“It may come as a shock …” wrote John Flynn, “to be told that[you] have never experienced that kind of society which [our] ancestors knew as the American Republic …” Flynn, the editor of the popular weekly the Saturday Evening Post, had already come to this conclusion in 1955. In his book The Decline of the American Republic, Flynn observed that Americans needlessly “live in the war-torn, debt-ridden, tax-harried wreckage of a once imposing edif ice of the free society which arose out of the American Revolution on the foundation of the U.S. Constitution.”

An empire needs a source of income suff icient to fund its military campaigns, regulatory regimes, and domestic schemes. It also needs a strong central authority to direct its ambitious new programs. In one short 12-month span, a year the writer Frank Chodorov calls the “Revolution of 1913,” the empire got the tools it needed. That year—the same year European countries abandoned the gold standard in preparation for World
War I—the old Republic ceased to exist.

WHERE THE MONEY COMES FROM

America’s current system of income tax is a twentieth-century invention. Previous attempts at creating a national tax had failed or had been thrown out because they violated tenets of the Constitution deemed essential by the founders. In its f irst 100 years, the United States supported its federal government with a series of what we would call “sin taxes” today, on

whiskey, tobacco, and sugar. By 1817, all internal taxes were abolished by Congress, leaving only tariffs on imported goods as a means for supporting the government.

The first income tax that citizens of the young Republic were forced to endure came about because Congress had been asked to fund the War between the States. In 1862, a tax on incomes between $600 and $10,000 was assessed at the rate of 3 percent, and the Internal Revenue Service (IRS) was created. The war was costing $1.75 million per day.2 The government sold off land, borrowed heavily, enacted various fees, and increased excise taxes, but it simply wasn’t enough. The income tax seemed like the only way to finance the war and service the country’s then-staggering $505 million debt. That tax was promoted as a temporary wartime measure. Temporary it was. In 1872, after servicing the Reconstruction, Congress yanked the “temporary” tax.

But that was not the end of it. The income tax appealed to empire builders because it alone offered enough cash to finance the enterprise. But it had another appeal—to the larceny and envy in the hearts of ordinary citizens. Following a banking panic in 1893, Senator William Peffer of Kansas, supported the progressive income tax in this way:

Wealth is accumulated in New York, and not because those men are more industrious than we are, not because they are wiser and better, but because they trade, because they buy and sell, because they deal in usury, because they reap in what they have never earned, because they take in and live off what other men earn… . The West and the South have made you people rich.

That sentiment was puffed up by Nebraska’s bellicose worldimprover William Jennings Bryan, who argued against the “equal taxation” requirement in the Constitution, in favor of the current progressive one:

If New York and Massachusetts pay more tax under this law than other states, it will be because they have more taxable incomes within their borders. And why should not those sections pay most which enjoy most?

This logic is simple. People who are more productive should be forced to pay a bigger share of their common expenses. But this kind of logic had no place in a free republic where all men were supposedly created equal; if they were equal they could each carry their own share of

the burden of central government. Under this new regime, men were no longer equal, but given differing loads to carry based on the whims of elected hacks.

With considerable foresight, one member of the House of Representatives predicted:

The imposition of the [income] tax will corrupt the people. It will bring in its train the spy and the informer. It will necessitate a swarm of off icials with inquisitorial powers. It will be a step toward centralization.

… It breaks another canon of taxation in that it is expensive in its collection and cannot be fairly imposed … and, finally, it is contrary to the traditions and principles of republican government.

When the tax was again introduced in 1894, a challenge went to the U.S. Supreme Court. In 1895, even among the cacophony of appeals in Congress to “soak the rich,” the Supreme Court declared the bill unconstitutional in a 5-to-4 ruling. In writing the majority opinion, Justice

Stephen J. Field quoted another case to support his conclusion:

As stated by counsel: “There is no such thing in the theory of our national government as unlimited power of taxation in congress. There are limitations, as he justly observes, of its powers arising out of the essential nature of all free governments; there are reservations of individual rights, without which society could not exist, and which are respected by every government. The right of taxation is subject to these limitations.”

But when the winds of empire blew, the old yellowed paper of the U.S. Constitution went f lying. Following The Panic of 1907, President Theodore Roosevelt sided with a faction in the Democratic Party that wanted to amend the Constitution to allow a national income tax. In

1909, President Taft stated that he had “become convinced that a great majority of the people of this country are in favor of vesting the National Government with power to levy an income tax.”

Of course, politicians are always able and willing to argue that “the people” want a government to have more power. If the voters see a free lunch in the deal, they’re for it. By 1913, just in time for Wilson’s emergence on the world stage, the Sixteenth Amendment had been ratified by enough states to put the income tax into law. The Amendment states:

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.

It wasn’t long before Congress exercised its new powers. Wilson even convened a special session of Congress to rush through the f irst tax law under the Sixteenth Amendment, in which earnings above $3,000 were subject to a 1 percent tax, gradually moving up to 7 percent on higher income levels.

With its rather modest rates, the original income tax was viewed as a benign inconvenience. As early as 1916, however, the top rate was more than doubled from 7 percent up to 15 percent. Then as cash was needed to send Pershing to France, the rate was hiked to a staggering 67 percent in 1917 and 77 percent by 1918. Even the low rates were raised. From their microscopic origin of only 1 percent, the rate settled into a “modest” 23 percent by the end of World War II. But by that time, the people of the old republic had grown to accept an income tax as a necessary evil. Now that the nation was an empire, it needed the money.

In our present era, the complexity of the Internal Revenue Code (IRC) has created an army of specialized lawyers and accountants. Even attempts at reform are out of control. A “technical corrections” bill exceeds 900 pages of adjustments. In fact, by the beginning of the twentyfirst century, the tax codes exceeded 7 million words, about nine times longer than the Bible; and the IRS was sending out about 8 billion pages of forms and instructions every year—at the cost of about 300,000 trees! All this effort translates to about 5.4 billion hours spent every year by Americans just complying with the tax rules.

