Tax Tyrranies

By Richard W. Rahn

Justice Oliver Wendell Holmes famously said, "Taxes are what we pay for civilized society," while his predecessor on the U.S. Supreme Court, Chief Justice John Marshall, also correctly noted, "The power to tax is the power to destroy."

At what point does taxation move from that necessary for proper government to tyranny?

The American Founding Fathers, in the Declaration of Independence, state as one of their grievances against King George III, that he imposed "taxes on us without our Consent." "No taxation without representation" was a rallying cry of the Revolution, and from that time it has been widely agreed that imposition of a tax without the consent of the governed is a form of tax tyranny. This is a reason why taxation under democratic regimes has greater moral legitimacy than taxation under nondemocratic regimes.

As democracy has spread throughout the world, fewer people are subject to this form of tax tyranny. However, in recent years some countries — primarily in the European Union — have tried, under the guise of "tax harmonization" and "unfair tax practices," to impose their desire for higher taxes on low-tax states. International organizations such as the United Nations and the Organization for Economic Cooperation and Development (OECD) have also made attempts to impose taxes on others without their just consent.

Another form of tax tyranny exists when governments impose tax rates above the revenue maximizing rate. It has been known for centuries that every tax has a rate above which it will be bring in no further revenue because people will cease engaging in the taxed activity, whether it is work, saving, investment or consumption of the taxed goods and services. Such high tax rates encourage development of underground or "black" markets, and/or the exodus of the particular activity.

For instance, high rates of taxation on capital cause people to move their money to lower tax rate jurisdictions. Extremely high rates of taxation on labor can cause people to even move from a given country or state. There are many well-known cases where highly paid movie stars, athletes and others have moved from their oppressive high tax rate home countries to more tax friendly places.

Unfortunately, many governments, including that of the United States, still have taxes and tax rates above the revenue maximizing rate. When this is known to be true, as it frequently is, it is nothing more than a form of tax tyranny imposed by a group of envious or mean-spirited officials. Occasionally, governments deliberately use taxation to alter certain behaviors, such as taxes on tobacco products, for which purposes tax revenue considerations are secondary.

Another form of tax tyranny exists when coercive taxation is used to fund government programs of little or no value, or where the expenditure programs are rife with corruption or mismanagement.

In his 1886 annual message to Congress, President Grover Cleveland stated, "When more of the people's sustenance is exacted through the form of taxation than is necessary to meet the obligations of government and expenses of its economical administration, such exaction becomes ruthless extortion and a violation of the fundamental principles of a free government."

Governments by their very nature tend not to be as well- and as efficiently managed as many private sector activities where people are spending their own money, but all too many political leaders in almost every country largely ignore their fiduciary responsibilities to the taxpayers by tolerating high levels of corruption and/or mismanagement. President Calvin Coolidge stated it succinctly, "Collecting more taxes than is absolutely necessary is legalized robbery."

Tax tyranny can exist when members of one group are singled out to pay a disproportionate share of the tax because of their religion, ethnic group, gender or other circumstance. Nowadays, this is most often seen in government abusing the idea of progressive tax rates. For instance, in the United States, the top 1 percent of the taxpayers pay 40 percent of the income tax, yet they have only 21 percent of the income. At the same time, the bottom 50 percent of the taxpayers pay only 3 percent of the tax while having 12 percent of the income.

Some politicians want to further increase the tax burden on the top 1 percent while reducing and even eliminating the tax all together on the bottom 50 percent.

When a majority shifts almost all of the tax burden to a small minority who must pay a grossly disproportionate share of their income, it smacks of tax tyranny. Two-dozen countries, many of whose citizens have suffered under the tyranny of communism, have instituted "flat taxes" to avoid this form of tax tyranny.

Finally, Nobel Laureate Milton Friedman said, "Inflation is taxation without legislation." Inflation is caused by government central banks increasing the money supply too rapidly. Taxing phantom capital gains due solely to inflation, or not allowing business to deduct true depreciation costs because of inflation, or not indexing tax rates to reflect inflation, are all types of tax tyranny; given that irresponsible government is the source of inflation.

Tax tyrannies reduce economic opportunity, job and income growth and undermine civil society. Tax tyranny will persist so long as politicians can buy the votes of one group of citizens by promising to shift the burden of government to others, and as long as judges continue to tolerate improperly levied taxes and tax discrimination.

Willful Misconduct
By Richard W. Rahn
THE WASHINGTON TIMES

It could probably be shown by facts and figures that there is no distinctly native American criminal class except Congress.

— Mark Twain (1897).

Twain's humorous quip, unfortunately, is all too close to the current reality. "Willful misconduct," a criminal offense, is legally defined as "intentionally doing that which should not be done or intentionally failing to do that which should be done, when knowing that injury to a person will probably result, or recklessly disregarding the possibility that injury to a person may result."

Congress, by failing to act in the case of a clear and present danger to parts of the American financial system, could reasonably be considered engaging in "willful misconduct." And here is why.

Decades ago, Congress created two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, to buy mortgages from banks with the goal of increasing the supply of mortgages to enable more Americans to become homeowners. (Fannie Mae was privatized in 1968, and Freddie Mac was created as a private company in 1970.)

It has been known for many years that both organizations were financial time bombs. Peter J. Wallison, former general counsel of the U.S. Treasury Department and now a senior fellow at American Enterprise Institute, wrote a book in 2001 warning of the unfolding disaster we now see, and recommended corrective action by Congress (as did other distinguished financial experts). Nothing was done.

