Author: Warren Coats

I specialize in advising central banks on monetary policy and the development of the capacity to formulate and implement monetary policy.  I joined the International Monetary Fund in 1975 from which I retired in 2003 as Assistant Director of the Monetary and Financial Systems Department. While at the IMF I led or participated in missions to the central banks of over twenty countries (including Afghanistan, Bosnia, Croatia, Egypt, Iraq, Israel, Kazakhstan, Kenya, Kosovo, Kyrgystan, Moldova, Serbia, Turkey, West Bank and Gaza Strip, and Zimbabwe) and was seconded as a visiting economist to the Board of Governors of the Federal Reserve System (1979-80), and to the World Bank's World Development Report team in 1989.  After retirement from the IMF I was a member of the Board of the Cayman Islands Monetary Authority from 2003-10 and of the editorial board of the Cayman Financial Review from 2010-2017.  Prior to joining the IMF I was Assistant Prof of Economics at UVa from 1970-75.  I am currently a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.  In March 2019 Central Banking Journal awarded me for my “Outstanding Contribution for Capacity Building.”  My recent books are One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina; My Travels in the Former Soviet Union; My Travels to Afghanistan; My Travels to Jerusalem; and My Travels to Baghdad. I have a BA in Economics from the UC Berkeley and a PhD in Economics from the University of Chicago. My dissertation committee was chaired by Milton Friedman and included Robert J. Gordon. I live in National Landing Va 22202

American Exceptionalism—where has it gone?

Americans are among the most generous people in the world.  World Giving Index – published by the Charities Aid foundation – averages the percent of the population giving money to charities, the percent who have volunteered time for an organization in the past month, and the percent who have helped a stranger in the past month. Americans are sixth, tied with Switzerland with a score of 55%. Australia and New Zealand are first and second with 57% followed by Ireland and Canada with 56%. Germany is 19th with 44% and France is 93rd with a score of 27%.

I have always been proud that visitors to the United States have generally found Americans to be friendly, helpful, and good-hearted. I realize that this is a bit hard to imagine these days with the negativism thrown from the right and the left at each other, but we still manage the occasional smile in the grocery store as we wait at the checkout line. However, views of America abroad have been declining for some years and have plummeted this year. http://www.pewglobal.org/2017/06/26/u-s-image-suffers-as-publics-around-world-question-trumps-leadership/

The reasons for this decline that leap out to me reflect the propensity of our government to throw its weight around. We have been at war almost continuously since 9/11 (Afghanistan, Iraq, Somalia, Syria, Libya, Yemen, Nigeria, and who knows where else). The U.S. has 662 overseas bases in 38 foreign countries and military personnel in 130 countries. Most American soldiers are fine young men but no one likes foreign soldiers on their streets for very long, even went they are well behaved most of the time.

I was discussing with a Pakistani friend the “special” qualities of the American government and American people that make us exceptional https://works.bepress.com/warren_coats/35/. He suggested that a growing number of people around the world see the United States as exceptional in the sense that it doesn’t think it needs to follow the rules it sets out for everyone else. We are seen as bullies. Ouch.

The most recent and embarrassing example of this was President Trump’s announcement that the United States recognized Jerusalem as the capital of Israel and would move the U.S. Embassy there. As background, on May 14, 1948 the British agreed when Israel declared its independence from the British mandate that ruled Palestine. The State of Israel was immediately recognized by the United States. After several rejections by the UN Security Council, Israel’s UN membership application was accepted by the General Assembly on May 11, 1949 in Resolution 273, which, among other things, defined the new country’s boundaries. Between June 5 to 10, 1967 Israel attacked and captured surrounding territories in Egypt, Jordan and Syria in what became known as the Six-Day War. Except the Gaza Strip and the West Bank most of the captured territory was returned as part of a peace agreement. Israel ended its occupation of the Gaza Strip in August 2005.

The termination of Israel’s “temporary” occupation of the West Bank, including East Jerusalem remains the subject of the Israeli-Palestinian peace negotiations. “Under the 1947 UN Partition Plan to divide historical Palestine between Jewish and Arab states, Jerusalem was granted special status and was meant to be placed under international sovereignty and control. The special status was based on Jerusalem’s religious importance to the three Abrahamic religions.”  “Jerusalem-capital-Israel”

In general, the international community rejects the use of brute force to change borders. Russia’s annexation of Crimea into Russia (though it was previously part of Russia before Khrushchev gave it to Ukraine in 1954) violated this understanding.

President Trump’s announcement about the status of Jerusalem violates standing U.S. and international policy. It was almost universally condemned. The US vetoed a Security Council condemnation of Trump’s action but the General Assembly overwhelmingly (128 to 9, with 35 abstentions) passed a resolution declaring that, “any decisions and actions which purport to have altered the character, status or demographic composition of the Holy City of Jerusalem have no legal effect, are null and void and must be rescinded.” White-House-vows-to-stand-firm-on-trumps-recognition-of-jerusalem-as-israels-capital/2017/12/23/

The General Assembly vote used a rarely exorcised power as explained by Paul Pillar. “Among the principal takeaways from the General Assembly’s action is that an international sense of justice and fairness matters.  Many states reject the notion that might makes right, which is how the Israeli government has treated its relations with the Palestinians, and how the Trump administration approached its lobbying on this resolution.” “Uniting-against-trumps-policies-for-peace”

When the UN voted Thursday (Dec 22) to condemn this action “Only seven countries—Guatemala, Honduras, Togo, Nauru, Palau, Micronesia and the Marshall Islands—were willing to stand with Uncle Sam and Israel and vote against the resolution.” “Next-year-in-Jerusalem”

Aside from keeping the favor Israeli Prime Minister “Bibi” Netanyahu and some wealthy American Jewish donors, there is no upside to this step to be found. The peace talks, such as they were, have been damaged. Even the “Permanent Observer Mission of the Holy See to the United Nations called for maintaining of the status quo of Jerusalem.” In its letter to the President of the General Assembly it stated that: “The unique identity of Jerusalem, which is of universal interest, consists in its particular nature as a Holy City, most sacred to the three monotheistic religions and a symbol for millions of believers worldwide who consider it their “spiritual capital”. Its significance goes beyond the question of borders and this reality should be considered a priority in every negotiation for a political solution.” “Holy-See-supports-Jerusalem’s-historical-status-quo”

