For the first time in 16 years the U.S. economy was reclassified from “totally free” to “mostly free.” But wait: The United States was totally free economically until 2010? That’s enough to suggest that the Index focuses on quite a narrow range of “economic freedom” criteria, rather than looking critically at the forms of State intervention most structurally important to the survival of big business and corporate power.

For example, by any valid measure of economic freedom, the passage of the WIPO Copyright Treaty, the Uruguay Round TRIPS (Trade-Related Aspects of Intellectual Property Rights) Accord, and the Digital Millennium Copyright Act would have been considered an upward surge in statism and protectionism unequaled since (at least) the Smoot-Hawley Tariff. “Intellectual property” is every bit as much a form of protectionism as are tariffs. Patents and copyrights serve exactly the same protectionist function for transnational corporations that tariffs did for the old national industrial corporations; in both cases they restrict who is permitted to compete in offering a given good to a given population.

But among the inside-the-Beltway “free market community,” Heritage is one of the staunchest advocates of global “intellectual property” enforcement expansion. Indeed, two lines out of six in its summary concerning its metric for “Property Rights” in the United States are taken up by this: “A well-developed licensing system protects patents, trademarks, and copyrights, and laws protecting intellectual property rights are strictly enforced.”

One-Sided Index

There are other suggestions of the one-sided nature of the Index, as well. For example, under “Labor Freedom” it simply states that “dismissing an employee is not burdensome.” Never mind for the moment that, from the standpoint of an employee, a bit of contractual security might be a good thing. (I doubt if the people at Heritage would generalize this disdain for contracts to all their other commercial dealings.) What’s important is what the article doesn’t say: “Quitting without notice is not burdensome.” In fact it is not burdensome; workers in most states are at-will employees unless a union contract specifies otherwise. But Heritage doesn’t consider the contractual burden on the worker or lack thereof a sufficiently important issue even to bear commenting on—and this in a section titled, mind you, Labor Freedom, not Employer Freedom.

The problem is that an index, ostensibly put forward as a general survey of economic freedom as such, is really a survey of economic freedom primarily as it affects the minority of the population that owns considerable amounts of capital and employs others. The idea that being employed is an economic activity, and that those who are employed have economic interests as much as those who do the employing, doesn’t even appear on the radar.

Yet another example of the Index’s bias is its “concerns” regarding bailouts of automakers over “expropriation and violation of the contractual rights of shareholders and bondholders.” Bill Beach, director of the Heritage Foundation’s Center for Data Analysis, laments that “the rule of law declined when the Obama administration declared some contracts to be null and void. For example, bondholders in the auto industry were forced to the back of the creditor line during bankruptcy.”

But note the glaring lack of concern for contractual rights guaranteed under GM’s contracts with the UAW. This one-sided concern with impairment of the obligation of contracts is fairly widespread on the “free market” right. The same people who protested the loudest about bailout “blackmail” in interfering with CEO salaries and benefits, oddly enough, were by and large also the source of the most strenuous calls for using Washington bailout money as a hammer to “impose discipline” on auto workers. So apparently, for a certain breed of “free market” advocate, the differential between a GM and Toyota assembly line worker is problematic—but the differential between a GM and Toyota CEO isn’t. What’s that thing I was saying before? Contractual security is a good thing—for everybody but workers.

This shortcoming is compounded by Heritage’s endorsement of Bush Treasury Secretary Henry Paulson’s original TARP program. Stuart Butler and Edwin Meese, in a 2008 article titled “The Bailout Package: Vital and Acceptable,” did express concerns lest the bailout take the form of a blank check—to the government, that is.

So they favored TARP, as such—a Hamiltonian program of using taxpayer money to prop up the bubble-inflated value of financial assets and preventing them from being marked down to market value. They just objected to any conditions on how the free money could be spent once the banksters got hold of it. I wonder how they feel about workfare. I understand that it was probably different people composing the different passages in question, but still it would be nice if the right hand knew what the further-right hand was doing.

Ignoring Primary Interventions

The Index fails to distinguish between the primary, structural forms of government intervention that prop up corporate power and the secondary, ameliorative forms of intervention that attempt to moderate its side effects. The State enforces a whole host of artificial property rights and artificial scarcities that serve as sources of economic rent to privileged firms, and maintains all sorts of regulatory cartels. The cumulative effect of these privileges, artificial scarcities, and cartels is to sustain corporate power on a global scale and create vast disparities in wealth.

These forms of intervention, these primary grants of privilege, don’t show up very prominently on the Index of Economic Freedom. What does show up is mainly the kinds of fiscal and welfare-state interventions that serve to limit the exercise of State-granted privileges and make corporate power less galling to average people. Is it only “statism” when it benefits someone besides the rich?

In fairness, while Heritage supports many of the legal privileges that serve as entry barriers at the national level, the Index does at least acknowledge barriers to small business formation at the state and local levels, comparing them favorably to other places: “The overall freedom to start, operate, and close a business, regulated primarily at the state level, is still strongly protected [in the United States]. Starting a business takes six days, compared to the world average of 35 days. Obtaining a business license takes less than the world average of 218 days. . . .”

