Where Montesquieu Was Wrong

Montesquieu's Spirit of Laws is remarkable. He outlines the basic principles of federalism: the three branches of government; the upper and lower house of the legislature; the independent judiciary. He discusses why federations of states work better than single states in establishing a republic. He contrasts the main forms of government: republics, monarchies, tyrannies and aristocracies with respect to the kinds of laws that are appropriate to each. Then, in a massive historical tour de force, he traces how various social, climatic, cultural, religious and other variables interacted with laws in a wide range of countries to make them effective or ineffective. He covers moral and religious law as well as monetary policy. The Spirit of Laws was written in the 1740s. The Founding Fathers relied on it heavily in writing the Federalist Papers and conceptualizing the Constitution and the earlier Articles of Confederation. Montesquieu is not the economist that Adam Smith was, but his political insight and the strength of his historical analysis, which spans ancient law and culture, to include law and culture of the ancient Egyptians, Greeks, Romans, Chinese, Japanese and the Barbarians, including a fascinating analysis of the Law of Salique, which he quotes at length and the customs of the Franks, Lombards, Visigoths, Ostrogoths, Burgundians and other Barbarian tribes in the times of Rome through Charlemagne are breathtaking. His expansive analysis of Rome could have constituted a book in itself. One of the things I found interesting is that as a Frenchman, Charles de Secondat Baron de Montesquieu, Montesquieu still conceptualized himself as a Frank and a German. When he mentions his "ancestors" he is thinking of a German tribe, the Franks, not Roman or Gaul ancestry. Also, he mentions that German tribal law was still dominant in the time of Charlemagne.

Here is his discussion of Roman depreciation of the currency, which he argues began when Rome was still a Republic during the Punic War. He does not believe that republics can inflate secretly, or that inflation is impossible in the modern world without it being evident:

"In the changes made in the specie during the time of the republic, they proceeded by diminishing it: in its wants, the state intrusted the knowledge to the people, and did not pretend to deceive them. Under the emperors, they proceeded by way of alloy. These princes, reduced to despair even by their liberalities, found themselves obliged to degrade the specie; an indirect method which diminished the evil without seeming to touch it. They withheld a part of the gift and yet concealed the hand that did it; and without speaking of the diminution of the pay, or of the gratuity, it was found diminished.

"We even still see in cabinets a kind of medals which are called plated, and are only pieces of copper covered with a thin plate of silver. This money is mentioned in a fragment of the 77th book of Dio.

"Didius Julian first began to debase it. We find that the coin of Caracella had an alloy of more than half; that of Alexander Severus of two-thirds; the debasing still increased, till in the time of Gallienus nothing was to be seen but copper silvered over.

"It is evident that such violent proceedings could not take place in the current age; a prince might deceive himself but he could deceive nobody else. The exchange has taught the banker to draw a comparison between all the money in the world, and to establish its just value. The standard of money can no longer be a secret. Were the prince to begin to alloy his silver, everybody else would continue it, and do it for him...If, like the Roman Emperors he debased the silver without debasing the gold, the gold would suddenly disappear, and he would be reduced to his bad silver..."

I guess Montesquieu never heard of Alan Greenspan, Ben Bernanke, and the Federal Reserve Bank!

Spreading Shortages Due to Greenspan-Bernanke Federal Reserve Policy--Woodrow Wilson Turns in His Grave

My wife just returned from a Food Emporium supermarket on the upper west side of Manhattan. She tried to buy light bulbs but all the light bulbs had been sold except for two packs in which one light bulb was broken each. Likewise, her best friend just returned from her house in Hawaii and said that there is rice rationing there. As well, my wife has repeatedly been unable to purchase spa and beauty products at our health club in Ulster County, New York and has been told by the sales people that there are backlogs on orders across the board. Suppliers have not been shipping. This is the first time that we have seen a shortage of light bulbs in the supermarket.

