Who Needs the Fed?

Project 2025 promotes "free" banking, which is to say, no pesky regulations or backstopping from the Federal Reserve. What could go wrong?

Policy wonks can't help themselves- they need to write down their plans so that all the world can see how brilliant they are, and how real they could be, if only others recognized their brilliance. In that way, the project 2025 plans from the Heritage Foundation have been a gold mine, at least for Democrats. And since the Republican Party couldn't be bothered to write down a platform, other than "anything Trump wants", this project serves as the functional platform of the current Republican campaign, written as it was by scores of officials from the first Trump administration, plus many others itching to be appointed to a second. And it is crazy- more like a project 1825 than anything we would want to look forward to.

One of its less publicized planks is its approach to banking. It heaps criticism on the Federal Reserve, and recommends, as the most effective solution, its abolition and a return to "free banking". Which means a world where no regulator controls the banks, and no federal reserve backs it up against panics and crises. And just to complete the return to barbarism, it recommends a return to the gold standard as well.

"In free banking, neither interest rates nor the supply of money is controlled by the government. The Federal Reserve is effectively abolished, and the Department of the Treasury largely limits itself to handling the government’s money. Regions of the U.S. actually had a similar system, known as the “Suffolk System,” from 1824 until the 1850s, and it minimized both inflation and economic disruption while allowing lending to flourish." - From Chapter 4

Needless to say, US history is littered with banking panics, runs, and depressions, usually due to the unregulated nature of this "free" banking and to monetary gold backing. It is hard to express just how absurd and damaging it would be to return to such a world. The Federal Reserve was conjured up after a long history of the establishment of the first national bank, then its destruction by Andrew Jackson, a century of economic instability with particularly damaging panics in 1893 and 1907. By 1913, the US finally had had enough, and set up an updated national bank in the form of the Federal Reserve, to regulate and backstop the banking system. 

Illustration from 1873, portraying "Panic" on Wall Street.

Unfortunately, until the advent of Keynesian economics, it didn't really know what it was doing, and was particularly ineffective during the Great Depression, making things worse instead of better. Even now, it amounts to a cabal of bankers who are more interested in jacking up interest rates than in national prosperity. MMT economists tend to think that interest rates should be kept low, and the functions of the Federal Reserve folded into the Treasury Department, with greater political oversight. The use of interest rates- which are such a blunt tool of economic policy- could then be de-emphasized, in favor of more dynamic fiscal policy to manage inflation and monetary conditions. It is worth noting that over the last eighty years, the Fed has routinely over-shot its mark in raising interest rates, ending up with recessions, and rapid, belated retreats to lower rates. It is only with the current cycle that it has achieved, at least so far, the dream of a soft landing, taming inflation while avoiding recession.

Recessions (gray) have regularly followed interest raising campaigns by the Fed, and not always intentionally.

But note that the word "depression" is no longer in our lexicon. For all its faults, the Fed has kept the economy on a much more even keel than was possible under the wild-west free banking era, when monetary conditions were hostage to whatever Yosemite Sam dug up in the Yukon, or how wildly bankers over-extended their issuance of notes. Banks built impressive buildings to foster the illusion of stability in an environment where stability was impossible, lacking the infinite backstop that the Federal Reserve can now bring to bear during a crisis. Both individual depositors and the population as a whole benefit. It is a classic example of the people of the US coming together to create an institution that makes our lives better, so that we can worry about other things than the next banking panic. 

This economic craziness is just one small example of the fevered imaginations of the right wing in current US politics, which seems to have crawled out from the former fringes of Lyndon Larouche and the Birchers to take over an entire half of our political system. And this is fundamentally thanks to the air given them by an appalling right wing media that cares nothing for truth or civility, rather making its money from button pushing, whining grievance, and reflexive anti-state propaganda. And people complain about social media! Just how long ostensibly reasonable and decent (even Christian(!)) people will wallow in this environment is anyone's guess, but our common, rational, and beneficial institutions will in the mean time be in constant danger.

• Luddites of today.
• We need to win this war.
• Profile in courage.

Correction- The Republican convention did actually come up with a platform.

Investing in the Future

People's Capitalism- the economics of James Albus.

A curious thing happened on the way to a recent post about the cerebellum. One of its primary theorists was not a neurobiologist, but an engineer, roboticist, and control system designer. It turned out that James Albus, mild-mannered government employee all of his career, had several side projects, another one of which was an odd blend of libertarian and communist economics, which he called peoples' capitalism. It incorporates some unconventional monetary theory, and throws in a proposal for oceanic algae harvesting as a bonus. All in all, Albus is clearly a fellow crank.

This book "Path to a Better World" is not easy to find, probably for good reason. Putting aside its lengthy self-encomiums and visions for a peaceful and problem-free future, the basic proposition is that the government should issue credit to everyone for the purpose of setting up a personal investment fund, which over time would then generate on everyone's behalf a steady and growing stream of income that will replace that lost from the automation revolution to come (and pay back the original loan). He estimates that if the annual increment is $5,000, the portfolio would be worth $1.5 million after 50 years, generating $55,000 of income. This would all be invested in government-approved vehicles like mutual funds, thereby increasing total capital investment. And lastly, to offset inflation, he proposes a payroll deduction-style system whereby some proportion of each person's income could be forcibly diverted to savings when inflation threatens.

One of the core justifications of these schemes is gaining a higher rate of overall capital investment. Albus recounts some of the interesting literature in economics that shows that productivity growth, overall growth, and an increased living standard all come mostly from capital investment. It is capital (as opposed to straight consumption of short-lived items like food and services) that funds the machinery, education, and training that continues to give back, year after year, productive services like roads, new inventions, manufacturing plants, and housing. We all know that the US has had a low rate of capital investment, which Albus contrasts with China's extraordinarily high rate, and thus high growth which is overtaking us.

Albus shows fanciful graphs going far into the future of the US maintaining a 9% economic growth rate, which would enable us to stay ahead of the Chinese indefinitely. The problem is that not all investment is productive. We learned from Japan that the dizzying rates of capital formation and investment in a developing economy that is committed to catching up with the first world do not last forever. As long as one is behind the technological frontier, productive investments are easy to find- just steal them from more advanced cultures. But once one reaches the technological frontier, the search is far more difficult. Much more investment is wasted in exploratory research, and it is less attractive to rip out current sunk investments to keep up with every tiny increment on the slowly advancing frontier. This explains why China's growth will inevitably slow, as did Japan's and ours.

This is not to say that we should not raise our capital investment rate, but that we need to be more judicious than simply shovelling more money into mutual funds. Since the value of the stock market is based on a relatively coherent estimation of future income flows to corporations, pouring in more money on behalf of passive small investors will mostly just nudge out other, more liquid, investors, keeping the overall level of investment stable (with the caveat that price/earnings ratios have indeed risen (perhaps doubled) over the last few decades as a larger pool of investors has flooded the market). This would be a good thing from an economic justice standpoint. One of the points of Albus's plans is to distribute capital ownership more widely, in preparation for the time when none have jobs, but all need income. But it is unlikely to raise net capital investment much or raise economic growth rates.

The ironic thing (given Albus's government career in the highest levels of its research enterprise) is that he is so focused, perhaps due to libertarian leanings, on pumping money into the private capital markets, that he neglects the real capital shortfall- that of public investment. It is now a common mantra that our infrastructure is crumbling, and that education is too expensive. Both are areas where government investment is the most productive way we have to build for future economic and social returns.