Both GSEs are now in trouble, with Fannie Mae reporting it has $74 billion of subprime and Alt-A mortgage debt but only has about $45 billion in capital. If the GSEs fail, there would be a snowball effect.

In a new AEI report, Mr. Wallison notes: "Thousands of financial institutions hold GSE debt — in amounts that exceed their capital in many cases — and a requirement to write down the value of this debt would weaken the entire financial system as a whole and surely worsen the economic outlook."

If this occurs, Congress would most likely panic and declare the GSEs' mortgage-backed securities are now credit obligations of the U.S. government. The GSEs' combined debt of $4 trillion (yes, trillion) would suddenly be added to the debt of the United States, which would substantially injure the credit position of the U.S. and hurt every American taxpayer, who would ultimately be responsible for its payment. Unfortunately, there is no present alternative to this doomsday scenario because the GSEs are not covered by the normal bankruptcy laws, and Congress has not passed measures for an orderly windup of their businesses — clearly, willful misconduct.

It has been widely recognized in recent years that U.S. financial markets have been losing market share to their foreign competitors — which means both a loss of companies and jobs in the United States.

There have been four major reports on the situation, whose authors included both Democrats and Republicans. All these reports have come to the same conclusions. U.S. regulations have grown rapidly and are now far more burdensome in time and money than those of many responsible foreign competitors — notably the United Kingdom.

Many of the new regulations do not meet even the most basic cost-benefits tests. These regulations are primarily on securities issuers and have had little to do with the problems of the mortgage industry, where the current financial problems lie. The other reason both new and old companies are leaving the U.S. is the high litigation risk associated with private class actions.

A number of responsible proposals are before both the Securities and Exchange Commission and Congress to correct the problems of excessive regulation and tort law abuses, but neither the SEC nor Congress has taken necessary corrective actions. In the meantime, Americans employed in the securities industries unnecessarily lose jobs, and American companies find themselves at an international competitive disadvantage — because, again, Washington officials are engaged in willful misconduct.

Last week, members of Congress hauled up oil company executives to berate and threaten them because of high gasoline prices. As almost everyone knows, prices are set by supply and demand. If increases in supply do not keep up with demand, prices rise. Congress has restricted the supply of oil and oil products by not allowing drilling in the North Slope of Alaska, and in many U.S. offshore coastal and on-shore areas. Politicians have stopped construction of proposed new refineries. These actions have increased the price of gasoline and oil for all, causing increased economic hardship, particularly for the poor.

Those members of Congress who vote for oil drilling and refinery restrictions and then blame others for high oil prices can be accused of willful misconduct.

In 2006, voters turned over the leadership of Congress to the Democrats because the Republicans had overspent and in other ways violated voters' trust. The Democrats, rather than learn from the Republican mistakes, are now engaged in even more willful misconduct. If they were private corporate executives and acted in such a manner, some might be convicted in a court of law, but members of Congress are protected from the consequences of many of their actions — except the wrath of the voters.

Perhaps if the incumbent party were thrown out every two years, eventually they would get the hint, and willful misconduct would cease.

The Specter of Stagflation

By Robert Samuelson

WASHINGTON -- "Stagflation" is back in the headlines -- but the term is being misused. We're told by eminent commentators that stagflation is the messy mixture of both high inflation and high unemployment. It isn't. Stagflation, at least as the concept was initially understood in the 1970s, meant something different. Yes, it signified the simultaneous occurrence of high inflation, high unemployment and slow economic growth; but its defining feature was the persistence of this poisonous combination over long periods of time.

Let's see why this is a distinction with a difference. The coexistence of high (or rising) inflation with high (or rising) unemployment is not an abnormal event. But it's usually temporary, because the higher unemployment -- stemming from an economic slowdown or recession -- helps control inflation. Companies can't pass along price increases; they're stingier with wage increases. It's only when this restraining process is not allowed to work that inflationary psychology and practices take root, creating a self-fulfilling wage-price spiral. Higher wages push up prices, which then push up wages. Then we get stagflation: a semipermanent fusion of high joblessness and inflation.

Naturally, no politician acknowledges the self-evident implication: that recessions, though unwanted and hurtful to many, are not just inevitable; sometimes they're also necessary to prevent the larger and longer-lasting harm that would result from resurgent inflation. Interestingly, many academic and business economists who have more freedom to speak their minds suffer the same deficiency. They treat every potential recession as a policy failure when it is often simply part of the business cycle. They thus contribute to a political climate that, focused on avoiding or minimizing any recession, may perversely aggravate inflation and lead to much harsher recessions later. The stagflation that began in the late 1960s and resulted from this attitude was indeed dreadful: from 1969 to 1982, inflation averaged 7.5 percent annually and unemployment 6.4 percent.

What's renewed interest in stagflation is the latest consumer price index (CPI), the government's main inflation indicator. For the year ending in January, all prices were up 4.3 percent. Excluding the temporary surges after Katrina, inflation hasn't been higher since July 1991. Even eliminating food and energy prices (about a quarter of the index), January's year-to-year increase was 2.5 percent.

