demand a return to constitutional government, a limited government not a living government.

Sarah Palin is one street-smart politician. And that is why she is now a "commonsense constitutional conservative."

Central Bankers are Useless

Wikileaks is all very well. But who needs to know that the Arab rulers in the Middle East are more pro-US than they like to let on, or that they are afraid of Syria and Iran. We knew that. We just didn't know the words they used.

We also know that good old Arthur Burns, Chairman of the Federal Reserve Board from 1969-74, was a pushover who let President Nixon push him around and inflate his way to reelection.

Now we have the old-fashioned equivalent of WikiLeaks to tell us.

It turns out that Uncle Arthur penned a diary in spiral-bound notebooks during his years in Washington, DC. His widow gave the notebooks to the Gerald Ford Presidential Library, and now we have Inside the Nixon Administration: The Secret Diaries of Arthur Burns edited by Robert H. Ferrell.

The diaries don't tell us anything new. We already knew that Arthur Burns was a pushover. It's made pretty obvious in bouncing titles like A History of Central Banking in Great Britain and the United States by John H. Wood.

In fact Central Banking shows pretty conclusively that 20th century central bankers were mostly completely useless bureaucrats. In the US there were only two that were any good. William McChesney Martin had his moment when he won the Fed vs. Treasury battle in the early Fifties by raising interest rates to end the accommodative policies during World War II. And Paul Volcker stopped the Seventies rot with bar-tight monetary policy to break the Nixon-Ford-Carter inflation.

The most useful commentary on monetary policy since the government gave us the Federal Reserve Board is that the dollar, worth about 1/20th of an ounce of gold in 1913, is now worth about 1/1400th of an ounce of gold. Here's another benchmark. When Uncle Arthur bought his spiral bound notebooks back in 1970 they cost $0.49. Today the notebooks cost $4.95. That makes today's dollar worth about ten cents in 1970 dollars. Thanks to our brilliant central bankers.

One of the justifications for our current policy of "mild" inflation is that it helps prevent meltdowns like the Great Depression of the 1930s and the frequent financial panics of the 19th century.

That's nice to know.

Diversity? What Diversity?

Everybody knows that liberals are all in favor of diversity. Except when they aren't.

For instance, in the light of the recent election, which party is the more diverse? Here's the way the Washington Post sees it.

The Republican Party's big gains in the House came largely from districts that were older, less diverse and less educated than the nation as a whole. Democrats kept their big majorities in the cities...

The Obama coalition remained intact. Democrats remained strong in areas with the party's core of minorities and higher-educated whites.

Republicans made big gains with the white working class, of course.

We've all been carefully taught to believe "diversity good," "minority votes good" by our liberal preachers, but what does it mean? It means that the Democrats do really well with people who get benefits from the government, but not so well with just about everyone else. In particular, writes Michael Franc, Republicans do really well with veterans.

How diverse is your party, honestly, if its voters are confined to the educated elite and its benefit clients in the inner city? Wouldn't it be much more broadly based if it had solid support in the great American middle class?

If you think seriously about the Democratic supporters, you have to be concerned. The black vote is up over 90 percent. That can only go one way, and that is down. And the Hispanic vote is notably driven more by economic status than by race. As Hispanics integrate into the great American middle class they start voting Republican. Obviously liberals will vote Democratic until the last government grant evaporates and the last abortion is performed, and good luck to them.

The Washington Post puts up a brave front, celebrating gains in Hispanic votes and hauling out demographer Ruy Teixeira: "Republicans do the best in areas that are typically not growing very fast and don't look like the present, or certainly the future, of the country," he says.

There's another way of saying that. People voting against the regime are people who are losing out in the Obama economy of stimulus and crony capitalism. Of course the losers are voting against the government. That's what they always do.

Politics always involves a lot of blind faith in your side, putting a shine on your party's prospects and painting a dark prospect for the other guys.

But is it really a glorious future for the Democrats if their voters are liberal experts and government beneficiaries? Surely the Democratic Party was built for better things than that.