Israelis themselves are deeply divided on this issue. The continued and unresolved occupation of the West Bank by Israel has and continues to provoke terrible behavior by both sides. Uri Avnery, an Israeli freedom fighter in his youth, decries acts by his country against occupied Palestinians in passionate terms (email me if you are interested in his email) as does Phillip Weiss: Ending-crisis-Zionism/

But American bullying did not stop there. Nikki Haley, U.S. Ambassador to the UN, delivered a disgusting and threat-filled speech condemning the U.S. rebuke. “The crude tactics included Nikki Haley’s rhetoric about ‘taking names’ and Donald Trump’s bombast about cutting off U.S. aid.  Among the Arab states that supported the resolution were the two states—Egypt and Jordan—that receive more U.S. aid than anyone other than Israel.  The very crudeness of the tactics, and the offense taken to bullying, probably made the tactics counterproductive.” (see Pillar article above).

Good hearted and freedom loving Americans are increasingly represented by governments that push our views and interests on the rest of the world. The rest of the world’s resistance is building. This does not serve our economic or security interests. How did the “essential country”—the “exceptional country”—become a big bully? In recent weeks we have also been asking ourselves how prominent leaders in the media, industry, and Congress have become sexual bullies. It seems that power corrupts. Eternal vigilance is still needed.

The Wedding Cake

Americans harbor many conflicting views on many subjects. Our right to freely express them is guaranteed in the American Constitution’s First Amendment. It is precisely this right that has enabled the LGBT community to convince an ever-growing number of our fellow citizens that they should be entitled to the same protections under the law as anyone else.

Public discussion of conflicting opinions in a spirit of civility and mutual respect is an important aspect of developing consensus as well as tolerance for other beliefs and ways of living. While we are required by the Civil Rights Act of 1964 to set aside our personal opinions and tastes when we open for business to serve the public (the non discriminatory public accommodations requirement), our personal views are much more likely to be meaningfully changed by persuasion than by legal requirements. “There-will-be-no-winners-in-the-supreme-courts-wedding-cake-case/2017/12/04/”

In 2012, Charlie Craig and David Mullins, a same-sex couple, walked into Masterpiece Cakeshop in Lakewood Colorado to order a cake for a celebration of their wedding. Jack C. Phillips, the owner and cake designer of the shop, refused to bake it on the grounds that he opposed same-sex marriage. In the case of Masterpiece Cakeshop v. Colorado Civil Rights Commission, now before the Supreme Court, Colorado’s Civil Rights Commission maintains that Mr. Phillips has violated the state’s public-accommodations law, which forbids discrimination against LGBT customers. The case pits the Constitution’s First Amendment protection of the right to free speech against the right of everyone, including gay and lesbian Americans, to the equal protection of the law on non discriminatory public accommodation. The Supreme Court must now decide how to balance these two rights.

Phillips argued that making him create a cake that celebrates a same-sex wedding would violate his First Amendment rights to free speech and free exercise of religion, by forcing him to express a message, and celebrate an event, that runs against his beliefs.  Messrs. Craig and Mullins argued that the cake shop had discriminated against them.  How can the rights and needs of each best be satisfied in our society of diverse beliefs?

There were many other cake shops happy to bake the desired cake. Why would Messrs. Craig and Mullins want to give their business to an unwilling baker? What goal was served by challenging the baker’s refusal in court? Did they think that a judge could force the baker to change his views about same sex marriage? Really? Public attitudes toward LGBTs have improved dramatically in recent years including attitudes toward same-sex marriage because of persuasion, not because of legal coercion. In fact, in 1996 legal coercion was used to prevent same-sex marriage with passage of the Defense of Marriage Act (DOMA). The Supreme Court fortunately overturned it in June 2015 in the case of Obergefell v. Hodges. What ever the Supreme Court decides, the LGBT community looses from this case. George Will: “A-cake-is-food-not-speech-but-why-bully-the-baker”/2017/12/01/

Everyone should worry about the threat of state-compelled speech, says gay marriage supporter Andrew Sullivan:  “It always worries me when gays advocate taking freedom away from other people. It worries me as a matter of principle. But it also unsettles me because some gay activists do not seem to realize that the position they’re taking is particularly dangerous for a tiny and historically despised minority. The blithe unconcern for the First Amendment in the war on ‘hate speech,’ for example, ignores the fact that, for centuries, the First Amendment was the only defense the gay minority ever had — and now, with the first taste of power, we are restricting the rights of others in this respect? Ugh. Endorse the state’s right to coerce speech or conscience and you have ceded a principle that can so easily come back to haunt you.” New York Magazine December 8, 2017.

The LGBT community should look first to improved understanding and then to tolerance of diversity. The courts are the last place to search for a workable balance between free speech and conscience and equal treatment of everyone under the law.

We will always have terrorists

The cancer of ISIS is metastasizing. As it losses its caliphate in the Levant, it is being reborn here and there across the globe. We will always have it or its successors or something like it, in the same way that we have always had gangs, mafia, murderers, and thieves. We can and should minimize their number and the damage they do but we will never eliminate them. The real issue is determining where we want the balance between freedom and security.

There are many reasons for the eternal existence of criminals and their crimes but one is that we are unwilling to create the police state and its repressive and intrusive measures that would be needed to eradicate them totally. In short, we prefer to live relatively free and accept some risks of terrorist acts relative to a safer alternative with significantly curtained freedom. As we evaluate government policies to protect us from terrorists, it is worth reviewing and keeping in mind where we have drawn the line between the risks of freedom and the restraints of greater and greater degrees of security. The line is always under review and adjusted a bit this way or that depending on conditions.

Some data from the U.S. helps us keep perspective. Over the past twelve months in the U.S. 104 people were killed by terrorists, 6 of whom were killed at the hands of Islamists. In comparison, 37,461 people died in automobile accidents in 2016. In response to the risk of death on the highway we regulate the right to drive, requiring a license, and enforce speed and other traffic regulations but we have not prevented people who qualify for a license from taking the risks of driving. A year ago I shared some interesting data on the causes of unnatural deaths in the U.S. in the following blog: https://wordpress.com/post/wcoats.blog/1025

On average 2,500 people choke to death per year while eating, yet the activity remains relatively unregulated.