Otherwise, there are some positive aspects to these ideas. What goes unmentioned is that the personal investment scheme will have to be heavily controlled by the government, since most people getting that kind of money are going to spend it. That is why so many poor people exist, after all, and so few capitalists. And the inflation control scheme is also rather heavy-handed, if effective, though one has to ask where this savings would go so as to not be inflationary. Putting it into mutual funds would put it into the markets again, and thus be ultimately inflationary. It would probably have to go into newly issued government bonds, which is to say, into a money black hole.

But the idea of spreading around capital and its income stream is very interesting. It is a far better idea than a simple UBI, which is structured as a sort of pittance handed out to keep the jobless from gathering into mobs with pitchforks. As we enter an economic era where capital is ever more dominant, through its comprehensive ability to generate economic value with ever fewer workers, the whole economic system needs to be rethought, with an eye to the middle class, not just the homeless and jobless. We already have vast pension funds and mutual funds, which have spread around the income flows from capital, if not taken effective control of the system from capitalists of the traditional variety. We already tax income and capital gains and inheritances to divert some of those gains to the common good. More of that kind of redistribution, of both capital and its proceeds, needs to happen in order to achieve the economic justice and stable future that Albus seeks.

• A criminologist takes a look at our president ... the dark triad.
• Who are the oligarchs?
• MAGA movie.
• Steps to fascism.
• Oligarchy in business isn't so good either.
• What does a financial risk manager say about climate change? $120 per ton of carbon.
• Economic democracy.

Economics is All About Redistribution

And new economies need new methods of redistribution.

"Redistributionist" is a dirty word for the right, like gun-grabber, bleeding heart, tree hugger, and statist. Yet we are currently treated to the spectacle of a Republican congress redistributing income, foregone taxes, and wealth to the tune of trillions, upwards towards the wealthy and well-connected. What does repealing the estate tax have to do with putting manufacturing workers back to work, or solving the opioid crisis? Nothing, naturally.

In a state of nature, everyone has a job, which is to wrest bare sustenance from a rich, but complex and mystifying world. No one is "employed", since everyone is self-employed. And if you or the small family you rely on fail in that task, the end comes relentlessly. This represents the primitive "job guarantee". Everyone has a job, and failure to do that job is penalized harshly.

A developed economy has a different relation to work. Most people still live by their labor and wits, but there is so much wealth and technological prowess that most people's work is completely dispensible. Whether we have lawyers, rock bands, and toothpaste is a matter of significant, but not existential, importance. Even the food production system is so broadly based that no single person's work is existentially important to anyone, even themselves, given a modest safety net. And this system can support large numbers of people with no jobs at all, with ease. Yet income remains tied to work, despite the fact that we are moving to a future where the ratio of work needed to labor available is plunging, taking the labor market and incomes with it.

Who runs this system? Whom does it serve?

The trajectory of all this is quite clear. Those with wealth receive the benefits of industrial productivity, which is increasingly capital-based rather than labor-based. Those with only labor to offer, even of a specialized and educated nature, get increasingly locked out of the income / redistribution system. Whether this will lead to a Keynesian crisis of lack of overall income and spending is not clear. The rich spend much less than their income, as witnessed in the recent revelations of overseas tax shelters holding trillions. But so far, the Fed and other institutions (here federal deficits play a critical role) are working mightily to keep the system churning, despite the extensive replacement of good jobs with bad jobs, and consequent declining worker pay (relative to productivity). The system is no longer working- labor is no longer an effective way to keep everyone employed and paid in a manner that befits an advanced society as productive as ours.

This is what the current class war is all about. Republicans are shamelessly doubling down against the very voters who thought they were supporting a better deal on jobs and a restoration of the middle class. Rather, this administration is pulling every available lever to entrench the rich/capital and pull the rug out from under workers, leaving them even more powerless and destitute than before. Who would have thought?

What should we be doing instead? Some propose a basic income, whereby every citizen gets a small income, merely for existing. This neatly cuts the connection between labor and income, but has many problems. First, it is not a decent income, but extremely minimal. So it ends up being miserable welfare, at best, for the poor, and an unnecessary gift to the rich. Second, it does not provide the reciprocal benefits to society, or the individual, that work does. To let so much personal energy go to waste, paying people to do nothing, presents both a moral hazard an an enormous social loss. We can do much better.

Social Security could be cited as an example of a very successful basic income, given to all. But it is explicitly tied to previous work, and serves a specific social function of supporting those who can not work any more. Public services like roads, public buildings, scientific research, and the like are also good examples of implicit income given to all, and surely health care should come under the same universal service category. But income for working-age people represents something quite different- it is the source of their freedom, and represents their service to the larger society. We need to find a way to preserve and enhance those relations while gradually disentangling it from the semi-feudal work-as-labor model in capitalism.

Basically, people should be paid for a wider range of activities. For example, voting could be paid. Serving on juries could be paid, far better than currently. Sending children to school could be paid. Positive social activities should be paid for, not just classed as volunteer activities or duties. Perhaps the biggest opportunity is in the non-profit sector. If the government funded non-profits on a broad basis, while enforcing governance, management, and mission rules, we could end up with endless opportunities for public service and fairly paid work.

Where would the money for all this come from? The main actor in the economic system is, to be frank, the government, not the private sector. The government prints the money, runs the central bank, and has first rights to production such as defense spending, police functions, and other necessities (which becomes particularly clear in war-time). The fact that capitalist enterprise and competition has been a beneficial and innovative way to organize the private economy to provide the bulk of most people's needs does not mean this will always be the case or needs to be the sole form of work and income. As mentioned above, capital is concentrating and the need for labor is gradually uncoupling from the need to produce goods. But it shouldn't be uncoupled from doing social good. Indeed, the capitalist system has led to enormous social harm, and seems to have led to an appalling revolution in values, putting the greediest and most predatory people in the most successful positions.

Thanks to mind-boggling political and intellectual corruption by which they have gained power through a supposedly populist political movement, these arch-capitalists are right now trying to entrench their feudal powers over workers by relieving themselves of taxes, by empowering corporations to rule more of our lives, enhancing the legal immunities of corporations and relieving them of any public purpose (especially in the case of media companies), by weakening our democracy and the state, and by keeping the labor market weak and workers dependent on the private sector for income. It is the last gasp of a system that will either turn towards an even uglier feudalism, or be turned back and regulated into a progressively smaller share of our economic, social, and political lives.

• Paradise papers and the so-called rule of law.
• But why shelter your riches from taxes when you've got a congressman in your pocket?
• And for that matter, why not appoint a tax evasion expert to head the IRS?
• "The United States, he noted, currently has one of the highest levels of inequality in the history of the world."
• Which Republicans want to make hereditary.

American Exceptionalism Rests on the Middle Class

What happens to our country when the middle class disappears? Review of Ganesh Sitaraman's "The Middle Class Constitution".

We are in a crisis right now in the US. Our government has been taken over by plutocrats who are busily reversing every progressive and public-spirited policy they can get their hands on. The worst nightmare of the nation's founders, revolving around demagogues, rule by extreme wealth, deepening political corruption, and mass immiseration, is coming to pass. Thomas Piketty's work on the nature and growth of economic inequality was the first major intellectual shot against this development, from an econometric perspective. Sitaraman's new book is the second, putting our economic inequality and its political consequences into historical and legal perspective, as a far greater matter than mere economics- rather, as a constitutional crisis.