From 1913 to 2005, the income tax has enabled, entitled, empowered, and engorged the federal government, states, and local governments, private enterprises, and millions of private citizens. Spending has grown by more than 13,592 percent.

The income tax gives the federal government a blank check to spend money, even money it does not yet have. The federal government lays a claim on all future economic activity of its citizens; its massive debts are a lien on the earnings of people who have not yet even drawn their first breaths. What’s more, the income tax could be used as both an economic tool and as a political weapon. Tax rates could be manipulated, for example, to punish or reward favored political groups.

When the Constitution was ratified in 1789, the colonists in the New World believed they had won for themselves a measure of freedom and independence. “A republic, if you can keep it,” Benjamin Franklin warned.

But by the end of 1913, a scant 124 years later, Americans were happy to lose their republic; an empire was what they wanted.

Regards,

Bill Bonner

Addison Wiggin

The Revolution of 1913 was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

And when bad stuff happens, you’re better off being somewhere else.

Where?

Generally, bad stuff seems to happen most often in cities. Why is that? Cities are where most people live. It is where governments are. And it is where the labor force is most specialized.

There are no subsistence farmers living in cities. Nor do urban populations “live off the land.” Instead, they depend on complex networks of commerce. The typical city dweller produces neither food nor energy. He sits all day in an office — completely dependent on others to provide power and food. Then, he goes home — still completely dependent on the division of labor for his most important needs.

Progress can be described as the elaboration of the division of labor. In man’s most primitive state, specialization is extremely limited. From what we’ve been told, the early man was the hunter. Early woman gathered…that’s about the extent of it.

As the tribe grows larger, specialization increases. One person might tend the fire. Another might be in charge of making clothes or arrows.

The advent of sedentary agriculture and towns caused a big leap forward in human progress and, not coincidentally, the division of labor. Some townspeople went out to tend the fields. Others began to focus on woodworking…or iron mongering…or making weapons…or clothes. Some played cards and hung around at bars. There was soon a homebuilding industry…and, not long after, merchants, prostitutes and bankers…and even shyster lawyers and tax collectors.

As the division of labor expanded, the average person became richer…and more dependent on others. In order to eat, someone else had to plant…and till…and harvest…and hunt…and gather. And then, when agriculture became mechanized, he depended on faraway people who produced oil and gasoline…and people who built tractors and combines…and bankers who financed industries and factories. And, of course, he was more dependent on money too. In the days when he bartered, money was no threat. Then, when he traded only with gold and silver coins, there were no monetary breakdowns…no hyperinflations…and no financial crises.

As the 20th century progressed, more and more people gave up agriculture, moved to cities and took part in other industries. Today, cities may have millions of residents — like Bombay with 14 million…or Sao Paulo with 20 million…or Mexico City with even more. All of these people are dependent on vast, stretched lines of communication and commerce.

Even the farmers themselves are now dependent on these sophisticated networks of commerce. They depend on money…and what it will buy. Agriculture has become monocultural. That is, a farmer is likely to produce only wheat. Or only rapeseed. Or only barley. Or only cattle. Gone are the chickens around the farmhouse and the pig in the back pen. If the system of transport and trade breaks down — or the money itself goes bad — thousands of farmers could go hungry too.

There are black swans all over the place, waiting to be discovered. And when a black swan appears, people in the cities seem to suffer most.

In the hyperinflation in Germany in 1923, for example, farmers had so much food they ran out of storage space. But they wouldn’t sell it to city slickers. The mark was losing value so fast, farmers preferred to hold their crops off the market, knowing that the price was soaring…and that if they sold, the money they got would soon be worthless.

People in the cities, meanwhile, were starving. Soon, gangs roved the countryside, raiding rural barns and houses…and occasionally killing farmers who tried to resist.

Plagues hit city dwellers hard too. Proximity seems to be a curse when an infectious disease appears.

And, of course, in time of war and revolution, cities tend to be the battlegrounds.

Advancing armies are rarely polite. But even if they are advancing through the countryside, they are usually advancing towards cities, which they attack. In the old days, cities were besieged, starved out, and then, when they were taken, the attacking soldiers were given three days in which to sack the cities. In other words, they had three days to commit whatever mischief and mayhem their imaginations suggested.

When bad stuff happens, progress goes into reverse — so does the division of labor. When an economy goes backward, much of the specialization that developed during the boom years turns out to be uneconomic, or unaffordable, or unwanted. People may be willing to pay someone to park their car when they are flush. But when they are broke, they will park their own cars.

As the division of labor goes backward, people also find they need to tend to their own food and energy needs. Here is where it gets very tough for people who live in cities. They have no stores of mason jars with food from their own gardens that they have canned themselves. They have no hams hanging in the barn or stocked away in the larder. They have no animals on the hoof that they can slaughter. They get no eggs from the chickens they don’t have…and they can hardly go into the local park and shoot squirrels to make a pie.

Instead, they are out of luck.

Generally, when the black swans come out you are better off in the country — with country-boy skills and old-time farms supplies.

We once met a fellow who had a keen appreciation for apocalypse. He was sure it was coming. So, he moved to Arkansas where, he said, “I’m protected by 300 miles of armed hillbillies.”

That’s something else to think about. Not only do you have to worry about food and energy, you also have to worry about your neighbors. If you have a nice little vegetable garden next to a large apartment complex, for example, you might have a hard time protecting your crops. And don’t count on fattening a calf in Central Park during a famine.

You need to be somewhere else. Where?

Regards,
Bill Bonner
Whiskey & Gunpowder

February 18, 2011

Urban Magnets for Disaster was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Housing is probably going down. Remember, Mr. Market has to destroy the idea that “housing always goes up.” When he’s finished people will think that “housing never goes up.”

Unemployment? People are gradually beginning to realize that the last ten years were the worst for creating new jobs in America’s history. If they keep thinking about it they will realize that it is not just the bust that is destroying jobs; there was something very wrong with the boom too.

Meanwhile, the markets are still calculating, figuring, deciding what things are worth. In the last couple of days, they’ve been thinking that maybe stocks and gold got a little too uppity.

