Monday, July 18, 2011

The Federal Budget and the Crisis of Democracy

This chart shows that there is little difference between Ryan's and Obama's budget proposals  That the Ryan proposal created controversy is evidence of a moribund political and economic system.  Chart courtesy of Chris Edwards of the Cato Institute.
This past April Michael Filozoff (h/t Candace de Russy) wrote a cogent analysis of Paul Ryan's budget proposal. The proposal created a stir but, as Filozof  shows, it is anemic--it accomplishes too little too late.  America will be the new Greece because, as Filozoff points out, Ryan is a congressman who faces biennial elections but the budget won't be balanced under his proposal until 2040. Ryan's proposal will reduce the deficit to a "whopping $385 billion" in ten years.  Why can't the budget be balanced now?

The American government has not been able to live within its means for 44 of the past 50 years.  An excessively democratic constitution that permits the majority to loot from those who produce wealth will not permit rational management.

I would add to Filozoff's analysis that the two party system is like a casino in which addicted gamblers liquidate their holdings.  There are two types of bettors. The conservatives, who bet on failed wars, and the progressives, who bet on failed social programs. Their wagers are colorful entertainment, but the casino owners are the only ones who win in the end.

The casino owners are specific special interests, starting with Wall Street.  Wall Street and a host of other special interests benefit from deficit spending and will resist, through the legacy media and through political pressure, any attempt to manage the American state rationally.  That is, Wall Street sells the financing on which government depends, directly profiting from deficits. It therefore pushes for deficits via the media, which legitimizes absurd federal programs. Wall Street profits from waste because the monetary expansion necessary to fund the waste is the sole reason that there have been consistent increases in the stock market since 1940. Wall Street's interests are linked inextricably to debt and to inflation because rising stock markets stimulate demand for their products.

In a free market when stocks go up new firms enter and profits (hence stock prices) decline. Stock markets have no reason to go up over the long term unless interest rates are artificially reduced over time and/or government regulation inhibits new firms. There is nothing in the theory of economics that predicts a consistently rising stock market. No economist has predicted stock market fluctuations based on economic theory (although some have used price earnings ratios and other indicators that have nothing to do with economic theory).

The Federal Reserve Bank has consistently expanded the money supply, reducing interest rates since 1932 to below market levels, and, since 1970, this has caused the real hourly wage to stagnate (due to inflation caused by the monetary expansion) despite productivity increases. There are, of course, short exceptional periods of rate increases to reduce inflation, but the chief trend-breaking exception was in the early 1980s under Jimmy Carter's and Paul Volcker's Fed.

Two effects of artificially depressed interest rates have been excessive expansion of Wall Street and bloating of stock and real estate prices at the expense of the real hourly wage.  As well, there has been misallocation in myriad other ways, to include dislocations that have come about because of Milton Friedman's policy, implemented by Richard M. Nixon,  of separating the dollar from the international gold standard and so expanding the dollar's role as a reserve currency around the world. This has made the dollar more valuable than it should be, resulting in the exodus of manufacturing. 

A Historical Perspective

The Ryan proposal hearkens back to a proposal of the first secretary of the treasury, Alexander Hamilton.  In 1795, right before he resigned, Hamilton wrote "Report on a Plan for the Further Support of Public Credit." In it he laid out a plan to extinguish the federal debt over 30 years.  According to Hamilton's biographer, Ron Chernow (p. 480):

He wanted new taxes passed and old ones made permanent, and he showed painstakingly that he had striven to reduce debt as speedily as possible...Hamilton's proposals were rolled into a bill passed by Congress within little more than a month of his departure as treasury secretary.

In fact, the large federal debt incurred from the Revolutionary War was not extinguished within 30 years, in part because of the War of 1812. As the statistics on Treasury Direct show, the national debt did not come close to being extinguished until Andrew Jackson was elected president in 1828. Then, it took eight years for him to abolish the Second Bank of the United States, the forerunner of today's Fed. In 1836, the year Jackson abolished that era's Fed, the national debt had been reduced to $37,513.  Abolition of the debt went hand in hand with abolition of the Fed. That did not end the federal debt, as subsequent presidents increased it. But the 19th century did not see consistent expansion of debt because Jackson abolished the Second Bank in 1836.


Currently, there is one candidate who favors abolishing the Fed: Ron Paul. In addition, there is a candidate who favors introducing competition into the monetary system: Gary Johnson.  Unless Americans choose to think outside the Fox and elect either Ron Paul or Gary Johnson, the radical incompetence that we have been witnessing will continue to the bitter end.  Meanwhile,  I am betting on gold and silver.

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