Despite being so rich, Warren Buffett is still ignorant of real economics

Buffett is clearly wealthier than I am, and I'll readily concede a "smarter" investor -- whatever "smarter" means. But he might want to use some of his billions and take some real economics courses. Walter Williams, Don Boudreaux, Russ Roberts at George Mason University, or Burt Folsom at Hillsdale College, could set him straight on free trade. And soon Buffett can take the class "History of [Economic] Thought" at Trinity University, which will be taught by Richard Ebeling. I'm proud to call Dr. Ebeling a friend, and I was saddened when he recently left his position as president of the Foundation for Economic Education to accept his position at Trinity.

Alternatively, Buffett can take sporadic lessons from me at no charge. I've previously written about his mistaken belief that a nation shouldn't import more than it exports. Now he could use a lesson on central banking and what it does. From his recent interview with El País (my translation from the original article's Spanish):

Buffett: It is certain that during the Bush era there has been a gradual reduction of taxes that the greatest fortunes pay, whereas the middle classes pay more and more. And I take advantage of each occasion I have to denounce it. On the subject of the crisis, it's evident that after what happened that we must have more regulation. Even the International Monetary Fund supports that. Perhaps not very short term, but all crisis brings about regulatory changes. I do not believe that they are deep, but without doubt what it has happened to banks and American investment banks will lead to stricter financial regulation.

El País: What has failed so that the mortgages garbage unleashed this storm? Do we attribute the errors to the banks or to bank supervision?

Buffett: The banks exposed themselves too much, they assumed too many risks. So the problem is evidently the banks. They are the guilty ones. It does not need to be put on anyone else.

EP: Crisis or recession?

Buffett: I believe that real problems could have arisen in the case of Bear Stearns' drop. The recession is a technical term defined by the National Bureau of Economic Research: two trimesters of falling GDP. We have not arrived at that, so technically we cannot speak about recession.

EP: If you ask someone who's remained unemployed in Spain like the United States...

Buffett: For the one who loses a job there's surely a recession. But to my surprise, the unemployment rate has not changed too much up to now. It shocks me that with everything that happened in financial markets, real estate markets and other sectors, that unemployment has not risen more. I would not be surprised that unemployment will increase in the next months.

EP: That means the worst is yet to come?

Buffett: The steps that authorities and supervisors have taken hold the possibility that problems of bigger size may arise. I do not believe that the situation will deteriorate in the financial markets. General conditions in the business world will deteriorate, but only for a time.

EP. Are there going to be more victims after Bear Stearns?

Buffett: In March we crossed over the worst moment and in my opinion the Federal Reserve's decision in the case of Bear Stearns was a great step forward. It was a decisive moment for the financial system. A line in the sand to contain the crisis. This incident helped eliminate the problem, or at least it was moderated for other investment banks.

...

Buffett: We have an enormous bubble in the real estate sector. Not in all of the country, but in states like California, Arizona or Florida yes we have a true bubble. And we have it because many of those houses were financed at 95% to 100% by banks that in many cases didn't even know what they were buying. Combined with the financial crisis, the repercussions of all that are going to be very painful.

...

EP: You do not seem very satisfied with what's happened in the Bush era. Between the Democrats: Barack Obama or Hillary Clinton?

Buffett: I would bend over backwards completely with both.

Note: the verb used there is "Me volcaría," and the root "volcar" means a variety of things. But from what Buffett says after, it doesn't sound like he meant the "upset" or "overturned" meanings.

EP: Obama or McCain?

Buffett: Either of the two Democrats before the Republican candidate, although McCain is a good sort, with notable political ideas. I will support 100% the Democratic candidate.

EP: Why?

Buffett: I am closer to their ideas on the tax system, on health care, on abortion rights, the right of the woman to choose if she wants to have a child or not. John McCain is a wonderful man, but he would not agree with me on those. I believe that if McCain wins, it is not going to do anything about the matter.

We'll begin from the top. Is Buffett really so blinded by ideological bias, like Hillary Clinton, that he won't admit why a rich investor deriving income principally from investments will certainly pay a lower tax rate? It's because the income is derived mostly from investments, since capital gains are taxed at a lower rate than income. Buffett and other liberals want to tax investments the same as income, which is absurd: actually, any capital gains tax is absurd, because someone had to earn income to invest in the first place, hence it's double taxation. Moreover, raising the capital gains tax to equal income taxes will wreck the financial markets by crimping the incentive to invest. No skin off Buffett's nose, though, since he's already made his billions, but it will screw over the millions of Americans who are trying to save for themselves. This is what liberals want, however: if people can't save enough for themselves, if they can't earn enough for themselves (being taxed to death or even being taxed/regulated out of a job), then they must depend on government.

The truth is that those evil "investment managers" may pay an overall lower tax rate than "a teacher," but the former will still pay far more in absolute dollars. And as "honorable" as we're taught to think the teaching profession is, society judges these investment professionals to be worth more, because they're paid more. And why not? They're the ones creating wealth and prosperity, first for others through their jobs, and second for themselves by investing their own money back into the economy. They deserve their pay. "The labourer is worthy of his hire," the Lord reminded us. If a neighbor happens to get rich from his job, and he coerces no one, what is it to the rest of us?

And Buffett's such a hypocrite. If he thinks he's not paying enough in taxes, then he can voluntarily pay more. As President Bush said in the last State of the Union address, "Others have said they would personally be happy to pay higher taxes. I welcome their enthusiasm. I'm pleased to report that the IRS accepts both checks and money orders." Since Buffett can pay higher taxes if he wants, we can surmise it's clearly not about his taxes being fair. It's that he wants to force others into his flawed notion of "fair."

