Category: Government

Serving Self Interest

If the goal of public policy is to maximize society’s wealth, in the broadest meaning of wealth (economic and cultural), what should that policy be? The invention and production of goods and services that enrich our lives (by providing food, shelter, safety, and entertainment) require a mix of cooperation and competition. How that mix is determined is the critical factor providing varied results in different societies. The Soviet Union represented one extreme of central determination and enforcement of the mix. The United States represents the other extreme encouraging individual determination of when and how to cooperate and when and how to compete based on each person’s self-interest.

What form of cooperation and competition maximizes society’s wealth and how should that optimal mix be determined? The exploitation of our self-interest to maximize wealth that has such extensive scope in the U.S. is guided by each person’s understanding of how their interests are best served.  Our moral code for how best to treat others and thus to be treated ourselves is a critical part of that understanding.

Alexis de Tocqueville, in his Democracy in America (1835), marveled at the extensive degree of voluntary cooperation in America. Americans joined together in church groups, civic clubs, charitable organizations, and sports clubs as part of their pursuit of their self-interests to a greater extent than in any other country in the world.

The tightest cooperative unit is the family, were trust between members is very high in dividing responsibilities while sharing its fruits, as they compete with other families for jobs and markets. Firms divide up tasks and cooperate in producing the best possible products and services with which to compete with other firms for market share (see Ronald Coase’s  The Nature of the Firm – Wikipedia). The Brooklyn Dodgers (now the Los Angeles Dodgers) cooperated within the club in order to better compete against other baseball clubs.

The wealth and success of America compared with the poverty and eventual failure of the Soviet Union reflects its better choices of the when and where and how much to cooperate vs compete. History has confirmed that those choices are best made by individuals pursuing their self-interest as they see and understand it. In Adam Smith’s foundational book: An Inquiry into the Nature and Causes of the Wealth of Nations (1776) Smith argues that when individuals pursue their own self-interest in a free market, they are led by an “invisible hand” to promote the general welfare of society. However, these invisible hands operate within and through a society’s legal, institutional, and moral environment. Well defined and secure property rights are particularly important.

The dramatic increase in material wealth for the average family and decline in poverty in relatively free market, capitalist economies over the past 250 years followed thousands of years of unchanging incomes and general poverty. https://humanprogress.org/trends/

I hope that our next generation of innovators and workers understand this.

More on constructive competition

In contrasting our treatment of others as competitors or enemies in my blog on “What to do About China”  I am reminded of the 120 days I spent in Baghdad as an advisor to the Central Bank of Iraq paid for by the USAID and supervised by the US Treasury. Our occupation of Iraq included staff from the US Treasury, USAID, Commerce Dept, State Department, and, of course, the Dept. of Defense. Competition by each of them to do a better job than the others would clearly be win-win making our overall occupation more successful. But too often one agency treated the others as enemies diminishing and undermining their efforts rather than supporting them. My biggest fear with my dual association with USAID and Treasury was that each would see me as on the other side, which would have undermined my effectiveness. Luckily the each saw me as on their own side.  “Iraq-An American Tragedy-My Travels to Baghdad”

Persuasion or Coercion

Alabama Sen. Tommy Tuberville might be right or wrong about opposing the defense Department’s policy “of providing travel expenses for service women seeking an abortion.” But President Biden is certainly right in claiming that Tuberville’s unilateral “blocking more than 300 military [nominations] with his extreme political agenda” is “jeopardize[ing] the country’s national security.”  “Biden Tuberville military clash”

The DOD must determine the policies that will attract the solders that we need in our All Volunteer Military. Those policies should be open to public debate. But Tuberville has chosen coercion to impose his views rather than persuasion to seek consensus . This is not proper in a free society governed by publicly endorsed laws. It prevents the sort of public debate that will most likely find the best balance between the opposing views of people living in the same space. And it will certainly deepen divides that will diminish rather than enhance civility. In short, it bad for the nation.

But our liberal democracy has survived for two hundred and fifty years because when the pendulum swings too far in one direction, it invariably swings back. Hopefully we are reaching the extreme of the pendulum swing of right-left antagonism. Efforts are growing to rebuild the civil dialog from which we can better live together in liberty. See for example groups like Braver Angles https://braverangels.org/   We should fight to preserve our freedom to live as we choose rather than to restrict the choices of others to live as they choose.

