Western Government Doing Their Best to Impoverish Their Countries

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I seldom become depressed, but when I consider that prosperity is created by “peace, easy taxes and a tolerable administration of justice” I really think that the U.S. and other Western governments are doing their very best to impoverish their countries.

A friend of mine, Michael Berry, whose missives I always read, could not have phrased this better than in “Importance of the Individual”, a recent report in which he quotes Milton Friedman (whose views I fully share in this particular instance) in an interview with Phil Donohue.

According to Berry, “On February 11, 1979 Milton Friedman took 2-1/2 minutes to explain the critical importance of the individual and choice in the free enterprise system to a doubting Phil Donohue. I wonder what Dr. Friedman would say 30 years later about our current predicament and the role government is assuming in our lives? The individual’s freedom and ability to choose and take risks to create value are, of course, all important life elements and a cornerstone of our country.

“Individual ability to choose and take risk is being suppressed. It is increasingly evident that it is the government that is defining risk and the taking of risk. The sanctity of Moral Hazard has now been repeatedly breached by both recent administrations. We must guard these life elements jealously. Please take time to ponder the Friedman interview.

“Unfortunately in the current partisan atmosphere in Washington the role of the individual and that of individual risk taking is being suppressed. When the President of the United States uses the ‘Bully Pulpit’ to criticize institutions for not ‘playing ball’ (Chrysler debt holders) and forces a CEO to resign (GM’s Wagoner), when a Treasury Secretary and Chairman of the President’s Economic Council team up to run an auto company (General Motors), and when no institution is too large to fail (the other side of individual risk taking) something is seriously amiss. Under the guise of saving the economy, there is a not so stealthy encroachment on the rights of the individual. No one is noticing.

“This is not, ‘Change We Can Believe In.’ It is ‘change we must be wary of.’ Where is Milton Friedman when we really need him? Think carefully about the following interview which was conducted 30 years ago. Another read of Friedman’s ‘Free to Choose’ is in order for all. We pray that Washington will not stray too far.”

Phil Donohue: When you see around the globe the mal distribution of wealth, the desperate plight of millions of people in underdeveloped countries. When you see so few haves and so many have-nots. When you see the greed and the concentration of power. Did you ever have a moment of doubt about capitalism? And whether greed is a good idea to run on?

Milton Friedman: Well first of all tell me, is there some society you know that doesn’t run on greed? You think Russia doesn’t run on greed? You think China doesn’t run on greed? What is greed? Of course none of us are greedy. It’s only the other fella that’s greedy. The world runs on individuals pursuing their separate interests. The greatest achievements of civilization have not come from government bureaus. Einstein didn’t construct his theory under order from a bureaucrat. Henry Ford didn’t revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty that you are talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you want to know where the masses are worst off, it’s exactly in the kind of societies that depart from that.

So that the record of history is absolutely crystal clear, there is no alternative way, so far discovered, of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.

Phil Donohue: Seems to reward not virtue as much as the ability to manipulate the system.

Milton Friedman: And what does reward virtue? You think the Communist commissar rewards virtue? You think a Hitler rewards virtue? Do you think… American presidents reward virtue? Do they choose their appointees on the basis of the virtue of the people appointed or on the basis of political clout? Is it really true that political self- interest is nobler somehow than economic self-interest? You know I think you are taking a lot of things for granted. And just tell me where in the world you find these angels that are going to organize society for us? Well, I don’t even trust you to do that.

Well, for sure you won’t find any angels at central banks around the world and in the economics faculties of universities. I needed quite a stiff drink after reading a Wall Street Journal article by Harvard Professor Gregory Mankiw, who advocates creating negative real interest rates through inflation and seems to have great sympathy for the outright expropriation of savers. Professor Mankiw needs no introduction. His great intellect was revealed on February 1, 2000, dead ahead of the NASDAQ collapse, when he expressed the view in the Wall Street Journal that “when you look at the mistakes of the 1920s and 1930s, they were clearly amateurish. It is hard to imagine that happening again – we understand the business cycle much better.”

The mindset of the US Federal Reserve and of a very large number of economists is perfectly reflected in the views of Mankiw, according to whom, “It May be Time for the Fed to Go Negative” (see Wall Street Journal of April 19, 2009). For the ease of the reader I have added some comments, which will be noted in italics and with a ‘MF’.

Mankiw: With unemployment rising and the financial system in shambles, it’s hard not to feel negative about the economy right now. The answer to our problems, however, could well be more negativity. But I’m not talking about attitude. I’m talking about numbers [MF: He means negative interest rates]… What is the best way for an economy to escape a recession? Until recently, most economists relied on monetary policy. Recessions result from an insufficient demand for goods and services – and so, the thinking goes, our central bank can remedy this deficiency by cutting interest rates. Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand.