Well, I have a proposal for him: why doesn't he pay my tax bills, if he thinks I'm not paying enough? He wouldn't miss that money, and according to Congress' idiotic, Keynesian-based idea that "consumption spending" is all-important, my spending would be more than his investment income, right? (Actually no, because economic growth is the same whether the same dollars are spent or invested.) If Buffett wants to give all his money away, then why not devote his foundation to tax relief? And God knows "middle-class" Americans will need it, once our taxes are hiked in 2011 -- because Bush's "tax cuts for the rich" will expire, except that the tax cuts will go up for a lot more than just "the rich."

Regarding the housing "crisis," Buffett wants to blame the banks and the banks alone. While lenders do share some measure of blame, as I'll get to below, it's not entirely their fault. Borrowers must shoulder some blame too, because they're the ones who were irresponsible enough to take loans that they couldn't repay. If you take out a loan, you're borrowing someone else's property. The person lent you property and expected it back, plus compensation for not having use of the property. So if a borrower uses government to force the lender to "rewrite" the contract terms to a lower interest rate, or even "forgive" the debt, that's stealing from the lender.

If a borrower takes out a loan that he knows he won't repay, that's fraud. It's irrelevant if the borrower truthfully represented his (in)ability to repay (meaning the bank failed to realize or perhaps "overlooked" it). If a borrower knew he lacks/will lack the means to satisfy the agreed-upon loan payments, then the borrower made a criminal decision to take someone's property and not give it back as promised. We should be prosecuting the hell out of these predatory borrowers, who are committing fraud and grand larceny by walking away from their mortgages (often literally). But most Americans have bleeding hearts, so they sympathize with the supposed "victim" and want to punish lenders instead. It's the same mentality by which juries award multi-million dollar judgments to plaintiffs in ridiculous personal injury lawsuits.

Lenders share some blame for being too eager to make loans, but all loans have a built-in penalty for that: lenders can lose potentially the entire amount of the loan, should the borrower default. Thus there's no need for statute or juries to penalize lenders merely for making bad loans; there should be punishment if lenders commit fraud, but that's never the case in the sob stories plastered all over the news. I've yet to see one case of a ARM where there wasn't a part of the contract stipulating how the interest rate would increase. There always will be a clause defining that, because lenders will want something enforceable in court (well not enforceable anymore, as I'll explain in a little), something clear enough to satisfy the "meeting of the minds" requirement of a valid contract.

I've always wondered, were these borrowers truly so stupid to think they'd get 1.9% forever? "Always read the fine print," the old saying goes, and just because it's small print doesn't mean it's unreadable. When something will last the next 30 years of your life, is it so unreasonable to read the agreement and perhaps consult a lawyer?

But lenders were coerced by Congress, who shoulders even more blame. Congress for two decades, but particularly in the last several years, has used legislative blackmail to "encourage" (i.e. force) lenders into giving loans to low-income people, notwithstanding that these borrowers are precisely the sort who likely couldn't repay. Let's be objective: should lenders give equal numbers of loans to low-income people as they do to higher-income people? Of course not; that risk makes no sense whatsoever. So when banks denied applications of low-income applicants, it wasn't based on race, but on qualifications. Banks are in business to make money, and the only color they care about is your money, not your skin. However, in the lower-income brackets there are more minorities than whites, so that's been perverted into "racism" and "discrimination." As I've mentioned before, Stan Leibowitz gave an excellent history of ACORN and other groups whining before Congress about "discrimination" in lending. Oh, but there should be discrimination, namely between those who can repay the loans and those who can't. "Discrimination" isn't inherently bad: the word means to determine differences. But ever since "the politics of victimhood" started taking root, everyone who wasn't qualified on true merit would cry "Discrimination!" and thus perverted the word's meaning.

The greatest blame is on the Federal Reserve, which made all of this possible with insanely low interest rates for the first half of this decade. As a line in one of my favorite movies goes, "Jesus, you can't make a buck in this market, the country's going to hell faster than when that sonofabitch Roosevelt was in charge. Too much cheap money sloshing around the world. Worst mistake we ever made was letting Nixon get off the gold standard." Nothing ever changes. As Bruce Bartlett told me, "The Fed always overdoes it."

We're not just finally feeling the effects, we have been for the last few years. We haven't seen this kind of inflation, and true inflation since we're talking purely about the money supply, since the early 1980s. And each time the Fed says it will "inject liquidity" and auction off more bonds, I cringe. It may have its financial uses, but the Fed is continually devaluing the dollar when it should let the financial markets correct themselves. The Fed made money so easily available and directly caused a credit crisis, of which the housing bubble is the most visible part. Lenders had every incentive to borrow as much as the Fed would create, since not partaking meant watching competitors help themselves and make profits. And the vast amounts available the borrow enabled borrowers to bid higher and higher offers on houses, driving up prices artificially. The Fed showed banks the carrot, giving banks the means to finance "no money down" mortgages, and Congress held the stick, namely the threat of investigations and regulations.

One of the most absurd explanations for the crisis is that it's the deregulation of the separation of commercial and investment banks; this two-paragraph concept was expanded into an entire book that my uncle briefly told me about. The repeal of the Glass-Steagle Act did encourage bank mergers, and eventually that banks would underwrite securities based on collateral-based loans like mortgages, but this wouldn't have been possible if the Federal Reserve hadn't made available such immense quantities of loanable funds.