The US has been since its founding exceptional on the world stage, not for our apple pie or iPhones, but for our democratic social system. Now the world is filled with democracies, so our position as one of the more mediocre ones in terms of governance, public services, health status, and overall happiness is perhaps not such a surprise. But at the beginning, we were truly revolutionary, and Lincoln was not far off when he posed the Civil War as a test whether government by the people would survive globally. (Switzerland, however, probably would have pressed on with its own experiments).

Why did this experiment happen here? According to Sitaraman, and to Toqueville, and to many of the founders themselves and other observers, it happened because the economic condition of Americans was substantially one of equality. Immigration put most people on a similar footing, which is to say, poor. The availability of land to all who wanted to work it provided a base of subsistence to these immigrants, and a foundation of modest wealth. The ideology of the early colonies and Republic was one of severe allergy to class distinctions, titles, and the like. There were some wealthy people, but nothing like the disparities that we would see later, either in the guilded age, or today.

Our constitution reflects these origins, and depends on continued rough equality with a predominant middle class. Sitaraman makes it clear that historically, constitutions have always reflected the economic conditions they sought to rule. Where feudalism and serfdom was the rule, so was autocracy. And oligarchy or autocracy have been the rule through the vast majority of human history, with democracy only possible at the lowest levels of rural and small-town society, where equality was likewise occasionally possible. Golden-age Greece, our democratic ideal, was more like an oligarchy of the free men of the city. Karl Marx had a point when he maintained that ownership of the means of production controls the nature of the class system, and thence the political system. Even Aristotle recognized, that while a true middle class polity was impossible in the power-economics setting of the ancient world, it would be the ideal polity, composed of that class of people who are neither so greedy and power-mad that they would factionalize and corrupt the system, nor so poor that their only wish would be to revolt and overthrow it.

Our rough equality continued through the frontier era, when anyone could pull up stakes and get land out west. Conditions were increasingly difficult the farther west one went, until the coastal paradise of California and Oregon gave one last great frontier of fertile land. This availability of land amounted to a job guarantee for its day, allowing any willing person to work and make money regardless of the willingness of an employer to hire. Farming certainly had its own terrible risks, between the weather, pests, and fluctuating markets. But no able person had to be destitute.

Now, we are neither an agricultural society, nor have any frontiers left. We exist in a new form of feudalism where employers have no governance responsibility to their employees. Employees are purely at will, and may be fired at any time for any reason. It is ironic that we so fetishize political freedom and legal equality, while practicing, in our corporate culture, the most retrograde feudalism. For all the regulations that modestly ameliorate this condition, most workers are in a dramatically assymetric and powerless position. It wouldn't be so bad if the economic system were not also unstable, experiencing crises of demand and investment that force millions of workers into destitution. Additionally, the closing of the frontier and other restrictions have made land, housing, and rents increasingly subject to scarcity costs far above their construction costs. This makes destitution a far more probable and chilling prospect.

Sitaraman cites disturbing research into our political system that makes the case that we are already living in an oligarchy/plutocracy. The fact is that each of our politicians is for sale, the media system is run by corporations, and much of the governmental regulatory apparatus that was supposed to protect us from the predatory special interests have instead been captured by them. This latest research shows that the actions of our political system accord essentially none of the time with the preferences of the lower 90% of the population, and all of the time with the preferences of the rich and super-rich. Our so-called leaders, thanks to various forms of legal corruption, are steeped in the social melieu of the rich, its super-PACs, and its propaganda organs, from cable channels, to think tanks, to lobbyists. The rest of us hardly stand a chance. Even at state and local levels, the rich have been funding dramatic new advances in corruption and propaganda, which have turned our nation into a sea of red.

This is how wealth translates to power, and the US may have entered a terminal loop where the plutocracy is so entrenched and so shameless about leveraging that power into yet more power, that there is nothing further to do, short of revolution. The breathtaking nepotism, incompetence, greed, and immorality of our current administration merely puts an exclamation point on a decades-long process that has not only reshaped the political system into a frank plutocracy, but reshaped the economic system as well into one that freezes out the middle class, by dramatically lowering taxes on the rich and reducing public facilities and services, among many other policies.

Middle classes do not happen by accident. The natural course of events, given the Malthusian pressures documented so dryly by Thomas Piketty and many others, is towards competitive differentiation, with winners gathering more power and wealth, which, once it reaches a high level, grows by natural accretion and compounding (where it is not more actively leveraged) far beyond anyone's needs, and losers finding it ever more difficult to find a way into a brutally rigged system. Classically, this was expressed by ownership of land, to which the answer has been land reform, which is to say, expropriation. Sitaraman provides a fascinating aside on the sequel to the Civil War.

"The most eloquent advocate for confiscation and redistribution was Thaddeus Stevens. The clubfooted Pennsylvania congressman proposed confiscating the estates of the top 10% of wealthy rebel planters, which at the time amounted to those with more than $10,000 or more than two hundred acres of land. With that land, which he pointed out would leave 90 percent of southerners untouched, every freedman could be given forty acres. The remainder wold be sold at auction and used to fund veteran pensions, compensate the injured, and retire the war debt. Steven's reasoning acknowledge that this ction would be revolutionary, but he also deemed it necessary for preserving republican government. "The whole fabric of Southern society must be changed," he declared in a speech to constituents in 1865: 

"Without this, this government can never be, as it has never been, a true republic. Heretofore, it had more the features of aristocracy than of democracy. The Southern States have been despotisms, not governments of the people. It is impossible that any practical equality of rights can exist where a few thousand men monopolize the whole landed property. ... If the South is ever to be made a safe republic, let her lands be clutivated by the toil of the owners, or the free labor of intelligent citizens. This must be done even though it drive her nobility into exile. If they go, all the better."

The book ends with a relatively standard plea, in the Bernie Sanders/Elizabeth Warren frame of argument, for higher consciousness of these facts and trends, in order to frame a new phase of social activism. Sitaraman has great respect for the Progressive era of the late 19th century, which brought us the progressive income tax, anti-trust, and the regulatory state, among other innovations. Thinkers and movements of this time took a fundamental look at our system and recognized that one more agency would not be enough- we needed constitutional amendments and deep reform. Today, with the Supreme Court wielding the First Amendment like bludgeon against the very citizens it was designed to protect, drowning them in corporate doublespeak, and with our politico-economic power system declining into bannana republic levels of dysfunction and disparity, it is time again to crank up the volume of protest, and direct it to fundamental and radical aims, such as taking money out of politics, remaking corporate governance on a more democratic model, and restoring a tax and public financing policies that sustainably strengthen the middle class.

• A clown is in charge of our economic policy.
• Pay should not be a big secret.
• Another lie ... and another.
• We need a new privacy regime.
• China is the last country to want any change in North Korea.
• They really are better than everyone else.
• Corrupt enrichment.
• Health care is one of the bigger drivers of inequality.
• Economic graph of the week. Corporations are saving more, growing fatter, while everyone else grows thinner.

Does No One Understand the National Debt?

In the debates, we could have heard adults talking about finances. But instead we heard infants yelling incoherently.

Here is a full exchange from the vice presidential debate:

QUIJANO: According to the nonpartisan Committee for a Responsible Federal Budget, neither of your economic plans will reduce the growing $19 trillion gross national debt. In fact, your plans would add even more to it. 

Both of you were governors who balanced state budgets. Are you concerned that adding more to the debt could be disastrous for the country. Governor Pence? 