The same critique applies to other indices of “economic freedom,” as well. For example, like Heritage, the Economic Freedom of the World Index (Fraser and Cato institutes) treats voting for anything called a “free trade agreement” as a proxy for supporting free trade. [Editor's note: See comments for correction.] Economist Dean Baker ridicules mainstream journalists for taking the “free trade” label at face value when the primary purpose of such agreements is to boost “intellectual property” protectionism rather than to reduce tariff protectionism. In the introduction to The Conservative Nanny State, Baker writes:

[N]ews reports routinely refer to bilateral trade agreements, such as NAFTA or CAFTA, as “free trade” agreements. This is in spite of the fact that one of the main purposes of these agreements is to increase patent protection in developing countries, effectively increasing the length and force of government-imposed monopolies. Whether or not increasing patent protection is desirable policy, it clearly is not “free trade.”

It is clever policy for proponents of these agreements to label them as “free trade” agreements (everyone likes freedom), but that is not an excuse for neutral commentators to accept this definition.

Nicholas Hildyard had a pretty good handle on what’s actually entailed in the neoliberal “free market” agenda promoted by these indices. The effect of the agenda “has not, in most cases, been to diminish either the state’s institutional power or its spending. Instead, it has redirected them elsewhere. It has also strengthened the power of many Northern nations to intervene in the economic affairs of other countries. . . .”

Of the kind of “privatization” that prevailed, for example, under Chile’s Pinochet and has since been promoted by assorted “structural adjustment” programs, Hildyard wrote:

While the privatisation of state industries and assets has certainly cut down the direct involvement of the state in the production and distribution of many goods and services, the process has been accompanied by new state regulations, subsidies and institutions aimed at introducing and entrenching a “favourable environment” for the newly-privatised industries. [“The Myth of the Minimalist State,” The Corner House, March 1998]

In practice, such “privatization” involves, first of all, spending taxpayer money on upgrades of State property to entice corporate buyers to take it off their hands—with the new outlays to make the property salable frequently exceeding the purchase price. The bidding process itself for State-owned industries and utilities has usually been governed by what Joseph Stromberg calls “funny auctions, that amounted to new expropriations by domestic and foreign investors” (“Experimental Economics, Indeed,” Mises.org, Jan. 7, 2004). The first order of business, subsequently, is massive asset stripping by the new corporate owners. And as Hildyard suggested, the newly “privatized” functions are carried out within a web of special regulations and protections to make sure the “private” firms are insulated from anything resembling genuine market competition.

A genuinely libertarian privatization policy, as recommended by Murray Rothbard in “Confiscation and the Homestead Principle” (Libertarian Forum, June 15, 1969), would treat State-owned utilities as the homesteads of those working them.

The same is true of so-called “deregulation,” which (as Hildyard pointed out) can more accurately be called reregulation. The nature of most so-called utility deregulation can be illustrated by the mid-1990s electrical “deregulation” in Texas, home of “free market” champions like Dick Armey and Tom DeLay. Writing at Mises.org, Tim Swanson stated:

[I]n the mid-90s, regulators, consumers and energy producers began to rearrange the market for “deregulation” in Texas. Incumbent providers such as TXU and Reliant were restructured in the name of free markets, but when the dust cleared, the only winners were members of the political class and corporations that had been State-sanctioned monopolies prior to the “deregulation.”

TXU was separated into two companies, Oncor and TXU Energy. Oncor was given the monopoly on all services including meter reading, energy delivery, etc. Additionally they own all of the poles and wires and are protected by law from competition. TXU Energy became a billing company (and owner of power plants), merely forwarding all of the customer service questions and problems to Oncor, and therefore providing no services themselves.

This is akin to the following: splitting AT&T into two separate companies, one (Nexis) that owns all of the cables, wires, PBXs, switching stations, call centers, etc. and provides all of the services, repairs, installations, etc., and the other company (Willy) whom [sic] simply sends you a bill at the end of the month, providing no value-added service.

Not only is it not deregulation (the same players exist with State protection) but more overhead is created through the creation of another billing company. [“Texas Sized Tomfoolery,” Sept. 9, 2003]

When the mainstream press and mainstream politics identify the narrow analysis associated with the indices as “economic freedom,” it’s no wonder that most people are wary of “free markets.” If I didn’t know better—if I didn’t know that real free markets were like kryptonite to corporate power—I’d hate them myself.

The story takes on a new aspect when we realize that Neil Barofsky, Treasury Special Inspector General of TARP, told both Rep. Thomas Carper of Delaware and Neil Cavuto of Fox Business News that GM repaid the loan with other borrowed money. How’s that again?

“It’s good news in that they’re reducing their debt, but they’re doing it by taking other available TARP money,” Barofsky said, according to Jamie Dupree of Cox Radio.

“It sounds like it’s kind of like taking money out of one pocket and putting in the other,” Carper said.

Barofsky nodded.

“The way that payment is going to be made is by drawing down on an equity facility of other TARP money,” he added.

In his exchange with Cavuto, Barofsky said:

“The one thing a lot of people overlook with this is where they got the money to pay the loan. It isn’t from earnings. They didn’t earn and extra 4 1/2 billion dollars. So there’s money in escrow.”

“Wait a minute,” Cavuto said, “They paid off a credit line with another credit line?”

“Exactly.”

Why is this not being widely reported?

Maybe they do get it. Maybe, just maybe, we, the electorate, and our political representatives are the ones who don’t get it.

