GOVERNMENT BY CRISIS

Politics Paralyzes Government Decisionmaking

FUTURECASTS online magazine
www.futurecasts.com
Vol. 5, No. 11, 11/1/03.

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Political zugzwang:

  This is a hell of a way to run a railroad - or anything else!
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Both parties are fearful of exposing themselves to attack if they dare to put the national interest above that of any powerful special interest.

  Even as this next period of prosperity shifts into high gear, all manner of economic problems keep expanding beneath the surface. And the two political parties - now so evenly balanced - find themselves in political zugzwang - fearful of making any decisive move to confront the problems - fearful of exposing themselves to attack if they dare to put the national interest above that of any powerful special interest.
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  Democratic governance is inherently corrupt. Indeed, political leaders in democracies don't even have to use their own money to buy votes. They use money from the public treasury. They commit the public's credit. Politicians are not elected to say "no" to their constituents.
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Why shouldn't all members of the electorate feel they are entitled to munificent benefits from the public treasury?

  Vast subsidies for wealthy agribusiness interests - tariff and quota protections for wealthy sugar plantations - tariff protections for steel industry dinosaurs - and innumerable lesser boondoggles - all seem politically untouchable. Not only is there no justification for these political expenditures, many actually harm the national interest by further impoverishing struggling third world nations. With these examples in front of them, why shouldn't all members of the electorate feel they are entitled to munificent benefits from the public treasury?
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Government policy mistakes are easy to make - and hard to rectify.

  This Bush administration is the most Keynesian administration since the Carter administration. Federal spending has soared by more than 20% during the Bush administration - only part of it accounted for by higher spending on defense and homeland security. For the first time since the 1970s, interest rates have been pushed down to negative rates compared to the rate of inflation. Deficits have soared.
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  There are some substantial differences between the 1970s and the present decade - as FUTURECASTS has repeatedly pointed out - but the economy is nevertheless again being driven by irresponsible Keynesian policies towards similar problems.
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  Fortunately, capitalist systems are very resilient. Even a modicum of responsible governance is sufficient to permit vigorous recovery from the problems caused by political and private stupidity. We have seen this story played out numerous times - in political systems both small and large. A few examples are provided at the end of this article.
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  Unfortunately, it now appears that neither political party is capable of acting appropriately with respect to these problems until after the arrival of some significant financial crisis forces action. Both parties are actively maneuvering just to be able to point the finger of blame at the other party.
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  Government policy mistakes are easy to make, and hard to rectify.
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Entitlement problems:

  Runaway entitlements and rising regulatory costs are major current driving forces behind the developing crisis. There are some significant ways in which the current situation is materially less threatening than that of the 1970s, but the entitlement problems are on the other side of the ledger. In the last three decades, entitlement burdens have grown massively.
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The Republicans have responded by taking money off the table. They are trying to limit government bloat by starving the beast for funds.

 

Wealthy incomes are very volatile - waxing and waning with the business cycle - as California has recently found out. A budget that depends too much on high marginal tax rates on the wealthy will inevitably be left high and dry during periods of economic decline.

  Unconstrained by market mechanisms, entitlement expenditures inevitably surge upwards towards unsustainable heights. Nevertheless, the politicians predictably remain heedlessly generous.
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  Vast new entitlements are incredibly being considered to add to the burden. Efforts to reduce the heavy impact of payroll taxes on low wage employees by provision of tax credits increasingly transforms pay-as-you-go entitlements into welfare entitlements.
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  Democrats routinely demagogue the entitlement issues
- making needed reform politically impossible. This tactic is unfortunately highly effective. As a result, the Republicans have given up trying to play this politically losing hand. Instead, they have responded by taking money off the table. They are trying to limit government bloat by starving the beast for funds.
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  This will definitely accelerate the arrival of the crisis period. However, when it comes, it will be far easier to respond to these problems if taxes are relatively low than if  taxes are already high. Higher taxes today can't solve these problems. They can only modestly  delay the onset of crisis. If you give the politicians more money, they will just spend it and scream for more.
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  The Democrats assert that higher taxes can put off the onset of these crises for many decades. Since the electorate feels that taxes are already high enough, the Democrats seek to rely just on higher taxes on the "rich." This has many obvious problems - that the advocates of these taxes will always determinedly ignore.
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    High marginal tax rates do extensive financial damage - distorting the economy in noxious ways - as FUTURECASTS has repeatedly pointed out. The advocates of high marginal tax rates have repeatedly convinced the electorate to shoot itself in the foot. The existence of these revenues will, of course, just lead to increased spending.
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  Moreover, wealthy incomes are very volatile - waxing and waning with the business cycle - as California has recently found out. A budget that depends on high marginal tax rates on the wealthy will inevitably be left high and dry during periods of economic decline. Then, it will be the middle class that will be left with the burden.
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    Envy is the most self-crippling of the common vices.
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Dollar devaluation:

  But the dollar is already being observably undermined by Bush administration heavy reliance on Keynesian palliatives.
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No nation has ever prospered with a weak currency. Strong currencies act like shields against the impacts of unexpected shocks that predictably periodically occur. Weak currencies leave economic systems vulnerable to such shocks.