PENCE: I think the fact that -- that under this past administration was of which Hillary Clinton was a part, we've almost doubled the national debt is atrocious. I mean, I'm very proud of the fact that -- I come from a state that works. The state of Indiana has balanced budgets. We cut taxes, we've made record investments in education and in infrastructure, and I still finish my term with $2 billion in the bank. 

That's a little bit different than when Senator Kaine was governor here in Virginia. He actually -- he actually tried to raise taxes by about $4 billion. He left his state about $2 billion in the hole. In the state of Indiana, we've cut unemployment in half; unemployment doubled when he was governor. 

PENCE: But I think he's a very fitting running mate for Hillary Clinton, because in the wake of a season where American families are struggling in this economy under the weight of higher taxes and Obamacare and the war on coal and the stifling avalanche of regulation coming out of this administration, Hillary Clinton and Tim Kaine want more of the same. It really is remarkable that they actually are advocating a trillion dollars in tax increases, which I get that. You tried to raise taxes here in Virginia and were unsuccessful. 

But a trillion dollars in tax increases, more regulation, more of the same war on coal, and more of Obamacare that now even former President Bill Clinton calls Obamacare a crazy plan. But Hillary Clinton and Tim Kaine want to build on Obamacare. They want to expand it into a single-payer program. And for all the world, Hillary Clinton just thinks Obamacare is a good start. 

Look, Donald Trump and I have a plan to get this economy moving again just the way that it worked in the 1980s, just the way it worked in the 1960s, and that is by lowering taxes across the board for working families, small businesses and family farms, ending the war on coal that is hurting jobs and hurting this economy even here in Virginia, repealing Obamacare lock, stock, and barrel, and repealing all of the executive orders that Barack Obama has signed that are stifling economic growth in this economy. 

We can get America moving again. Put on top of that the kind of trade deals that'll put the American worker first, and you've got a prescription for real growth. And when you get the economy growing, Elaine, that's when you can deal with the national debt. When we get back to 3.5 percent to 4 percent growth with Donald Trump's plan will do, then we're going to have the resources to meet our nation's needs at home and abroad, and we're going to have the ability to bring down the national debt. 

QUIJANO: Senator Kaine? 

KAINE: Elaine, on the economy, there's a fundamental choice for the American electorate. Do you want a "you're hired" president in Hillary Clinton or do you want a "you're fired" president in Donald Trump? I think that's not such a hard choice. 

Hillary and I have a plan that's on the table that's a "you're hired" plan. Five components. First thing we do is we invest in manufacturing, infrastructure, and research in the clean energy jobs of tomorrow. Second thing is we invest in our workforce, from pre-K education to great teachers to debt-free college and tuition-free college for families that make less than $125,000 a year. 

Third, we promote fairness by raising the minimum wage, so you can't work full-time and be under the poverty level, and by paying women equal pay for equal work. 

Fourth, we promote small business growth, just as we've done in Virginia, to make it easier to start and grow small businesses. Hillary and I each grew up in small-business families. My dad, who ran an iron working and welding shop, is here tonight. 

And, fifth, we have a tax plan that targets tax relief to middle- class individuals and small businesses and asks those at the very top who've benefited as we've come out of recession to pay more. 

KAINE: The Trump plan is a different plan. It's a "you're fired" plan. And there's two key elements to it. First, Donald Trump said wages are too high. And both Donald Trump and Mike Pence think we ought to eliminate the federal minimum wage. 

Mike Pence, when he was in Congress, voted against raising the minimum wage above $5.15. And he has been a one-man bulwark against minimum wage increases in Indiana. 

The second component of the plan is massive tax breaks for the very top, trillions of dollars of tax breaks for people just like Donald Trump. The problem with this, Elaine, is that's exactly what we did 10 years ago and it put the economy into the deepest recession -- the deepest recession since the 1930s. 

Independent analysts say the Clinton plan would grow the economy by 10.5 million jobs. The Trump plan would cost 3.5 million jobs. And Donald Trump -- why would he do this? Because his tax plan basically helps him. And if he ever met his promise and he gave his tax returns to the American public like he said he would, we would see just how much his economic plan is really a Trump-first plan.

One can see that the question is heavily weighted, and Pence laps it right up, going the moderator one better by calling the national debt "atrocious". Then he spins a total fantasy about how trillions on tax breaks for the wealthy will bring it down.

Kaine on the other hand does not address the question at all.

What was so unfortunate about this whole exchange is that it failed to give Americans an adult discussion about what the debt is, and its role in the government and the economy. And moderator Quijano led the way into this infantilism, though she is far from alone in sharing this tired, conventional wisdom.

Firstly, the federal system and debt are nothing like state debts or household debts. States do not issue currency and do not print money. Like the various Euro countries, states are bound by an income/outgo ledger. They have to fund their budgets from taxes, or if the federal government is generous, grants and other aid from above.

The Federal government uses taxes as well, but it has the additional job of running the whole economic system, including the currency. The national debt is in truth an economic management tool, whereby growth is accommodated and inflation managed by creating money to spend more than it receives in taxes. Yes, there is, and should be, a perpetual deficit so that economic growth can be met with the issuance of new money. Who gets that new money? The federal government does, to spend into the economy. Treasury bonds represent a legalistic (and in actuality unnecessary) tool to avoid issuance of more currency (which is also a debt/liability of the federal government) using the issuance of a longer-term debt that rewards rich people for saving, presumably with less inflationary impact than currency, but in practice with little different impact at all.

We have been brought up to think that the Fed manages the money supply. But it only controls interest rates, and even there can not get very far ahead of or behind the market. Interest rates have a profound impact on the money creation by banks. Yes, private banks create money too. Every new loan is a creation of new money, and every payment you make on a loan disappears into a monetary black hole. Banks can create money/loans on the strength of their capitalization, and on their regulatory authorization from the government, and lastly on their estimation of market conditions and the worthiness of particular borrowers.

But this new money is very unstable, as we learned in the last financial panic. Private loans can be called in, bank capital can vaporize, borrowers can skip town, and glitzy real estate developers can go bankrupt ... multiple times! Thus we need someone else and some other mechanism to keep the monetary system stable, and that is the federal government in its spending and money creation capacity, which is shared between the Fed and the Treasury.

The federal debt represents that part of the national liability pool that is stable, and is managed in part with an eye towards economic growth and inflation. If inflation and growth are both low, as they are now, the proper federal policy is to spend more money while taking in less tax. Which in turn implies growing the federal debt. The textbook case was in the depths of the banking meltdown, when congress reluctantly approved almost a billion dollars of extra spending and debt. That was far from enough, but certainly helped stabilize the monetary system and economy.

As Alexander Hamilton first said (or did he sing it?) "A national debt, if it is not excessive, will be to us a blessing". This was in the context of the new federal government taking on the various war debts of the former colonies, now states, in both a political sense and in a financial sense, that a well-managed debt is (as England had shown) a tremendous benefit to the national state and economy.

Secondly, the debt is not something that anyone has to "pay off". The calculations that state it in terms of each citizen's personal share are wildly off the mark. We may in sum have a cultural debt to our predecessors for creating that much wealth (the obverse of debt) that is now circulating through the hands of bondholders, other investors, our infrastructure, etc., but it is not a weight hanging over anyone's head. Even if interest rates were to rise, so would inflation and GDP, making the effective debt and its debt service little different. Bondholders like their bonds, roll them over perpetually, and would dislike being paid off in cash.