General Michael Flynn

We all deserve to know whether Donald Trump colluded or cooperated with Putin and Russia in any way to illegally help his presidential campaign. I have full confidence that special counsel Robert Mueller’s investigation will provide us with the truth of that question one-way or the other.

I also strongly support former President Obama’s (Russian restart) and President Trump’s desires to build the closest and most cooperative relationship possible with Mr. Putin’s Russia that is consistent with American interests and values. This means that conversations—many conversations—between the Trump administration and Russian officials are not only proper, but also highly desirable.

The revelations that such conversations occurred tell us nothing about whether the Trump administration has been doing anything improper. Then enter General Michael Flynn.

Sunday’s Washington Post contains an article with the headline “Inside the day that set in motion Michael Flynn’s guilty plea”. The day in question was Dec 29, 2016, well after Trump’s election and four weeks before his inauguration. The day before President Obama had “imposed sanctions against Russia for its alleged interference in the election.” Flynn called Russian Ambassador Sergey Kislyak, “urging Moscow not to retaliate — and Russia later surprisingly agreed.”

On the face of it this is neither appropriate nor inappropriate. We would need additional information to come to such a conclusion. However, Flynn lied to the FBI about having such a conversation, which raises the suspicion that it was inappropriate. Unrelated to his work with the Trump administration, General Flynn failed to get clearance before doing work with foreign governments, nor did he register as their agent, as required by law. Generally Flynn seems to have a habit of lying. Later Flynn pleaded guilty to perjury as part of a deal to fully cooperate with Mueller’s investigation in exchange for not being charged with these other crimes.

So if Flynn was not making improper deals with Russia, why did he lie about it? Hopefully we will know in the course of time, but it could be because he belatedly learned that his “conversations with Kislyak violated the Logan Act, a 1799 law that prohibits private citizens from conducting U.S. foreign affairs without the permission of the government.”

No one has every been convicted of violating the Logan Act and a strong argument could be made that such acts by a President elect and his team are not covered.

I want to know the truth. Trump lies so regularly that he has no trust from anyone who really cares about the truth. But to be fair, Flynn’s conversations with Kislyak is not evidence of anything inappropriate. Let’s not jump to conclusions until we have enough information to do so with some confidence that they are correct.

What is SALT really about?

Here is the proper way to understand the SALT issue—whether State and Local Taxes should be deducted from taxable income on which federal taxes are levied.

Assume that taxpayer 1 (Jack) in state A and taxpayer 2 (Mary) in state B both have earned incomes of $150,000 each. If Uncle Sam needs to raise $60,000 each year from its income tax and applies a flat tax on each taxpayers’ total income, it would need to impose a tax rate of 20% (150,000+150,000=300,000*0.2=60,000). Each taxpayer would pay $30,000 in federal taxes.

Assume that Jack chooses to buy an expensive car costing $100,000 while Mary makes a more frugal choice and buys a $40,000 car. No one would think that they should be allowed to deduct the cost of their cars from their incomes for purposes of their federal income tax, but what if they could? Jack would now have $50,000 in federally taxable income (150,000-100,000) while Mary would have taxable income of$110,000 (100,000-40,000). To raise the same $60,000 needed by the Feds, the federal tax rate would need to be increased to 37.5% (50,000+110,000=160,000*0.375=60,000). Of the $60,000 in federal tax revenue, Jack would pay $18,750 (50,000*0.375) and Mary would pay $41,250 (110*0.375). Not only does Jack get a better car but he also pays less taxes. In fact, this tax treatment subsidizes Jack’s expensive car to the amount of $11,250 (30,000-18,750). This is likely to lead Jack to buy a more expensive car than he would have chosen if spending only his own money. Clearly that would be neither fair nor economically efficient.

Replace “car” in the above example with “state government expenditures”. Jack may well choose to have (and pay the higher taxes to finance) more extensive state government services than does Mary. That is fine as long as you are free to choose whether you live in state A or state B. But should Mary be forced to pay (subsidize) some of Jack’s tastes for larger state government expenditures? Surely not, but that is exactly what allowing tax payers to deduct their SALT from their taxable income for federal tax purposes does. Eliminating that deduction would restore fairness and remove any artificial inducement for larger state expenditures. In this way, every one would be free to support the level of state spending they are willing to pay for.

Our Free Press

A free press is an important pillar of a free society. In addition to reporting what is going on—who said and did what—the hard hitting investigative reporting of The Washington Post and other news outlet has exposed corruption and abuse of power from the Watergate scandal of Richard Nixon to the sexual misconduct of Donald Trump, Bill Clinton, Roy Moore, Harvey Weinstein, Bill O’Reilly, Roger Ailes, Kevin Spacey, Charlie Rose, Mark Halperin, Al Franken, and Representative John Conyers to name a few (more on this later). Such scrutiny of the behavior of those in positions of power is a critical service that is vital to the preservation of the integrity of our government.

One way to undermine the role of our free press is to challenge its integrity—to create doubts about the honesty of news reports—to label news as “fake news.” I am not suggesting for a second that news reports are never wrong or that we should not scrutinize them with some care and skepticism, but if the public comes to believe only those news sources that repeat what they already believe, one of the most important institutions protecting our freedoms (the fourth estate) would be seriously weakened.

We know that Mr. Putin’s Russia has been actively undermining faith in Western institutions by their citizens. In the U.S. and Europe Russia has used social media to plant fake news with both the right and the left in order to fan social divisions. One element of this campaign has been to undermine confidence in news reporting in general.

According to Hedrick Smith, former New York Times Moscow Bureau Chief and author of the global best-seller, The Russians: “Putin has turned to cyber warfare, using his intelligence services and computer hackers rather than military force to disrupt the West – and we can expect more of that in the 2018 elections and beyond…. It’s kind of Putin’s revenge for the fact that we pushed the Russian bear back in the cave by moving the frontiers of NATO into the Baltic states—Lithuania, Estonia and Latvia. And (Putin) sees us as being behind the overthrow of the pro-Russian president in the Ukraine. So he’s hitting back.” (Putin wants new cold war) Putin also needs external enemies—external distractions—to divert the attention of Russians from deficiencies at home.