Child labor

How much should the government protect us from things?  What form should government protection take? When does “protection” become top down coercion?

The US Labor Department wants to roll back some of the relaxation of “child labor” restrictions allowed by some States. https://thehill.com/homenews/education/4123821-dol-cracks-down-on-child-labor-while-states-loosen-laws/  What should we (or for minors—our parents) be allowed to decide for ourselves and what should the government be allowed to decide for us?

Back to my childhood in Bakersfield again. I was absolutely thrilled when I was able to earn money delivering the morning newspaper. I can’t remember my age exactly, but I think it was 14 or 15. I got up at 5:00 or 6:00 in the morning when a stack of the morning paper was dropped on our porch. I rolled them up and put them in a backpack, mounted my bicycle, and threw them as close to the porches of the subscribers on my list as possible. Bakersfield being semidesert was pleasantly cool in the summer mornings and very cold –freezing cold—in the winter. It virtually never snowed in Bakersfield because if virtually never rained, but it certainly froze any water around in the winter. The wide swing of temperatures between the night and the day is typical of deserts.

Having this job absolutely thrilled me more than the modest money I earned. Prior to qualifying age wise to deliver newspapers, I made money growing tomatoes in our back yard and selling them to the neighbors door to door. They were thrilled to buy my big red delicious and very fresh from the vine tomatoes. No one minded that I might have been breaking some law or other. When I became 16 and had a driver’s license, I went to work for Fedway Department store as an assistant to the parking lot attendant. The next year I was promoted to a salesclerk inside the store. These were weekend jobs.

The money I made was helpful (75 cent per hour if I recall correctly) but the experience was even more valuable. I loved having these jobs. They were indications of growing up. If for some reason and some how they were bad for me (exploitive?? Ha ha), it was rightly up to my parents to say no. Big Brother is overreaching into our lives again. Helicopter moms are bad enough.

Student Loan Forgiveness

“Writing for a 6-3 majority split along ideological lines, Chief Justice John Roberts ruled in Biden v. Nebraska that President Biden lacks the authority to enact his signature student loan cancellation plan by executive fiat.” “What’s going on with student loans?”

Please note that the Court said nothing about the merits of forgiving such debt nor that Congress could not do so if it so decided. It said that the President does not have the authority to do so without Congressional authorization. So, it is now back to Congress to debt the merits of the issue. I expressed my views on several occasions, most recently last November.

Econ 101:  Student Loan Forgiveness

How to destroy the U.S.

The United States has the largest economic output (GDP) of any country on earth and the eighth highest income per capita at $59,939, below Luxembourg, Macao, Ireland, Switzerland, Norway, Iceland and Qatar. The world average per capita income is $17,100. The factors contributing to America’s prosperity would require volumes to fully explain. But the essence of our flourishing can be summarized in a few sentences.

Americans, individually or together in companies, have produced more than the citizens of other countries, because they trust in and rely on well defined and honestly enforced property and other individual rights that enable them to profit from their efforts—they believe in and follow the rule of law. That profit includes the freedom to live as they choose. We don’t always agree on which rules and laws would best facilitate our rights and interactions, but we trust in the process of public debate, adoption and enforcement of such rules.

Someone wanting to weaken American would attempt to undermine our trust in the above (trust in the institutions that formulate and enforce the rule of our agreed laws). Don’t confuse criticisms of weaknesses in our laws and their enforcement meant to strengthen and improve them with attacks on their legitimacy and fundamental honesty meant to undermine and discredit them. The former are from patriots and the later from our enemies. Look around you and see who is trying to improve American who is trying to tear it down and weaken it.

Resolution of First Republic Bank

JPMorgan Chase’s purchase of First Republic Bank appears to be a standard purchase and assumption resolution of a failing bank. The Federal Deposit Insurance Corporation (FDIC) has organized hundreds of such bank resolutions there by painlessly purging bad banks for the banking system. The only mistake in my view was selling it to the country’s largest bank.