The real danger of excessive spending by the federal government is inflation. If federal spending (enabled by borrowing/printing in excess of taxation) rises too much, that excess money drives prices up, in a process that may be pleasant and politically easy at the beginning, but becomes very onerous to unwind later on. So there is certainly a point to keeping a lid on inflation, via Federal Reserve independence, etc. But of late, we have been too focussed on fighting the last war (that of the 70's inflation) and not enough on the current one of restoring growth and fighting deflation in the US (see also Japan on how diffucult this fight can be).

What is so ironic about all this is that during our painful recession, it has been the Republicans in congress who have been most vociferous in fighting more spending and debt (at least when a Democratic president is in office; otherwise, debt and spending go up dramatically). They are the ones who have put the brakes on macroeconomic management and growth, all in an effort to pin the resulting poor economic performance on Barack Obama. Well, we have eeked out a little growth anyhow, and Obama easily gained a second term, with a protoge ready to be shoed in to boot, so their destructive efforts have not, thankfully, been sufficiently effective politically, though they have been extremely damaging economically and socially.

And effectively, both parties have the same macroeconomic policy on the debt- expand it. Republicans do so by reducing taxes for their friends, and Democrats do so by spending, also often to help their friends. So all the bluster about how terrible the debt is turns out to be a back-door way to screw with the other party's ability to carry out its priorities, ending up in gridlock. We really can do better by having an adult discussion about finances, while judging those other priorities directly.

So to hear this debate moderator going on about the debt, which she, and the whole media, and the candidates themselves, so thoroughly (or willfully) misunderstand, is sad and disappointing, not to mention flagrantly biased. We need higher debt right now, and specifically we deperately need more spending on our infrastructure to get the economy back on track and pointed to the future. That would be far more productive than complaining about trade deals, or the manufacturing jobs that are long-gone, not to mention the immigration crisis that happened over a decade ago.

• "Inflation targeting has become the poisoned chalice of macroeconomic policy"
• Perhaps 2008 was all about a failure to regulate banks.
• Pence- a worthy running mate.
• The Taliban overruns another district in Afghanistan.
• What people need is work.
• Rent: everyone worships the market, but everyone works as hard as possible to get out from under its rule.
• Some more psychoanalysis of Trump.
• And lying analysis.
• Annals of Republican cowardice.

Say's Law

The convolutions of economics, cranks, and class.

The class war has deep roots, and is fought on many fields, in many guises. One of the most interesting and influential is the field of economic theory, which as Paul Krugman persistently points out, has undergone startling episodes of battle, tide turning, and forgetting over the last century. One battle is over the meaning, interpretation, and validity of Say's law.

Enunciated by Jean Baptiste Say, who lived through the French revolution as an economist and businessman, and founded the first business school, the law states that production calls forth demand. If an excess of some good is produced, someone is sure to want it, at some price. More importantly, in general, if production in an economy increases, that production will be eagerly sold by its producers and bought by someone, even if the price might be less than expected. For instance, if a technological change makes it much cheaper to make computer memory, demand for that memory is sure to materialize, even as its cost and price go down. And if productivity decreases the prices of many goods, that allows consumers to buy more of other things, and have higher living standards. To some degree, this law makes assumptions about human psychology- that entrepreneurs meet a market, and that prices provide the flexible mechanism to bring supply and demand into agreement, pretty much at all times.

Unfortunately, Maynard Keynes claimed by the 1930's that Say's law was invalid. Then classical-minded economists tried to reclaim its validity by the 1950's and the debate has proceeded onwards, though mainstream economists give it little explicit credence these days. Its significance lies in the issue that if one grants that production can occasionally and on a wide scale be glutted, or demand be deficient in aggregate, that opens the door to solutions that come from elsewhere than the free, unfettered market- i.e the state as a manager of the macroeconomy. And this causes ideological heartburn to many on the right.

The Great Depression was an obvious case in point. Why did economic activity grind to a virtual standstill? The people still had the same needs they had before, and the skills, factories, and materials were the same as well. Yet a plague of unemployment and, frankly, deficient demand ripped through the economy causing misery for millions. Conventionally-minded economists, called "liquidationists" maintained that the financial fever would quickly work itself out if all businessmen cut their costs to meet the new (lower) demand, and if workers accepted the lower wages that they deserved given the reduced business conditions. A new equilibrium would be found at a new, if lower, level. Indeed, they argued that it was the perverse reluctance of workers to accept lower wages that led to the whole problem, preventing a new equilibrium from being achieved rapidly.

But we need to go back a step to the start of the process. How is it that business conditions could deteriorate so dramatically in the first place, if production always calls forth appropriate demand? Keynes didn't dispute that a supply-demand equilibrium, particularly of labor, would eventually be achieved, in the long run. But when? His quip was that in the long run, we are all dead. An event like the Depression, caused by a dramatic collapse of the financial system which drained wealth, consumption and investment, and thus effective demand out of a system whose actual, human demand was unchanged caused unprecedented misery, though milder depressions were common enough through economic history. This misery is prima facie evidence that Say's law is invalid in the short term in macroeconomic terms. Demand can be dramatically deficient, especially in modern economies with enormous financial superstructures whence investment and credit flow (or don't flow).

So why the continuing discussion? There are strong ideological forces at work. The Mises, Rand, Hayek, Austrian wing of the right, seeing themselves as the last pillars of human freedom, find it hard to accept that, into this breach of deficient demand should step the only actor with the wherewithal to do so: the state. Not only that, but the amelioration of the misery of the working class (though also the much more modest misery of the business class) by way of public works and other forms of macroeconomic management, (even including the printing of paper money in place of proper gold!), reduces the power of the employer class. Which is certainly relevant to the class war. This attitude is ironic, if one defines human freedom as the freedom of most humans, but that is how the class war works. It is the freedom of the upper, employer, feudal overlord class that concerns the Austrians and conservatives, not that of the workers who are dependent upon them. Under this system of thought, there can be no such thing as involuntary unemployment, there being always some work somewhere at some wage, for the worker willing to take it. If only workers were willing to be paid pittances, everyone could be happy!

Thus one gets quotes like: "The short answer is that there is still need and place to assert Say's Law whever anybody is foolish enough to deny it. It is itself, to repeat, essentially a negative than a positive proposition. It is essentially the rejection of a fallacy. It states that a general overproduction of all commodities is not possible. And that is all, basically, that it is intended to assert." - Henry Hazlitt, "The Failure of the 'New Economics'", 1959. Hazlitt's book is little more than a screed, but can still be found in my local library, proudly placed right next to Keynes' general theory, a sign of the seriousness with which it once was taken, and perhaps is, in some quarters.

Say's law was reflected more recently in the ideology of supply side economics, whose contention was that prosperity arises from unleashing job creators from taxes, regulation, unions, and other obstacles, so that production can increase and the benefits trickle down to everyone. Subsequent history has not been kind to this theory either, yet it remains the cornerstone of Republican platforms in this year's campaign, for obvious reasons of the class war.

Unfortunately, Keynes had an even deeper insight about Say's law, which was that even if the employers had their way, and reduced worker wages and positions as rapidly as they liked to bring their businesses back into equilibrium with demand, they would not, on a macroeconomic basis, be successful any more rapidly. As wages sank, so would demand, since over the whole economy, income equals demand minus savings. As income heads south in a massive depression, so would demand, in a downward spiral whose limit is reached when something changes in this dynamic- when money comes out of mattresses for consumption and capitalists eat into savings, setting a floor for demand, given the (reduced) stocks of money available.