All these figures exceed the Federal Reserve's informal inflation target of 1 percent to 2 percent a year: a range deemed so low that it constitutes effective price stability. And these aren't the truly disturbing numbers. The more upsetting figures are those for the last three months. In this period, the full CPI rose at a 6.8 percent annual rate. Without food and energy, the increase was still 3.1 percent. Medical services were up 5.1 percent, women's and girls' apparel 7.3 percent (again, at annual rates). Inflation is accelerating.

Price increases of individual items can have many immediate causes: poor harvests for food; OPEC for energy; uncompetitive markets for health care; corporate market power for drugs. But persistent inflation -- the general rise of most prices -- has only one cause: too much money chasing too few goods. It's not a random accident. The Federal Reserve regulates the nation's supply of money and credit. The Fed creates inflation and can control it.

Since August, the Fed has been under enormous pressure to ease money and credit. It has. The overnight Fed funds rate has fallen from 5.25 percent in early September to 3 percent now. Politicians are clamoring for the Fed to prevent a recession. Banks and other financial institutions want cheaper credit to enable them to offset losses on subprime mortgages. There is fear of a wider economic crisis if large losses erode confidence and, by depleting the capital of banks and other financial institutions, undermine their ability and willingness to lend and invest.

Unfortunately, the Fed shows signs of overreacting to these pressures and repeating the great blunder of the 1970s. Underestimating inflation then, the Fed repeatedly shoved out too much money and credit in a vain effort to keep the economy near "full employment." Now, switch to the present. Again, the Fed has underestimated inflation. It expected the economic slowdown to suppress inflation spontaneously. But so far, the lower inflation hasn't materialized in part because, outside of housing, there hasn't been much of an economic slowdown.

It's true that the Fed is treading the proverbial tightrope. No one wants a financial crisis; but no one should want the return of stagflation either. The American economy -- a marvelous but flawed engine of wealth -- periodically goes to speculative or inflationary excesses. If most of those excesses aren't given the time to self-correct, we may be trading modest pain today for much greater pain tomorrow. Trying to prevent a recession at all costs is a fool's errand that could ultimately backfire on us all.

The Triumph of OPEC

WASHINGTON -- For much of its 47-year existence, the Organization of the Petroleum Exporting Countries (OPEC) has been a cartel in name only. It could not control oil prices because many of its members regularly breached the production quotas that were intended to regulate the market. So OPEC followed oil prices up and down, as supply and demand shifted. But now OPEC may be the real deal: a cartel that works. If so, that's bad news for the rest of the world.

Look no further than last week's OPEC meeting in Vienna. Oil ministers declined to increase production despite a strong case for doing so. Not only were oil prices fluttering above $100 a barrel, but the United States is either in or near a recession and much of the rest of the world faces an economic slowdown.

What's wrong is that a fall of oil prices is one of the mechanisms by which a recession or economic slowdown corrects itself. Lower prices for gasoline, home heating oil and diesel fuel improve consumer purchasing power. They muffle inflation and increase confidence. In this sense, they're an important "automatic stabilizer" for a faltering economy.

Oil producers don't much care. High prices have been good to them. Since 1999, annual oil revenues for OPEC countries have more than quadrupled, to an estimated $670 billion in 2007, says energy economist Philip Verleger Jr. What's less clear is whether OPEC has merely benefited from tight oil markets or has acted as a true cartel, restricting output and raising prices. The right answer is: both.

Of tight markets, there's little doubt. Two massive oil miscalculations both aided OPEC. First was a widespread underestimate of world demand, especially from China. Since 1999, China's oil use has almost doubled, to 7.5 million barrels a day (mbd) in 2007. (In 2007, world oil use was 86 mbd, up 13 percent from 1999. American oil use was 20.8 mbd, up 7 percent.) Second was an overestimate of supply. War, civil strife and nationalization have depressed production in Iraq, Nigeria, Iran, Venezuela and elsewhere. Total global capacity might be 4.5 mbd higher without these setbacks, says the Energy Policy Research Foundation (EPRINC).

But that's only the half of it. Go back to late 2006. Crude prices were slipping from about $70 a barrel in August toward $50 a barrel. A true cartel would cut production to prop up prices. That's what OPEC did. In two steps, it reduced oil output by about 800,000 barrels a day, notes economist Larry Goldstein of EPRINC. "By July, 125 million barrels of oil inventory had been wiped out," he says. At the end of 2007, inventories (measured by days of supply) were at their lowest point in three years. Prices rose.

OPEC's present market power dates to early 1999, says economist Verleger. Oil prices then were about $10 a barrel. The 1997-98 Asian financial crisis had cut demand; supply was essentially unregulated. Saudi Arabia undertook frantic negotiations with other major producers, including Iran, Kuwait, Venezuela and non-OPEC members Russia, Norway and Mexico. The result was an agreement to cut production sharply. Compliance with output quotas was surprisingly good; countries were terrified by the collapse of their oil revenues.

We are paying for past shortsightedness. Dependence on oil imports, now almost 60 percent of U.S. supply, is inevitable. But we could limit OPEC's market power by curbing our demand and increasing our supply. As the worldwide gap between supply and demand rises, it's harder for producers to control the market. More have spare capacity; more are tempted to increase production to raise revenues. Today's surplus is concentrated in a few countries, especially Saudi Arabia, which can adjust production to influence prices.