As part of this attack on American institutions they have called the news media “the enemy of the American people,” and planted statements such as: “It’s frankly disgusting the way the press is able to write whatever they want to write, and people should look into it.” New York Times /2017/10/12/ And in a direct attack on the First Amendment, this: “Why Isn’t the Senate Intel Committee looking into the Fake News Networks in OUR country to see why so much of our news is just made up-FAKE!” Money CNN/2017/10/05/

If you didn’t catch it already, I played a little trick on you in the previous paragraph. Those of you who have been paying attention will have spotted that the above quotes attacking the American press and fake news were not Russian propaganda but from President Trump. He also said in a February White House press conference:

“I’m making this presentation directly to the American people with the media present … because many of our nation’s reporters and folks will not tell you the truth and will not treat the wonderful people of our country with the respect they deserve.

“Unfortunately, much of the media in Washington, D.C., along with New York, Los Angeles, in particular, speaks not for the people, but for the special interests and for those profiting off a very, very obviously broken system.

“The press has become so dishonest that if we don’t talk about it, we are doing a tremendous disservice to the American people, a tremendous disservice. We have to talk about it. We have to find out what’s going on because the press, honestly, is out of control. The level of dishonesty is out of control.”  (Trump: media out of control)

Why does Trump do this? Some think that Trump’s attempt to undermine confidence in the news media is part of a well thought out strategy to raise doubts about the veracity of news reports critical of him. It is all “fake news.” I am more inclined to think that he is simply unable to control his anger whenever his ever present and huge ego is bruised. He and his ego are more important than the health and well being of our country, as when he complained about a lack of gratitude for his helping get the release of three UCLA basketball players caught shoplifting in China. On November 15, Trump tweeted:

“Do you think the three UCLA Basketball Players will say thank you President Trump? They were headed for 10 years in jail!”

A few hours later at a press conference the three did just that, but the father of one of them, LaVar Ball, downplayed Trump’s role in his son’s release precipitating the following Presidential tweet:

“Now that the three basketball players are out of China and saved from years in jail, LaVar Ball, the father of LiAngelo, is unaccepting of what I did for his son and that shoplifting is no big deal. I should have left them in jail!”

Are you shocked or have you acclimated to the new normal? I leave it to you to decide whether Trump is reflecting his concern for the well being of our country or his ego. (Trump-college-basketball-players-helped-free-china-left-jail)

Undermining our faith in our institutions and in particular our news media is a serious matter. It is dangerous whether promoted by Russia or Trump. (Trump’s dangerous attacks on the press.) The press and its supporters, to their credit, are fighting back. (US-press-freedom-tracker-documenting-press-freedom-violations)

As David Ignatius put it: “Amid the slithering mess of problems that emerged in 2017, the one that bothers me most is that people don’t seem to know what’s true anymore. “Facts” this year got put in quotation marks.

“All the other political difficulties of the Donald Trump era are subsumed in this one. If we aren’t sure what’s true, how can we act to make things better? If we don’t know where we are on the map, how do we know which way to move? Democracy assumes a well-informed citizenry that argues about solutions — not about facts.” He suggests the reestablishment of newspaper ombudsmen and would “like to see [Google, Facebook, etc.] using machine learning to interrogate supposed facts to establish where they’ve been — how they first surfaced, and how they were passed from user to user.” (“Getting-back-to-facts/2017/11/23/”)

At the same time, the American press deserves some of the criticism it has received. The following article by Chris Wallace puts the case very well: Trump-is-assaulting-our-free-press-but-he-also-has-a-point The distinction between news and opinion is sometimes blurred.

Here are two quick examples: The-FCC-has-unveiled-its-plan-to-rollback-its-net-neutrality-rules. The Post article linked here provides a reasonably balanced report on those favoring and those opposing the FCC’s proposed return to more or less the legal situation prior to 2015. The problem, as is often the case, is that the article’s headline is not written by the article’s authors and the headline gives a totally misleading impression of what is proposed: “FCC plan would give Internet providers power to choose the sites customers see and use” However, the headline writer probably reflects the better disguised biases of the reporters (to their credit). My own blog on the subject from last May is far more balanced if I may say so myself: https://wcoats.blog/2017/05/17/net-neutrality/

The discussion now underway on Republican tax reform legislation provides another example of press bias. Every morning I read the Wall Street Journal followed by the Washington Post, which should provide a bit of balance. But I have found press reporting (editorials and opinion pieces are free to say whatever they want) on this subject sufficiently biased to provoke me to blog twice on it: https://wcoats.blog/2017/11/12/tax-reform-and-the-press/    https://wcoats.blog/2017/11/18/salt-more-press-nonsense-on-tax-reform/

And finally from my highly selective short list was the recent Post headline: Trump boosts Moore in Ala. Senate race despite sexual misconduct allegations (Trump-boosts-Moore-in-ala-senate-race-despite-sexual-misconduct-allegations)  This is very interesting (and amazing) on several levels.

Trump does not indorse Moore in this article but speaks out against his opponent: “’We don’t need a liberal person in there, a Democrat,’ Trump said about Moore’s opponent, former federal prosecutor Doug Jones, who has led in some recent polls in the state.”

The WSJ version of the same story was titled: “Trump Signals Support for Roy Moore Over Democratic Opponent.” WSJ 11/22/2017 With regard to the multiple sexual misconduct claims against Mr. Moore, “Mr. Trump pointed to the can­di­date’s state­ments: ‘Look, he de­nies it… He to­tally de­nies it. He says it didn’t hap­pen. And, you know, you have to lis­ten to him also.’”

A few hours later this article was updated as follows: “Trump said, ‘He totally denies it.’ Previously, the White House said that Mr. Trump believed Mr. Moore should leave the race if the allegations proved to be true.”