How much more civilized if the demand can be made up before all the parties are reduced to extremis- if the state steps in with a tool kit that can include public works, tax cuts, reduced interest rates, and all the money required to make it happen, when the private financial system goes through one of its regular collapses. But that requires a state with great technical and moral resources. That was the work of the New Deal and the Greatest Generation, who not only won World War 2, but demonstrated in doing so that the state could dramatically re-establish demand through the economy and keep it going through efforts like building the interstate highway system and winning the Cold War.

One can argue whether the prosperity of that era was due to tremendous technological advances, the artifical demands generated by wars hot and cold, and / or the newly installed Keynesian macroeconomic management. But its wide demographic distribution was a matter of the power of workers, which was aided at the time by strong unionization and the Keynesian economic policy. These conditions required some decency on the part of the elite, to recognize their choice between reform and revolution.

The US has always been run by a rich elite, from the founding onwards. The question is whether these elites work for all, as Washington and FDR did, or for themselves, as the slaveholders did who wrote the evil lines into our constitution which took so much blood to expunge. The retreat and even forgetting of Keynes, under the assault from Milton Friedman, the Chicago school, and other ideologues of the right, which has resulted in the withering of the position of workers and the vast inequality seen today, results from a callous and short-sighted (not to mention corrupted) elite culture, mostly on the right, whose current candidates to a man (and woman) promote the interests of the rich in the most blatant ways, such as planning big federal deficits to give them money through the tax system.

So, we have to ask what is the point of freedom, and of the economic system. Governments are certainly capable of destroying freedom in a quest for economic and moral perfection (and power). At the same time an unfettered, unregulated capitalistic system destroys the freedom of its workers just as surely, ending up in feudalism. Predators are on every side. Say's law and the other ideological structures of classical and right-wing economics hide a presumption in favor of the capitalist, championing the freedom of the 1% while treating labor as a faceless, disposable commodity. We need a middle way, as exemplified by the mid-20th century compromise, and indeed the social democracies of Europe, where the democratic state acts as the balance-wheel to promote the freedom of all classes in rough proportion, as well as their prosperity.

• Continuing relevance and reaction to Keynes.
• The great depression before the Great Depression.
• The monetary straightjacket comes from abject and destructive fiscal failure.
• Message from the markets: We are looking at being Japan for the new decade or more, with little growth, especially in Europe. That is not good for any future-denominated investment. 
• Vulgar scientism, in economics.
• How to help Trump voters? Elect a Democrat.
• The Big Short, and what is legal.
• Low wages plus EITC plus food stamps ≠ American Dream.
• Koch enterprises.. the evil deepens.
• State of the UAW.
• State of the Russian economy.
• State of acid rain ... worse than it could have been.
• The Super Bowl halftime shows where America is going ... tie dye pinwheels and black power.
• Bill Mitchell on exchange rates and inflation.
• Quote of the week, on who is progressive.

"Twitter chatter aside, when it comes to judging who's more progressive than who, political scientists have an app for that—at least for those who've served in Congress, as Sanders and Clinton both have. It's the DW-Nominate first dimension, scaled from +1 to -1, which explains the lion's share of how members vote. For the two years when they served in the Senate together, Sanders had a score of -.717, making him far and away the most liberal member. Number two, Sheldon Whitehouse had a score of -.507, while number 15, Hillary Clinton had a score of -.403. The difference between Sanders' score and Clinton's was greater than the difference between Clinton and Evan Bayh, the second-most conservative member of the Democratic caucus at the time. So in short, the difference between them in terms of who is most progressive is both objective and huge."

• For instance, the Fed and Bernie Sanders.

The Federal Budget Should Never Balance

Honest ... the deficits are OK. The sovereign government has a critical role in economic stabilization and prosperity.

The household analogy is a very durable one: the idea that, since taxpayers and households need to balance their budgets, that the government should as well. Politicians across the spectrum enunciate this mantra / analogy as though it were self-evident. The irony is that although liberal politicians may speak such lines with less formal conviction, it is Republican office-holders who have shown time and again over recent decades the most willingness to throw such balance out the window, in pursuit of tax cuts, with their ensuing deficits. Nothing personal, of course, just class war as usual!

The recent British debacle of liberalism kowtowing to a Tory narrative of austerity and budget-cutting is one more example of the false consciousness that is damaging particularly to liberalism, but also to everyone else who participates in modern economies. Because, in truth, the federal budget should never balance. Its imbalance is the most powerful tool we have to keep the economy stable and growing.

For households, and for dependent government entities like cities and states, the budget constraint is absolute ... there is no free money, and no use to a deficit. They may have capital accounts, with bonded debt for capital needs, like houses and roads. But every such debt has to be paid off eventually. Banks occupy a special place in this system, since they can create money, via the loans they fund. But every cent of these deposits (though not the interest ... where does that come from?) is matched by the loan note on the bank's books. Banks also have a zero-sum balance sheet.

A federal government with a sovereign, floating currency is an entirely different beast. It is the entity that creates the (high-powered) money that everyone else uses. It is not constrained by a zero-sum balance sheet. Therefore the propaganda of a federal government "running out of money" or being broke, or having to live within its means ... are all meaningless. The federal treasury (in combination with the central bank) can spend money at will on whatever it likes. The idea that it has to issue bonds to "fund" spending not matched by tax receipts (i.e. deficits) is an economic fiction. Such policies are legal fossils from another age, where money was not printed by fiat, but was backed by gold / silver. The fact of the matter is that federal spending provides the money to those who buy such bonds, and the bonds do little but replace one form of low-risk saving with another, rather than altering the buyer's behavior, affecting inflation, etc. Plus give a stream of income to the wealthy.

But obviously, there is a constraint on federal spending and money creation. That is the overall level of economic growth and monetary inflation. Since the government is free to create money, it assumes the risk of fostering inflation and the responsibility to manage monetary growth to keep pace with the various forms of economic growth: population growth, productivity growth, and trade deficits, if any. Additionally, economics has found that modest inflation, on the order of 2%, is beneficial to encourage productive investment over inert savings (such as gold). Add all these categories of monetary growth together, and you get a virtually constant need for federal deficits. This is why, as a matter of fact, we in the US do have perpetual deficits, why making the federal budget go into surplus creates highly unstable economic conditions, and why politicians seeking to balance the federal budget are charlatans.

Taxation is part of this scheme as well, of course. While deficits may be required in perpetuity, they are not typically enough on their own to fund the whole government. Additionally, the central role of the fiat currency has to be established at the outset. Taxation fills both roles, creating a need for the "legal tender for all debts, public and private" which is demanded by the government for taxes, and which it uses to commandeer a large share of the private economy, above and beyond the annual growth it funds with new money.

So much for normal economic times and methods. It is in crisis when the powers of the federal monetary system become most important and evident. Where in the old gold standard days, a government could do nothing during the frequent business collapses, busts, depressions, etc., a modern federal government can spend exactly as much as is needed to make up for the evaporation of bank credit and the money that bank credit represents. The government can resolve deflation in a matter of a few pen strokes. Properly handled, there is no need for economic slowdown or unemployment at all, since the full gap of private credit-based money (which characterizes a depression) can be made up as needed by federal spending of new money.