Americans rant at foreign producers on the silly presumption that they should subordinate their interests to ours. But we refuse to do much that would actually limit their freedom of action. It was only last year that Congress raised fuel-efficiency standards for new cars and light trucks. We have steadfastly rejected higher gasoline taxes to curb unnecessary driving and strengthen demand for fuel-efficient vehicles (better to tax ourselves than let foreigners tax us through higher prices). And we have consistently restricted oil drilling in Alaska and elsewhere.

By doing so little to check its own thirst for imports, the United States has contributed to OPEC's present triumph. The extent of that triumph will be tested this year and next. Non-OPEC oil supplies -- from Brazil, Canada and Kazakhstan, among other places -- will increase. Meanwhile, a weaker global economy may dampen demand. Even OPEC may be unable to hold prices at today's high levels. Whatever happens, the long-term threat of a global oil cartel will remain. We should be taking the hard steps to limit its power. Considering our past complacency, we probably won't.

High Finance Laid Low

By Robert Samuelson

WASHINGTON -- Except for oil executives, no group of business leaders is now more resented than the titans of finance -- bankers, traders, hedge fund managers. They are blamed for causing the housing crisis, global financial turmoil and a possible recession. But this sweeping indictment, though true, is only half the story. The job of modern finance is to allocate Americans' nearly $2 trillion in annual savings to its most productive uses; the paradox of finance is that its virtues and vices come tightly packaged together.

What we call "financial services" -- insurance and real estate, as well as banking and securities trading -- has been a growth sector. In 1976, it was 15 percent of gross domestic product; now it's 21 percent. The expansion has produced many benefits: more credit for families and businesses; more investment choices for people saving for retirement and anything else; more investment capital for start-ups and smaller firms. Unfortunately, financial advances have also created periodic episodes of massive waste that threaten to destabilize the entire economy.

The subprime-mortgage debacle is not a rare exception. Before that, there was the tech bubble of the late 1990s when stock valuations floated into La-La Land and anyone with a business plan ending with .com could get money from venture capitalists. Earlier, the junk-bond mania of the late 1980s ended badly. According to finance professor Josh Lerner of the Harvard Business School, there seems to be a regular cycle of financial innovation (good), imitation (good up to a point, because it provides competition) and finally suicidal excess. Herd psychology reigns.

The idea that enlightened government regulation can outlaw this cycle is at best an optimistic exaggeration. Some of Treasury Secretary Henry Paulson's new proposals for regulation are worth adopting: merging the Securities and Exchange Commission and the Commodity Futures Trading Commission; expanding the Federal Reserve's powers. But the basic problem is that as long as people are benefiting from innovation and investors are making money, it's hard to impose restraints on the excesses. Only a crackup brings clarity.

In 2005, foreclosures on subprime mortgages totaled a modest 3.4 percent. Warnings about abusive and reckless lending practices went unheeded, as overpaid Wall Street investment bankers stuffed the mortgages into ever more complicated securities. In the disastrous aftermath -- the foreclosure rate is now nearly 9 percent and rising -- it's easy to forget the brighter side of financial innovation.

Consider mortgages. In 1980, they came in one flavor: 30-year fixed-rate loans. Because fees and closing costs were so high, it was hard to refinance into a cheaper loan even if interest rates fell. The rule of thumb was that rates had to drop 2 percentage points before refinancing made sense. Now homeowners can choose from many mortgages with different maturities, as well as fixed and floating rates. Lower fees and transaction costs (from automated underwriting, among other things) make refinancing attractive if interest rates drop a half a point or even less.

The story is similar for other innovations. Personal investment choices have mushroomed. In 1980, households had half their financial assets in bank deposits and savings accounts; only 34 percent were in stocks and a meager 2 percent in mutual funds. Since then, Americans have diversified: In 2006, 25 percent of household assets were in mutual funds, 28 percent in stocks and 28 percent in bank deposits and savings accounts.

Or take a more sophisticated innovation: the rise in the 1980s of "leveraged buyouts" (LBOs), now known as "private equity." On balance, the threat or reality of a takeover has improved corporate performance, says finance professor Steven Kaplan of the University of Chicago. But there's also a dark side, he says. In the speculative climaxes, the LBOs' bet is that companies can simply be bought with cheap money and later sold profitably in a rising stock market. If the bet fails, defaults will ensue.

It is often wrongly said that the present problems originated in the mindless financial deregulation begun in the 1980s, as if everything would be fine if the old financial system remained. Actually, the old system -- dominated by banks and savings and loans -- collapsed. Many S&Ls failed when high inflation raised interest rates on their short-term deposits above the levels on their long-term mortgages. Banks suffered huge losses on energy, commercial real estate and developing-country loans. Securitization and other new forms of financing filled the void left by weak banks and S&Ls.

So modern finance has a split personality. Greed, shortsightedness and herd behavior compromise its usefulness. But regulation cannot cure this dilemma, because regulators can't anticipate all the problems and hazards either. The best protection against human fallibility is to insist that major financial institutions have ample capital to absorb unexpected losses. Paulson's recommended reforms barely dwelled on that; Congress should.

Thoughts on the Colombia trade deal

Kevin Drum and Matthew Yglesias have posts up on the free trade agreement with Colombia and wonder whether it's worth all the trouble it's going to create. Let's respond!

Kevin's post boils down to the following facts: a) Trade contributes somewhat to rising inequality and stagnant wage growth at the lower end of the wage spectrum; b) There's little appetite among the American people for freer trade; and c) Trade is pretty free anyway, so why worry about piddling deals like the one with Colombia. In conclusion, Kevin paraphrases Senator Clinton: "Taking a breather to rethink how we approach trade seems pretty reasonable at the moment."