Now people actually believe the Fed can alleviate the crisis by throwing more money at it, when it was the cheap money that caused the problems in the first place? A company can alleviate financial problems and stave off bankruptcy by diluting shares to raise capital. But if it constantly does so often that it becomes policy, investors will trust the company less and less. Why should the Fed be any different when it continually dilutes the money supply?

Buffett would have clarified the general nature of the problem, that it's not just housing, if he knew anything about real economics. He's a great investor, as I said, but did that, or his nickname "The Oracle of Omaha," or now being the world's richest man go to his head, that he goes by his own economic definitions? In this interview, he says the U.S. isn't in a recession, per NBER's definition. Yet he recently told Der Spiegel that "I believe that we are already in a recession. Perhaps not in the sense as defined by economists....But people are already feeling the effects of a recession." So which is it?

I'm actually not surprised that unemployment is so low. By our own historical standards, we're average, and our unemployment statistics in France or Germany would be considered an economic boom. The dollar is in bad shape, and that is a big problem, but overall the U.S. economy is far more resilient than Buffett or the other doomsayers think. Housing isn't the majority of the economy, despite its rippling effects, as are the major banks. Bear Stearns earned $9.2 billion and $5.9 billion in gross revenue in fiscal years 2006 and 2007, respectively. Its operations, including its $1.2 billion dollar headquarters in midtown Manhattan, could have completely vanished off the planet, its 14000 employees could have all stopped working, and it still would make hardly a dent in the $14 trillion American economy.

I tried explaining that a little while back to a pseudo-capitalist who said Bear Stearns was "too big to fail." Nonsense. A free market, with no bailout, would have sorted it out just fine: other companies would have bought out the pieces, and the employees would have naturally gravitated to other jobs, and this Schumpeterian "creative destruction" would have made things all the more efficient. But so many, Buffett included, are fans of the Bear Stearns bailout. Did he really have that big a long position in BSC? Or is he just another pseudo-capitalist who wants the "free market" and "competition" only when it suits him?

Then we have his Democratic bias, showing he's just a limousine liberal at heart. No surprise there. The money he's giving away will do many good things, but that's not enough. He has to force people into his own politics, using the weapon of government.

A lesson for Warren Buffett on international investment

Berkshire Hathaway recently announced that it's buying an 80% stake in Iscar Metalworking. An Israeli newspaper quoted him as saying, "I plan further acquisitions of Israeli companies in the future." Buffett also said, "There are dozens of countries in which we would be happy to buy the right business."

Side note: see what happens when a country strives for a free market? It will attract investment capital from all over the world, leading to prosperity and encouraging even more freedom. Are you listening, Hugo Chavez and Evo Morales, you tyrants who are leading your countries down the path of economic destruction? Manuel Obrador won't listen, and he might just win Mexico's presidential election. Obrador opposes foreign investment, though Pemex (Mexico's nationalized oil company) cannot survive with foreign capital. Apparently Obrador would prefer that Mexico stay poor if achieving prosperity means those evil foreign capitalists also profit.

This international transaction ought to show Buffett the error of his ways, but it's likely he will still believe that the U.S. should force zero trade deficits, restricting imports so they don't exceed exports. However, trade gaps are, by definition, balanced by foreigners' investments in the country running the trade deficit. Foreigners have to do something with the money they earn from selling goods and services, so they buy assets in that country. But it doesn't even matter that it's the same foreigners buying assets, which might surprise people that have the false idea that trade deficits are inherently bad.

Israel is running a trade deficit, which is actually typical of growing economies today, and Buffett is helping to balance it by acquiring Israeli assets. It wouldn't matter if Buffett were involved in 0% or 100% of all exports to Israel. Buffett would eventually do business with someone who would eventually do business with someone who exports goods and services to Israel. The money might get converted from shekels to euros to pounds sterling to dollars, and then Buffett would convert them back to shekels. It all balances out in the end.

Another example: I spend money at my local supermarket, which buys nothing from me. I'm not going to worry about that, or that none of the employees together do an equivalent amount of business directly with me. Their own spending will spread throughout the economy (the global economy if need be), and everything will balance out in the end. One might invest $100 that week via my employer's brokerage arm, but only a very, very small fraction of the fees will help pay my salary. Or he'll invest $100 through another firm, with similar fractions spreading throughout. So how do I eventually get back the money I spent on groceries? The flows are too complex to spend time on, really, and it doesn't matter anyway: money is the ultimate fungible commodity. Some people track the travel of dollar bills as a curiosity, but it's obvious that one bill is as green as the other. A penny here, a penny there, and it eventually adds up. So just like I don't worry about the precise source of each paycheck, I don't worry about the precise source of foreign investment to balance out a trade deficit. Actually, I don't worry about trade deficits at all.

A trade deficit is neither good or bad, only an indication that domestic consumers would rather spend their money while foreigners supply capital. There's no danger of foreigners buying up an entire country, Don Boudreaux just explained, because as an economy grows, new assets are created that foreigners can buy. Foreigners' particular preferences even directs the creation of new assets just like domestic consumers' desires would. One example I have emphasized is real estate, especially in New York City. Some foreigners contract to buy luxury apartments even before construction has begun on the high-rises, because they need to do something, after all, with the money they earn from selling their goods and services to Americans. The dollars eventually come home.

As if we already didn't know Pat Buchanan is an idiot

He supports a bailout for American automakers, the supposed necessity of which I debunked the other night.