These shortages are directly attributable to Fed policy, specifically of the Greenspan-Bernanke Fed. Across the board shortages and price inflation result from malinvestment attributable to excessively low interest rates that fund Wall Street and the commercial banking industry. Thus, the public has subsidized Wall Street to build houses that no one can pay for. The inflationary consequences of the Greenspan-Bernanke policy over the next 30 years will cause many headaches. Although a shortage of spa products or light bulbs are inconvenient, and I can hedge by buying commodities indexes and the like, the Greenspan-Bernanke Fed's three decade-long Christmas for Wall Street, hedge funds and real estate developers has resulted in the death of children in the third world and significantly lower incomes for the average American worker.

It distresses me that double talk--e.g., blaming the results of the Fed's decades-long inflationary stance on third world trade--that characterized discussions about the inflationary recession of the 1970s is again appearing, this time among "conservatives". Social-democratic conservatives seem eager to claim that the interventionist Fed policies of the last three Republican and Clinton administrations have not caused across-the-board inflation in commodity prices, flat wages of workers, wealth transfers to speculators, and child starvation in the third world. They are the friends of big government.

The only solution to flat earnings, reduced wages, inflation and shortages is to get government out of our money supply. That means establishing the kind of gold standard in which Woodrow Wilson believed when he established the Federal Reserve in the first place in 1913. Wilson had voted as a "Gold Democrat" for the New Democratic (Gold) Party in 1896. He did not anticipate that the New Deal coupled with the social democratic (Roosevelt-Rockefeller-Nixon-Bush) wing of the Republican Party would declare against the gold standard. And who would have thought that following Richard ("We are all Keynesians now") Nixon, so-called conservatives have become bigger apologists for government control, regulation and debasement of our money supply than their left-wing social democratic colleagues.

6 Ways Greenspan Caused the Current Economic Crisis

Fiona King of CurrencyTrading.Net just forwarded an excellent blog that she posted concering Alan Greenspan's role in the current economic crisis. I disagree with her policy prescription, but most of her analysis is accurate. Her policy prescription (which is to increase financial regulation) will lead to more of the same problem. But King's blog is excellent.

The problem with more regulation is that, as Enron demonstrated, regulation is an infinite regress. Unscrupulous actors (be they government officials or corporate executives) find ways around the regulation, and the regulator (if not corrupt, which they usually are) has to increase control. But increasing control terminates economic actors' freedom and flexibility. Freedom and flexibility are necessary to growth. Without the ability to respond to market change and to innovate, the economy stagnates. The end result is a controlled system that is like North Korea's or Cuba's at worst and Europe's at best. Stagnant growth is associated with innovation's being forestalled by regulators, corruption, exclusion of people of low socio-economic status from economic opportunity and declining living standards. Regulation solves nothing. It creates poverty.

Moreover, King accepts the explicit purpose or ideological rationale for the Fed and misconstrues its underlying purpose. The Federal Reserve is a wealth transferral device that serves financial interests at the expense of workers (see Howard S. Katz's book Paper Aristocracy for a detailed discussion of this point). The idea that a small amount of inflation will help workers but a large amount of inflation will hurt them is fallacious. A small amount of inflation will transfer a small amount of wealth from producers to investors and bankers, and a large amount of inflation will transfer a large amount of wealth from producers to investors and bankers. Greenspan inflated alot, and alot of wealth has been transferred. Warren Buffett, George Soros and the folks who have bought up Greenwich, Connecticut and the Dakotas have grown wealthy while the average worker has seen flat wages. That is what the Fed will do so long as it is permitted unrestrained freedom to inflate the money supply.

It is the Fed that needs to be regulated through a metallic standard. Any other system leads to abuse and wealth transferral from poor to rich. How many decades of this do progressive-liberals need before they accept that their idea has failed?

The Greenspan Fed has done what the Fed does in a big way. In the 1920s, the Hoover Fed reacted stupidly to the banking crisis of that era, and the depression resulted. In the post World War II period, the Fed has generated inflation, and the result has been flat real earnings since the mid 1970s and reduced innovation. As the federal government responds by transferring even more wealth from producers to Wall Street and commercial banks, such as respecting the Bear Stearns bailout, the public becomes poorer and the assets of multi-millionaires and billionaires are protected.