From all we can tell, the Great Correction continues. And here’s a report from The New York Times that tells us where it leads:

OSAKA, Japan – Like many members of Japan’s middle class, Masato Y. enjoyed a level of affluence two decades ago that was the envy of the world. Masato, a small-business owner, bought a $500,000 condominium, vacationed in Hawaii and drove a late-model Mercedes.

But his living standards slowly crumbled along with Japan’s overall economy. First, he was forced to reduce trips abroad and then eliminate them. Then he traded the Mercedes for a cheaper domestic model. Last year, he sold his condo – for a third of what he paid for it, and for less than what he still owed on the mortgage he took out 17 years ago.

“Japan used to be so flashy and upbeat, but now everyone must live in a dark and subdued way,” said Masato, 49, who asked that his full name not be used because he still cannot repay the $110,000 that he owes on the mortgage.

…For nearly a generation now, [Japan] has been trapped in low growth and a corrosive downward spiral of prices, known as deflation, in the process shriveling from an economic Godzilla to little more than an afterthought in the global economy.

“The US, the UK, Spain, Ireland, they all are going through what Japan went through a decade or so ago,” said Richard Koo, chief economist at Nomura Securities who recently wrote a book about Japan’s lessons for the world. “Millions of individuals and companies see their balance sheets going underwater, so they are using their cash to pay down debt instead of borrowing and spending.”

Regards,
Bill Bonner
Whiskey & Gunpowder

October 27, 2010

Slow Growth or Contraction was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The Associated Press reports:

Whitman denounced the allegations as a “baseless smear attack” by Democratic challenger Jerry Brown in what has become a dead-heat race five weeks before the election.

The central issue is whether Whitman knew about a letter that the Social Security Administration sent her in 2003 that raised discrepancies about the housekeeper’s documents – a possible tip-off that she could be illegal.

The letter is the foundation for claims by former maid Nicky Diaz Santillan that Whitman and her husband knew for years she was in the US illegally, but kept her on the job regardless.

For two days, Whitman forcefully denied receiving any such letter and said she fired the $23-an-hour housekeeper last year immediately after learning she was illegal.

Revelations about the illegal housekeeper have also thrown Whitman’s carefully managed campaign completely off track and opened the door for Democrats to accuse her of hypocrisy.

“The essential fact remains the same,” said the husband, “neither Meg nor I believed there was a problem with Nicky’s legal status,” the husband said. “The facts of this matter are very clear: Ms. Diaz broke the law and lied to us and to the employment agency.”

Shame…shame…shame. What were they thinking? Were they thinking at all?

We don’t know if there’s been any progress in the case. But from what we know so far, it appears that the Whitmans had a woman in their employ who gave good and faithful service for nearly 10 years. Then, when they discovered that her papers were not in order they dropped her like a dirty dishrag.

It is illegal to knowingly employ an illegal immigrant. That is a shame too. On both counts. It’s a shame you need the permission of bureaucrats to travel, live and work where you please. It’s a shame the employer has been turned into an accomplice.

There are far too many greasy laws and far too many people ready to obey them. If the Whitmans had had any sense of integrity or loyalty they would have kept poor Nicky on the payroll. Then, when the scalawags in the press found out about it they could have answered honestly: so what?

But one after the other, the candidates, the governors, the preachers, the radio talk show hosts – the sinners confess their crimes, ask forgiveness, and claim rehabilitation. They sniffle. They cry. They admit their transgressions and misdemeanors. They whip themselves like penitents… Then, life goes on.

But what are the crimes? One falls from grace because he has fondled a stewardess on an airplane. Another has had a fling with an Argentine. One has wiggled his foot in a provocative manner in a public lavatory in Minnesota. Another has used drugs. And more than a few have slept with people other than their spouses.

What would you expect? They are only human. Barely. They are politicians and exhibitionists who enjoy making a public spectacle of themselves. They like their lofty positions in front of the media. They may enjoy their fall from grace even more, provided it keeps their names in the paper.

How we miss the old timers who had the courage of their predilections! To a politician from the great state of Louisiana the following story is attributed:

He called a press conference to reply to allegations that he was spotted consorting with a “known prostitute.”

Holding up the accusing newspaper, he said:

“It says here that I was seen coming out of the Central Hotel at 6 o’clock in the morning after sleeping with a known prostitute. Well, I can tell you that every word of this allegation is a lie.

“It wasn’t the Central Hotel, it was the Downtown Hotel. It wasn’t 6 o’clock in the morning; it was 7 o’clock. She wasn’t a known prostitute; I never laid eyes on her before in my life. And we didn’t sleep a wink.”

But the present generation of political figures is as spineless as the public itself. We live in a nation of sheep led by jackasses. We stand in line to be searched by airport goons, when we know perfectly well we have no intention of blowing up anything. We meekly fill in census forms…separate our garbage…and obey the speed limit even when there are no cops around.

Even so, turning out a trusted servant, merely because she has run afoul of the paper checkers is low and unforgivable. There must be some especially hot corner of Hell set aside for such people.

Besides, illegal immigrants are to be treasured. They are the last real Americans. Like the first ones, they brave hardship and danger to get here. The first immigrants crossed unforgiving seas in small barques. The last cross a hard border, patrolled by drug gangs and border police. Like Puritans, they come without passports…without work permits…with nothing more than the shirts on their backs and a desire to work. They worship their own gods, and otherwise ask only to be left alone. Do some turn to delinquency, felony and voting? Of course, they do…they’re only human too. But most get along passably well without the benefit of US social welfare legislation, democracy or larceny.

Most show up with no money in their pockets; instead, all they have is their scraps of paper or cheap cell phones…with the telephone number of a cousin in Houston or the address of a friend in Los Angeles – just like the immigrants who crowded into Baltimore, Philadelphia and New York in the 19th century. And like the first immigrants, they cannot sit their fat derrieres down in a cushy government job…nor even ask the assistance of welfare agencies, food stamps or other giveaways. Every contact with the white-skinned “gringos” is as dangerous and repulsive to them as contact with the red men was for the original settlers.