He complains that other nations are manufacturing powerhouses that sell more to us than we sell to them. Do I sell any bananas to my local grocery store, let alone an equal quantity that I buy from it? Have I sold two computers to Dell, to balance the two wonderful machines I've bought since last year? Of course not, and the same principle applies to everything else. It's perfectly normal to buy more from someone than you sell to the same; it's all balanced out in the end. Your trading partner may not even buy something else directly from you, but rather trade with someone else who might trade with you, or trade with someone else who trades with someone else who trades with you, ad infinitum. Trade isn't a matter of starting and ending points, but rather a complex web where everything (everyone) is connected -- perhaps not directly, but eventually connected through others. The bottom line is this: do you produce enough to buy what you want? For as Bastiat taught us, "Man produces in order to consume. He is at once both producer and consumer."

And Pat Buchanan complains that other nations don't tax their industries like we do. So the solution is for other countries to implement onerous taxation and reduce their own manufacturing output, in turn reducing the standard of living for everyone? Walter Williams put it best: "Imagine that you and I are in a rowboat. I commit the stupid act of shooting a hole in my end of the boat. Would it be intelligent for you to respond by shooting a hole in your end of the boat?"

As Bastiat taught us over a century and a half ago, it's a gift when other countries can sell us something at a lower price than if we made it ourselves. Consider his five points:

(1) That to equalize the conditions of production is to attack exchange at its very foundations.
(2) That it is not true that job opportunities within a country may be choked off by the competition of more favored countries.
(3) That, even if this were true, protective tariffs do not equalize the conditions of production.
(4) That free trade equalizes these conditions as much as they can be equalized.
(5) Finally, that it is the least favored countries that gain the most from exchange.

So why should we think it's "unfair" when South Korea buys very few cars from us? They specialize in building cars there, so it makes no sense for them to import American cars that cost more because of shipping, and which are probably unreliable. By definition, there is a balance in everything that exchanges hands, unless the South Koreans want to hold on to physical dollars (which does them no good). So the South Koreans buy American-made heavy machinery like John Deeres and Caterpillars, Boeing aircraft, maybe American-written computer software. They can also buy U.S. Treasury securities, or dollar-denominated U.S. assets like stocks and corporate bonds, or use the dollars to buy crude oil and other globally trade commodities that are priced in dollars. As I said in my first lesson for Warren Buffett, any currency eventually comes home:

Israel is running a trade deficit, which is actually typical of growing economies today, and Buffett is helping to balance it by acquiring Israeli assets. It wouldn't matter if Buffett were involved in 0% or 100% of all exports to Israel. Buffett would eventually do business with someone who would eventually do business with someone who exports goods and services to Israel. The money might get converted from shekels to euros to pounds sterling to dollars, and then Buffett would convert them back to shekels. It all balances out in the end.

The latest reason to ignore anything Warren Buffett says about the economy

Warren Buffett thinks the economy is already in a recession and will get worse. As I've shown before, he might be a great investor, but he knows nothinga bout real economics. In the last round, I debunked his "We're already in a recession claim." Actually, he debunked himself, telling El Pais the U.S. is not in a recession, after telling Der Spiegel that the recession's already here.

More importantly, while 1Q 2008 GDP was low by our standards (although "normal" by French standards), it was still positive. So have all other quarters of GDP since...2001. "Recession" means two consecutive quarters of economic growth, so how can we be in a recession when we haven't had a single negative quarter yet?

Could Buffett justify claims of a "recession" based on other economic indicators? Hardly. I debunked the latest job numbers a few weeks ago, which were because of 200,000 new entrants to the workforce. Hourly earnings and productivity are still up. Do people care about weakening industries and credit markets? No, they care more about what they bring home, and their employers care about how efficiently they produce. That's the remarkable resilience of the American economy: it still grows despite all the supposed weaknesses in construction growth and consumer spending. In the end, their changes are merely shifts in economic activity, because a decline in one can mean an increase elsewhere in the economy -- other growing industries the mainstream media doesn't like to admit are growing, and/or personal saving that fuels business investment. Obviously if construction spending and consumer spending fall, but economic growth is still positive, there are more-than-offsetting gains elsewhere in the economy.

Where's the recession, Buffett?

Worrying about the trade deficit

Perhaps the biggest economic news Friday morning was that the U.S. trade deficit soared to its second-highest level ever. With that, inflation fears and higher oil prices, stocks took a bit of beating by the market's closing.

With impeccable timing, Dan Boudreaux explained Thursday how Warren Buffett misunderstands the trade gap, using simple scenarios to illustrate the underlying principles of trade. Many people, including "the world's greatest investor," fail to understand that there's intrinsically no difference between labor in one country versus labor in another. Let's say that my neighbor wants to support someone local by buying from him, which is his right; isn't it also my right to buy from whoever can supply a good or service for the cheapest price?

Does a family make their own shoes, or their own shirts, or build their own cars? Of course not. The principle of comparative advantage is independent of families, towns, states and provinces, and why not national borders too? Consider that when I purchase Florida oranges, well, that denies my fellow New York state residents a job growing oranges. When I buy Idaho potatoes or Midwest beef, that deprives my fellow New York state residents of those jobs. Such arguments are patently absurd, most people would agree. So why would the same people probably think "it deprives honest, hard-working Americans of jobs" when we import Chinese-made stuffed animals or Central American textiles? It doesn't "deprive Americans of jobs" any more than I can "deprive" fellow New Yorkers of jobs. What it does is push my fellow New Yorkers toward jobs where they have comparative advantage.