There is no other purpose of the Fed. The idea that the few percent reduction in unemployment that results from short term stimulus really is the Fed's purpose is naive.

King points out that in response to the technology stock bubble (which, I add, also resulted from the Greenspan Fed):

"The Fed, under the leadership of Dr. Greenspan, moved quickly to slash its bechmark Federal Funds Rate to 1%, the lowest level in nearly 50 years. At the time, Dr. Greenspan was acclaimed by economists for mitigating business cycle volatility and returning the economy back into a period of rapid growth. In hindsight, however, this period of easy money may have enabled the run-up in housing prices that caused the current housing crisis...This in turn resulted in a weak dollar..."

King adds that Greenspan failed to stop incompetent lending strategies by the financial community that had been authorized by the Home Ownership and Equity Protection Act of 1994. As well:

"the inability of the financial system to absorb the shock from the unexpectedly high default rate on subprime loans. This failure to anticipate can be traced back to 1998, if not earlier, when the Federal Reserve spearheaded a bailout of Long Term Capital Management (LTCM), a large hedge fund which lost nearly $5 Billion trading complex securities. Some would say that this created a moral hazard situation, whereby banks became comfortable taking larger risks because of the foreknowledge that they would be bailed out if their bets went sour."

King adds that Greenspan was indifferent to asset bubbles. All of this is accurate. Although this analysis is accurate, I am concerned that the prescription that results is more of the same policy pattern that caused this problem. Regulation created the Fed. The Fed caused the asset bubble because of inflation. American workers have seen decreased opportunities and flattening real incomes because of the Fed's inflation and because of regulation.

King's prescription is even more regulation. I disagree.

Progressive-Liberal Economists Murder Children

Economist Ben Bernanke


Weep and pray for children in nations with food shortages, who have been starved by the progressive-liberal Fed policies of the Greenspan and Bernanke Fed. For the past three decades progressive-liberal economists have advocated creation of money, that is, liquidity or credit, to stimulate real estate investment. This misallocation of resouces inhibited food production by transferring resources away from commodities production to construction.

Keynesian progressive-liberal economists have caused a global food shortage. Too little food being produced and the transfer of land to developers mean that agriculture cannot adjust to increasing demand. The Fed's actions, in response to the claims of Keynesian economists, are starving children. The economists are murderers because they have induced the world's banking community to engage in policies that have starved children. Now, their chief concern is that the starvation not impede Wall Street's profit picture.

Recently economist James Galbraith responded to my blog about his television appearance, claiming that higher interest rates would be a catastrophe. But the policies that the Fed has adopted, i.e., creation of money by lending it to hedge fund managers and commercial banks at public expense, has resulted in starvation around the world. Keynesians don't view the starvation that their policies have caused to be a catastrophe. Only a decline in Wall Street's profit picture is a catastrophe to them. Starving children is a detail of no economic consequence to their models.

Inflation Is More Important Than Taxes

The New York Sun rightly criticizes the New York Times for its monomaniacal obsession with raising taxes. However, the Sun is too sanguine about the Republican candidates' interest in lowering taxes.

While I do not gainsay that Republicans tend to support reduced taxes while Democrats tend to favor increasing them, and I agree that this is a mark in the Republicans' favor, I would add that neither party has been responsible about balancing the budget, reining in spending, or maintaining a steady money supply. In particular, the Republicans have been on a spending spree that has included a considerable taint of corruption. As well, the Republican administrations since 1980, as well as the Clinton administration, have aggressively expanded the money supply at a rate far faster than productivity and population growth warrant. The result has been a 3.7% inflation rate since 1979, and it has only been that low if you (as does the Department of Labor) exclude house prices. Including house prices, the Republicans have given us an inflation rate of over 4% annually over the past 29 years. This dismal performance should be an especially sore topic for New Yorkers, many of whom have been forced to leave the City because of escalating housing prices boosted by ever-escalating Wall Street salaries.