In Arizona, apparently, they can be stopped and asked for their papers at any moment, without cause or provocation. In other states, they need to be careful too…lest they be stopped for speeding and the secret gets out.

Nor can they claim minimum wage, race discrimination, disability, union scale, priority parking, unemployment compensation or any of the other chisels and hustles available to homegrown labor. The illegals have to earn their way.

So raise a glass. Raise a hat. Raise a voice. Say “gracias” to these…the last real Americanos.

Jerry Brown is right; Meg Whitman deserves to lose.

Regards,
Bill Bonner
Whiskey & Gunpowder

October 15, 2010

Nothing Is More American Than Working was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The Dow fell 140 points. This was baaaad…because it shows that the stock market does not really buy Bernanke’s storyline.

You’ll recall that when we left off last week, Ben Bernanke assured the world that while the recovery was not exactly what he had hoped for, he nevertheless had the situation in hand. He said he had the tools necessary to fix the problem and would do whatever was required.

The initial reaction was positive. The Dow rose more than 160 points on Friday. Some analysts thought the market’s downward trend had been broken. But it needed follow-through on Monday. Instead, the market fell.

The fact is, there is no recovery…and no recovery is possible…and investors are beginning to realize it.

Then what is going on? A “Great Recession,” say some analysts. A “depression,” say others.

There is a good article in The Financial Times that helps understand what is really going on. It’s by Ken Rogoff and Carmen Reinhart; you’ve heard of them before, dear reader. They are the ones who researched dozens of episodes of financial crisis and sovereign default throughout history.

Today, they write in the FT about what happens after a financial crisis. Well, what do you think? Do you think you get a “recovery”? Do things go back to normal? Is the recession over quickly and painlessly?

Not at all. Instead, there is rarely anything you would recognize as a “recovery.” Things do not go back to normal because they weren’t normal before the crisis. Crises are caused by abnormal conditions — usually too much credit, too much debt, too much spending and too much speculating. Then, when the bubble blows up, it typically takes a long time for the economy to get back on its feet.

Over the following ten years, unemployment usually stays higher than it was before the crisis.

Growth rates are usually lower.

And ten years after a blow-up in real estate house prices are still usually BELOW where they were when the crisis hit.

But what if the feds really get on the ball and try to turn things around? Then, watch out!

We read an article on dying yesterday. Here’s a question for you, dear reader. Would you rather live in a recessionary economy or die in a booming one? We’ll take the recession. Probably most people would. Heck, make it a depression.

There are a lot of illnesses for which there are no cures. Still, people will spend a fortune…and endure unspeakable treatments…in the hopes that they will be the one in a thousand who survives.

So too are people ready to believe that Dr. Bernanke can cure what ails the US economy. We don’t think so. Because we don’t think the economy is “sick.” We think it is healthy…and finally correcting the mistakes of the Bubble Epoque.

Leading economists and the feds have believed, for example, that there was some problem of “liquidity” that was temporarily blocking the flow of cash and credit. They believed the problem could be solved by making more money available. That was why the Fed bought an extra $1.4 trillion of the banking sector’s suspicious “assets.” They wanted to make sure the banks had money to lend.

Well, now the banks have plenty of cash. Businesses too have record holdings of cash. Even households are rebuilding their cash accounts.

But who’s borrowing? Who’s spending? Who’s buying new houses, for example? (New house sales are currently taking place at the slowest rate ever measured.)

CNN: “Credit if finally available, but no one wants it.”

Why don’t people borrow?

Because it’s not a liquidity problem. It’s a debt problem. A solvency problem. And it won’t go away by making more cash and credit available. Instead, all those bad decisions, bad loans, and bad investments have to be cleaned up. And that takes time. And while the economy is de-leveraging, people are becoming more cautious…more risk-averse…more modest in their expectations.

What do Rogoff and Reinhart say about governments’ efforts to fix these problems? What does history show?

They say the feds often make the situation worse.

Not only do governments typically pour bad money after good, they also disrupt the process of correction. Insolvent banks are kept alive. Big businesses that ought to go broke and be sold off are instead propped up…the lights are kept on by government subsidies, preventing new competitors from occupying the space. Consumers and investors keep waiting for the promised “recovery”…for the cure…for the fix. Instead of quickly adjusting to the new circumstances, they delay…they hesitate…they postpone unpleasant changes.

They might quickly sell a house at a loss, for example. They could then go on with their lives. But when they hear the feds tell them they have a new program in the works…or a new stimulus bill in Congress…or new action by the Fed…what are they supposed to think?

“Maybe I should wait and see if this new effort does the trick…” they say to themselves. “I’ll feel like a real fool if I sell now and then the feds get a new bull market going.” “Maybe I should wait before accepting a job at a lower salary; it says in the paper that the economy should recover by summer…”

The economic setbacks of the 19th century were sharp, but fairly short, affairs. The contribution of modern economics has been to stretch them out and make them worse.

Regards,
Bill Bonner
Whiskey & Gunpowder

September 1, 2010

What’s Bad for Bernanke Is Worse for You was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The Daily Mail account put the blame for these disturbances on Germany’s finance minister, who warned the Greeks that “the German government does not intend to give a cent.” At least Bild, a popular German newspaper, was trying to be helpful. It suggested that Greece sell Corfu…and that Greeks get up earlier and work harder.

Meanwhile, from Iceland comes news that every voter with an IQ above air temperature has cast his ballot against a bailout plan. The Icelanders were slated to make good $5.3 billion in bank losses. But why shackle common voters to the banks’ losses? The plan was so outrageous and so unpopular that Iceland’s normally compliant Prime Minister called for a referendum. Given a chance to vote on it, 93% said no. The other 7% probably read it wrong.

Insurrection is in the air. In England, government employees are preparing the biggest strike since the ‘80s. In America, dissatisfaction with Congress is at record highs; four out of five of those polled say, “Nothing can be accomplished in Washington.”