Matt's post helps to rebut the first charge. As he observes:

[The FTA] actually involves very little changes on the US side at all. In essence, Colombian goods already flow very freely into the United States except for in our more famously protected sectors (agriculture, etc.) and what we're offering Colombia here is a very solemn promise to keep it that way.

The Colombia FTA is hardly unique in this regard -- this is pretty much what the state of play was prior to NAFTA as well. So the effect of these kind of FTAs on U.S. wages is less than minimal.

It also explains why ratifying this FTA is a good idea -- it locks in U.S. policy. As I've posted previously, the reason these agreements are a good idea is precisely because they prevent the drift towards protectionism that is otherwise inevitable in a pluralist political system. As for Kevin's desired "pause," let's face it, there is going to be zero momentum towards further liberalization beginning in 2009 regardless of whether this FTA is passed. Kevin's pause is happening whether anyone likes it or not.

After analyzing the content of the deal, Yglesias concludes the following:

All things considered, this seems to have almost no implications for American well-being, and if I were a member of congress I think I would consider this an excellent moment to let me vote be dictated by pure partisan politics or possibly corruption. If I were a blogger, I would say that lowering barriers to the importation of foreign goods on a unilateral basis would be good policy for the United States and that using bi- or multi-lateral trade negotiations to try to get other countries to adopt "pro-business" policies is a pretty dubious undertaking.

The first point is incomplete and the second point is factually incorrect.

The biggest benefit of the FTA with Colombia has little to do with economics and everything to do with our bilateral and regional relationships. Go back to NAFTA. Kevin is right to point out that the agreement's economic effects were not terribly large. On the other hand, even skeptics of trade liberalization -- Dani Rodrik, Paul Krugman, and Joseph Stiglitz -- supported NAFTA because it locked Mexican economic reforms, promoted political reforms, and cemented a stronger bilateral relaionship.

There's no reason to believe that the same effects would not take place with Colombia. Matt has been stressing the killings of labor activists in Colombia. However, the EPI graph he highlights shows a pretty dramatic reduction in these killings since 2003.

Question to Matt: what's the best way for the United States to help reduce those killings even further -- ratifying or rejecting the FTA? I'd argue the former. FTAs matter more than unilateral reductions of trade barriers because they decrease the likelihood of policy reversals (which, again, is why Hillary Clinton's proposals to renegotiate FTAs every five years or so is such a God-awful idea). Ratifying the FTA with Colombia increases the likelihood that labor killings will continue to decline.

A final point: for freer trade to be politically sustainable, there needs to be some kind of reciprocity, which can't happen via unilateral reductions in trade barriers. Historically, unilateral reductions have had a minimal impact on the openness of the global economy. In the 19th century, the repeal of the Corn Laws mattered a hell of a lot less than the Cobden-Chevalier treaty in opening up European economies to each other. In the 20th century, GATT mattered a hell of a lot more than any unilateral U.S. policy in leaving the misbegotten trade policies of the Depression behind.

UPDATE: On the other hand, I should point out that Drum is 100% correct on this point he makes in a follow-up post:

Question: which is more important to the cause of free trade: (a) passage of the Colombian trade pact or (b) reining in the monstrosity that is U.S. farm policy? The answer is (b) by several light years. So why do we hear so much about the dire consequences of failing to pass a piddling bilateral trade deal... but almost nothing about the dire consequences of the hideous $300 billion distortion caused by the latest round of farm subsidies — most of which goes to big agribusiness, not struggling family farms? How about a little more noise on the farm front?

The problem is even bigger than Drum realizes, since cutting back agricultural subsidies are also the key to completing the Doha round.

The Brushedback Economy

Brother Can You Spare 10 Grand?

by Peter Schiff

The grainy footage of Great Depression soup lines and Hoovervilles now in heavy rotation on the major news outlets has been largely counterbalanced by a parade of economists who reassure us that such a protracted downturn is currently inconceivable. Their confidence stems primarily from the belief that government safety nets enacted since the New Deal, together with a Fed chairman who is a self-professed depression buff, will prevent a replay of the 1930s. As usual, this analysis is woefully optimistic and sidewalk pencil sales may in fact be a growth industry.

Although Bernanke may have spent much time studying the Great Depression, his understanding of it is anything but sound. That epic slowdown resulted from a series of policy mistakes, first by the Federal Reserve and then by the Federal Government. Bernanke’s view is that these mistakes were simply not large enough. What the current Fed chairman does not grasp is that the seeds of the Depression were sown during the “roaring” 1920s when the Fed, in an effort to support the British pound, kept interest rates much too low. It was this unnaturally cheap money that fueled a raging stock market bubble. In 1929, when the Fed finally came to its senses and raised rates, the bubble finally popped. In his reading of this history, Bernanke ignores the effects of the overly easy policy and simply lays blame on the tightening.

As the recession progressed, both Hoover and Roosevelt, in politically inspired efforts to ease the pain, repeatedly interfered with free market forces working to correct the imbalances. This ultimately turned what would have been an ordinary, though perhaps severe recession, into what we now call the Great Depression. This time around, the Greenspan/Bernanke Fed blew up even bigger bubbles and both the Fed and the Federal Government now show an even greater commitment in preventing free market forces from rebalancing our economy. As a result, similar to the way that the “War to End all Wars” had to be rechristened after 1939, future historians may need to come up with a new term for the Great Depression.