From CNN news: “President Donald Trump on Tuesday defended embattled Alabama Republican Roy Moore, all but endorsing the Senate candidate who has been accused of sexual assault and child sex abuse. “He denies it. Look, he denies it,” Trump said of Moore. “If you look at all the things that have happened over the last 48 hours. He totally denies hit. He says it didn’t happen. And look, you have to look at him also.” But to repeat, Trump did not endorse Moore.

Trump’s tolerance of “questionable” behavior by Republican’s is not extended to Democrats. When he returned from Asia he tweeted on Nov 16 about a picture in which Al Franken is holding his hands above Leeann Tweeden’s breasts, while they were on a 2006 USO tour to entertain U.S. troops.

“The Al Frankenstien picture is really bad, speaks a thousand words. Where do his hands go in pictures 2, 3, 4, 5 & 6 while she sleeps?”

He continued in a second tweet, “And to think that just last week he was lecturing anyone who would listen about sexual harassment and respect for women.”

Trump seems to suggest that we should believe the denials of Republicans and investigate the denials of Democrats. He had wisely kept silent to that point about Moore’s pedophile charges, presumably not to remind the public of his own admitted sexual misdeeds (plus the large number of claims he has denied). Here is the full list: President Trump-and-accusations-of-sexual-misconduct-the-complete-list . The mystery is why when he consulted his advisor on such things (himself, of course) he decided to break silence on the subject—condemning Sen. Franken while giving Moore a pass. I suggest that he change advisors.

We have sadly and dangerously grown used to the routine lying of Trump and others. We live in a world of fake news. There have always been limits on our generally wide-ranging freedom of speech, however. Famously, we may not shout fire in a theater when we know there is none. The balance between the First Amendment’s protection of free speech and protection against willful defamation, for example, can be tricky. The following article provides a useful discussion of this balance in the context of the defamation case against Trump by one of his claimed sexual abuse victims, Summer Zervos, a contestant on Trump’s reality television show, “The Apprentice.” “She accused then-presidential candidate Trump of sexual harassment that purportedly occurred in 2007. Trump denied the allegations, and, in his characteristically understated style, tweeted that those allegations, and similar allegations made by other women, were “nonsense,” lies,” “phony” and “100 percent fabricated.” Zervos then claimed that Trump’s comments amounted to defamation.” (Trump’s attack on Summer Zervos blows hole first amendment) This might prove more damaging to Trump than the Russia investigation.

SALT—More press nonsense on tax reform

The elimination of State and Local Tax (SALT) deductions from the proposed tax reforms working their way through Congress has become a hot topic. Fine, but please keep the discussion honest. Sadly my local newspaper, The Washington Post, is not setting a good example: “In-towns-and-cities-nationwide-fears-of-trickle-down-effects-of-federal-tax-legislation”

First a word about tax reform vs tax reduction. We are now in the 9th year of economic recovery, one of the longest on record. It won’t go on forever. Ideally the Federal government’s budget should balance its expenditures and revenue over the business cycle. That allows for aggregate demand stimulating deficits during business downturns. These deficits result from so called automatic stabilizers—the fall in tax revenue from the fall in taxable income plus increased transfer payments to the unemployed. But a cyclically balanced budget also requires budget surpluses during the business expansion phase. The U.S. economy is now fully employed (in fact, unfilled vacancies exceed those looking for work). The Federal Reserve has finally increased inflation to its target rate of 2%. We should now have budget surpluses to make room for the deficits that will follow during the upcoming downturn.

But our fiscal situation is much worse than that. The large increase in “entitlement” expenditures for my greedy generation as we retire (greatly increasing unfunded social security and health benefits) will push our fiscal debt held by the public, now at 77% of our Gross Domestic Product (GDP), to over 150% of GDP within 30 years if current laws remain unchanged. See the figure below.

Taxes will either need to be increased (not reduced) or entitlement expenditures reduced (which means increased less than current law provides). My point is that reducing tax revenue at this time is irresponsible without at least matching expenditure cuts. The proposed tax reforms now in congress would increase the debt by $1,500 billion dollars over the next ten years on a static forecast basis, meaning without taking into account the increased growth and thus tax revenue that might result from the tax reforms, which no one expects to wipe out all of the static forecast of $1,500 billion.

Fed debt      Congressional Budget Office forecasts

While it is irresponsible to cut tax revenue at this time, it is highly desirable to reform how that revenue is raised. The existing taxes distort the economy and thus reduce our incomes in a number of ways. They grant favors to many special interest groups via allowing them to deduct specific expenditures from their taxable incomes (i.e. from the tax base). These so called tax subsidies encourage activities over what the private economy would otherwise under take. One very damaging example is the deduction of interest payments by businesses and individuals, which has encouraged excessive borrowing and indebtedness. The most popular of these is the mortgage interest deduction by homeowners. This tax subsidy benefits homeowners relative to renters, i.e. it benefits the wealthier at the expense of the poor. How well meaning middle and upper income American’s can justify this with a straight face is beyond me.

But what about the SALT deductions? By eliminating such deductions, i.e. by broadening the tax base, the same revenue can be raised with a lower tax rate. Other things equal (such as revenue), lower tax rates are good because they influence taxpayer decisions less. For example, companies are more likely to invest in the U.S. rather than abroad if the corporate tax rate is reduced from its current 35%, virtually the highest in the world, to 20%, which is closer to the rate in most developed countries.

Reducing tax subsidies to state and local governments is also good because it reduces an artificial encouragement for larger state and local government expenditures. If Californians are willing to pay more state taxes for larger state expenditures they are welcome to do so. But there can be no justification for transferring federal tax revenue from states with lower expenditures and matching taxes to California and other high spending states. To a large extent the existing SALT deductions transfer income from poorer states to wealthier ones. Who can support that with a straight face?