More importantly, when I buy Florida oranges and Midwest beef, it really doesn't matter if I sell something to them in return, only that I can afford what I buy from them. Likewise, it doesn't even matter that we export anything at all to our trading partners, just as long as we can afford to buy their imports. That both sides are equal is not a necessity of trade. It's important to remember what Adam Smith wrote in The Wealth of Nations, Book 4, Chapter 3, part 2:

Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon which, not only these restraints, but almost all the other regulations of commerce are founded. When two places trade with one another, this doctrine supposes that, if the balance be even, neither of them either loses or gains; but if it leans in any degree to one side, that one of them loses and the other gains in proportion to its declension from the exact equilibrium. Both suppositions are false. A trade which is forced by means of bounties and monopolies may be and commonly is disadvantageous to the country in whose favour it is meant to be established, as I shall endeavour to show hereafter. But that trade which, without force or constraint, is naturally and regularly carried on between any two places is always advantageous, though not always equally so, to both

By advantage or gain, I understand not the increase of the quantity of gold and silver, but that of the exchangeable value of the annual produce of the land and labour of the country, or the increase of the annual revenue of its inhabitants.

Wow, looks like Warren Buffett needs to read some Adam Smith. Buffett believes in forcing a zero gap in trade, i.e. we can import a dollar's worth of goods and services only if we export a dollar of goods and services. Notwithstanding that's bad economics, I question the logistics of how you can do that with any reasonable transparency -- what are we going to do, require a foreign ship to stay in port until one of our own ships starts unloading in Tokyo or elsewhere? Or would quotas be set where we'd plan to export, say, $25 billion to China, and thus export a maximum of $25 billion? Never mind the higher prices that protectionism brings: imagine all the inevitable and wasteful rent-seeking that would precipitate, as companies on both sides lobbied to get their share!

I've come to prefer calling it a trade gap, not a trade deficit, for two reasons. First, "deficit" has such a negative connotation for most people, and unnecessarily so when it comes to trade. Second, Buffett and most others think "deficit" is necessarily debt.

Some have stated that foreigners shouldn't get so many dollars from us, that we shouldn't "export our wealth." Again, there's no intrinsic difference in the labor. An American earning $1 can circulate it through the U.S. economy. However, what is to stop a Chinese textile worker, a Brazilian sugar harvester or a Belgian chocolatier from earning that $1, then spending the $1 on American goods or services? Or the foreigner could instead save that $1, which his major bank of country's central bank could invest in U.S. assets. Either way, the dollar can easily work its way back, in time, to the U.S. economy. After all, it does no good for foreigners to simply hold dollars, unless their central bank wishes to augment their reserve holdings. (Even so, China notably turns its U.S. dollar reserves, currently something like $450 billion, into U.S. Treasury securities.) Another example to think about is that most OPEC nations want to sell oil for only dollars. So China, Japan and anyone else can buy petroleum with the dollars they gained from trade surpluses with the U.S., and what will the Saudis, Yemenis et al do? They'll buy U.S. goods and services, they'll invest the money in U.S. securities, or they'll buy something from someone who wants dollars.

It's true that some of the trade gap is returned to the U.S. as interest-bearing investments, like bonds, but not all. As Boudreaux stated here, foreigners have some options for using their dollars. They may purchase stock or real estate, counting on the value to appreciate over time; maybe some of the stock pays dividends, but those aren't debt. The benefit most people don't realize is that after selling to Americans, foreigners can very easily take those acquired dollars and invest them somehow in the American economy; this means Americans don't have to supply that capital ourselves, and we thus have more money for consumption spending. So effectively, we have our cake and eat it too. This isn't indefinitely sustainable, of course, because at some point there won't be any more assets to buy -- or another possibility that I'll examine at the end, that a vast economy like the U.S. will have assets left, but foreigners won't have enough savings to buy them.

Donald Luskin once used the example of a runner. There are appropriate times for a runner to sprint, though he can't do so indefinitely. So it is with debt. John Stuart Mill said, "War is an ugly thing, but not the ugliest of things." I say, "Debt is an undesirable thing, but not the most undesirable of things." No one goes into debt strictly for the sake of being in debt, but because the interest payments are worthwhile. No sane person wants a mortgage of $X as an end in itself, but because that debt is preferable to having to wait to own the house.

The mainstream belief is that at some point, foreigners will decelerate their purchases of U.S. assets once they believe the U.S. can no longer afford the interest payments on the "current account deficit." When that happens, Americans are supposed to reduce consumption spending and start saving more. (Just over three years ago, Andy Xie of Morgan Stanley had a couple of wild predictions about that scenario, neither of which came true.) But a current account deficit is not all debt, as Boudreaux has explained, especially that it's often double-counted. When foreigners receive $X from selling us goods and services, then invest half of that in U.S. Treasury bonds, the actual debt is half of $X, not 1.5 times $X. I also point to the interest that the U.S. federal government pays on its debt, which is part of the current account deficit but certainly not debt.

Catherine Mann once noted that the U.S. current account (the trade gap, interest payments and unilateral transfers) is currently sustainable, but not forever so. She predicted, "At current exchange rates and assuming a resumption of sustained growth in the world economy, by 2005 the current account deficit will be about $600 billion — more than 5 percent of GDP." She made this in 2000, which was quite a nice mark to hit. Other economists, though, would just harp the "Unsustainable!" line and say that current account reversal would have to come "this year." If it didn't come to pass, they'd repeat the claim next year, and the year after that. It brings to mind a joke, "Economists have successfully forecasted ten of the last three recessions." Think of those who predicted the Red Sox would win the World Series in 1919, then 1920, and so on.