Purchase and assumption resolutions involve the simultaneous purchase of a failing bank’s good assets and the assumption of its deposit liabilities by a good bank and putting what’s left into bankruptcy (wiping out its shareholders and some or all of its corporate debt). Its the risk of loss to shareholders that provides the market scrutiny of bank risk taking. “Institutional and Legal Impediments to Efficient Insolvent Bank Resolution And Ways to Overcome Them”

Money (currency and demand deposits) should not be at risk of a bank failure. Depositors should not need to evaluate the safety and soundness of the bank they chose to hold their money in. So the FDIC insures deposits up to $250,000. But all deposits in the last three banks to fail were made whole whether insured or not and there is talk that all deposits should be explicitly (rather than just implicitly) insured. Central Bank Digital Currency (CBDCs) would provide such total protection to those holding it (retail CBDCs would be issued/administered by commercial banks and fully backed by an equivalent amount at the central bank).

Public “runs” on banks in order to move vulnerable deposits to cash or a safer bank, result from the fact that banks can fund long term loans with callable deposits. They can lend your deposit to someone buying a house with a 30-year mortgage. This works as long as banks keep enough cash or quickly liquidated assets on hand to cover any deposit withdrawals their depositors might want to make. An alternative to deposit insurance for all deposits is to isolate demand deposits from bank lendable resources by requiring that they be 100% back at the central bank (as with CBDCs) and not available to cover any losses on other bank activities.

It is time to take so called narrow banking (or The Chicago Plan) seriously. CBDCs are the natural vehicle for this restructuring of our money and credit systems.  “Protecting bank deposits”

Econ 101: SVB and bank runs

What is a bank run and how can we prevent them? A bank run, as I am sure you all know, is a rush by depositors to withdraw their deposits for fear that the bank will not have the money to give them. But there is a lot to unpack there in order to understand what is going on and how runs might be prevented.

It is important to understand the difference between debt and equity—between lending a specific amount of money with specific terms and investing an amount of money in exchange for a share of the earnings (or losses) of the recipient. When you buy shares in a company, it has no obligation to return your money. If you no longer want to invest in that company, you can sell your shares to someone else or the company might, at its discretion, buy them back. Its failure to “return” your money cannot be the cause of a company’s bankruptcy (take over by creditors to collect what the company is no longer able to return).

The deposits that we make in our banks are a special case of debt finance of whatever the banks do with our money. As we know, they lend much of it to people and companies for one thing or another and invest some in hopefully safe assets like Treasury bills and keep a tiny bit on hand for when you need cash. But the deposit contract says that you have the right to withdraw (or pay to someone else) any or all of it whenever you want to. Thus, banks must keep sufficient liquid assets in order to satisfy such withdrawals by selling them in the market when you demand your money back. The Federal Reserve, our lender of last resort, also has facilities for lending to banks needing cash against the collateral of bank assets.

The difference between illiquidity and insolvency is critical as well. A bank is solvent when the value of its assets match or exceed the value of its liabilities (such as your deposits). But having sufficient good assets doesn’t mean that that bank can always honor your deposit withdrawal demand. That is a question of liquidity. Does the bank have enough of its assets backing your deposit in forms that it can pay out immediately (cash in its vault, deposits at the Federal Reserve that it can transfer to another bank or use to buy cash, or assets it can quickly sell such as t-bills, or credit lines with other banks or the Fed, etc.)?  “The difference between bank liquidity and capital” Thus, even a solvent bank (positive capital) might fail to honor your withdrawal demand if it doesn’t have sufficient liquid assets. “The big bailout-what next?”

Usually, a bank becomes insolvent when more of its loan assets default than the bank has capital to cover such losses. But as we will see in the case of Silicon Valley Bank, insolvency can also result from a decline in the current market value of a “good” asset.  When depositors suspect that their bank might be insolvent, they will withdraw their money while they still can. This tends to use up the bank’s liquid assets compounding the risk of default. As the word spreads the classical bank run takes off (electronically these days rather than long lines outside the bank as in the old days).

The SVB, which specialized in financial services to start-ups and technology companies, enjoyed a huge increase in its deposits over the last four years, increasing from $49 billion in 2018 to $189.2 billion in 2021 dropping back to $175.4 billion at the end of 2022. It invested most of those deposits in “safe” long term government and similar debt. While the default risk for these assets was negligible, the risk of a loss in current market value if market interest rates increased was high. No one will pay the face value of a 3% ten-year bond while current market rates for the same maturity are 4%. The rapid increase in interest rates as the Federal Reserve reversed money growth to fight inflation tanked the current market value of a large share of SVB’s assets making it impossible for it to come up with the cash depositors might demand if they “ran”. That is how runs work. On March 10 SVB was put into receivership.