Bailout Incentives

The current outrage about banker behavior coming from Mr. Obama and the White House brings back memories of my own behavior when my two teenage boys were regularly coming home late at night in the family’s second car with just enough gas fumes left in the tank to make it down the driveway. “When are you going to understand?” I would shout the next morning after being frustrated in an attempt to get a car out of the driveway to get to work. “Why do you have to be so selfish? Don’t you know there are other people in the family who need to be able to get around, too? Don’t you get it?”

After giving one more sanctimonious lecture to them about caring for others, we would go our separate ways–until the next time, when the car ran out of gas with one of the boys halfway home from town.

You see, trying to be a providential father, I had a rule about gasoline. I provided one tank of gas a week for my two sons’ use. And they used every drop of it.

After a few more gas-outs, I began to get it. Instead of ranting and raving about their selfish behavior, I changed the rule. I began giving them the dollar equivalent of a tank of gasoline each week. Guess what? No more out-of-gas car in the driveway. No more running out of gas on the way home. In fact, they pretty much quit using the car. They walked or called a friend to pick them up.

They had money, and money was better than gasoline. And when there was a gas-out, they paid. Finally, I really got smart. Welfare turned to workfare. Many of my problems about gas and cars went away.

The problem for Obama with the bankers is a lot like the situation I faced with my sons. It’s about bailout incentives. This is not a story about good and evil, or selfish and unselfish behavior at all, even though casting it that way plays well on the hustings.

Cousin Jack’s Shack

Economists and others call the problem “moral hazard,” but let’s not get caught up in jargon. The essence of the problem is captured in the lyrics of Irving Berlin’s 1940s’ song, “Doin’ What Comes Natur’lly.” The relevant refrain goes like this:

Cousin Jack insured his shack
And now he plays with matches
He’ll collect just wait and see
Doin’ what comes natur’lly
Doin’ what comes natur’lly

Of course, no fire insurance company will write a policy that covers the full replacement cost of a home or shack. The owner must bear a substantial part of the risk; he must coinsure. Insurance companies are also pretty careful about writing a policy in the first place. Casualty insurance contracts are short, and if the risks are high and the exposure large, the insurance folks will be around frequently to inspect and give instructions about how to behave. (But of course, all this tends to change when the insurance companies get government bailouts.)

Consider some of the institutions surrounding consumer banking. Yes, there is FDIC insurance, and yes, FDIC regulators check frequently in attempts to make certain the car does not run out of gas. But no bank voluntarily buys deposit insurance; banks are required to buy it. And there is no competition for the business. Before the days of government deposit insurance, the owners of the banks were personally liable to depositors; they often listed their personal guarantees in bank advertisements. Then, up until the 1980s, there were state-operated deposit insurance companies as well as the federal program that began in the Great Depression, but the state programs got in trouble too.

Government insurance companies are usually not price-savvy; they do not respond to shareholders; they pay no shareholder dividends; they hardly ever modulate insurance premiums to reflect risky behavior; they do not run the risk of being taken over by other firms as a result of financial market monitoring. In short, these institutions are not bottom-line driven; they face no bankruptcy constraints. The FDIC is a political creature living in a commercial halfway house.

When the deposit institutions got in trouble in the 1980s, the politicians gave them another tank of gas, and they tended to use it. To make matters worse, following the great 2007 credit-market meltdown, the politicians doubled the gas allocation. And deposit institutions responded accordingly. They wanted to drive a bit faster and more often, which is to say they tended to take on more risk. In an effort to offset the risky behavior, the regulators came around more frequently and frowned a lot more. Now the FDIC is mandating higher premiums paid three years in advance in an effort to cover Cousin Jack’s adverse behavior.

The presence of government-provided deposit insurance is the alpha, but certainly not the omega, of all that is troublesome with banking. In fact, even though deposit insurance guarantees the bulk of deposit institutions’ liabilities, the effects on Cousin Jack’s careless behavior begin to pale when compared with TARP and TARP-related events.

An Odd Kind of Regulated Public Utility

As noted, once the credit-market crisis came, government responded first by upping the ante on deposit insurance. That quieted the depositors’ panic, and Cousin Jack relaxed a bit. Then the politically elected and appointed rolled out a green carpet to troubled institutions with injections of cash, arranged marriages between strong and weaker firms–and, to make matters worse, began paying interest on the reserves provided. The banks got a 100 percent sure thing with interest. Cousin Jack was assured that gas would be no problem. So why not take the family on a much-needed vacation? Bonuses and pay became an issue.

With incentives askew and bankers responding predictably, Obama frowned, gave the bankers sanctimonious lectures, and ordered his pay czar and the Federal Reserve chief to put the screws on executive pay. He then said the bankers needed to pay a tax on their uninsured liabilities, just to keep them honest. U.S. banks now face a complex of regulatory spaghetti. What they can lend, how they lend, and to whom they lend are regulated with greater stringency. How they pay and how much they pay is regulated. How much and what kind of debt they incur are regulated. And most recently, what they do with excess capital to increase earnings is further regulated. Yet while the spaghetti thickens, there is a lot of uncertainty as to which financial institutions will get caught in the mix, when, and how. Regulatory uncertainty takes its toll on decision-makers: If in doubt, keep quiet, lay low, and avoid risk. The banks are on the way to becoming a strange breed of regulated public utilities without the benefit of due process.

There is talk about financial institution reform, but so far, I’ve heard no conversation about letting the boys buy their own gasoline.