I personally believe sustainability's end is not when foreigners believe the U.S. can no longer afford the interest payments, but when foreigners can't afford to invest any more here. As long as the rest of the world's major economies are stagnant, I don't believe there will be a shortage of foreign investment in the U.S. economy. After all, most of the EuroZone is flat and Japan is back in recession, so where will foreigners want to invest their savings? Right here in the U.S. of A. Some of the Eastern European economies are starting to do well with liberalized tax reform, but they don't have the sheer quantity of available assets that the U.S. does, and the U.S. is still (overall) a safer nation in which to invest.

A lot of things are worth paying others to do

The Star Stage Deli, on 55th Street just west of 6th Avenue, has quite good food. They make a very good cheeseburger, and their french fries are cut nice and thick, though I find their grilled panini lacking. Today, they had an excellent pepper steak that made quite a good lunch. I could have cooked some beef myself, cooked peppers and onions, and whipped some mashed potatoes, but at what cost? Paying $8.62 or so was quite a bargain considering how it freed me to do what I consider more valuable things.

That's the beauty of purely voluntary trade: everyone benefits. The deli workers earn more than if they simply produced food for themselves, leaving them that much more prosperous. I benefit by having much more free time, not to mention the convenience of not having to bring Tupperware containers from home, and of course the better taste of freshly cooked food.

I wrote last night about my intensive method of polishing shoes, which is an exception because no one else can do the job as I desire. However, when my shoes need new heels, it's much like buying lunch: I suppose I could order replacement Vibrams and appropriate nails, sand things, and do an overall job as well as any cobbler. However, someone did it for me for $16, and I'd have used far more than $16 worth of my time to do it myself. So at lunchtime, I dropped off my favorite dress shoes at the shoe-repair shop next door to the Star Stage Deli. They have a very fast turnaround; my shoes were ready by 5 o'clock, and if they weren't busy, maybe 10-15 minutes. Since I was in the vicinity anyway to buy lunch, and the shop is along the way to my usual subway station, the cost in terms of my time was minimal.

Believe it or not, there's a valuable economics lesson here. Today, I had a trade deficit of $8.62 with the deli, and $16 with the cobbler. Am I exporting my income to others? Did I really lose $24.62? Is my family being deprived of the opportunity to do that work for me? Wouldn't it be better if my family charged me $10 to cook my lunch, and $20 to put new heels on my shoes? After all, that would give them so much more money, and if they're restricted to buying things from me (at higher prices than others charge), I'll be better off too...right?

As my patron saint might have said, "Absurd!" The problem with restricting trade is that it may force higher wages, but it does not create higher wealth. So then why do Americans fear trading with China, or any other nation that offers us the same (even higher-quality) products and services for cheaper prices? If it's not a bad thing for me to run a "trade deficit" with a business, why is it so different when it's between nations? Also, why do so many Americans believe that we must keep our currency between ourselves? Do any of us worry about keeping money between ourselves and our friends, refraining from buying from anyone outside our circle? Whether it's buying more from China than the Chinese do from us, or immigrants mailing money to their families, the dollars will come back to us in one way or another.

Should government force delis to lower their prices, and force my employer to raise it, to "equalize" each transaction? That's completely absurd, of course. It's also absurd to think that anyone at the deli, or all people at the deli, should buy exactly as much from me as I do from them. Then why do people like Warren Buffett think the U.S. should force imports to be no more than our exports? And why do people, generally pseudo-economists and publicity-seeking politicians like Chuck Schumer, think it's economically sound to "correct" the trade deficit via currency manipulation?

Real economics does not recognize borders, and real economics is very scalar. Like two triangles of the same shape but different sizes, the principles behind transactions have the same shape, whether we're talking about two people or two nations.

Previous:
Walter Williams on the trade deficit
Worrying about the trade deficit
So you wanna revalue the yuan?
A lesson for Warren Buffett on international investment

Obama and Geithner's "Money PPIP"

So far, it looks like the White House couldn't make up its mind what to tell Martin Crutsinger about the name of the new bureaucratic boondoggle. This version of his article calls it the "Public Investment Corp." This version calls it the "Public-Private Investment Program."

I prefer "PPIP" because it sounds like the 1986 comedy with Tom Hanks and Shelley Long, so named because the lead characters keep pouring money into a house that's falling apart. The federal government is simply pumping our money into sustaining companies that should be allowed to fail, and propping up asset values that need proper valuation. Once more, the government has been behind everything that precipitated this mess, from instituting mark-to-market accounting at the worst time possible to "rescue" efforts like TARP and PPIP that prevent us from placing true values on these assets.

Few realize how government has sparked the "crisis" and is purposely continuing it. I've written about this across many posts over several months, but I'll put it all here; just follow my explanation for each link in the chain. Right when markets panicked and CDOs and other securities plunged in value, the feds deliberately imposed mark-to-market so that banks' balance sheets would be impacted negatively -- and banks are forced to cease lending if their net assets became negative. The assets are deemed worthless, though, only because TARP and the like are discouraging people from sitting down and determining a real value (as opposed to a bureaucrat's politically motivated guess). Let's say an asset on the market is worth 1 cent on the dollar, and an investor might buy it at 10 cents in the hope it will eventually be worth 50. But the feds are talking about buying it at 70 (easy when taxes always come from other people!), so how can anyone determine the true value? Why would anyone bother?