How information is presented can have a significant effect on how it is understood or viewed. How did Renae Merle and Peter Jamison of The Washington Post (see link above) report the proposed elimination of the SALT deduction? They reported that, “In San Diego County, the elimination of what is commonly called the “SALT” deduction could affect about a third of households, said Greg Cox, a member of the board of supervisors. The average middle-income resident would lose a $16,000 deduction.” They failed to note that the third of households affected are the wealthiest third. According to CNBC: “More than half of taxpayers who are earning $75,000 and above claim SALT deductions on their federal income tax returns as do more than 90 percent of taxpayers who make $200,000 or more.”

share of SALT

Furthermore, the figure $16,000 is misleading in two respects. The loss of a $16,000 deduction would increase taxes for a single person earning $200,000 annually by $5,280 at the current tax rate of 33%. However, broadening the tax base by eliminating the SALT and other deductions allows raising the same revenue with a lower tax rate. To measure the actual tax impact both effects must be combined. Current congressional proposals are to reduce the rate for the above person to 25%, which would result in an increased tax of $4,000. None of this would affect the poor directly. I assume that Renae Merle and Peter Jamison were just careless rather than letting their biases get the best of them, but you can make your own judgment.

The SALT deduction cannot be justified on either economic or fairness grounds, but there is sadly a good chance congress will cave in to the pressure from the wealthier states to keep it or at least some of it.

 

 

 

Tax reform and the press

I have written several articles about the need for serious tax reform in the U.S. and set out the basic principles of good tax law accepted by most economists. “US Federal Tax Policy”, Cayman Financial Review, Issue 16, Third Quarter 2009. https://works.bepress.com/warren_coats/47/  Cayman Financial Review, July 2013

Taxing consumption is best, but if income is taxed, it should be broadly defined and taxed uniformly. Income tax reform should follow the mantra “broaden the base and lower the rate” for the revenue needed to finance whatever the government spends. The main dispute tends to focus on whether and how progressive the tax rate should be. I favor a flat rate as the fairest and simplest regime. This means that a person with twice the taxable income would pay twice the tax. Many others favor a progressive rate—a marginal tax rate that increases with income—, which means that someone with twice the taxable income might pay 3 or 4 times as much in taxes. In 2016 the “top 1%” by income paid over 50% of all federal income tax revenue collected and the top 20% paid 84%.

I raise this issue because any judgment of whether a reduction of the top U.S. marginal tax rate from its current 39.6% to 38.5%, as currently proposed by the U.S. Senate, increases or decreases the fairness of the system depends on whether you consider 39.6% fair or too high or too low. I consider it too high and a reduction to 38.5% too little, so I would say that the tax reform is unfair to the top income groups by not lowering the top tax rate enough. The press almost uniformly refers to any cut in the top rate as favoring the rich (rather than reducing discrimination against the rich).

But what prompted this note was the blatant bias reflected in the following Washington Post article that claims to report the winners and losers in the current Senate tax reform proposals. Winners-and-losers-in-the-Senate-GOP-tax-plan   In the losers column the article states the following for the poor:

“The poor. More than 70 million Americans don’t make enough money to have to pay federal income taxes. Many of those people currently receive money back from the government because they qualify for refundable credits. Under the Senate plan, those credits aren’t going away, but they also aren’t growing. On top of that, the plan raises America’s debt, which will likely require cost cuts somewhere down the line. Republicans have proposed sizable cuts in the past to some safety net programs used by the poor.”

According to the author of the article, Heather Long, the poor lose because they don’t gain anything!!! Seventy million of them don’t pay taxes to begin with so there is not much that tax reform can do to lower their taxes. The existing tax credit paid to these people will remain but is not increased. Thus Heather concludes that the poor are losers because they didn’t gain anything. I agree with Heather’s implicit objection to the plan’s increasing the federal government’s debt, but avoiding that would require higher taxes for someone and has nothing to do with making the poor worse off that I can see.

Any tax reform that is revenue neutral (unfortunately this one will increase the debt by 1.5 trillion dollars over ten years.) necessarily increases taxes for some while lowering them for others.  It should not be judged by whether it will result in President Trump paying more taxes or less, as some press would have it.  It should be judged by whether the resulting realignment of tax obligations is fairer and economically more efficient (neutral). Sadly it is rarely discussed in these terms.

The Vietnam War – the movie

Whether you lived through it or are viewing it as ancient history, Ken Burns and Lynn Novick’s The Vietnam War is shattering. I alternately wept and retched. It was a serious mistake that took over twenty years to back (or crawl) out of. The loss of life was staggering. Estimates of war related deaths between 1954 and 1975 vary from 1.5 to 3.6 million people. Of these 58,220 were U.S. military personnel. Less reliable estimates of South Vietnam military (ARVIN) deaths range from 100,000 to 250,000 and of North Vietnam military and their South Vietnamese collaborators (the Viet Cong) around one million. Estimates of civilian deaths range from 225,000 to 500,000 of which 195,000 to 430,000 where in the South.

But these deaths only scratch the surface of the costs of this war in blood and treasure. Those injured numbered 1,170,000 people. The sight of returned American solders without legs (which seemed more common than missing arms) became relatively common in the 1970s. Greater still was the emotional damage to those who participated in and witnessed up close the human waste of this war, the emotional anguish of those with the courage to refuse to fight what they (and history) considered an immoral war, which included Mohammad Ali, and the scars to our nation, which most of us witnessed from afar, and all can now see again in the Burns/Novick film.

The film balances the horrible visual images of the wasted and mutilated bodies of old men, women and children sprawled or piled along the roads with the personal human stories of individual participants. The terror in the faces of women and children running through the streets is excruciatingly hard to watch. But the contemporary interviews of solders and reporters who had participated in the war and the Americans back home who demonstrated against it gave a very human touch to the pointless horror they looked back on.

As the war dragged on from the 1960s into the 70s solders increasingly questioned the wisdom of torching the homes of impoverished South Vietnamese with no way of knowing whether they were the “good guys” or the “bad guys.” These men, and in some cases women, served faithfully and bravely in what was increasingly, obviously a pointless slaughter. And our Presidents—Kennedy, Johnson, and Nixon—lied to us about what was going on—not the easily provable and obvious lies Trump tweets throughout the day, day after day, but serious lies most of us believed until near the end. The Burns/Novick film presents it all—all sides, including fascinating interviews with a number South and North Vietnamese—in as humanized a way as possible for such an unbelievably inhuman undertaking.

What have we (or should we have) learned as we wage war in Afghanistan, Syria, Somalia, Libya, Iraq and Yemen to name the most conspicuous cases and not to mention the threats of war in Iran and North Korea?