There is no clear evidence that interest rate cuts stimulate lasting employment gains, because “lower interest rates encourage households and businesses to borrow and spend.” If an industry is plagued by overcapacities (the oil and mining industry in the 1980s and 1990s), lower interest rates (interest rates fell throughout the 1980s and 1990s) are irrelevant. (The same applies for autos now.) In addition, interest rate cuts that encourage households to borrow and spend may not help employment in the country that implements such policies (the US after 2001) but instead in another country (China), where production costs are lower and where a large pool of savings is available for capital spending. (Also, it is not consumption that creates prosperity but capital formation.) To his credit, Mankiw recognizes this problem. He writes:

Mankiw: The problem today, it seems, is that the Federal Reserve has done just about as much interest rate cutting as it can. Its target for the federal funds rate is about zero, so it has turned to other tools, such as buying longer-term debt securities, to get the economy going again. But the efficacy of those tools is uncertain, and there are risks associated with them…

So why shouldn’t the Fed just keep cutting interest rates? Why not lower the target interest rate to, say, negative 3%? At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand.

The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less. Unless, that is, we figure out a way to make holding money less attractive.

At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that. Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10%. That move would free the Fed to cut interest rates below zero.

People would be delighted to lend money at negative 3%, since losing 3% is better than losing 10%. Of course, some people might decide that at those rates, they would rather spend the money – for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw – it’s a benefit. [MF: I think that most people would choose to invest in another country where savings wouldn’t lose 3% per year.]

The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it. John Maynard Keynes approvingly cited the idea of a carrying tax on money. With banks now holding substantial excess reserves, Gesell’s concern about cash hoarding suddenly seems very modern.

Silvio Gesell (1862-1930) was a rather obscure economist, but a cult formed around his more outlandish socialist and land nationalization ideas. He was the author of Die Reformation des Münzwesens als Brücke zum Sozialen Staat (The Reformation of the Monetary System as a Bridge to a Social State – read “socialism”).

In fact, I had forgotten about him until Mankiw brought him up, but I remember well how my history teacher in high school – who also had a socialist tick, but was an outstanding historian – discussed him at length in the context of socialism and land reforms through expropriation. (Right throughout the course of history, this has never worked. Also, Gesell’s tax on cash had more to do with soaking the rich than stimulating consumption.)

In 1919, Gesell was called to take part in the Bavarian Soviet Republic by Ernest Niekisch. The Republic offered him a seat on the Socialisation Commission and later appointed him as the People’s Representative for Finances. Fortunately (for the world), his term of office lasted only seven days. After the bloody end of the Soviet Republic, Gesell was held in detention for several months and was later acquitted of treason. Unfortunately, he never had the opportunity to read George Orwell’s Animal Farm – published in 1945 – which refuted most of his arguments for a “social state”.

Regards,

Dr. Marc Faber
for The Daily Reckoning Australia

Marc Faber
Dr. Marc Faber is the editor of The Gloom, Boom and Doom Report and author of Tomorrow's Gold, one of the best investment books on the market. Headquartered in Hong Kong for 20 years and now based in northern Thailand, Dr. Faber has long specialized in Asian markets and advised major clients seeking bargains with hidden value, unknown to the average investing public.
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Comments

  1. That’s a very powerful, if not disturbing, article. And what’s scary is that I couldn’t disagree with you. President Obama’s Stimulus Bill will likely stimulate the national deficit in the years to come. Some analyst estimated that America could have as much as 10.5 trillion dollars worth of debt in just 10 years. If so, how will the next generation prosper?

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  2. Quoting Johanne:

    “If so, how will the next generation prosper?”

    As much as I hate to say this, I’m not sure they will. When you tally up all the debt accrued from financing the 25-year-party (1982-2007), from trying to contain the economic crisis, from “stimulating” the economy out of recession, and from providing entitlements to the Boomers, I can’t see how the next generation will be better off than their predecessors. It just doesn’t add up.

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  3. “You know I think you are taking a lot of things for granted. And just tell me where in the world you find these angels that are going to organize society for us? Well, I don’t even trust you to do that.”

    Talk about bang on the money.

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  4. Marc is is depressed because “western” governments consistently fail in their role to ensure that free markets underpin either capitalist or public sector endeavours.

    There has not and never will be pure examples of (so called) capitalist or socialist economic models. People won’t stand for it and will always demand that politicians (or indeed dictators) compromise future (free market) prosperity for the sake of short term gains and pork barrel wins.

    I note that Marc does not include some asian political models in his criticism. The most depressing aspect of it all is that command economies (such as China) actually have potential to properly support effective free markets better than the pluralist democratic models that exist in Europe, North America, Oceana and Japan.

    I get the feeling that Bill is similarly depressed (in his sell everything mode) while Dan is clearly saying that if all else fails you can’t go wrong with the essentials such as vodka and energy stocks and perhaps a few other tangibles. Perhaps they are all a bit close to the action and need to step back a bit and breath the air.

    The economic landscape has changed and will continue to change. There are no economic models which are currently up to the job – though a rewrite of most texts is on the cards.

    An eclectic command economy model is in my view likely to be adopted by Europe. This is what Merkel and Putin want (and what the British and French will soon want) but there can be no agreement on what to cherry pick. And the smaller eurpoean economies will hate it!

    Dan and Bill are better positioned (than me) to comment on likely shifts in the North American landscape as long term income and consumption drops to sustainable levels.