See, it's all "legal" when the feds create a shadow holding company to hide AIG's bad assets on another ledger, the same fraudulent practice that got Enron and WorldCom in trouble. When it comes to mark-to-market, however, banks must list all assets on their balance sheets, thus assuming all liability for losses! So when one doesn't have positive net assets so it can lend under FDIC rules, the feds so graciously step in with a cash infusion (courtesy of everyone who doesn't make a living via government, in the form of taxes and inflation). Now PPIP will "help" banks by effectively whiting-out these assets, putting taxpayers even more on the hook for the initial purchase plus any future losses. The circle is complete.

I've explained before that "There's plenty of investable money around the world, but no one wants to sink it in *these* securities. They're really that bad. Even Warren Buffett wants the federal government to bail things out, instead of seizing a profit opportunity and jumping in himself. Surely he could put up a 'mere' $1 billion without blinking, but he's smart enough to recognize that the possible returns aren't worth the current asking price." Why do so few see the warning sign that when the private sector is staying away from buying these assets, maybe they're not such great deals? Now, a lot of these assets are worth next to nothing and even zero, but some still have value. Who's to say that a particular security, comprised of notes from such-and-such a neighborhood, isn't a good return in the end? Actually, none of us can -- unless you're well-connected with the government, none of us can really tell if any given neighborhood has people who will get a housing bailout!

Note that I was wrong, though, about the source of the funding for all these programs. However, last September I (and most people) just couldn't imagine the initial $750 billion TARP, then the $787 billion "stimulus," the $1.2 trillion the Fed recently announced it will create, and now the new $1 trillion so that the Treasury can buy up "toxic assets" under PPIP/PIC. Every new dollar that the feds are spending can come only from whatever new money the Fed can create. There just isn't enough of a tax base; there just isn't enough money to borrow.

Trillion, billion, the prefix to the "illion" has sadly lost all meaning. This is pure insanity, and with Obama and Geithner accelerating what GWB began, things will stop only with a disastrous crash.

Update: what irony in Christina Romer's misuse of "silver bullet." Over time, it's been twisted into the simple meaning of something that will work effectively. Proper usage refers to killing an otherwise invulnerable creature (like vampires in old pre-Stoker folklore, or Wolfman in modern monster tales). Romer said, "I don't think Wall Street is expecting the silver bullet," so Wall Street had better beware.

Thou shalt pay thy taxes to The One, lest thou incurrest his wrath

What a picture for Yahoo News to use.



From the first moment Obama pushed his "jobs bill" (i.e. jobs for his political supporters with the cost of others' unemployment), he said it would be "paid for." Yesterday he continued to claim, "And it will not add to the deficit. It will be paid for." The truth came out the morning after the original announcement: it's all about tax hikes. As part of a "deficit reduction plan" Obama would have us believe is unrelated, "Obama to propose 'Buffett tax' on millionaires". How dare people believe that they're entitled to the fruits of their labor, how dare they believe that they get to keep their wealth as the reward for their successful decisions!

Anytime a politician says anything close to "largely by raising taxes on wealthier families," every working American had better hang on to his wallet. USA Today spins it as "going after tax breaks for oil companies and the owners of corporate jets." Bill Clinton said on October 19, 1992, "I will tell you this: I will not raise taxes on the middle-class to pay for these programs." How did that work out for us? I was a teenager yet saw through the lie right away. His "shocking" tax hike proposal a mere four months later was shocking to me only because it didn't come sooner. Even the New York Times called it his "plan to raise the taxes of almost all Americans in order to lower the Federal budget deficit."

And beyond the immorality of taking someone's money by force to give to others, Obama's plan is accounting fraud. John Watson at American Thinker pointed out:

The president's new "Jobs Bill" will take over $400 billion from taxpayers over ten years to pay for it, but the expenditures will be authorized right away. There is, however, an inconvenient truth about which the president has failed to remind us: today's Congress cannot bind a future Congress. Therefore, if the government wants to spend $400 billion right away, then they need to find a way to cut $400 billion of spending right away, not by some non-binding ten year ruse. To do otherwise only increases today's deficit.

This scheme would supposedly add 2.7% to a $15 trillion economy. There's just one problem: it wouldn't work for the same reason the $787 billion stimulus didn't work. It's the worst economics: $400 billion in tax hikes means taking $400 billion from spending or savings that would have happened in other forms. Bastiat's lesson on broken windows is economics' quantum singularity from which there is no escape.

The Reichstag fire of the financial world, part II: scapegoats and a bait-and-switch

The original Reichstag fire needed a scapegoat, and today's financial Reichstag fire is no different. The scapegoat needs to be an innocent party who was found there. He doesn't even need to be plausibly guilty, only that the public will accept whatever story the government feeds them.

Capitalism was "there" in this financial Reichstag fire, and it was "guilty" in that investors and investment managers made bad decisions, but it's hardly plausible guilt once you investigate and realize that everything happened because of deeper causes than those bad decisions. Capitalism is merely taking the blame for the "financial crisis" that government engendered and fueled.

As I explained in a comment over at Cafe Hayek,

muirgeo, I'd like you to explain how the creation of GSEs, which then "recycle" money back into lending markets and subsequently, which were THE culprits in using securitization to disguise bad assets, is "laissez-faire."

When the government is involved, there's no free market: *someone* is being pushed or pulled. You've argued otherwise around here for a long time, but that does not change the fact that any "bubbles" were purely the result of government interference in natural market happenings. If you think what's happened is the result of laissez-faire, I'd hate to see what your idea of interventionism is.

"Speculate don't produce" is what government encourages everyone to do when it gets involved in investments, whether the Mississippi Scheme of 18th century France, the South Sea Bubble of 18th century England, or the latest American "crisis."