Ill-conceived policies to encourage homeownership channeled cheap credit into housing markets. Land-use and zoning policies restricted the supply of housing in key desirable markets. In The Housing Boom and Bust, Thomas Sowell of the Hoover Institution has shown how these policies brought about a crisis in housing and finance.

Others have told the story from a number of perspectives and with varying emphasis on different factors. My purpose here is to focus on the policy responses to the crisis and ask whether they have been helpful or harmful.

TARP

On October 3, 2008, Congress enacted the law creating TARP (the Troubled Asset Relief Program), which was authorized to spend up to $700 billion to purchase troubled assets from financial institutions. A little more than a month later, then-Treasury Secretary Henry Paulson announced that rather than buying troubled assets, the Treasury would use the money for capital injections into banks in return for preferred shares.

Regardless of one’s attitude toward bailouts generally, Paulson’s original plan was a recipe for disaster. To help the banks he would have needed to overpay for the assets to the detriment of the taxpayers. If he had paid then-current prices, accounting rules would have forced all firms holding such assets to write them down (not just those selling the assets). Financial institutions holding dubious mortgage-backed assets were desperately trying not to write them down because that might have threatened their depleted capital base. It is fair to say that Paulson failed to grasp the underlying problems at these institutions when he first proposed the program.

TARP became a capital-relief plan. It harkened back to the Reconstruction Finance Corporation (RFC) of the Great Depression. Under Jesse Jones and in conjunction with Franklin Roosevelt’s Bank Holiday, all the nation’s banks were examined and divided into the good, the bad, and the ugly. Call it his version of a “stress test.” Those deemed beyond hope were never reopened. Those troubled but salvageable were eligible for RFC capital injections. Jones also extracted resignation letters from senior management of institutions being bailed out. If he deemed existing management best suited to run the bank, it could stay. If not, it was replaced.

In comparison, Paulson’s strategy was “ready, shoot, aim.” Banks received government injections of money to replace depleted capital, with nothing explicit extracted in return. There were vague promises that banks would resume lending but there was nothing enforceable. The banks were stress-tested only after having received government funds. There were second and even third rounds of bailouts for some banks, indicating they had been weaker than thought. We know that at least one—CIT, a financial institution that received $2.3 billion in TARP money—should have been allowed to close. Instead it eventually filed for bankruptcy, and the taxpayer funds were lost.

Moreover, in what has become a national disgrace, existing management at bailed-out banks remained in place. The Bush administration failed to impose even the level of control exercised under FDR.

On the one-year anniversary of the announcement of Paulson’s reversal on TARP, I was asked by Newsweek for my assessment. “It hasn’t done what [Paulson] said it would,” I said. “Yes, it saved some banks from going under, but did it restore the health of the banking system? Absolutely not.” I stand by that assessment today.

What Does Government Stimulate?

The fiscal response to the crisis of the Bush/Obama administrations has been to spend their way out of the recession. In the process the nation’s debt has skyrocketed. There are deficits and debt as far as the eye can see, and our children’s future has been mortgaged. The 2009 fiscal deficit was double that of 2008. It is running at 10 percent of GDP, and former Fed governor and Bush adviser Larry Lindsey estimates deficits will run at 7 percent of GDP for a decade.

Because of the work of Milton Friedman and his monetarist followers, countercyclical fiscal policy fell under a cloud. First, they argued that recessions are difficult to forecast and we only typically know we have entered one after the fact. The monetarists also argued that fiscal policy was subject to the cumbersome legislative process and thus could not be quickly implemented. Once spending began, its effects were only felt slowly. All this wisdom was forgotten in the panic of the Bush administration and then more so in the Obama administration.

The Economic Stimulus Act of 2008, passed in February of that year, mainly sent $100 billion in checks to households in early summer to stimulate consumption and jump-start the economy. As Stanford economist John Taylor, author of Getting Off Track, has shown, the money did nothing and the economy slid into recession later that year. Any economist worth his salt knows that temporary government cash infusions will likely be saved and at best have transitory effects on spending.

Undaunted by that failure, the Obama administration decided to up the ante on the theory that there had just not been enough fiscal stimulus. It replaced billions in spending with trillions in spending: the stimulus package added on to TARP. In the next section I also discuss Fed spending masquerading as monetary policy.

What is the record? It appears that the recession may have ended in the third quarter of 2009. That would make it less than one year in duration–not atypical in that sense. Most of the Obama stimulus money has yet to be spent. (Recall Friedman’s arguments on fiscal policy.) It may be good electoral politics to claim credit for a still-nascent recovery. But it is poor economics. More likely, the self-adjusting forces of the market have been at work.

Clearly, nothing the government has done has been able to lower the unemployment rate. GDP is an abstraction; being out of work is a reality. In October the unemployment rate exceeded 10 percent. (It fell back to 10 later.) A broader measure of unemployment exceeded 17 percent. These numbers put the flesh on the skeleton of policy debates. More ominously, we now are seeing indications that wage rates are falling. As the Wall Street Journal reported, Professor Kenneth Couch of the University of Connecticut estimates that displaced workers returning to work will on average take a 40 percent pay cut.

Double-digit unemployment rates and double-digit wage cuts are depression statistics. In what way is government spending “stimulating”? In an editorial the Wall Street Journal concluded that “no matter how hard or imaginatively the Administration spins, the reality is that the stimulus has been the economic bust that critics predicted it would be.”