Rather than acting as safety nets, the programs now being devised by government will act more like snares, further impeding market forces from righting the ship. But for those who insist that a new “New Deal” is needed, it is important to retain a sense of scale. Prior to the massive expansion of Federal programs in 1933, the government was very small relative to the economy of that time. Though I believe that many of the economic policies of the New Deal were unwise and simply prolonged the Depression, at least back then we could afford them. Today of course, the Federal Government is already enormous, and any increase in spending will either have to be financed by further borrowing from abroad or though additional money printing by the Fed.

For his part, Bernanke blames the Depression on the Fed not printing enough money. Had the Fed done precisely what Bernanke now thinks they should have, the Great Depression would have been much worse. Had the Fed tried to re-inflate the stock market bubble or keep it from bursting in the first place, it’s the dollar that would have collapsed, and Depression-era America would have looked liked Weimar Republic Germany. As bad as the Great Depression was, hyperinflation would have made it even worse.

The good news is that there is still time to alter course and steer clear of both hyper-inflation and depression. The bad news is that if we remain on our current course that is precisely where we will end up. Our days of dominating the global economy are clearly coming to an end. The only question is will we follow the path of Great Britain or Argentina?

The Assault on Free Markets

Those blindsided by the recent financial meltdown are now loudly blaming the free market for its failure to police its own excesses, and are calling for greater regulation to prevent future disasters. But for those who clearly observed the problems developing (in high definition slow motion) the blame can be directed squarely at the policies of the Greenspan/Bernanke Federal Reserve. As has been the case countless times in history, the free market will now pay the price for government incompetence.

In Senate hearings this week, all parties involved completely ignored the Fed’s own culpability in igniting the speculative fever. It’s as if a senior prom had turned into a wild bacchanalia, and angry parents now question why the chaperones failed to notice the disrobing or why the DJ played provocative music, all the while ignoring the bearded gentleman pouring grain alcohol into the punch bowl.

A perfect illustration of the Fed’s failure to take responsibility can be found in Bernanke’s explanations regarding inflation, which he solely attributes to the effects of the rapid increase in global commodity prices. He failed to mention that commodity prices are rising as a direct consequence of his monetary policy, which is debasing not just the U.S. dollar, but currencies around the world. Rather than accepting the blame for creating inflation, Bernanke is shifting the blame to the free market. The Senators are happy to let him get away with it as it provides more evidence to support the “need “ for more government to save the economy from the disastrous effects of unbridled capitalism.

When asked how we got into this mess, Bernanke replied that our problems resulted from an excessive credit bubble characterized by aggressive leverage, reckless lending, and extreme risk taking. Absent from his explanation was the Fed’s role in irresponsibly setting interest rates below market levels, which mispriced risk, got the party started and kept it raging into the wee hours of the morning. The expressed goal of the Fed for much of this decade was, and is, to encourage and facilitate borrowing and lending.

During his testimony, Bernanke continued to claim that Bear Steams was not bailed out as shareholders only received about $10 per share. Of course, $10 is better than zero, which is what they surely would have received if the Fed hadn’t thrown taxpayer money around. What about Bear’s creditors though? Although the collapse of Bear Stearns would have cost bond holders dearly, the bailout essentially makes them whole. Here again, the Fed creates even greater moral hazards by encouraging excessive risk taking. By bailing out lenders who extend excessive credit, the Fed simply invites more of that behavior. The free market must be allowed to properly price risk. Lenders need to know that when they lend money, whether to highly leveraged investment banks and hedge funds, or to over-stretched homebuyers or credit card users, they risk not getting paid back. By interfering with this process the Fed simply guarantees more losses and even bigger bailouts in the future.

Also, leveraged speculators need to know that it is not “heads they win, tails the taxpayers lose”. Wall Street executives amassed fortunes by making extremely risky bets. Now that those bets have soured, why is it taxpayers that have to swallow the losses? Wall Street billionaires earn their bucks on the backs of the middle class, who made little on the way up, but foot the entire bill on the way down.

While Bernanke talked about the underlying strength of our economy, he claimed necessity in saving Bear Stearns from bankruptcy as it would have brought down our entire financial system. How sound can our economy be if the failure of one investment bank could topple it? Does this now mean that no more major banks or brokerage firms will be allowed to fail? Since we routinely accused Japan of practicing “crony capitalism” what do you suppose we should call our version?

Not to be outdone in rewarding reckless behavior, earlier in the week Congress passed $15 billion in tax breaks for homebuilders, who had made their fortunes overbuilding during the bubble and unloading their shares to a gullible public. By threatening to hold back on their political contributions, these same homebuilders are awarded still more billions. The last ones we should be subsidizing are homebuilders. After all, the last thing we need right now is more homes.

The legislation also contained a provision that offers generous tax credits to individuals who buy homes out of foreclosure. While this is billed as a benefit to homebuyers, it is just another hand out to lenders, as those qualifying for the tax breaks will simply pay more at auctions as the tax breaks subsidize higher bids. The real winners are the creditors who get more in foreclosure than would have been the case had buyers not had their bids subsidized by the government.