In turn, Wall Street's salaries do not result from Wall Street's market performance, nor from Wall Street's production of value, but rather from unrealistically low interest rates (which are the chief reason for the past 50 years' stock market growth); low interest loans to big business; and incompetently executed mortgage programs that have resulted from the low interest rates. The low interest rates are a government and public subsidy to the financial community. They are a form of welfare. If Wall Street created value, it would not whine every time the Fed raises interest rates. Firms that create value, unlike Wall Street, do not mind high interest rates because their value-creation and efficiency cover rising interest rate costs. Government agencies, commercial banks and Wall Street firms require government subsidies like low interest rates because they do not create value.

The inflated salaries and exit payouts to Wall Street executives and hedge fund managers come from the Fed's artificial expansion of the money supply. The past 29 years' orgy of liquidity has amounted to a large welfare transfer to the ultra-rich, resulting in stagnant real wages and the exit of mainstream jobs from the U.S.

As well, and more ominously, the Fed's monetary expansion has largely been absorbed by foreign governments, who now hold many times the total number of dollars in circulation in the US. Although the argument is made that there is no reason to think that foreign dollar holders will act against their economic interests, multiple large dollar holders (the Saudis, Europe, Japan, China, etc.) each with nearly or more than a trillion dollars who stand to lose significantly in case of a run is a desperately unstable situation. A run or crash in this market could mean hyper-inflation in the US. It is a fools' strategy, and the Republicans have led us to it, with the Democrats' complicity. I have never consented and had not been aware until recently that the money I use every day has been the basis for a large scale shell game that has provided unprecedentedly large payoffs to financial operators while the average American sees stagnant real wages.

Although the Republicans might favor a few percent lower taxes than the Democrats, we live in a dream world where both parties have ignored responsible household management. We risk the coming years to be dire ones because of our unwillingness to demand competence and fairness from our government, and our willingness to believe that counterfeiting dollars can make us wealthy beyond transferring wealth from the general public to debtors.

Needed: Across the Board Deregulation--And Fast!

My old friend Lenny Rann just forwarded a report that analyzes the proximate sources of the current dollar decline. The report argues that the investment banks had packaged sub prime loans with AAA loans when they sold mortgage backed securities to foreign investors. In turn, the foreign investors realized that they had been duped and this in turn eroded confidence in the ethics of the American dollar. They are now withdrawing money from dollar investments and turning elsewhere because of the erosion in confidence in the good faith of the American investment community and declining confidence in the dollar. I had put 1% of my portfolio in Powershares's dollar bearish fund, but it may be smart to put more as the dollar is declining daily. This is a massive phenomenon and will disrupt many of our expectations. A breakfast in Dublin runs close to $100 now. Your bank account is being turned into monopoly money by the Fed and the Bush administration.

The last 30 years has been a disappointment. I had hoped that the early gains in deregulation in areas like transportation would continue and that a trend toward greater freedom in economics would be matched with enhanced emphasis on the rule of law and markets. Instead, America has opted for a different course. Enhanced emphasis on whimsical regulation; the nanny state of Mayor Michael Bloomberg in New York; continued regulation and protection of big business; refusal to repeal tariffs in fields like sugar; continued incompetence in education and refusal to introduce curriculum reforms advocated by Diane Ravitch and others to improve primary education; continued emphasis on credentialism and college degrees as opposed to results and productivity in the marketplace; and a perverse Wall Street Capitalism facilitated by the Fed and high income tax rates that inhibit imagination and new business formation. The result is that more and more Americans work in stores and in pointless economic activity.

The regulated economy will not function when the dollar loses global support. There will be widespread poverty if the left's nostrums, more regulation, more taxation, more power to incompetent elites and more credentialism are put into play. Instead, what is needed to respond to the failure of Wall Street capitalism is a return to fundamentals. It is only through deregulation; hard money; lowered income taxes; and an end to the wholesale waste and corruption of big government that America will be able to return to a leadership position and improve wages.