Herewith, an attempt to deconstruct the rebel yell. By way of preview, it’s not the principle of the thing, we conclude; it’s the money.

There are more clowns in economics than in the circus. They invented an economic model that has been very popular for more than 50 years — particularly in the US and Britain. It began with a bogus insight; John Maynard Keynes thought consumer spending was the key to prosperity; he saw savings as a threat. He had it backwards. Consumer spending is made possible by savings, investment and hard work — not the other way around. Then, William Phillips thought he saw a cause and effect relationship between inflation and employment; increase prices and you increase employment too, he said.

Jacques Rueff had already explained that the Phillips Curve was just a flimflam. Inflation surreptitiously reduced wages. It was lower wages that made it easier to hire people, not enlightened central bank management. But the scam proved attractive. The economy has been biased towards inflation ever since.

Economists enjoyed the illusion of competence; they could hold their heads up at cocktail parties and pretend to know what they were talking about. Now they were movers and shakers, not just observers. The new theories seemed to give everyone what they most wanted. Politicians could spend even more money that didn’t belong to them. Consumers could enjoy a standard of living they couldn’t afford. And the financial industry could earn huge fees by selling debt to people who couldn’t pay it back.

Never before had so many people been so happily engaged in acts of reckless larceny and legerdemain. But as the system aged, its promises increased. Beginning in the ‘30s, the government took it upon itself to guarantee the essentials in life – retirement, employment, and to some extent, health care. These were expanded over the years to include minimum salary levels, unemployment compensation, disability payments, free drugs, food stamps and so forth. Households no longer needed to save.

As time wore on, more and more people lived at someone else’s expense. Lobbying and lawyering became lucrative professions. Bucket shops and banks neared respectability. Every imperfection was a call for legislation. Every traffic accident was an opportunity for wealth redistribution. And every trend was fully leveraged.

If there was anyone still solvent in America or Britain in the 21st century, it was not the fault of the banks. They invented subprime loans and securitizations to profit from segments of the market that had theretofore been spared. By 2005 even jobless people could get themselves into debt. Then, the bankers found ways to hide debt…and ways to allow the public sector to borrow more heavily. Goldman Sachs did for Greece essentially what it had done for the subprime borrowers in the private sector — it helped them to go broke.

As long as people thought they were getting something for nothing, this economic model enjoyed wide support. But now that they are getting nothing for something, the masses are unhappy. Half the US states are insolvent. Nearly all of them are preparing to increase taxes. In Europe too, taxes are going up. Services are going down. And taxpayers are being asked to pay for the banks’ losses…and pay interest on money spent years ago. Until now, they were borrowing money that would have to be repaid sometime in the future. But today is the tomorrow they didn’t worry about yesterday. So, the patsies are in revolt.

Several countries are already past the point of no return. Even if America taxed 100% of all household wealth, it would not be enough to put its balance sheet in the black. And Professors Rogoff and Reinhart show that when external debt passes 73% of GDP or 239% of exports, the result is default, hyperinflation, or both. IMF data show the US already too far gone on both scores, with external debt at 96% of GDP and 748% of exports.

The rioters can go home, in other words. The system will collapse on its own.

Regards,
Bill Bonner, The Daily Reckoning
for Whiskey & Gunpowder

March 15, 2010

Collapse Is Inevitable was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

It’s true that there are some signs of “stabilization.” The unemployment rate is not getting badder as fast as it was a few months ago. And house prices seem to have stopped falling – for the moment.

It’s also true that the economy managed to register positive ‘growth’ in the last quarter… mostly thanks to government spending and inventory restocking.

The trouble is, all of these things are consistent with a depression — especially a depression that the feds are fighting every inch of the way. In the 1930s, there were several years of growth… and there were great years for the stock market too. Then, things fell apart again. The nation ended the ‘30s not one penny richer than it had been when it began them.

And Japan has seen some good years and some bad years, too, since its depression began in 1990. Oddly, Japan’s population is falling… so in per capita terms, Japan’s downturn hasn’t really been so bad. Per person, the Japanese got richer over the last 10 years.

It’s also true that we use the term ‘depression’ a bit differently than most economists. Most economists believe GDP growth represents increasing prosperity. They think a depression is merely a recession, with negative GDP growth, that lasts longer and goes more deeply than normal.

Our definitions are better:

A recession is a pause during a period of growth. A depression marks the end of the period of growth… giving the economy a chance to make adjustments so that a new period of growth may begin.

GDP growth alone is a fraud. The gross number just doesn’t tell you anything worth knowing. It doesn’t really matter how fast an economy is growing. What counts is how fast it is growing per person… and whether that ‘growth’ is real or phony.

Growth is not the same as prosperity…

Someday, we promise you, modern economists will be ranked below doctors who bled their patients to death and jungle tribes who threw maidens into volcanoes. They are quacks.

These imposter economists think they can fix a recession and prevent a depression. When the private sector stops spending they urge the public sector to step in and replace the missing private spending. That, in a nutshell, is Keynes’ theory.

A nutshell is the appropriate container. Because there’s a world of difference between private spending and government spending. Private spending is voluntary; people choose to spend their money on things they really want. When the government spends, on the other hand, it is merely squandering stolen property. It may look like private spending. But it’s not at all the same thing. You can hand out checks to people; it’s not the same as when people earn money. You can build bridges and airports too… but they are only valuable to the extent that they are used efficiently. And you can hire all the government employees you want; they don’t necessarily add to the sum of human happiness or wealth (most likely they subtract from it!).

Just look at societies that put everyone to work. There was no unemployment in Cambodia under the Khmer Rouge! Or in the Soviet Union. North Korea is another good example today. They all show that putting people to work for the government doesn’t make them rich… it makes them poor.

Yet, these modern economists — Martin Wolf at The Financial Times, Paul Krugman at The New York Times, Bernanke, Summers and Geithner in Washington — believe that they can control and cure a depression. All they have to do is to keep the GDP expanding… and keep unemployment from rising. How? Just spend money!