Indeed, the labor story helps us to see the dark side of stimulus spending. A good chunk of it has gone to state governments to support bloated budgets in the face of collapsing revenues. Those fiscal transfers are being done, at least in part, to placate public-sector unions, which want to protect the incomes and pensions of their members.

Fiscal stimulus has failed. What about the monetary variant?

Monetary Stimulus

The Fed’s response to the crisis has drawn mixed reviews among free-market economists. Some approve of the Fed’s easing in 2008–09 as a response to an increased demand for money (falling velocity). Nearly all market-oriented economists are disquieted by the explosion of the Fed’s balance sheet as it takes on more and more assets of dubious quality. It will be extremely difficult for the central bank to dispose of such assets when it inevitably comes time for it to tighten. The Fed will likely suffer losses, and such losses impact the taxpayer. (The Fed’s surplus is paid to the Treasury.)

Many economists have been critical of the Fed for its targeted-credit policies, which amount to credit allocation. They favor one sector at the expense of others, and constitute fiscal policy rather than monetary policy. The Fed’s leadership is dismayed at its loss of approval by the general public and fears calls for greater political oversight. But the backlash is of the Fed’s own making.

In the end its fortunes are tied to the economy’s. Most Americans do not know the technicalities of monetary policy. But Fed Chairman Ben Bernanke has taken an active and public role in defending the policy response to the crisis (under both Bush and Obama). Under Bernanke the Fed has promised much and delivered little.

Just as Americans fear the spending and budget deficits, many understand that easy money helped get us into the crisis. Now Dr. Bernanke has prescribed the strongest dose of cheap money ever administered. How can the elixir that caused the boom cure the bust?

The Bernanke Fed is engaged in a policy of reflating (re-inflating) the economy: stimulating money demand to restart economic growth. It justifies the policy on the basis of Professor Bernanke’s own research that shows the evils of deflation. But what prices is he trying to prop up? All prices? Even in hyperinflations, some prices fall. Is he trying to prevent downward adjustment in wages? As suggested above, wage rates in hard-hit sectors may be falling at double-digit rates. Is he preparing for double-digit price inflation? If so, gold is underpriced at $1,000 an ounce.

Astute observers increasingly fear that what is being reflated is another asset bubble. At present, the asset bubble is concentrated in commodities (such as gold, copper, and oil) and Asian real estate. In what is known as a carry trade, global investors are borrowing dollars at low interest rates to invest in property in cities like Hong Kong and Singapore. Instead of bringing prosperity to Americans, the Fed’s policy is fueling speculation. Instead of production in the United States, the Fed’s easy money is creating paper wealth for Asian property owners.

The rise in commodity prices is perhaps most ominous. The U.S. economy remains weak and unemployment elevated. Yet Americans are already paying higher prices for gasoline. They are facing the prospect of renewed inflation and economic weakness: stagflation. That would be an updated version of the economy of the 1970s. The Fed is thereby impoverishing Americans. Is it any wonder many are calling for a reconsideration of its role?

Yet governments do that computation for countries. Do trade deficits between countries matter? They do, but a lot less than most people think. A high trade deficit is not a definite sign of an economy’s weakness, and a low trade deficit or high trade surplus is not a definite sign of an economy’s strength.

First, let’s define our terms. By the most comprehensive measure, there can never be a balance-of-payments deficit. If we import a higher dollar value of goods and services than we export, then the extra dollars we spend on imports balance that difference, and the net balance is zero.

Of course, when people refer to a balance-of-payments deficit they are not thinking about this comprehensive measure; they’re thinking about a narrower measure—the merchandise trade deficit. This is the difference between the dollar value of what we spend on imports and what we are paid for exports. In 2008, the latest year for which these data are available, Americans spent $840 billion more on imports than foreigners spent on U.S. exports. Offsetting this was a U.S. surplus on services of $144 billion. The net balance of trade on goods and services, therefore, was $696 billion. To put this into perspective, this was about 4.8 percent of the total U.S. gross domestic product.

Where did this $696 billion go? It went to other countries, of course, but most of it came back in one of three forms: 1) foreign purchases of American bonds, mainly government bonds; 2) foreign purchases of other assets such as stocks, land, and property; and (3) so-called direct investment whereby foreigners build plants and equipment in the United States.

Is this bad? Consider each in turn.

1) If foreigners refused to buy government bonds, the U.S. government would need to offer higher interest rates to make holding the bonds attractive to Americans. That would drive up the cost of financing the U.S. budget deficit. We can decry this deficit—and I do—but given that it exists, which is better: having the irresponsible federal government paying a higher or lower interest rate? I vote for the latter.

2) One reason foreigners invest in U.S. stocks, land, and property is that the United States is still a relatively safe haven for investment. Granted, it’s probably less safe than it was before the U.S. government changed the rules with its bailout, the so-called Troubled Asset Relief Program (TARP), and with the so-called stimulus package. But it’s still safer than investing in much of the rest of the world. So rather than being bad, the size of this investment is actually good.

3) The same reasoning applies here. It’s good, not bad, that foreigners find it attractive to invest directly in the United States. It’s especially good for U.S. workers. The more capital there is per worker, the higher worker productivity is and, therefore, the higher are real wages.