Of course, for all the talk about taxpayer bailouts, none of the senators bothered to mention that, for the moment, no tax increases are actually on the table. Instead, the bailouts are being financed by savers, pensioners, wage earners, investors and the elderly on fixed incomes, who all suffer staggering increases in their costs of living, as the Fed uses inflation to rob Main Street to pay off Wall Street.

"What's Missing Here?"

One of the familiar tropes of the anti-war caucus is that Iraq had no links to terrorism prior to the American invasion but now it has become a breeding ground of terrorists who will destabilize other countries. The first part of the argument—the claim that Saddam-era Iraq was not linked to terrorism—should have been demolished by the recent Iraq Perspectives Project report. (Unfortunately, its findings were generally misreported by the MSM.) The second part of the argument—the claim that Iraq is exporting terrorism—has now come under serious assault from, of all people, the French.

In a blockbuster article, Elaine Sciolino of the New York Times yesterday reported that French security experts are retracting their earlier claims that, as then-Interior Minister Dominique de Villepin put it in 2005, Iraq-trained jihadists would “come back to France, armed with their experience, to carry out attacks.”

Writes Sciolino: “Compared with the thousands of European Muslims who joined the fight in Afghanistan in the 1990s through organized networks in Britain, the number of fighters going to Iraq has been extremely small, according to senior French intelligence officials.” Although she doesn’t say so, the number of terrorists leaving Iraq to conduct attacks elsewhere has been even smaller. (As far as I know, the only successful example was Abu Musab Al Zarqawi’s bombing of three hotels in Amman, Jordan in 2005.)

Sciolino, relying on interviews with French officials, offer four possible explanations for why the predicted terror surge has not occurred:

1. “The logistical challenges and expense of reaching Iraq … particularly with Syria’s making episodic efforts to halt the use of its territory as a transit route.”

2. “Iraqi insurgents currently neither need nor welcome European Muslims who lack military training and good Arabic-language skills — except if they are willing to conduct suicide missions.”

3. “ The fight in Iraq is no longer just a jihad against foreign occupiers, but also a confusing civil war pitting Muslim against Muslim. Many young people have family and ethnic ties to Pakistan or North Africa, making those places more attractive destinations, and further advancing those regions’ potential for recruiting and radicalizing young Muslims.”

4. “[L]aw enforcement authorities, particularly in countries like France, Italy and Spain, say they are convinced that their sweeping legal authority to eavesdrop, make arrests, hold suspects for long periods of time and win convictions on the vague charge of association with a terrorist enterprise has made it easier to take preventive action.”

All of those explanations seem plausible to me. But it strikes me that Sciolino is missing an important element of the puzzle: namely that the group that her newspaper insists on calling Al Qaeda in Mesopotamia (which the rest of the world knows as Al Qaeda in Iraq) is losing big time. It has been routed out of its strongholds in Anbar, Baghdad, and Diyala provinces and is now being hunted down in its last remaining lairs in Mosul and vicinity.

Along the way Al Qaeda has managed to alienate its natural constituency—Iraqi Sunnis—through its counterproductive, barbaric behavior, which has resulted in the death of far more Muslims than “crusaders” (i.e., Americans). In letters seized by coalition forces, Al Qaeda in Iraq leaders acknowledge that they are in an “extraordinary crisis,” that the successes of U.S. and Iraqi security forces have created “panic, fear and the unwillingness to fight,” and that their security structure has suffered “total collapse.”

Jihadists flocked to fight in Afghanistan in the 1980’s because it was seen as a winning war. Some are still coming to Iraq, but in nowhere near the same numbers: it is now seen as a losing cause. Moreover, most of those who do come to Iraq never leave. A few seek out their 72* virgins through staging suicide attacks. Most are caught or killed by coalition and Iraqi forces. (Some have called this the “flytrap” theory.)

In other words, it seems reasonable to assume that the success of the surge (which has catalyzed related developments, such as the willingness of some 200,000 Iraqis to join the Iraqi security forces or American-funded neighborhood watch groups in the past year) is blunting the potential of Iraq to become a breeding ground for international terrorism. It is more than a little odd, therefore, not to see the word “surge” anywhere in Sciolino’s article. Is it possible that neither this correspondent nor her sources wants to credit American military action for what may be a major victory over Islamist terrorism?

Superdelegate count a mystery

By MICHAEL CALDERONE |

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Some outlets require an on-the-record commitment to count as an Obama or Clinton vote. Photo: AP

When it comes to the Democratic superdelegates, the math is fairly simple. Unlike the complex and seemingly impenetrable formulas required to determine the number of pledged delegates won by Barack Obama and Hillary Rodham Clinton, the superdelegate breakdown is as straightforward a calculation as it gets.

It boils down to this: There are 794 elected officials and party leaders who make up the pool of superdelegates. Each either supports Clinton, Obama or is uncommitted at the moment.

Yet despite the simplicity of counting superdelegates, neither the campaigns nor the news organizations tracking them can agree on where the tally stands. The only point of agreement is that Clinton appears to hold a lead.

As of April 9, for example, MSNBC reported Clinton had 256 superdelegates in her camp to Obama's 225. But The New York Times saw a much tighter race: 221 Clinton superdelegates compared with 209 for Obama.

Other news organizations tracking superdelegate votes for Clinton and Obama, respectively — including Politico (249-225), CNN (243-215) and The Associated Press (252-224) — also stood at variance with each other.