The GDP calculators can’t tell a phony expense from a real one. Whether the government spends money to do something that is not worth doing… or hire someone who is not worth hiring… or just gives away money to someone who is not worth giving money to… the GDP quants don’t know the difference. They think one dollar spent is as good as any other…

… Even if it is a dollar that didn’t exist! (Don’t get us started on that one… )

And who knows if a job is worth doing? Only the person who pays for it. That’s the trouble with government employment; the people who pay the bills don’t make the hiring decisions.

Modern economists don’t even bother to think about it. All they care about is the unemployment rate… not about whether the job is actually useful or efficient. Want to boost the job rate? Easy. Just hire people. Does this make people better off? Of course not.

The Financial Times had a full page in its Wednesday edition devoted to China’s empty towns. Bloomberg has been on the story too.

It is the story of what actually happens when government meddles in an economy.

Last year, China ordered its banks to lend money to infrastructure programs in order to offset the worldwide financial meltdown. The banks responded, doubling their lending.

Observers in the West were stunned… and envious. If only we could ‘get things done’ like that, they lamented. If only our governments had more authority and control over the economy!

But let us go back a year and put ourselves in the shoes of the bankers. They must have had loan requests. Some of them they must have judged worthy of funding, others not. But how was it possible that the number of project deemed creditworthy doubled in the space of a few months?

Well, it didn’t happen. Instead, the Chinese government merely changed the rules of the game. The banks, under pressure to loan out money, reacted by lending it out… to marginal projects. Now, we’re beginning to read about them in the paper — mostly towns without any people. Just wait until China blows up. Then, we’ll read about banks without money. Stores without customers. And businesses without a prayer.

Regards,
Bill Bonner
The Daily Reckoning

February 24, 2010

Quack Economists and the Fraud of GDP was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Where is the real bubble? Is it a bubble in commodities? Or a bubble in the people who buy them?

By the charts ye shall know them — bubbles, that is. The lines roll along nicely, calmly, along the bottom of the page, then all of a sudden, the line shoots up. When you see a chart like that, whether it is the price of tulip bulbs or shares in the South Sea Company, you know what will happen next. The line will go down!

What goes up must come down. A bubble is an extraordinary thing. And all extraordinary things tend to become less extraordinary over time. “Regression to the mean,” is what statisticians call it. The “mean” marks the territory that is normal. Whenever anything ventures into abnormal territory, chances are very high that it will soon come back on familiar ground.

Take an extraordinary person, for example. More than likely, his children and grandchildren will be more like everyone else than like him. It must be a terrible burden to be the son of an extraordinary man; people look at you like you were a dot-com stock in ‘99 — they expect something exceptional. Almost inevitably, they are disappointed.

Or take a Great Empire. What is an empire but an extraordinarily successful state? It stands out in history because it has managed to lord over its neighbors. Yet, what empire lasts? None…all regress to become commoners…ordinary nations.

Or take the weather. A rainy spell may last for a long time. But the more days it rains, the more dry days will be needed to bring the rainfall down to “normal” levels.

Regression to the mean is one of the surest bets an investor can make. Let prices go to extraordinary levels and he’s almost guaranteed that they will come back to normal. In markets, the regression to the mean principle is even more certain than it is in nature. Because extraordinary prices set in motion a series of actions and reactions that almost always bring them back in line. Highflying oil prices, for example, touched off a series of derriere-kicking trends and events.

On the supply side, the industry is spending 4 times as much on exploration and development than it did when the century began. The price of drilling equipment rentals has more than tripled. And now, believe it or not, a young man graduating from an Ivy-league college with a degree in petroleum engineering earns more money than a man who goes to Wall Street.

On the demand side too, changes are underway that cut the amount of oil used. The cure for high prices is high prices. Bubbles are self-correcting. The higher prices cause people to look for alternatives — or simply not use so much. US imports of oil went down over the last 12 years. And, for the first time ever, Americans were driving fewer miles.

Another track of the feedback loop is the economy itself. High oil prices work like higher interest rates or higher taxes — removing money from domestic commerce. The effect is to “cool” the economy…chilling demand for energy.

Elsewhere, substitutes for oil are being developed at breakneck speed — including wind, solar, and bio-fuels.

Regression to the mean works. Markets work. Lower energy prices seem a cinch.

But now we introduce an annoying fillip. While the bubble in oil prices was expanding…another, much bigger bubble was shaping up — and hardly anyone noticed.

Where? Just look in the mirror. At our own species. In the many, many thousands of years of our prehistory, we were hardly worth counting. There were tribes of us all over the globe…but they were small…barely holding their own against other species in the competition for food and resources. It took until about 1800 to get the population up to one billion. Worldwide. Then, man was a big winner. Numero Uno of creation. By 1930 another billion had been added. And another billion was added in the next 40 years. That brings us to about 1970, when the earth hosted about 3 billion two-legged yahoos. Since then, the population has more than doubled. The line shot up, in other words.

But we are a proud and egotistical race. As our numbers rise, we think the road will rise to meet us. What a shock it would be to find that the whole species was mean-reverting, just like everything else! What a surprise to find no road at all — that we are running off the edge of a cliff, like lemmings. More below…

Being in the right place at the right time is far more important than brains. Luck provides better investment returns than talent. Too bad. Because our luck seems to be running out.

George Soros has said the great credit expansion that was born with the baby boomers… and has lasted as long as we have… is now over. Not long after came word that the “end of abundance” is here too. That’s what it said on page 9 of the Financial Times. And then, Bo Diddley died. All the palmy trends of the boomer generation seem to be coming to an end.

Naturally, the world’s leaders were worried. They gathered in Rome that same week for the customary monkeyshines. Even Robert Mugabe — who is banned from traveling in Europe — put on a false mustache so he could dine out on the Via Veneto, leaving his lieutenants in Harare to beat and starve Zimbabwean voters. Poor Mugabe. Goebbels would have gotten a warmer reception at a meeting of Jewish orphans.