Dollars on the Penny

What if the money doesn’t come back in any of the above three forms of investment but, instead, is held in U.S. dollars? That’s even better for Americans. Instead of giving up capital in return for merchandise, we are giving up paper money. According to the Bureau of Engraving and Printing, the average cost of a unit of paper money is 6.4 cents. Because of the production process, the cost is probably higher for a one-hundred-dollar bill, and presumably a disproportionately high number of such bills is held abroad. But it’s still likely to cost under 25 cents to print a one-hundred-dollar bill, and the bills take an average of 89 months to wear out. Getting valuable goods in return for paper money that sells for dollars on the penny is a good deal for Americans. Jay Leno, in a 1980s ad for Doritos, said “Crunch all you want. We’ll make more.” Similarly, if people in other countries hold on to their paper U.S. bills, the Federal Reserve can make more.

But aren’t we as a nation, by spending more on imports than our exporters earn, actually saving less and implicitly giving up capital for consumption goods? Yes, we are. But that’s the result of decisions that millions of us make individually. And it really doesn’t matter, at an individual level, whether we save less to buy imports or to buy domestically produced consumption goods. Either way, we’re giving up capital for consumption. Is this a bad idea? We’re showing by our actions that we think it’s not. We’re showing that many of us value those high-quality Toyotas more than we value the shares of General Motors stock or U.S. government bonds that we could have bought instead. Do you think you’re giving up too much capital for consumer goods? Then spend less and save more.

I mentioned earlier that a small balance-of-payments deficit is not necessarily a sign of economic strength. Between 1980 and 2008, there have been only three years in which the United States has had a merchandise trade surplus: 1980, 1981, and 1991. Those were all years in which the U.S. economy was in recession. That is no coincidence. When economic growth is high, we tend to spend a higher share of our income on imports. The years with the highest merchandise trade deficits also tended to be the years with the highest economic growth.

What about the danger that foreigners will own a large share of the U.S. capital stock? First, it’s not a danger. Even if it happened, it would simply mean that U.S. workers would work for foreign employers. While some of these foreign owners would be worse than U.S. employers, some would be better. Incidentally, during the 1988 U.S. presidential campaign, Democratic candidate Michael Dukakis told workers at a St. Louis automotive parts plant: “Maybe the Republican ticket wants our children to work for foreign owners . . . but that’s not the kind of a future Lloyd Bentsen and I and Dick Gephardt and you want for America.” The problem? The workers he was speaking to were employed by an Italian corporation.

Second, the amount of U.S. capital owned by foreigners at the end of 2008 was $23.4 trillion. But the amount of foreign capital owned by Americans was $19.9 trillion. This difference of $3.5 trillion is only about 7 percent of the $48 trillion total value of physical assets.

To look at the $3.5 trillion another way, it is less than $70 trillion. Why is that relevant? Boston University economist Laurence Kotlikoff says that’s the amount by which the present value of the U.S. government’s future promises to spend exceeds the present value of the government’s future projected tax revenues.

Now that’s something to worry about.

Meanwhile, the Obama administration said it would cut by half (on average) the compensation of the highest-paid people at the seven companies still on taxpayer life support: AIG, Bank of America, Citigroup, General Motors, Chrysler, GMAC, and Chrysler Financial.

So here’s the puzzle: Is such government intrusion into the compensation process a good or bad thing?

Before answering, let’s remember that the taxpayers have been compelled to rescue lots of companies, banking and otherwise, over the last two years. The people’s exposure is immense. Neil Barofsky, special inspector general for Treasury’s financial sector rescue, says enormous surprise bailout costs will befall the country in addition to the $159 billion the Congressional Budget Office projects TARP will lose. Barofsky was referring to the cost of government borrowing and the potential cost of rewarding risky behavior.

Besides that, the Fed has been buying up billions of dollars in “toxic” (that is, worthless) mortgage-backed and other paper with money created from thin air. The new money threatens to ignite a monster price inflation when the banks begin to lend it. The impending dissipation of the people’s wealth at the hands of the Fed(eral Bureau of Counterfeiting) is another cost of the bipartisan government bailout of corporate finance. It’ll be a massive tax on the middle and working classes.

Well, then, shouldn’t the government have something to say about what goes on in those companies on the dole, executive pay in particular?

It’s tempting to say yes, but I think the best answer is no. I’m not totally comfortable with that answer, but it seems better than the alternative.

First off, we must reject the propaganda that the Treasury and the Fed are acting as the taxpayers’ agents by taking control of corporate compensation. Nothing can be further from the truth. They are the taxpayers’ adversaries and are only looking out for themselves. After all, they are the ones that exposed the taxpayers to these huge liabilities in the first place.

Moreover, it’s not really the taxpayers’ money the politicians are looking out for. In real terms, it’s now their money by virtue of legal plunder. The Bush administration tried to sell the public on the bailout by suggesting that the toxic assets (or bank shares) acquired by the government might one day be resold at a profit for the taxpayers. But if the assets do sell for more than the government paid, will taxes be cut to reflect the profit? Fat chance. Politicians tend to spend every penny they can get their hands on—and then some. It is they who would profit, not the taxpayers. They ain’t us.

Another reason to oppose government conditions on bailout money is that they are likely to make things worse. I seriously doubt whether anyone at the Fed or Treasury is qualified to design compensation packages that would encourage just the right amount of risk, not too much or too little.

A third reason to reject this government intervention is that it will serve as a justification for further intervention. Pay czar Kenneth Feinberg already says he hopes the pay scheme will become a model for the rest of Wall Street.