  • Fighting other people’s wars on other peoples’ land that we know little about is foolish. In fact “foolish” is far too mild a characterization. It is reckless in the extreme. It is insane.
  • Wars are between real people, many if not most of who may have nothing to do with the struggle. The costs to them in lives and limbs should be taken into account when evaluating whether America’s interests are really served by foreign military engagement.
  • The intense patriotism and sense of adventure of American solders is similar to the motivation of ISIS fighters. I admire them and their courage because they were my guys who believed they were fighting for my safety. I see them through my eyes, but I was struck by how similar their motivations for fighting a perceived enemy were to what seems to be the motivations of ISIS fighters. That should give us pause.
  • Foreign adventures—a few trainers, or solders to lend a hand—almost always sound better at the beginning than by the end (when there is an end).
  • Real people, especially our youth who tend to do the fighting, cannot easily escape the emotional damage of the horrible acts they are required to undertake. This cost should receive its due weight in evaluating whether our interests are really served by participating in foreign wars.
  • Madeleine Albright’s famous comment that “what is the good of having the world’s most powerful military if you can’t use it?” should have landed her in jail.

We must defend and protect the homeland without question. It should be very hard to justify sending American troops anywhere abroad to fight for whatever reason. We should have very clear answers to the following questions: Why should we be there and who are our enemies? Who are we fighting and to what end? We almost never do.

 

Sound Money

Philadelphia Society Address on Oct 14, 2017

Introduction

Sound money is a necessary but not a sufficient condition for a healthy economy. How can we best achieve and maintain it?

For almost two hundred years the gold standard did a good job of producing sound money but its weaknesses ultimately led to its abandonment and exchange rates were allowed to float.

The movement in the 1980s to independent central banks with a stable price level mandate, such as an inflation target, delivered several decades of sound money—this was called the great moderation. But is came at the expense of increased exchange rate volatility and asset bubbles.

We need to return to a monetary regime with a hard anchor. But money fixed in price to a single commodity, such as gold, will not provide as stable a value as a price fixed to a larger basket of goods.

The discretion of the central bank to control the supply of money should be replaced with market determination of the money supply. To achieve this money should be issued under currency board rules. Specifically the public should be able to buy all of the currency they want at the currency’s official prices and redeem any of it they no longer want at the same price.

The Gold Standard

The essence of the gold standard was the obligation of the issuer of gold backed money to redeem it for gold at an officially fixed price. This limited the amount of money that could be issued.  The United States set the price of fine gold at $19.49 per ounce in 1791 and raised it to $20.69 in 1834. The Gold Standard Act of 1900 lowered it slightly to $20.67.  In 1934, Congress passed the Gold Reserve Act, which raised the price of gold to $35 an ounce and prohibited private ownership of gold in the United States.  Lyndon Johnson’s guns and butter deficit spending over heated the U.S. economy, which raised doubts about the U.S.’s ability to honor its gold commitments. By late 1971 the U.S. no longer had enough gold to honor its redemption commitment, and President Richard Nixon suspended the U.S. commitment to buy and sell gold at its official price. Yet, an official price remained, and was raised to $38.00 per ounce in 1971 and to $42.22 in 1972. In 1974, President Ford abolished controls on and freed the price of gold, which rose to a high of $1,895 in September 2011 before falling back to $1,304 this morning (October 14, 2017). More importantly, as gold has never been very representative of prices in general, prices of goods and services on average in the U.S. rose 500% over the 45 years since Nixon closed the gold window.

Floating Exchange Rates and Inflation Targets

When Nixon closed the gold window he also imposed wage and price controls, which lasted for three years. The dollar no longer had a “hard” anchor. It was no longer redeemable for anything and new policies were needed to regulate its supply. Over this period the Fed implemented monetary policy via adjustments in the overnight interbank lending rate (the Fed funds rate) in light of, among other things, its objectives for the growth of monetary aggregates. When wage and price controls were finally lifted the CPI increased a staggering 12% in 1974.

In the face of the Fed’s persistent over shooting of its narrow and broad money target ranges and the entrenching of higher and higher inflation expectations in wage and price increases, Federal Reserve Board Chairman Paul Volcker led the Board and the Federal Open Market Committee (FOMC) on October 6, 1979 in a dramatic change in the Fed’s approach to implementing monetary policy by shifting to an intermediate, narrow money target, operationally implemented via a target for non-borrowed reserves. The new approach required the Fed to relax its Fed funds rate targets and it increased the band set by the FOMC for the Fed funds rate from 0.5% to 4%. However, the fed funds rate rose temporarily to over 22% and GDP fell by over 2% in 1982—actual and expected inflation were reversed and fell below 2.5% by 1983. The new approach had defeated inflation but it was not easy to implement and by the end of 1989 the Fed abandoned it for the more traditional fed funds rate targeting.

At about the same time radical innovations in the development of monetary policy rules were launched by the Reserve Bank of New Zealand, which came to be known as explicit inflation targeting. An inflation target provides a clear and explicit rule that permits flexible operational approaches to its achievement. Given Friedman’s long and variable lags in the effect of monetary policy on prices, setting monetary operational targets (almost always the equivalent of a fed funds rate) must be based on the best model assisted forecast of its consistency with the inflation target one to two years in the future. A longer target horizon provided more scope for smoothing any output gap (employment). Full transparency of the policy and the data and reasoning underlying policy settings is required to gain the benefits of the alignment of market inflation expectations with the policy target.

The RBNZ’s development and adoption of inflation targeting was an important development in the pursuit of rule based monetary policy with floating exchange rates that accommodated flexible implementation. It swept the world of central banking. While the Fed did not adopt explicit inflation targets until 2012, it clearly pursued an implicit inflation target long before that.