At 84, Mr. Mugabe is almost living proof of Haeckel’s biogenetic law. It maintains that the history of the individual rehearses the history of the species. In Mugabe’s long life, from prison cell to presidential palace, he is the history of revolution… a Kerensky and a Stalin… the liberation struggle’s saint and its monster, too… all in one. To black Africans he is a big disappointment. To whites he is proof that Ian Smith was right all along. When Ian Smith left the top man role in Rhodesia, the country was the ‘bread basket of Africa’ with a currency as strong as the pound. Now it is a basket case whose peoples’ bones stick out and whose dollars are already as worthless as a campaign promise.

But everything follows the same laws — from embryo to corpse… from boom to bust… from seed to fruit to rot… nothing escapes, neither an individual, an empire, a species, nor a market.

This is not the first time in our lifetimes that the world has seen this kind of show. In the ‘70s, Paul Ehrlich, like Malthus before him, foresaw a crowded, hungry world. In his popular book, “The Population Bomb,” he said hundreds of millions of people would starve to death. This was a world in which England couldn’t even exist; he said it would disappear by the year 2000. He was wrong about that. He was wrong about a lot of things. Julian Simon challenged him, arguing that a free economy always reduces real prices. On September 29th, 1980, the two made a famous bet — on whether the prices for 5 basic metals — chromium, copper, nickel, tin and tungsten — would actually go down, inflation adjusted, in the following ten years — despite population growth. What happened? Simon won. On the 29th of September, 1990, the prices of all 5 were lower. Ehrlich settled up with a check for $576.07.

In theory, Simon will always win a bet like that; competition and technology always force prices down. But Ehrlich wasn’t wrong about everything. And Simon wasn’t right about everything. While one believed the weight of numbers would send the world to Hell… the other had a god-like faith that the market would always save it, guided by an invisible hand to progress and prosperity. But while Simon is right in theory, the invisible hand is not always the gentle paw that he imagines; it does not necessarily call out for more booze just because the crowd gets thirsty. In fact, sometimes it vanishes altogether, allowing a Mugabe to ruin a country… instead of permitting the free market to build it up.

Simon had the good luck to make his bet at the beginning of a major decline in commodity prices. Oil, for example, hit an all-time high over $100 a barrel, in current dollars, in December 1979. Ten years later, it was trading near $30. And by 1998, the price had fallen to $10. Had he made his bet ten years earlier or ten years later, he probably would have lost.

Back to the raw facts facing the Roman holidaymakers: Over their plates of crespelle all fiorentina, delegates will learn that high food prices are putting millions of people on the verge of starvation. Then, as they wash down their peposo with a tide of Barolo or Chianti Classico, they will reflect on how this came to be. The “green revolution,” someone will mention, seems to have run its course. (Out of politeness or imbecility, no one will mention the Fed’s easy money policies.) Ehrlich’s population bomb never exploded, they might come to believe, because irrigation, selective breeding, and the use of petroleum-based products greatly improved farm productivity.

But now, the green revolution has turned brown. It is as mature as the credit cycle… or Robert Mugabe himself. The water is running out. Opposition to bio-engineering is growing. And petro-chemical inputs are both less effective and much more expensive than they used to be. Result? In 1961, crop yields grew by 10% per year. Lately, they’ve increased less than 1% per year.

Meanwhile, in 1970, there was about 1 acre of arable land on the surface of the planet for every pair of feet. But the feet have multiplied — just like Erhlich said they would — from a bit over 3 billion people to more than 6 billion; and now the species is expanding like sub-prime debt. Just look at a chart. Human population looks just like the Nasdaq in ‘99 or oil in ‘08. This bubble-like population explosion, along with urbanization, highways, pollution, desertification and so forth, has cut the amount of farmland per person in half. Meanwhile, the number of people bellying up to the bar continues to grow by 11% per year — more than 10 times faster than crop yields.

Everyone wants a drink; but there’s only so much beer on tap. Who knows? This may be a good time to short the whole damned race.

Regards,
Bill Bonner

November 19, 2009

Editor’s Note: This article originally appeared in The Daily Reckoning as “Boomer Trends Coming to an End.” To view the original article, please click here.

Human Population Bubble and Regression to the Mean was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Our views are different, but not extraterrestrial. Once upon a time, not so long ago, they were even respectable. The gist of our message two weeks ago was that debt is dangerous. It feels good at first. But give a society too much debt – either in its private sector or the public sphere – and someone’s going to get killed. That’s why the present situation is such a delight to serious economists; it offers more data points. We get to see how much straw the feds can add before the poor camel’s back breaks.

What’s the best way to get through a debt crisis? Straight through was our advice last week. For at least a thousand years, the business cycle went round and round without help from central bankers or economists. It is only since these geniuses have been on the case that really serious problems have arisen. The Panic of 1920 – in which the US government did nothing but cut taxes and spending – was quickly forgotten. The Panic of 1929, on the other hand, was followed by massive rigging and jiving by the authorities. It took 20 years and a world war to overcome; today it is still remembered today as the Great Depression.

Martin Wolf, speaking, gravely, for the world’s intelligentsia in The Financial Times last week, proclaimed that: “the only thing worse than rescuing the system would have been not rescuing it.” But he is wrong; of all the many blessings economists may bestow upon a grateful people, improving the economy is not one of them. An economy is a natural thing. It can be improved by the striving of entrepreneurs, the prudence of bankers, and the sweating of field hands. But when it comes to the macro-economic policy, forbearance is the quality that pays. Any initiative on the feds’ part inevitably makes things worse.

The Bubble Era, like the Great Depression, was largely -but not completely – the result of government initiative. Artificially low interest rates – intended to counter the modest downturn of 2001 – sent the wrong message. Consumers – notably those in Britain and America – bought things they couldn’t afford. Producers – notably those in Asia – made things for which there was no real market. Debt piled up. Mountains of it.

As consumers bought more and producers made more the economy grew. But much of the economic “growth” of the 2001-2007 period was fraudulent. It was based on debt spending, not on genuine increases in purchasing power. Debt pretends to be real money. It looks like the real thing, but it is not. It stimulates the economy like counterfeit money. It causes production and consumption, but of the wrong sort. Former Reagan era Office of Management and Budget director David Stockman estimates the level of “counterfeit GDP” at $4 trillion in the US alone.