My final reason for saying no to the pay czar and bank regulators is that I want to make sure that such bailouts never happen again. Maybe the people will be less likely to acquiesce the next time if they see the current corporate rescue for the plunder it is.

We can’t change the past. The bailouts happened. Now we have to deal with the consequences. We should concentrate on stripping government of the power to bail out companies in the future. We should also begin to fully separate State and banking. A good start would be to abolish government deposit insurance, which only lulls depositors into a false sense of security and creates the very systemic risk the regulators say they want to avoid.

* * *

“Green jobs” are the magic words promising to bestow prosperity and environmental bliss through costless government manipulation. Do you need more reason to be skeptical? Andrew Morriss performs the debunking. Richard Fulmer adds an insight on the shortcomings of alternative energy sources.

In the mixed economy, is freedom’s glass half full or half empty? George Leef shows that this is more than a philosophical question.

Walmart inspires hisses and hosannas. Which are more deserved? Art Carden sorts it all out.

These days it’s especially popular to scapegoat anyone engaged in complex financial transactions not readily understood by laymen. Example: short sellers. They’re accused of manipulating the stock market for personal profit, so the government has its eye on them. Warren Gibson comes to the defense of this valuable yet unappreciated group.

The government’s money managers are willing to risk inflation to avoid deflation. Good idea? Steven Horwitz distinguishes good deflation from bad.

One of the great pieces of American folklore is that businessmen don’t like regulation. Bruce Yandle sets the record straight.

Here’s what our columnists have come up with this time around. Lawrence Reed declares himself a Locofoco. Donald Boudreaux won’t let Chinese currency manipulation keep him up at night. Stephen Davies demonstrates the power of historical myth. John Stossel looks at the tax system and doesn’t like what he sees. David Henderson says don’t fear the trade deficit. And Theodore Levy, encountering the claim that markets for medical care cannot work, remonstrates, “It Just Ain’t So!”

Volumes about the alleged failure of the market, a crusty old individualist, the law, and American public policy undergo scrutiny by our reviewers.

As we see in Moore’s new movie, Capitalism: A Love Story, Moore is offended by some truly offensive things: banks engaging in wild speculation without concern for the risk, taxpayer bailouts for banks and other businesses, cozy relations between Wall Street and Washington, politicians getting favors from companies that want benefits from government, and big institutions pushing less powerful individuals around. True, he’s offended by some inoffensive things as well, such as the cut in the 90 percent top income-tax rate years ago. But by and large, what he rails against should be railed against.

Had he called his movie State Capitalism: A Love Story, I might be applauding (with some reservations). But he’s targeting the more ambiguous “capitalism,” which he uses interchangeably with “the free market.” He can be forgiven for this, however. Most people would say that the current U.S. economic system is capitalist. Moore has probably heard that all his life. He’d hear it if he watched a Fox financial program. Would Ben Stein or Lawrence Kudlow disagree? Moore has also heard Republican politicians—George W. Bush, for example—praise the existing system, with all its deep government interventions, as capitalist. Bush did this even as he and Treasury Secretary Henry Paulson, former chief of Wall Street behemoth Goldman Sachs, stampeded Congress into passing the $700 billion TARP bailout last year. Moore takes such people at their word: The free market is capitalism, and capitalism is what we have today.

Vulgar Libertarianism

Can we blame him for thinking this way?

Yes, it’s sloppy thinking, and had he been more curious and read beyond the confines of “Progressive” literature, he could have gotten the straight story. But many knowledgeable advocates of the free market contribute to the confusion by exhibiting what Kevin Carson calls “vulgar libertarianism,” or what Roderick Long describes as “the tendency to treat the case for the free market as though it justified various unlovely features of actually existing corporatist society.” How often have you heard a free-market advocate condemn pro-business intervention in one breath, then defend existing dominant corporations in the next—as though they did not arise in the interventionist environment just condemned? Pro-market is not the same as pro-business. If some market advocates don’t understand that, why should Moore?

This may go a long way in explaining Moore’s aversion to profit—at least other people’s. He associates profit with business, which he associates with (state) capitalism. So for him, profit per se is suspect. But he should see a problem here. Does he think he’s exploiting moviegoers when his production company ends up with a profit? Do the co-ops and worker-owned firms he loves exploit their customers when they sell their products for more than their money costs?

Cornered like this, Moore might say he’s only against the excessive profits that capitalist market power permits. But now we’re back where we started. To the extent that intervention hampers competition by erecting barriers to entry—which is the usual effect, intended or not—protected firms are free to charge higher prices and reap more profits than would have been the case in an open market. Corporate power and privilege derive from political power and can’t exist without it. In contrast to existing capitalism, the truly free market would have no legal barriers to competitive entry, assuring that prices and returns are economically justified and not the fruits of privilege. Only the State permits business to make profits by withholding benefits from consumers.

But Moore doesn’t know this. What he “knows” is that the choice is between the current corrupt system—and it is corrupt—and some vaguely defined scheme of control by benevolent politicians, which he calls socialism and democracy.

In his movie Moore expresses affection for socialism, but he’s not clear what he means. He never advocates collectivization of the means of production or the abolition of markets. Instead he suggests that socialism means workers having a say in how the companies they work for are run. But why assume that’s anti-free-market? He praises worker-owned companies and notes that hundreds of them exist in the United States today. He might be surprised to learn that these things are entirely compatible with the free market. In fact, it’s a perfectly libertarian intuition to abhor being subject to the arbitrary whim of anyone—yes, even a private employer. If government regulatory and tax obstacles to new competition and self-employment did not exist, workers would have their maximum bargaining power and widest array of alternatives. I imagine we’d see more departures from the traditional firm. People used to get their “social insurance” from mutual aid societies. Maybe in a true free market, we’d see a bigger role for the employment counterpart to these public, yet not governmental, organizations.

