free lunches and the rule of law

"Nothing is free in this world."  That is one of the quotes I heard growing up on almost a daily basis.  Usually it was from my father, once again reminding me of something that I needed to do.  However, there may be no more of an apt quote to describe wealth creation in our society.  Contracts and business relationships are based on a symbiotic relationship between two parties: each offers something the other desires, and the parties offer to provide something the counter-party desires in return.  At the end of the day, each side is better off as they receive a benefit that they could not provide to themselves, and in order for the transaction to occur that benefit must at least be equal to the value of the payment in the mind of each party.  Hence, these transactions are often wealth generating, as each party is in a position they think that they are better off, and therefore more wealthy, than they were prior to the transaction.

In my opinion the Obama Administration does not recognize the market as a wealth creation mechanism or at the very least underestimates its importance.  Private transactions are the engines of economic growth, and if Obama were truly interested in turning around the job market and reinvigorating the economy he would put into place polices that further increase the incentives to do business such as lowering marginal tax rates, reorganizing and simplifying federal agencies in order to decrease complexity in industry and lower the barriers to entry, and begin addressing long term budgetary issues no so that markets will be reaffirmed in their belief of the long term solvency of the federal government (keeping low the cost of credit).

However, all of these policies have tradeoffs, be it decreased federal revenue, loss of some services or decreased payouts to those receiving entitlement payments (although it is worth to note that most of these savings would be at the expense of future benefits, not those currently on social security and medicare).  Many countries are already taking such measures, and they aren't your traditional list of unfettered capitalists: the United Kingdom, Germany and even partially France.  However, back in the good old U.S. Obama has made federal government spending in the form of jobless benefits, stimulus, and other spending programs the key to his economic development strategy.  According to Obama and the neo-Kenyesians who push this strategy, the U.S. economy's main problem is lack of demand, and that by pouring money into the system in the form of government contacts and welfare, demand will be boosted and the economy will grow.  This is partly the policy justification for the stimulus back in 2009, the continued extensions of jobless benefits and the current push to provide bailouts to that state governments so that they are not forced to make tough political decisions such as whether to fire teachers or raise taxes.  Obama continually dismisses the negative effect this spending has on the budget (which is completely financed through borrowing as the deficit is in the trillions of dollars) claiming that the extra debt is hardly a drop in the bucket compared to our total liabilities.  Therefore Obama is basically selling the position that the spending is all gain and no pain: we will experience growth now and the cost will be little more than interest payments down the road.

This brings me back to the adage, "Nothing in this world is free." Obama's policies seem to run afoul of this rule, and luckily more and more people are beginning to notice it.  Despite the administrations claim that the stimulus has created around 2.5 million jobs, which it has no way of supporting or justifying, there is little sign that it has had an overall positive effect on he economy.  The administration prefers these types of policy choices, whereby they can tout benefits immediately and push any potential liability down the road.  Well by this logic, why do we ever stop stimulating the economy? If wealth can be created simply by government spending, we should have government spend as much money as possible.  It's the elusive free lunch! The truth is that this type of spending dose little to encourage long term investment - the engine of wealth creation - and its adverse effects are simply kicked down the road.  This is endemic in many of Obama's policy choices: the healthcare bill, extension of jobless benefits, and all the other debt financed spending.  You know the day of reckoning for this debt is coming when even Western Europe is getting serious about fiscal restraint. Mr. Obama, there is a reason your European colleagues have rejected you calls for a new round of stimulus: even they no longer buy the hype that you can spend your way to growth.

On a slightly unrelated note, I also wanted to briefly discuss an issue that has become more and more troubling.  Since coming into office President Obama has done more to circumvent the rule of law there perhaps any president since FDR.  First, there was the Chrysler and GM bailouts, where Mr. Obama first "put his boot on the heel"of secured creditors in order to appease his union constituency (I documented it at the time here, here, here, here and here).  The bankruptcy system in this country is the envy of the world, and although it may sound counter-intuitive that is a very good thing.  Banks freely lend to businesses and homeowners because they have a mechanism to have that loan repaid even if the borrower defaults.  Usually this insurance takes the form of a security interest in property, whereby the bank will legally be allowed to take title upon default.  However, the system will only work if security priority rules are objective, straightforward and made prospectively.  Without this type of certainty, the lenders will not have faith in the system, and lending will dry up.  Just ask any entrepreneurs in Africa or Eastern Europe about their access to credit in countries that don't have such rules.  The economic growth of these countries suffers enormously as a result.