The Depreciating Dollar

The New York Sun, New York's best newspaper, has run a front page editorial concerning the dollar, which the Sun argues, should be called the "Greenspan" instead of the "greenback". The reasons are in part that Greenspan's biography the Age of Turbulence came out today; the Fed's Open Market Committee will meet tomorrow to discuss whether to lower interest rates (depreciating the dollar further); and the Sun is increasingly concerned about the depreciating gold value of the dollar. Over the past two years the Sun has editorialized that the dollar declined from 1/265th ounce of gold in 2000, when President George W. Bush took office, to 1/500th of an ounce of gold in December 2005, to 1/637th of an ounce of gold in November 2006 to, well Kitco reports at 3:17 that gold has risen to $717 in light of tomorrow's Fed meeting, so it's 1/717th of an oz. of gold per dollar.

The problem facing the dollar is in some ways like previous inflations, such as the German inflation of the 1920s. In some ways, though, it is unique because never before has a fiat currency both served as a worldwide medium of exchange and been subject to aggressive depreciation in value. There are a number of interesting ramifications of this story that my friend Howard S. Katz has exposed through the years in his book The Paper Aristocracy; through his blog and through his investment advisory services.

First, Katz has brought the effects of monetary expansion on income inequality to the attention of libertarian politicians such as Ron Paul and to the attention of all who will listen. The left's game plan, evidenced during the great depression, has been to use disruption caused by mismanagement of the money supply, such as the 1929 stock market crash, the depression of the 1930s and the concomitant political strains, to agitate for quack nostrums like extension of government regulation that does nothing to cure the monetary problem and instead cripples the economy and interferes with legitimate business. Once again, we see an increase in agitation concerning income inequality just as the past two decades' monetary expansion is peaking.

Second, the effects on income inequality this time, which Katz discusses in his blog, may be more extreme than in the past. Because the monetary expansion has not resulted in the same degree of inflation as it normally would, interest rates have been reduced to very low levels, corporate profits have been energized and stock markets boosted to high levels. This seems to have turned Keynesianism on its head. The traditional Keynesian model is that stimulation of economic activity would create new jobs (hence the Phillips curve's trade off between inflation and unemployment) and workers would not object to the erosion of their real wages, essentially because they are suckers.

Instead, in the late 20th century and early 21st century world, which is far more globalized than Keynes's world of the 1930s, monetary stimulus may have reduced demand for US labor even as real wages have fallen. It may have done so because executives have been granted stock options that motivate them to maximize shareholder value more aggressively than they did in the prior postwar period. Rather than risk a higher degree of innovation, the executives focused on cost cutting, i.e., moving plants and services, to include white collar ones, to lower wage countries. These steps had some effect on stock values, enhancing the income inequality that naturally occurs because of monetary expansion and that is part and parcel of what the Fed does. Thus, traditional Keynesian economics has become not only a kind of deception (relying as it does on monetary illusion) as it has always been, but also has become increasingly outdated because of globalization. Real wages are stagnant; the stock market increases; but high paying jobs flee the country, all due to the Fed's monetary policy combined with aggressive stock option programs.

Third, the Fed now functions like a casino manager. The US dollar does not function just as a traditional money supply that provides a store of value; a medium of exchange; a unit of account and a standard of deferred payment. Rather, the dollar has become a commodity that is held by investors all over the world as a form of speculation. This new function puts the Fed in the role of casino game manager that needs to determine whether enough "chips" have been manufactured---chips that have meaning only so long as there are gamblers to use them.

Although economists have meaningful credentials, there is no reason to believe that they understand how to market casino chips. I am sure that Ben Bernanke, like Alan Greenspan, is a brilliant guy, but he is no better at marketing than a layman. Should Americans have faith in an institution like the Fed, which claims to manage the money supply while quietly extending its role to facilitator of a global crap shoot? Isn't it time to rethink the Fed altogether?