What would Moore think about a system in which no one could collude with politicians to legally plunder the rest of us for his or her own benefit and everyone was free to enter into any cooperative arrangements to produce and offer goods to others in voluntary exchange? Michael, that’s the free market!

The Nirvana Fallacy: A Love Story

Of course, Moore naively looks to government to provide things. His movie laments that FDR died before he could see his Second Bill of Rights enacted. Roosevelt wanted government to guarantee everyone a good education, job, home, health care, and so on. Has Moore ever wondered where government would get the resources for this? He can’t really believe that somewhere there’s a massive pot of collective wealth waiting to be distributed. He must realize that the tax system would provide the money. But how can he not know that if government appears to penalize wealth creation with confiscation, less wealth will be created?

Moore is unaware that he commits the “Nirvana fallacy.” This is the erroneous idea that our choice is between the admittedly imperfect world we’re bound to live in if government leaves us alone and an imagined utopia in which benevolent and all-wise rulers oversee and regulate everything. Of course that is not the choice. Moore’s preferred system, whatever he calls it, would be run by individuals whose insights into the public interest would be no sharper and whose motives no purer than other people’s. However, since they would wield political power—which is the legal authority to compel obedience—they would be far more dangerous than anyone in a free market could ever be. He knows how corrupt politicians are. Why does he think different people would run things in his utopia? Does he really want them in charge of everyone’s job, education, health care, housing, pension, and the rest? It’s hard to understand why he isn’t uncomfortable with the idea of the people being tenants and employees of the State.

Whether he realizes it or not, Moore favors a system in which an elite necessarily would make critical decisions for the rest of us. He’d be incredulous to hear that, but if he ever comes to understand it, libertarians might end up with an unlikely ally.

For a socialist Shaw demonstrated good sense with that quotation. Unfortunately, America has become a laboratory in which his hypothesis is being tested.

The theory of government I was taught says that government provides benefits, primarily security, to the entire population. In return we pay taxes. But lately the government has been a distributor of special privileges, taking money from some and giving it to others. America is now about evenly split between those who pay income taxes and those who consume them.

The Urban-Brookings Tax Policy Center recently disclosed that close to half of all households will pay no income tax this year. Some will pay less than zero—that is, they’ll get money from those of us who do pay taxes.

The Tax Policy Center adds that this year the average income-tax rate for the bottom 40 percent of earners will be negative and that their cash subsidy will equal 10 percent of the total amount the income tax brings in, thanks to the Earned Income Tax Credit and President Obama’s “Making Work Pay” program.

The view from the top also shows the lopsidedness of the tax system. The top 20 percent of earners make about 53 percent of the income in America but pay 91 percent of the income tax. The top 1 percent pay 36 percent. The IRS says the bottom half of earners pay less than 3 percent.

How the Other Half Votes

This presents a serious problem because government has such vast powers to dispense favors. As Shaw suggested, people who pay no tax will not hesitate to vote for politicians who promise big spending. Why not? They will get stuff without having to pay for it.

Yes, working people who pay no income tax still pay taxes: sales tax and payroll (Social Security and Medicare) taxes. But the income tax is big and visible, so it’s a problem that a growing number of people don’t pay but get benefits from those who do.

Frédéric Bastiat, the great nineteenth-century French economist, defined the State as “that great fiction by which everyone tries to live at the expense of everyone else.” I don’t know if he envisioned one half of the population living off the other half.

It’s important not to confuse the interests of the taxpayers with the interests of the politicians and other tax consumers. Yet that is done all the time. When the government bought toxic assets (of zero market value) from the banks, it said taxpayers would profit when the economy recovered and the assets once again commanded a positive price in the market. Even if we make the dubious assumption that the government is savvy enough to buy low and sell high, it’s not the taxpayers who would benefit from any profits. The politicians will spend every penny rather than cut taxes.

To put it bluntly, we are not the government.

The built-in unfairness of the tax system has prompted a range of tax-reform proposals, such as a flat tax and replacing the income tax with a sales tax. These alternatives are better, but they have their drawbacks, too. For that reason, there is something more urgent than tax reform: spending reform.

The true burden of government, the late Milton Friedman said, is not the tax level but the spending level. Taxation is just one way for the government to get money. The other ways—borrowing and inflation—are also burdens on the people. The best way to lighten the tax burden is to lessen the spending burden. If government spends less, it takes less. And if it takes less, the tax system will weigh less heavily on us all.

Once again, we find wisdom in Adam Smith: “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.”

This makes perfect sense. If banks don’t engage in risky lending again, how ever will the government be able continue “rescuing” them.

FEE Timely Classic:
“Economic Fascism” by Thomas DiLorenzo

“The deal is the latest sign that both banks and the government are eager to end an extraordinary period of federal support for the financial industry. It would leave Wells Fargo alone among major banks in still holding federal aid.” (Monday, Washington Post)

I’m not so sure “eager” is the right adjective.

FEE Timely Classic:
“The Financial Bailouts:’See the Needle and the Damage Done‘” by Lawrence H White