...

So at what point do you think something goes from being private to being government? The answer is easy, actually: zero. Once government is involved, there's no more free market, and no more private control. "Some" private ownership doesn't count; it's still a government operation.

If Fannie and Freddie had been fully private corporations, investors would have never had the confidence they once did, and the GSEs consequently would have never gotten to this level. But investors had far more faith than was warranted, because there was always, always the implicit promise of a federal bailout. No matter how "privatized" they were on paper, the feds would never let them fail. That moral hazard prevented rational decision-making by both investors and Fannie and Freddie's executives.

But for decades we'll assuredly hear continuously that "capitalism failed, just like it failed in the late 1920s" -- except that then, as now, it was government intervention in markets that created a bubble, caused a crash, and made the crash worse. Even today, many of our children are taught the myth that "FDR saved capitalism" when the New Deal only made things worse, and not even World War II spurring manufacturing output could pull the U.S. back into prosperity.

I've tried explaining to a certain state-worshipping twit that the New Deal didn't work, for if it did, why was there a "Roosevelt recession"? All he could do was point to GDP, which was an artificial increase. When you look at other indicators that Keynesian policies cannot inflate, like unemployment, business investment, and unemployment, the New Deal didn't exactly put people to work like it's believed today. I disagree with Boudreaux on one thing: I still maintain FDR did indeed make things worse, not just prolonged. But don't take my word for it. The Treasury Secretary at the time, Henry Morgenthau, himself admitted unemployment was still bad -- back to square one with a much greater national debt (which is what I mean by "worse"). Tyler Cowen explained why the New Deal didn't work (quite an amazing thing to be published in the NY Times!), and he previously linked to papers explaining why World War II didn't help the economy, either. Robert Higgs in October had provided his own explanation of why the war did nothing.

It still doesn't matter how much we debunk flawed history and historical interpretations. People are so brainwashed that the vast majority of future Americans will readily swallow the "Capitalism failed!" mythos about the current government-manufactured crisis, as most Americans do today about the government-manufactured Great Depression. Capitalism has been the easy scapegoat for at least 80 years (a century if you want to count the events behind the creation of the Federal Reserve). Even government isn't stupid enough to deviate from a winning strategy.

What makes current circumstances a little different is that we've just seen one of the most devious bait-and-switch schemes ever played.

At first George W. Bush, Hank Paulson, et al, decided that the Treasury would buy up several hundred billions dollars worth of "distressed securities" -- which private investors correctly wouldn't dare sink money into, at least not at what the federal government is offering. To paraphrase Milton Friedman, isn't it amazing how you're willing to offer so much more, and take a huge risk, when you're spending other people's money? The feds could offer far more on the dollar than private investors would risk, and we should see warning signs when even Warren Buffett, a proponent of the bailout, was putting $5 billion into Goldman Sachs instead of these bad assets.

Oh, but not only mortgage-backed securities, it was quickly decided, but maybe the bailout could extend to bad credit card loans, student loans and auto loans! By this point, you couldn't even call it a "farce" -- it was not just absurdly beyond "bailout," but starting to dwarf any other federal giveaway, ever.

But then Hank Paulson announced, no, they won't buy these assets after all. What's the catch? No catch, just that the federal government will continue with buying up stakes in the top nine U.S. banks.

You have to hand it to him: that was one hell of a bait-and-switch. McQ understands that much, but he just needs to connect the dots. After observing what's really happening, we must ask ourselves the real question: why?

As I said before, it's about controlling the U.S. financial system. Not regulation, not "helping," not "ensuring fairness," but outright control. Control money, and you have the greatest control of the people. Simply put, there was never intent to buy up the "distressed securities," whether to prop up their values for investors or to "take these toxic assets off banks' balance sheets to improve their liquidity." That was all a smokescreen. The real plan all along was to start nationalizing the banking industry. It isn't just the top nine banks who received federal funds, but plenty of regional banks too.

Why the elaborate game, though? Because Americans needed to be softened up to the notion of the federal government buying up stakes in banks. They'd otherwise balk at it: it would smack too much of "socialism" to conservatives, and "fascism" to liberals. If government creates a crisis, however, or just the specter of one, its officials and allied pundits can blabber economic malarkey for weeks until the people nod their heads and say,"Uh huh, that sounds good." Most people don't have the intelligence or learning to comprehend all these grand plans, even if they'd work, and in the end they're so numb to it all that the powers of darkness can alter or drop the original plans, revealing what their true intentions were all along.

And we're constantly being told it's all for our benefit:



The actual headline reads, "Massive new programs aimed at loosening credit." But wait a minute, a bailout for whom, paid for by whom? Where is the money coming from?

This time it's from the Federal Reserve, not the Treasury, so it's not a matter of our tax dollars, right? Of course, we'll have to worry about a pesky thing called inflation, produced by central banks and central banks alone, as the Federal Reserve pumps many more hundreds of billions of dollars into the global economy.

Here's some food for thought. I was recently telling a friend that the last time the euro was under $1.30 was mid-2006, when gold was still in the $600 dollar range. So while the dollar has strengthened vis-à-vis the euro, we can still look at gold prices to see the inflation. By this particular measurement, and it's not absolute since there are others, I'm figuring about 15% inflation in the last couple of years. That doesn't affect everything, e.g. oil and gasoline prices which are falling rapidly because of expectations that demand will continue to decrease, but forget the babble about unsustainable trade deficits: inflation is never sustainable, but inflation at this high rate will produce very bad results sooner rather than later.