The fraud was discovered, though misunderstood, when sub-prime debt began to implode. The economy had been kissed hard; millions of houses had been built, bought and sold. Now, owners couldn’t pay for them. All of sudden, the counterfeit money began to shrivel up. Lenders, investors, and householders all began to de-leverage; paying down the debts as fast as they could, defaulting on those they couldn’t.

Rather than come to the obvious conclusion, that they should never have meddled with the economy in the first place, the feds began rescue operations on a breathtaking scale. The British government increased spending to 140% of revenues. America now runs a stimulus program nearly equivalent, in economic impact, to WWII. Not since 1945 have the two pages of its ledgers – debits and credits – told such different stories, with almost $2 of spending for ever $1 in tax receipts. Britain will add almost 50% to its government debt in the next three years. David Stockman expects the publicly held US national debt to almost double in the next five years.

Even at those levels, many economists think the government should do more. Nobel Prize winner, Paul Krugman is one. Richard Koo is another. They’ve warned that the US (and by extension much of the rest of the world) could suffer a Lost Decade, like Japan, if the government slacks off before consumers have finished de-leveraging. At least they understand what is going on. Too bad they missed the point of it. The problem is too much debt, not too little spending. Leveraging up the public sector doesn’t help. Even government debts must be paid – if not by the borrower, then by the lender. The feds are smooching more ardently than any debt lover in history; next, we get to see who dies…or at least who defaults.

Regards,
Bill Bonner

November 4, 2009

Editor’s Note: The above article originally appeared in The Daily Reckoning as “The Kiss of Debt.”

Debt Is Dangerous, Especially of the Government Kind was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The quote comes from Ben Franklin. But it was recalled to us neither by America’s president, nor Britain’s Prime Minister. Instead, the Telegraph in London reported it from the mouth of Cheng Siwei, a “top member of the Communist hierarchy.”

What goes around comes around. The Anglo-Saxons have forgotten what makes a successful economy. The Chinese have remembered.

Just look up Warren Harding on Wikipedia. The first entry you will find is not the 29th president of the United States of America, but a rock climber with the same name. But what do you expect? History is nothing but a long list of disasters in chronological order. Historians love calamity. And they reserve their highest accolades for those who cause them. The same is true in financial history. Those who make it big are those who make it worse.

It is safe to assume that no one working at the Federal Reserve or at the White House has a picture of Warren Gamaliel Harding over his desk. Yet, if American presidents were ranked on the basis of how well they faced up to financial disaster, Warren G. Harding might be somebody. His handsome face would be carved on Rushmore. His likeness would grace the $100 bill. Harding was the last American president to deal honestly with a major financial crisis. Every president since has tried to scam his way out of it.

By the time Harding took office in ’21 the Panic of 1920 was taking the unemployment rate from 4% to nearly 12%. GDP fell 17%. Then, as now, the president’s subordinates urged him to intervene. Secretary of Commerce Herbert Hoover wanted to meddle – as he would 10 years later. But Harding resisted. No bailouts. No stimulus. No monetary policy. No fiscal policy. Harding had a better approach; he cut government spending and went out to play poker:

“We will attempt intelligent and courageous deflation, and strike at government borrowing which enlarges the evil, and we will attack high cost of government with every energy and facility which attend Republican capacity…it will be an example to stimulate thrift and economy in private life.

“Let us call…for a nationwide drive against extravagance and luxury, to a recommittal to simplicity of living, to that prudent and normal plan of life which is the health of the republic.”

Within a decade, Harding’s views were collectibles. But in 1921, he still saw the economic world as a moral world ordered not by man, but by God. This was not the result of long study or deep reflection on his part. He was probably the dummy everybody said he was. As Keynes pointed out, politicians are always in thrall of some dead economist. At least Harding was in thrall to the good ones.

“No statute enacted by man can repeal the inexorable laws of nature,” he announced. “Our most dangerous tendency is to expect too much of government…”

Harding was not the first to see the economy as a ‘natural’ order…one that you disturbed at your peril. A Taoist named Zhuangzi, who lived about the same time as Alexander, observed: “Good order results spontaneously when things are let alone.”

Later, economists of the Scottish enlightenment, notably Adam Smith and Adam Ferguson elaborated. Smith, like Harding, saw the economy ordered by the invisible hand of God. Ferguson saw markets as a ‘spontaneous order,’ which were the “result of human action, but not the execution of any human design”.

The same basic insight led Irving Fisher – the greatest economist of the 1920s – to come up with his debt-deflation theory of depressions. After people had borrowed, they needed to pay back. Busts followed booms; there was no getting around it.

Warren Harding may never have been the brightest bulb on the White House porch, but intuitively he understood that proper macro-economic policies were more the product of virtue than of genius. Debt led to trouble; that’s all he needed to know.

Keynes came along a few years later. Keynes was a genius; everybody said so. And he had an answer for everything. Nature? Government could do better. Debt? Don’t worry about it, he said. Why not just let capitalism sort itself out? Without government intervention, it will only get worse, said Keynes.

But Harding had already proved him wrong. Harding did the very opposite of what Keynes recommended. Instead of increasing government spending, he reduced it. He cut the budget almost in half. He slashed taxes too…and cut the national debt by a third.

Japan at the time struggled with the same downturn. But it had no Harding at the helm. Instead, its masters prefigured Keynes, trying to stay the correction using price controls and other interventions. The result was a long-drawn-out affair that lasted until 1927 and ended in a bank crisis. In America, meanwhile, by 1922 unemployment was back down to 6.7%. By 1923 it was down further – to 2.4%.

This lesson was entirely lost on the world’s economists. When the next crisis hit a decade later, they turned to Keynes. Of course, it turned out to be a moral world after all. They got what they deserved.

Regards,
Bill Bonner

October 26, 2009

Macroeconomics for the Keynesian Dummies in Government was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.