    Coffee Addict
    June 12, 2009
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  5. I think the argument circles around the word ‘greed’
    It has a slightly ambiguous meaning. Greed could mean
    1) ‘grab as much as you can, bend or break the rules, lie cheat, defraud, etc’.
    It could also mean
    2) ‘Be very productive and supply as many goods as you can, to honestly out-compete the competition, and reap the rewards.

    Normally the 2nd meaning is not technically ‘greed’, and the 1st meaning is what is meant by greed.

    It seems to me, that the term ‘Capitalism’ has come to mean (1), though it possibly started out meaning (2). The free AND FAIR market, is what (2) has come to mean.

    A semantic debate, yes, but, its very hard to say wether Friedman means (1) or (2), by the word greed.

    Of course no person who commits fraud is going to admit this, so we can only guess at what his motives are by examining the semantics he uses. Sounds to me like Friedman means (1).

    So whats wrong with that, says the sceptic?
    Actions have reactions, is the answer.

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  6. It doesn’t take long to work out what to take and leave from Friedman, Keynes and Hayek. And with Stiglitz you leave every utterance in the romantic socialist’s trough.

    The challenge is to overcome poor systems of supposed representative governance built in common to serve unchallengable & unaccountable burgeoning bureaucratised elites and the cronies that clip the ticket.

    It is when the bills came in that both socialism and western styled democracy were proven to have failed one after the other that Orwell is reinstated as the oracle of modern times.

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  7. Many will emigrate, Johanne. Always have… .

    Biker Pete
    June 12, 2009
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  8. Biker – A copy of the bulk of an email I sent off to a mate (who is on the government “gravy train” a motza, but a top bloke nevertheless) under an hour ago. With a name changed to protect the “guilty” plus one word to avoid offending sentitive souls:

    This superannuation stuff and the whole Ken Henry tax review thing is getting bloody ugly from where I sit XXXX. Especially as the opposition has XXXX that make grape seeds look ginormous.

    It’s starting to shape up to be another defining moment in Australian Socialism – Similar to Whitlam’s single mother’s pension in its capacity for societal change. Well and good for them that’s on the government gravy train. And those who stand to benefit from corporate tax rates being lowered. But definitely a bit iffy for those like me who don’t even have the good grace to be in debt.

    Plus we’ve got extremely high inflation happening. But the RBA says the cost of borrowed money has come down, so it inflation isn’t high at all. Which means it can put off raising interest rates.

    I’ve got to get a clearly thought out escape strategy in place – Akin to being a “Reverse Boat person” maybe? Might have a yarn to you about it if that is OK? Treasury reckons stagflation is not in the cards – I think we have it.

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  9. Love ya stuff, Ned! I’m probably the ultimate escapist in this group… love the twisties… roll with the punches … but ready to bail out of anything that’s going sour long before it s(t)inks! All I need is confirmation that they will F*** (fool) with Super and we’ll both pull ours. ! It’s our hedge against major debt and I’m happy to just live on rents, our ten acres… and a current passport. You’d think that a retirement fund set up four decades ago, in order to be independent, might be a little sacrosanct… but it looks increasingly like Henry may make a grab at it. Glad we have the houses… and inlaws and family abroad. I’ve always fancied a harbour house overlooking Victoria Harbour (Vancouver Island) and a cruising yacht large enough to carry a bike… and ply Georgia Strait, up to Alaska and down to Seattle. (“Bad dog!” growled the missus, as she swatted my ear and yanked at my leash… !)

    Biker Pete
    June 12, 2009
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  10. Yes a tax review by a government department that never needs to turn a profit or turn an idea into money..that is all we need. I doubt we will get something out of the review like the government should focus on spending more efficiently or Kev should eat C-rations on a C-130 instead of gourmet meals on the VIP jet :)

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  11. Greg – For a country that relies on banks, housing and mining, the government’s response in the crisis has been uncomplicated enough. Look after the easy stuff at home first by protecting Banking and Housing. With the option of dropping the corporate tax rate a bit further down the track to ensure Mining is as internationally competitive as it can be. (All other things being equal, it could be quite good for Oz mining stocks I suspect?)

    But, the additional expenditure and shortfalls in revenue are going to have to be compensated for by someone over time. Especially as the option of putting Kev on any sort of rations is “out of scope” for the Ken Henry tax review. Quite seriously – Point 6 of the Terms of Reference specifically says:

    “6. The review’s recommendations should not presume a smaller general government sector and should be consistent with the Government’s tax to GDP commitments”

    Source: http://taxreview.treasury.gov.au/content/Content.aspx?doc=html/reference.htm

    As if the fallout from the GFC isn’t enough to think about, Aussies have got this little ideological timebomb waiting to go off in our own backyard as well.

    Biker – Yep, my passport is current. And my patriotism is being tested. There is the potential for some pretty fundamental breaches of trust to happen in relation to super. Vancouver Island – A bit rich for my blood I think. But depending on personal circumstances, a bloke would be a bit silly to not be considering alternatives that might suit his budget.

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  12. There’s some nice little islands in Vanuatu. Tax free, organic food, self sufficiency not a problem….I’m checking it out next week.

    Reply

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