The original sin of modern banking is financing long term loans/investments with money (demand and savings deposits). Islamic banking, what uses equity investing, is wiser in this regard. During the Savings and Loan crisis in the U.S. in the 1980s and early 90s (financing mortgages with deposits) more than 1000 S&Ls failed when interest rates increased. But in fact, the U.S. bank regulation regime has some good features. While bank risk taking is subject to many, often costly, regulations, the ultimate check on risk taking comes from the knowledge of bank owners that they will lose their entire stake if their bank becomes insolvent. The Federal Deposit Insurance Corporation (FDIC), which oversees America’s deposit insurance scheme, has developed effective bank bankruptcy and resolution procedures that allow it to take over and resolve insolvent banks with barely a ripple. A favorite tool is the so-called purchase and assumption transaction by which a healthy bank buys the assess of the insolvent one and assumes its liabilities (deposits), usually over a weekend. Thousands of insolvent banks have been resolved by the FDIC in the last fifty years.  See “Institutional and Legal Impediments to Efficient Insolvent Bank Resolution and Ways to Overcome Them” by Warren Coats and Arno Liuksilo “Warren Coats-17”

Most bank depositors pay no attention to the financial condition of their bank because their deposits are insured against losses, which until last week had been raised to $250,000. But the government has now implicitly extended such insurance to all deposits via accounting and other tricks, thus removing any remaining check on bank risk taking from all depositors. On Monday, President Biden announced that no depositors in SVB (and Signature Bank of New York) would lose any of their deposits.  Following the banking crisis of 2008, the Dodd-Frank law further strengthened financial sector regulations. The most important and helpful provisions of this 2,300 page law provided for significant increases and strengthening of bank capital requirements.  

The overuse of debt rather than equity financing is a more general weakness in our economy. The IRS should stop subsidizing it. Interest on borrowing is deductible from taxable income while dividends on equity financing are not. While increasing bank capital makes them less run prone, a simpler and easer to regulate approach is to remove the cause of runs all together by eliminating any risk that your bank can’t honor its obligation to return your money on demand. Another few thousand pages of laws and regulations might catch the last mistakes (though it is hard to see why regulators didn’t address the obvious duration risks taken by SVB), but there is an easier, less costly solution. Bank failures result from the mistakes of banks (their owners and managers) and the failure of depositors to more carefully evaluate the soundness of the bank in which they deposit their money. But depositors have little competence to evaluate bank soundness, and why should they be expected to?

Money (bank deposits) should be fully separated from credit. Deposits should not finance loans. Those financing investments should share in its risks (and rewards) via equity financing. “More than decade ago Professor Kotlikoff and [John Goodman] proposed “limited purpose banking” in The New Republic and in Investment News. The idea is that credit market institutions should be intermediaries between savers and investors and should not themselves use depositors’ money to make risky investments.”

When we deposit money in banks for safekeeping and making payments there should never be any doubt about the bank’s ability to return it on demand and thus no reason to “run” on the bank to protect our deposits. This is the essence of the Chicago Plan which would replace so call fractional reserve banking with 100% reserves (deposits at the central bank). When my bank deposit is backed totally by my bank’s deposits at the Fed, I would know with certainty that they were 100% safe and instantly available.  The “Chicago Plan” and New Deal Banking Reform | Levy Economics Institute (levyinstitute.org) Narrow banking schemes have a similar motivation. “A proposal for the feds balance sheet”

The District of Columbia

A foreigner dropping into “The District” from wherever, would be flabbergasted by the local debate over Statehood, home rule, etc. for the District.