The GM and Chrysler bailouts were one example were the rule of law in credit allocation was eroded, and the BP shakedown for a cool $20 billion is another.  First, and let me make clear, it is completely BP's liability to compensate those who were adversely affected by this oil spill.  No one challenges this point.  In order for capitalism to properly function, an negligent or intentionally injured third party must be compensated when another party's actions have caused it economic damage.  This forces companies engaged in risky enterprises to take risk into consideration and price it into any business plan.  Just making BP pay these damages will incentivize other oil companies to either beef up their safety and security measures, purchase more insurance or a combination of both.  This is a good thing and example of the market's ability to absorb new information and price assets accordingly.  However, I absolutely do not agree with the President's choice to force BP to set aside $20 billion for claims to be distributed by a third party.  Although this may have been a smart business decision by BP (showing the public it s serious about its obligations, providing a low overhead way of distributing damages and otherwise forgoing at least part of what will be millions in legal fees by settling with some people quickly), BP's original announcement came after a meeting between its Chairman, Mr. Obama and Attorney General Holder.  I'm sure the threat of criminal investigations didn't come up in that meeting.  No I bet there was no quid pro quo at all.  Why would the Justice Department want to investigate the BP Chairman of the Board at all? How could a swedish director have any type of criminal liability for an explosion that happen in the Middle of the Gulf of Mexico?  The reality is there is no possible way to impose criminal liability on a director for this type of accident, although the threat of such an investigation is one hell of a bargaining tool...


What's more is the fact that Mr. Obama is once again rewriting the rules for creditors in an attempt to put politics ahead of the rule of law.  BP could not possibly come up with $20 billion cash without severely affecting its liquidity and cash flow.  Therefore it is making payment in roughly $1.5 billion quarterly installments.  However, until the total is paid, BP was forced to allow the federal government to put a lien on approximately $20 billion of BP's assets.  This may sound fair, but in reality this is giving the Feds first crack at BP's assets should a bankruptcy occur.  This secured interest is now on par with other secured creditors and I have no doubt that in the event of a bankruptcy the feds would be fully repaid at the expense of older creditors.  Although it may sound innocuous and just for the claims of those who have been damaged by the spill to be given a higher priority than creditors, this is simply not how our system works.  Congress designed the secured credit system as a way to ensure the adequate allocation of credit and it has worked exquisitely over time.  Capital from all over the world flows to the U.S. because of the protections it is provided and the impartiality of the courts that uphold the rules.  By turning the law on its head and giving the damages of tort victims higher priority than creditors, some faith and belief in the system is lost, and the rule of law eroded away.  Although innocuous in the short term, over time this trend will have devastating effects on our financial system.  Creditors will begin to price this uncertainty into the price of credit, making it more expensive.  Politically risky activities will begin to find it harder and harder to find credit at all.  This culture of ignoring the dictates of the rule of law, coupled with our increasing debt will, if let unchecked, eventually destroy credit allocation as we know it in this country.  Don't think the U.S. will be a financial powerhouse for ever, as money is the most fungible of all assets, and the flow in to the U.S. is surely vulnerable if the risk of loss is too high.  To protect against this, we must maintain the rule of law and not succumb to the political allocation of capital and economic rights that is more akin to Iran or Venezuela.

The Final Version of Obama's Spending Bill

Well as many of you probably already know, the House and Senate have reached a compromise on Barack Obama's first major piece of legislation: his economic spending bill. Notice how I don't call this bill a stimulus. Although this bill may stimulate some economic areas, mostly the bureaucratic infrastructure of the federal government, it is truly a spending bill that will benefit the special interest groups that inevitably benefit from any type of Washington spending. The Wall Street Journal has a breakdown of the 1,073 page, $787 billion spending bill here. Just a couple of the many things that caught my eye: $6.3 billion in grants to state and local governments to increase "energy efficiency;" $20.0 billion in increased food stamp spending; $6.3 billion for "money for federal power marketing administrations in electric power transmission systems;" about $500 million to indian reservations (many native americans on these reservations don't pay taxes); $1.1 billion to compare the effectiveness of medicare, medicaid, and SCHIP; $6.4 billion for communities to upgrade waste water treatment (for an example of how the city Copley, Ohio will spend this money, see here); and $40.6 billion to states to help balance their budgets.