Note, however, that such a gap can not be made up by the central bank alone. As currently constituted, central banks can lower short-term interest rates and can lower long-term rates by way of "quantitative easing", but they can not inject money directly into the economy. If banks do not want to lend, or borrowers do not want to borrow, no interest rate is going to induce them to do so. And they will be particularly shy of lending after having just lost their shirts in a credit-destroying debacle. Thus it is critical for the rest of the government to not sit on its hands, but spend as needed to cover the monetary shortfall created by declining economic conditions, or a credit crisis in the private banking system.

Of course, it isn't all spending and free money. When boom times come, (as measured by very low unemployment and rising inflation), the federal government needs to have the discipline to take away the punch bowl, using its tools of fiscal retrenchment, taxation, and higher interest rates to restrict inflation. Past governments have shown some laxity in this department, as is tempting and unfortunate. We spent the seventies perplexed by the connection between high government spending and inflation, before Paul Volker pulled the plug with a high interest rate-induced recession. But the fact is that the current atmosphere permeating central banking and conservative politics is far too scared of inflation, fighting a war that was won decades ago. The focus on austerity and budget constraints is not really about inflation anymore, but about keeping workers powerless and underpaid in a perpetually under-performing and under-employing economy.

Tom Tomorrow, on markets.

• For more on MMT & Keynesian economics, see a blog by Bill Mitchell.
• Brad Delong on Fed structure, mandate, and policy.
• Surowiecky on Stieglitz and inequality. 
• Krugman/Thoma on Keynesian policy.
• Robert Schiller on the idiocy of conservative economics: "But adhering to an approach that overlooks these factors is akin to doing away with fire departments, on the grounds that without them people would be more careful – and so there would then be no fires."
• Why do governments love banks so much?
• The bureaucrats knew a thing or two about Vietnam.
• What lack of competition and regulation is costing us in internet service.
• Buying the feudal political system you want ...
•  ... Leads to weakness in the Western (and antipodean) political class.
• The curse of year-around plenty in the tropics.
• Is complexity in scientific data opening the door to obfuscation and worse?
• Economic graph of the week ... median income:

Europe Engineers Another Versailles, in Greece

One person's take on the Greek economic crisis and the fallout of the Euro.

What happened in Greece? The narratives are shockingly divergent. On the one hand, Germans view Greece as a spendthrift poor relation who borrowed up the gills and now wants sympathy and even more money to throw down the drain. Nein!

On the other hand, Greeks are suffering depression conditions even worse than our Great Depression, and surrendered utterly in their most recent deal with the Trioka, (aka Germany), who are behaving like the Nazis of yore in destroying Greek independence and sending them into incredible poverty. The deal dictates that the Greek government run substantial budget surpluses as far as the eye can see, despite presiding over an economy in free-fall. It is reminiscent of the Versailles treaty that likewise tried to wring blood from the stone of then-Germany for its culpability in World War I.

Who is at fault and what is to be done? Greece is obviously heavily at fault, both for borrowing when lenders of Euros were willing to lend, and for not running an economy that maintains a rough trade balance with the rest of the Europe and the world, necessitating that borrowing (and for running a government that can not even collect taxes competently). But who were the lenders? As in our own sub-prime crisis, are the lenders who gave money so irresponsibly to the most corrupt and dysfunctional government of Europe, in full knowledge of its poor trade position, not a little to blame? Or mostly?

That is the first issue, that debtors should not be always and entirely to blame when debts go bad. Just ask the Donald. He has no qualms about redemption through the magic of bankruptcy, and Greece likewise should have few compunctions, morally, about reneging on its debts. But then it shouldn't expect any more bailouts or lending, of course. That would be the deal.

Obviously, having just been through a confidence-shattering banking crisis, the Germans and others are not excited about leaving their banks holding the bag for their bad loans to Greece. So they are extracting all the blood they can. And their bargaining position is excellent, because Greece's trump card, its willingness to leave the Euro at the same time it defaults on its Euro debts, seems to be unplayable since 80% of the population favors, even after all this misery, staying in the Euro.

Leaving the Euro would have the beneficial aspects of 1) allowing Euro debts to be more easily reneged, since Greece would henceforth have its own currency and not rely on Euro institutions; 2) allowing currency devaluation that is desperately needed to bring Greece's trade imbalance under control by automatically making imports expensive and exports cheap; 3) allowing the government to get out of its troika-imposed austerity and run budget deficits as any normal & sovereign government in its position (with trade deficits and depression conditions) would do. It is worth noting that the Euro zone is not a democratic entity. There is no president of the Euro, or popularly elected legislature, etc. It is a bureaucratic monster with little accountability, specifically constructed along the lines of a central bank to be independent of political control, except for its masters, who are the leaders and technocrats of the European economic powers, aka Germany. Which leaves little say for countries like Greece.

In the Euro system, if it were run properly, Greece would have no more currency or budget flexibility than the State of Alabama has. Alabama doesn't print its own money, or budget with ongoing fiscal deficits, or benefit from natural adjustments of a floating currency in its trade. It resembles a household that uses money originating from outside and must balance its books. Sure, there may be debt in the form of long-term bonds, but there is no scope for the many uses of a truly soverign currency. At the same time, the welfare state of Greece would be willingly under-written by the Euro zone in toto, as would some attempts at fostering economic growth, instead of making Greece sell off its public assets and endure decades of austerity.

It is thus remarkable that the Greek people are so attached to the Euro, and to being part of the European political project in general. They see themselves, indeed, as the historical and cultural heart of Europe ... where it all began. I think there are some class aspects to this position as well. The upper crust in Greece are much more tied into the European system and benefit far more from inexpensive imports than the lower classes. They would naturally regard leaving the Euro as unthinkable, and lead the political system in that direction. Also, they have so far been able to game that system so well, with all the loans and corruption, that it might seem as though the party might not have to end, even at this late date.

In any case, in or out of the Euro, Greece has to start balancing its external trade. In the absence of currency devaluation, which provides the cleanest and most progressive way to accomplish this, that takes the form of paying people fewer euros, enduring lengthy recession, and hoping that everyone with any prospects doesn't flee to other countries before a new balance between internal average pay (lower than that of their dominant trading partner Germany) and tradable productivity is found.

The role of the government in all this is something of a side-show. It ran all kinds of deficits over the Euro period, and incurred many debts. But its future budget surplus and extra taxation can not do the heavy lifting of bringing the total trade balance back on course. And what if different regions of Europe have persistently different trade balances? Not every country can be better than average. What then? In the US, different states have clearly different trade balances, and while Federal spending makes up some of the difference and supplies a safety net, in the end some states become poorer than others and send their labor out to more productive ones. The rust belt rusted out, and Social Security and unemployment insurance was not enough to save it. Property values there may be a fraction of what they are on the coasts, but the prices of other goods are typically set nationally, making these regions suffer on a permanent basis. This is one price of currency union, that laggard regions that have trade deficits with productive regions have no means of trade/currency adjustment, and can become hollowed out ruins.

That fate awaits Greece and the other poor relations of the Euro zone, unless more robust and regular means of "adjustment" are found. So far, profligate lending filled that role, until the party ended. But the need for such transfers did not end, indeed is especially acute now, with unemployment at unimaginable levels in Greece and Spain. Greece's debt should in all decency be a dead letter in its entirety, for example. Germany can't keep selling its wares to the other Euro countries, not buy enough in return, and expect the system to sail on without someone coming knocking.

• Stiglitz on Greece.
• New Yorker on Greece.
• Who caused the crazy? Too much religion, or too little?
• The evolution of hate-words.
• Coal, at least, is slowly dying in the US.
• The Taliban is still about.
• This week in the WSJ: Martin Feldstein warns of new depression due to Fed pumping of stock prices, turns around and advocates raising the interest rate.
• The traffic is soul-crushing.