Monetary stability, defined as price level stability, improved significantly, but exchange rate volatility increased. The Great Moderation of the 1990s and early 2000s that resulted from more stable domestic prices was followed by the Great Recession. The Great Recession of December 2007 to June 2009 highlighted the failure of inflation targeting to take account of asset price bubbles and “inappropriate responses to supply shocks and terms-of trade shocks”.[1]

What followed can only be described as a nightmare (largely because of the over leverage and other weaknesses in the U.S. financial system). After properly and successfully performing its function of a lender of last resort and thus preventing a liquidity-induced collapse of the banking system, the Fed went on to undertake ever more desperate measures to reflate the economy. These Quantitative Easings (QEs)—quasi-fiscal activities—have been widely discussed and have contributed little to economic recovery.[2]

The conclusion from the above history is that monetary policy is being asked to deliver more than it is capable of delivering. Central banks are generally staffed by very capable people, but they can never know all that they need to know to keep the economy at full employment as employers and jobs keep changing. The quality of forecasting models has greatly improved in recent years, but they remain unreliable. The policy strategy and intentions of the Fed and other inflation targeting central banks have become admirably transparent, but given the uncertainty of its next policy actions, markets remain spooked by every new data release and speech by Fed officials. Yet inflation in the U.S. and Europe remain below the 2% targets of the Fed and of the ECB.

Despite the huge increase in the Fed’s balance sheet, which banks are largely holding as excess reserves at the Fed, monetary growth in the U.S. averaged only about 5.5 to 6% over the past four years or about the same as its long run average (for M2). My assessment of the slow pace and modest size of the economic recovery in the U.S. is that regulatory burdens have discouraged investment while many internet related investments continue to drive down costs of many economic activity (a sort of unrecorded productivity increase).  Easy money is once again inflating asset prices (stocks and to a lesser extend again real estate).  But who knows for sure?

The idea that central banks can micro-manage monetary conditions to smooth business cycles is a conceit. In my opinion, central banks have given their price stability mandates their best shot and failed. The successful, countercyclical management of the money supply with floating exchange rates is simply beyond the capacity of mortals.

Return to a Hard Anchor

The Fed should give up its management of the money supply and return to a system of money redeemable for something of fixed value – a so-called hard anchor for monetary policy. This means linking the value of money to something real and managing its supply consistent with that value (exchange rate). Such regimes do not magically overcome an economy’s many and continuous resource allocation and coordination challenges, but by providing a stable unit in which to value goods and services and to evaluate investment options, and sufficient liquidity with which to transact, such regimes facilitate the continuous adjustments private actors need to make for an economy to remain fully employed and to grow.

But fixed exchange rate regimes, including the gold standard in one of its forms or another, have historically had their problems as well. These problems generally reflected one or the other of two factors. The first was the failure of the monetary authorities to play by the rules of a hard anchor, which is to keep the supply of money at the level demanded by the public at money’s fixed value. The pressure to depart from the rules of fixed exchange rates generally came from fiscal imbalances or mistaken Keynesian notions of aggregate demand management. However, even when central banks aimed actively to match the supply of its currency to the market’s demand with stable prices it proved beyond their capacity to do so.

The second source of failure came from fixing the value of money to an inappropriate anchor. When the exchange rate of a currency is fixed to another currency or to a commodity whose value changes in ways that are inappropriate for the economy, domestic price adjustments can become difficult and disruptive. Fixing the exchange rate to a single commodity, as with the gold standard, transmitted changes in the relative price of gold to prices in general, which imposed costly adjustments on the public.

These historical weaknesses of monetary regimes with hard anchors can be overcome by choosing better anchors and by replacing central bank management of the money supply with market control via currency board rules.

Currency board rules give control of the money supply to the market—to the public. As an example, a strict gold standard operated under currency board rules would increase the money supply whenever the public wanted more and was willing to buy it with gold at the fixed gold price of a dollar. If the public found it held more money than it wanted it would redeem the excess for gold at the same price.

I led the IMF teams that established the Central Bank of Bosnia and Herzegovina with currency board rules, and it functions in exactly this way. It has no monetary policy other than issuing or redeeming its currency for Euro at a fixed exchange rate in passive response to market demand. It has worked very well. I was also involved in establishing currency board rules for the Central Bank of Bulgaria, which has also enjoyed stable money ever since.

The hard anchor should not be just one thing. The relative price of any individual good or commodity will vary relative to prices in general. Thus a small representative basket of goods should be chosen for the anchor. Earlier proposals for broader baskets suffered from the assumption that buying and redeeming the currency should be against all of the items in the basket. That would be cumbersome and storage and security would be costly. Currency board rules should provide for indirect redeemability, by which the currency would be purchased with or redeemed for designated AAA securities (e.g., U.S. Treasury bills) at their current market value.

Exchange Rate Volatility or a Global Currency

A major cost of the current system of floating exchange rates with inflation or other targets is the uncertainly and wide swings of exchange rates. Over the last decade the USD/Euro exchange rate varied over 40 percent. The classical gold standard was associated with a flourishing of foreign trade in part because the gold standard was a world currency, which there for eliminated exchange rate risk. There would be considerable benefit to world trade, economic efficiency, and growth if all or most countries adopted the same hard anchor for their currencies. The International Monetary Fund’s SDR already exists for this purpose but would need to be modified in several important ways in order to operate under currency board rules and to change its valuation basket from a basket of currencies to a basket of goods.

Conclusion

Experience with monetary regimes with floating exchange rates has been mixed. Almost all major currencies have become more stable in the last three decades but at the expense of increased exchange rate and asset price volatility. The United State, as well as most other countries, would benefit from a return to a monetary system with a hard anchor, but fixed to the value of a small basket of goods rather than to just one, and whose supply is determined by the public’s demand via issuing and redeeming it indirectly for a liquid asset of comparable value according to currency board rules. The benefits of such a system would be increased the more widely it was adopted. One of the virtues of the gold standard was that it was global.

Reference

Warren Coats, “Real SDR Currency Board”, Central Banking Journal XXII.2 (2011), also available at http://works.bepress.com/warren_coats/25

________________, “What’s Wrong with the International Monetary System and How to Fix it?” April 20, 2017. https://works.bepress.com/warren_coats/38/

Jeffrey Frankel. “The Death of Inflation Targeting”. Project Syndicate, May 16, 2012.

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[1] Jeffrey Frankel. “The Death of Inflation Targeting”. Project Syndicate, May 16, 2012.

[2] See for example, Warren Coats, “US Monetary Policy–QE3” Cayman Financial Review January 2013.