Regardless of what you think of the spending yourself, these expenditures can hardly be called "stimulus" spending. All that is going to occur is the size of government is sure to increase, and this money will be spent in inefficient ways, on parties chosen as the "winners of the grant" by the federal government. What gets me the most angry is even the most arduous supporters of government spending admit that most government programs are inefficient and an overall drain on the economy. Let me give you an oversimplified, but still telling, example.

One of the shows I watch on A&E is called "Parking Wars." The show sends camera crews on the road with Philadelphia Parking Authority meter maids, and films the scenes that occur at the PPA towing facility when people attempt to get their cars back after they have been towed. Now, the city of Philadelphia voted over 90% for Barack Obama in the last presidential election, and traditionally the city has been a Bastille for big spending, big government liberals (for a possible explanation for why Barack Obama received such a high percentage of the vote when democrats only account for about 75% of the city's registered voters, see here). So it is a safe assumption that most of the people on the show who are in trouble with the PPA are also supporters of Barack Obama, the democratic party, and big government. However, the reason the show is so hilarious is the amount of frustration people have when they are forced to deal with government employees. Most of the time the people become enraged when they learn the long bureaucratic process they have to go through, and the huge governmental fees they must pay to get their cars back after they have been towed. First, they show up at the impound lot. Then they learn that they have to go to traffic court before they get their car back. They then go to traffic court, plead guilty and pay their violations. Then they get back to the impound lot with the notice from traffic court allowing them to regain access to their car only to learn that they can't get it back because although the title is in their name, the car is registered in their wife's name. So they are forced to bring their wife down to the impound lot. Each time they return they are forced to wait from the back of the line, which could take several hours alone. And finally, just when they are about to get their car back, they have to pay towing and storage fees in excess of their actual violations. No doubt that various other governmental "fees" are included on the bill. And the whole time the scream about how they hate having to deal with city workers! And this is just one example of several similar scenarios that occur on the show on a routine basis. As you could guess, this cat and mouse game enrages everyone involved, government workers included, although no one seems to ask why the process needs to be so difficult.

Although this example is parking, I am sure that the bureaucratic experience is the same for many other governmental programs such as social security, medicare, and OSHA just to name a few. Privatization of such a process, where competition leads to driving costs close to those at the margin, would greatly increase the efficiency of such an experience, and lower costs overall. Now not all programs could be privatized overnight or even ever, but non-essential government functions surely could. I don't want to discuss the entire privatization issue here, but I simply want to point out that almost everyone is in agreement the government does not operate in an efficient manner. There is a tremendous dead weight loss due to administrative costs of government programs. Almost quarter of a billion dollars in the current stimulus is earmarked simply for spending oversight. Oversight alone. And that money is used to make sure that the stimulus money is used properly. It would not be used to try to increase the efficiency of government spending, just to make sure the right people in government get the money. Who are these people getting the actual big bucks in this stimulus you ask? Life long bureaucrats without no agenda other than making sure their agency looks important and that their own jobs are secure. Not to say there aren't people in these departments trying to spend the money wisely, but at the end of the day the only incentive for them while spending the money is to make sure that they will still have a job once the money is spent. Its just human nature. Until we realize that when government gets involved it only drives up costs, and theses costs hit the poorest americans harder than middle and upper class americans, we cannot as a country grow our economy at the greatest possible rate. But for now, we can all take solice in the fact that almost a trillion dollars, or about 6% of our total GDP, is going to be spent and only a small portion of Americans will actually see results. If you are one of the lucky ones who work for the government congrats on fooling everyone else out of their own money once again.