The superdelegate head count discrepancy is no small matter, for Clinton’s hopes of winning the Democratic nomination are predicated on a strategy that hinges on winning enough superdelegate votes to overcome her expected deficit in pledged delegates at the end of the primary season.

Richard Stevenson, the political editor of The New York Times, provided a good reason why news outlets keep coming up with different tallies: “This is an art rather than a science.”

Its being an art rather than a science is in large part due to the motivations of the superdelegates themselves. Many of them are acutely aware of the political sensitivities surrounding their votes, and they act accordingly — some by hedging or obfuscating their positions.

The disparity can also be traced to news-gathering techniques. Some media outlets rely on the campaigns for guidance on the count, others require an on-the-record commitment to count as an Obama or Clinton vote and a few use a combination of both.

“We survey all of them, or at least the diminishing pool who have not decided or declared publicly, on a fairly regular basis,” Stevenson said.

Currently, The Times lists 242 superdelegates wading in the “preference unknown” pool. But in an example of the kind of questions confronting news organizations, one of those listed as “preference unknown” is Margaret Campbell, a DNC member from Montana.

Campbell has already publicly endorsed Obama. But she was forced to “retract” her endorsement earlier this week because state party rules prevented her from endorsing a candidate. Since she is technically uncommitted because of the retraction, the Times counts her as “preference unknown.”

But Politico counts her as an Obama superdelegate since the retraction was based on a technicality, rather than an actual change of heart. The Politico tally, which lists individual superdelegate names and their preferences, is sourced to candidate press releases, news accounts of endorsements, Roll Call’s list of endorsements, Democratic Convention Watch blog and independent reporting that includes communication with the campaigns and interviews with the superdelegates themselves.

For the Times, superdelegates also have the option of confidentiality, Stevenson said. But at the same time, the “threshold is a firm commitment” so as not to include “leaners" — a requirement that, according to Stevenson, could be one reason the paper’s superdelegate count is lower than some other news outlets

The Times count, like others, is just an estimate, so the Associated Press number is listed just under it on NYTimes.com, for the sake of comparison.

Since the business of keeping a running superdelegate count is a timely process that requires constant monitoring or the ability to make hundreds of phone calls, many news organizations rely primarily, or solely, on the AP list.

At the AP, the job of overseeing the delegate count falls largely on the shoulders of demographics reporter Stephen Ohlemacher, who oversees the most comprehensive superdelegate count going, utilizing the vast network of AP reporters from Washington to every statehouse in the country.

The AP tries to call every single superdelegate. At this point, Ohlemacher estimates, the AP has been in contact with 95 percent of all superdelegates — yes, a few dozen stragglers aren’t returning calls.

As for Montana’s Margaret Campbell, Ohlemacher said that she is not currently listed in Obama’s column, though that might change after he does more reporting.

The AP released its first full superdelegate survey in early December, and has done so after three pivotal election nights: New Hampshire, Super Tuesday and Ohio/Texas. Ohlemacher declined to say when the next full count will be, but based on past history, a safe bet is around April 22.

One major difference between the AP's count and others is the minimal involvement with the Obama or Clinton campaigns.

“I have seen lists from the campaigns,” Ohlemacher said, “but we do not rely on them.”

Although Ohlemacher said the campaign numbers have not been “wildly inflated,” he expects that “they’re always going to be a little higher than what our count would be.”

Chuck Todd, political director at NBC News, says that the campaigns are not going to present numbers that could be easily proved wrong.

So there’s a de facto honor system in place, considering that with the number of reporters and bloggers obsessing over the superdelegate count, the campaigns surely don’t want to be viewed as cheating.

And that’s good for Todd, considering that his count began with guidance from the campaigns.

Unlike the AP, which started from scratch, NBC’s political unit received guidance from the campaigns about how many superdelegates they claimed and which ones — even those not publicly committed — were expected to offer support. Todd and his team then followed up to confirm the information coming out the campaigns with individual superdelegates.

“The super number is a fluid thing,” said Todd, adding that overall it’s “more like snapshot.”

Also, it can change with the speed of the 24-hour news cycle, often through random tips streaming in from low-level supporters, Todd said, or just “people who have become delegate junkies.”

Those “delegate junkies” include reporting novices who are also attempting to provide an accurate superdelegate count — such as the two men behind what’s become a go-to superdelegate website, Democratic Convention Watch.

The pair, who insist on anonymity, consists of “Matt” and his partner on the site, “Tom.” A network administrator by trade who writes under the name “Oreo,” Tom said they started the superdelegate count in early January “because all the big media places were giving numbers and not names.” Since few outlets at the time provided the superdelegates’ names, he said, superdelegates could switch sides without accountability.

So the two began listing all the names they could find through campaign releases or lists supplied to them from the Democratic National Committee.

Now they also use readers’ tips and do their own research to pull together a list of committed superdelegates. Some superdelegates have even commented on the site which way they’re leaning or have assisted the site’s creators in keeping an accurate count.

DemConWatch’s current totals are 245 for Clinton, 221 for Obama — different, of course, than the other news outlets but still falling within the same range as their better-equipped (and -funded) competitors.

And there’s another major difference in how they’ve kept a running superdelegate tally: while individual Democrats chime in with assistance, the two campaigns have been absent from the process.

“I’ve e-mailed them,” Tom said, “but I’ve never heard anything back.”