Free Banking: How Good, and How Free?

A fixation of libertarians is banking without any government control, or free banking. Did it work? Can it work?

What if we could get the government off our necks and out of our pockets, reverting to a more blissful state of nature when human relations were voluntary and markets rendered, by their invisible hand, everything we need? That is the dream of libertarians, especially monetary libertarians, who yearn to go back to gold and back to a time when anyone could issue any kind of money they pleased.

It is difficult to take all this seriously, but let's try. We would have to put aside the myriad problems of the gold standard. The gold (and silver) standard did one thing very well in its day, which was to keep money similarly valued over long periods of time. A ducat was worth something reasonably similar for hundreds of years, as was a Pound Sterling, i.e. a pound of silver. The intrinsic scarcity of these metals, and the nature of mining that added to stocks in very rough proportion to human economic activity (at least when economic growth was very slow), made them natural stores of value, virtually universal among pre-industrial human societies.

Free banking has actually happened, apparently most purely in Scotland in the 1700's and 1800's, till the evil British put the Bank of England in charge of monetary policy for good, in 1844. In this system, banks competed by issuing notes on their stocks of gold. These notes constituted their funding for loans, and acted as currency. This was truly a fractional reserve system, where on a certain stock of gold, they could issue several times the value in notes, and expect that redemptions back to gold would be rare enough that they would not, in normal circumstances, face a "run" on those reserves. Their motivation, therefore, was to have their notes be as trusted as possible, and thus as long in circulation as possible, so that loans could be made in large amounts. This style of banking goes back a long way, back to the Venetians and probably beyond. The early US in the 1800's had a similar system, though free banking enthusiasts look askance because it was heavily regulated (and corrupted!) by the states, not to mention that it ended up being extremely unstable, with numerous runs, collapses, and depressions.

Free banking is not really free, in my estimation, but highly restricted in several respects. First is the gold standard. The only commonly and universally recognized form of money at the time was precious metal, for which the notes served merely as an IOU. But were everyone to wish to convert their notes to gold for safe-keeping in their mattresses, (say, if war beckoned), the system would fall apart instantly. So it was a sort of ponzi scheme from the start, as is, in fairness, most banking. The gold standard meant that many banks could operate simultaneously, recognize each other's notes, and clear each other's payments, (and have the motivation to do so), because ultimately, they knew they could settle in gold if the need arose. Crises arise, now as then, when one institution loses this trust, faces lack of credit from intermediaries and / or customers, and spirals immediately into liquidation.

Under what I would take as true libertarian principles, really free banking would be something quite different, where a bank could issue money based on any form of value at all, and compete in the marketplace of customer trust. Its reserves could be land, or timber, cows, or cockle shells. Perhaps this would reduce in practice to the old gold standard, or perhaps to the money of some well-run state far away, as many dollarized economies practice it today(!) In any case, the use of gold/silver would not be forced on the banks and their customers, but be their own choice of funding / backing.

The second restriction was the nature of the bank corporation, which had unlimited liability. Thus, unlike our own corporations, which can escape any adversity through bankruptcy, the owners (partners) of classical banks were on the hook if there was a run or over-lending and their gold stores ran out. The Scottish system had one spectacular failure, of the Ayrs Bank, which reportedly ended up with virtually no losses to the note holders because the partners were cleaned out. Obviously, this rested on a legal system that was willing to hold the partners to literal account, something that seems to be oddly lacking in the current business climate. Likewise, the legal system had to underpin the gold standard, recognizing its central role of value in economic life.

Additionally, arch-libertarian Murray Rothbard brought out a rather tart paper about how unfree the Scottish system actually was, since its banks evaded their gold redemption requirements with great determination, and relied instead on Bank of England notes for most redemptions, treating it as their central bank. It is actually an excellent article about banking in general, graced with terror over proto-Keynesian "rank inflationists".

"Professor Sydney Checkland points out that Scottish banks expanded and contracted credit in a lengthy series of boom-bust cycles, in particular in the years surrounding the crises of the 1760s, 1772, 1778, 1793, 1797, 1802-03, 1809-10, 1810-11, 1818-19, 1825-26, 1836-1837, 1839, and 1845—47. Apparently, the Scottish banks escaped none of the destabilizing, cycle-generating behavior of their English cousins."

"The Scottish system was one of continuous partial suspension of specie payments. No one really expected to be able to enter a Scots bank . . . with a large holding of notes and receive the equivalent immediately in gold or silver. They expected, rather, an argument, or even a rebuff. At best they would get a little specie and perhaps bills on London. If they made serious trouble, the matter would be noted and they would find the obtaining of credit more difficult in the future."

"Bailey overlooked the fundamental Ricardian truth that there is never any social value in increasing the supply of money, as well as the insight that bank credit entails a fraudulent issue of warehouse receipts to nonexistent goods."

Anyhow, given these important restrictions and traditions, the Scottish system was quite competitive and reasonably robust for its day, with a few large and many small banks. The one thing it didn't do was serve the state, which by time was becoming used, in England, to running the monetary system for purposes of both inflation control and its own funding, especially in war. As Rothbard notes, the Scottish system had led to credit gyrations and substantial inflation, issuing roughly fifty times as many notes as the underlying gold/silver. This allowed economic growth, but also was completely unsustainable in terms of a true gold standard.

In the end, we return to the questions that were current in the 1800's as modern banking began to take shape. Should fractional banking be allowed in any form, or should money be 100% backed by the precious metals of tradition? If fractional banking be allowed, how should the creation of money be controlled to prevent the incessant cycles of boom and bust which appeared inherent to the free system whereby banks printed paper money in response to business demand for credit? If fractional banking be not allowed, how could one accommodate economic growth when the supply of money failed to grow- that is, when one's mines (or Imperial thievery) failed to crank out as much new metal as proportionately required for growth in population and technology? Would everyone end up being "crucified on a cross of gold"?

The answer, obviously, is that neither a 100% gold standard, nor free, unregulated banking, are optimal. Given the world's current wealth of about $250 trillion, an ounce of gold would have to be worth $50,000 to back wealth at 100%, which seems not just unrealistic, but obscene and a threat to our natural environment, given the mining this price would entail. Historically, as economic growth far outstripped metal mining, central banks took over macroeconomic policy with regard to money creation, inflation & interest rate control, bank regulation, reserve requirements, and many other practices. Central banks have made their share of grievous errors, particularly in the Great Depression. But some lessons have been learned, and our latest brush with the pitfalls of ponzi banking was significantly less bad than the Great Depression.

Nor is a stable store of value over long periods of time the only point of having a monetary system. Rather, it should exist to increase prosperity and human well-being. Gold is still available, after all, to all and sundry who wish for that imperishable store of value. For the rest, modest and controlled inflation using an elastic supply of money, as a spur to productive investment and labor over pure saving / mattress-stuffing, may be a more desirable feature of an optimal monetary system, combined with active state management to maintain value over booms and busts in the business cycle.

• Stiglitz on banking and credit catastrophes. A failure of mainstream economics.
• Bill Mitchell on basic Keynes.
• "Faith" is not faith.
• "Free" enterprise is anything but. There is always a network of consequences.
• The 1% vs Social Security.
• Modi calls Pakistan a spade. There is no "good" Taliban.
• All our money is belong to your national debt. Paul Krugman schools Rand Paul.
• The atheists are OK.