More Stimulus BS

The weekend version of the Journal had an editorial entitled The Stimulus Tragedy that further highlighted everything that is wrong with the direction the Obama administration is heading. I'm not sure what is sadder, that Barack Obama actually can call this pork barrel spending an economic stimulus or that Americans are actually retarded enough to buy it. One example of how the money is being wasted is chronicled here with regards to the $142 billion in "education" spending. Just to put that number in perspective, it is almost double the total expenditures of the entire Department of Education for all of 2007. And to think that Republicans originally came to power in Congress in 1994 campaigning to eliminate the Department of Education altogether, but I guess the easiest way to fix something is to throw more money at it. I'm sure it will be used better this time around. Once again Washington is doing what it does best, making itself bigger while not really doing much else.

Welcome and a Stimulus Intro

First of all, I'm not sure who is actually going to read this thing, but I've decided that I complain a lot about a lot of different issues, so in order to reach a larger audience I've decided to start my own blog. What I am actually going to write about is still very much up in the air, but I think it is going to be a mix of many different topics. I am passionate about sports, especially Philadelphia and Penn State teams, so I'm sure they will come up at some point. I am also very disgusted with the direction America is moving on the political front, both parties included, so politics and economics will also probably be a large source of potential posts. Lastly, everyday life, especially the stupidity of dumb people, tends to get me angry sometimes, so I'm sure there will also be some very random posts about some very random topics. I am hoping to update this thing at least once a week for as long as I can fit it into my schedule. Hopefully I don't burn out. Well, please add any comment with things you want to discuss or hear me rant about, but otherwise let's jump right into my first entry.

I read the Wall Street Journal on a daily basis, and I found an article from Monday's paper entitled How Government Prolonged the Depression by Harold Cole of the University of Pennsylvania and Lee Ohanian of UCLA extremely well researched and articulated. The main premise of the article is that FDR's New Deal programs actually lengthened the great depression by slowing private economic growth and creating an economic situation that maintained high unemployment.

Now I went to a very good public high school in a suburb of Philadelphia. I took American history in 8th and 11th grades and learned all about FDR and the New Deal. I was taught, as I'm sure many of you were, that FDR was one of our greatest presidents and that it was his policies that led us out of the great depression. What complete bullshit. It enrages me that this kind of stuff is taught with no other alternative explanations. This theory of the end of the great depression are based on the Keynesian theories that government deficit spending during a recession is good and will help spur new economic growth. I can say fairly certainly that in 2009 most respected economists (that communist Paul Krugman excluded) have rejected Keynes' viewpoint and adopted the Austrian and Chicago schools of economics expressed by Friedrich Hayek, Ludwig von Mises, Frank Knight and Milton Freidman. However, I never learned any of these names in school. Instead I was force fed the usual crap you hear about FDR creating new jobs and helping curb out of control capitalism that was rampant in the 1920's.

Well there are so many things wrong with the last statement that I won't address them all here, but I do want to address the idea that massive deficit spending by the federal government is good way to strengthen the economy and end a recession because it is directly relevant to the proposed $800 billion stimulus being debated by Congress and supported by President Obama. Once again the American people are being fooled into thinking that this will save the economy and "change" America. In reality this "stimulus" bill is nothing more than a massive spending bill for pet projects for special interest groups. For a more detailed breakdown of how the proposed bill will be spent see Highlights of $825 Billion Economic Stimulus Plan. Although the spending seems to most like it is being spent on worthwhile causes, as is true with 95% of government spending, it will surely be spent more on bureaucracy and greasing the chops of powerful lobby groups than going towards legitimate projects like roads and bridges. Due to administrative costs, government spending is inherently less efficient than private distribution of capital.

If Obama were serious about saving the economy he would issue an $800 billion tax cut that would cut the marginal tax rate, not issuing useless $500 rebates. For a tax cut to stimulate economic growth it must be at the margin. In other words, the tax cut must lower the rate that applies to the last dollar of the individual's taxable income. If tax cuts are not marginal, as in the case with so called "rebates," then there is no incentive for an individual to produce more and earn more income. As we saw with the Bush tax cuts, cutting marginal tax rates create the incentives necessary to create growth and actually increase government receipts even though the average tax rate is lower.

Instead of cutting the marginal tax rate, Obama wants to increase deficit spending to the highest levels in American history. I am going to address the effects deficit spending, the national debt, and the true cost of an entitlement society in a later entry. I am sure you are all very excited. Anyway, sorry for the length of this first post. I'm sure later updates will be much shorter. As I said comments are appreciated, whether you love or hate my ideas, so say what you want. Thanks for reading.