The powers of Congress enumerated in Article 1, Section 8, of the U.S. Constitution include the power to govern a federal district:

  • “Clause 17: To exercise exclusive Legislation in all Cases whatsoever, over such District (not exceeding ten Miles square) as may, by Cession of particular States, and the Acceptance of Congress, become the Seat of the Government of the United States, and to exercise like Authority over all Places purchased by the Consent of the Legislature of the State in which the Same shall be, for the Erection of Forts, Magazines, Arsenals, dock-Yards, and other needful Buildings;”

The Residence Act passed by Congress on July 17, 1790, established what is now called the District of Columbia, or Washington D.C., as the capital of the United States. Maryland and Virginia ceded between them 100 square miles of their territory for this purpose.  Congress moved from its first capital in Philadelphia to Washington in December 1800. On February 27, 1801, 212 years ago today, the so-called Organic Act was approved giving control of the District to Congress “and took away the right of residents to vote in federal elections.” District of Columbia retrocession – Wikipedia

And in 1812 our British friends burned down the White House forcing James Madison to live in what is now the Arts Club of Washington (of which Ito and I are members).

In March 1847, Congress and Virginia’s General Assembly approved the return (“retrocession”) of Virginia’s contribution to the District of Columbia but the retrocession of Maryland’s contribution failed to pass Congress. Turning Maryland’s part of the district into a new state makes no sense to me at all. But neither does Congress’s continued control over all of Maryland’s portion of the District.

The provisions of the Constitution giving Congress legislative power over the lands needed for and occupied by its facilities would be fully met by returning most of the District to Maryland (thus restoring full voting and other citizen rights to its residents). Virginia did it and so can (and should) Maryland.

Trade once again

Everyone understands that without trade they would be dirt poor. If everyone had to be self-sufficient, they would be lucky to survive. It’s almost as obvious that the wider we can trade the more we can specialize in our comparative advantage raising the incomes of everyone. Where many stumble is at their national borders (though within national borders of large countries some regions restrict trade with other national regions to protect otherwise less efficient enterprises thus lowering incomes in general).

Why should trade be restricted across national borders? Three reasons stand out: two legitimate and one not. A potentially legitimate reason concerns national security. Requiring that products necessary for defense be domestically produced, even at greater cost, reduces the risk of supply chain disruptions. The risk is that this excuse is easily abused to the extent that such protection can turn illegitimate or corrupt.

A second legitimate reason also concerns resilience. The most efficient allocation of productive resources must take account of the risks of disruption to supply chains. We buy insurance for many assets and activities, thus incurring a certain cost, to protect our incomes from risks (large or small) of interruption and potentially larger losses. When buying goods or inputs from cheaper producers located far away, we are exposed to larger risks of supply interruptions. American manufacturers, for example, take these risks into account in deciding where to produce and purchase inputs to their products sold in the U.S.

A government bestowed financial favor on a firm or industry (trade protection, industrial policy) is always part of a quid pro quo. The firm delivers favors to the politicians who favor it.  Government protection of otherwise uncompetitive firms increases their viability and profits but at the expense of lower income for the rest of us. Countries that heavily indulge in such protection have suffered lower levels of income. “Trade protection and corruption”

Following World War II, and the establishment of what became the World Trade Organization, barriers to trade (domestic protectionism) were gradually reduced via bilateral and multilateral trade agreements. In the 62 years from 1959 to2021, real United States’ per capita personal income, when measured in constant 2012 dollars to adjust for inflation, increased 297.1%, from $13,971 in 1959 to $55,477 in 2021. This huge increase is the result of increased productivity per worker. But such productivity gains are only possible because of trade (within or across national borders).  “The case for trade”

Weaknesses in government programs to facilitate worker adjustments that are a necessary part of a dynamic, growing economy and other geopolitical factors are undermining the freest and most efficient trade (domestic and global) that our prosperity has depended on. “Geo Economic Fragmentation and the Future of Multilateralism”  “End globalization?”

The Economist magazine has argued that: “One problem [with protectionism and industrial policies] is their extra economic costs. The Economist estimates that replicating the cumulative investments of firms in the global tech-hardware, green-energy and battery industries would cost $3.1trn-4.6trn (3.2-4.8% of global gdp). Reindustrialisation will raise prices, hurting the poor most. Duplicating green supply chains will make it costlier for America and the world to wean themselves off carbon. History suggests that vast amounts of public money could go to waste…. Yet rescuing the global order will require bolder American leadership that once again rejects the false promise of zero-sum thinking. ”  “The destructive new logic that threatens globalisation”

Misinformation and corruption are undermining the basis of our incredible prosperity just when we need to pull together to deal with global warming. We must resist and fight back to restore and preserve our efficient market economies.  They would not exist without trade.