Friday, May 25, 2007

Corporate versus Private Welfare: The Case of Inflation

Is it better to advocate welfare for corporations via loose Fed policy and inflationary interest rates, or is it better to advocate welfare for individuals who are otherwise in poverty? The concept of the marginal utility of money suggests that it makes more sense to advocate welfare for the poor than welfare for the rich. The poor value an incremental dollar more than the rich do, therefore society's welfare is increased to a greater degree by assisting the poor than by assisting the rich.

Given just these two points of view, (1) that government ought to act to support the wealthy, or (2) that government ought to act to support the poor, the latter view is preferable. As I have previously blogged, Fed policy tends to support the wealthy. This has been true historically, and it especially has been true today. As the Carlyle Group's chief investment officer William E. Conway has pointed out in a private internal memo:

>"As you all know (I hope), the fabulous profits that we have been able to generate for our limited partners are not solely a function of our investment genius, but have resulted in large part from a great market and the availability of enormous amounts of cheap debt. This cheap debt has been available for almost all maturities, most industries, infrastructure, real estate, and at all levels of the capital structure. Frankly, there is so much liquidity in the world financial system, that lenders (even “our” lenders) are making very risky credit decisions. This debt has enabled us to do transactions that were previously unimaginable (e.g., Hertz, Kinder Morgan, Nielsen, Freescale), and has resulted in (generally) higher exit multiples than entry multiples."

Mr. Conway is not alone in benefiting from cheap debt, which is due to Fed policy and amounts to a form of welfare. Rather, almost the entire board of directors of the American Enterprise Institute benefits from cheap debt. The AEI's board is entirely composed of executives of major corporations who benefit from cheap debt because they enjoy increased compensation from inflated stock values.

Doug French of the Ludwig von Mises Institute has an excellent blog today about Tulipmania in Holland in the 1630s. Much like today's stock market, hedge fund and real estate bubbles, applauded by AEI and Weekly Standard's Irwin Stelzer, French traces the history of the monetary inflation in Holland due to discoveries of silver and gold in the New World and Holland's policy of free coinage of money, which drew bullion from Japan, the New World and elsewhere in Europe. He shows that monetary inflation caused Tulipmania, one of the earliest speculative bubbles.

French points out that:

"Total balances more than doubled from less than four million florins in 1634 to just over eight million in 1640. More specifically from January 31st 1636 to January 31st 1637 — the height of the tulipmania — Bank of Amsterdam's deposits increased 42 coinage, the Bank of Amsterdam, and the heightened trade and commerce in Holland served to attract coin and bullion from throughout the world...In 1648, when the Peace of Westphalia acknowledged the independence of the Dutch republic, the latter stopped the "free" coinage of silver florins and only permitted it for gold ducats, which in Holland had no legal value. This legislation discouraged the imports of silver bullion, checked the rise of prices, and put an end to the tulip mania."

Unlike the Bank of Amsterdam, it is unlikely that the Fed will signficantly reduce its counterfeiting any time soon. The AEI need need not fear.

I opened with the wrong question: "Which is preferable, welfare for the rich, i.e., cheap debt, or welfare for the poor?" I would suggest neither. It is difficult to arrive at a political position in today's world, which is driven by two species of ideologues: Republicans who favor monetary expansion, low marginal taxes, crony capitalism and welfare for the rich; and Democrats who favor monetary expansion, crony capitalism higher marginal taxes, and welfare for the very, very rich in the name of the poor. I suppose the Republicans are somewhat better and somewhat more honest, but only barely so.

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