 

If Europe engages in "competitive devaluation" in response to the weak dollar, then inflation rates will soar and gold becomes the last financial resort.

  As yet, the monetary movements are modest. The fantastic productivity gains of the U.S. economy are a powerful force for stability and financial strength. However, the politicians have been enacting spending policies sufficient even to overwhelm the financial strength of a still flexible and vibrant economy. And Keynesian monetary policy keeps pushing U.S. international accounts further into the red.
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  In fact, U.S. economic growth - pushed by Keynesian policies from the 1960s through until late in the 1970s, and again since 2001 - has shown a substantially more than proportionate tendency to increase imports. The propensity to import grows much faster with Keynesian stimulated growth than with growth dependent entirely on productivity increases. In other nations, import growth lags demand growth. But in the U.S., each 1% increase in demand is accompanied by 1.8% increase in imports.

  The publisher of FUTURECASTS explained and forecast this phenomenon more than 35 years ago, in Blatt, "Dollar Devaluation" (1967). This is a powerful weakness inherent in Keynesian policies that most economists have determinedly ignored.

  The substantial inflation of commodity prices that has already taken place should be of substantial help to struggling third world nations that depend on these commodity exports. The increase is not just in gold, but in major industrial raw materials like copper, aluminum, platinum and nickel. Modest rates of currency appreciation in Europe and Asia should materially boost living standards in those regions.
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  No nation has ever prospered with a weak currency. Strong currencies act like shields against the impacts of unexpected shocks that predictably periodically occur. Weak currencies leave economic systems vulnerable to such shocks.
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  As inflation increases, it first causes capital to stagnate and then causes decapitalization. Not only can inflation occur in the presence of substantial levels of unemployment - it ultimately always causes unemployment. Inflation above de minimus levels cannot be "managed." See, "The determinants of purchasing power" in "Capital as Purchasing Power." 
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  If Keynesian monetary policies are used to keep real interest rates at negative or near negative rates (compared to the rate of inflation), as at present, the possibility of major disruptions in supplies of oil and other essential raw materials is much heightened, and the dollar will continue to weaken. If the dollar keeps weakening, the euro could replace the dollar as the world's primary reserve currency - transferring to Europe all the benefits that strong reserve currencies bring.
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  However, economic systems that are too rigid to adjust to the changing competitive climate caused by currency fluctuations can experience more loss than gain even from currency appreciation. Europe - with its many rigid economic systems - may thus find it difficult to maintain monetary discipline. If it cannot maintain monetary discipline - if it engages in "competitive devaluation" - then inflation rates will soar and gold becomes the last financial resort.
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The dollar must continue to fall and gold must continue to rise and interest rates must rise until the U.S. is forced to permit relatively high real interest rates - which will inevitably bring sluggish economic conditions at best and a possibly severe recession at worst.

  Monetary volatility can be disastrous even for the most flexible of economic systems. The adjustment process imposes a heavy burden of capital expenditures at best. Rapid currency fluctuations increase business risks, imposing another heavy burden on capital.
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  The benefits of floating currencies exist only if reasonable levels of monetary discipline are maintained and the currency fluctuations are slow. The burdens of currency volatility strengthen the forces of protectionism that can destroy prosperity worldwide.
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  Today, the U.S. enjoys massive benefits because of the status of the dollar as the world's primary reserve currency. To a certain extent, this means the U.S. can print gold. People worldwide willingly absorb massive sums in dollars and low interest dollar denominated securities.
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  The devaluation of the dollar imposes the costs of U.S. budgetary deficits on nations and peoples  worldwide. U.S. dollar-denominated debt is being "paid off" by the process of inflation not just in the U.S., but in all nations that rely on the dollar as a reserve currency - and even more by those nations - like China and Japan - that absorb vast quantities of U.S. Treasury obligations to prevent the dollar from depreciating against their currencies. This mechanism relieves people in the U.S. of a considerable portion of the inflationary burden of irresponsible monetary policies.
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  Obviously, this is not a situation that is indefinitely sustainable. If dollar weakness continues too long and too rapidly, the world will inevitably look elsewhere for reliable reserves that retain value. Many will also look elsewhere even for a currency of account for international transactions.
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  Currency volatility will demonstrate the benefits of fixed exchange rates even to the Keynesian economists who would rather place their faith in the good behavior of the world's politicians. Currency volatility may thus reestablish the desirability of the gold standard - a system that imposes monetary discipline on unwilling political leaders. It is now blatantly evident that the dollar must continue to fall and gold must continue to rise and interest rates must rise until the U.S. is forced to permit relatively high real interest rates - which will inevitably bring sluggish economic conditions at best and a possibly severe recession at worst.
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  But the Federal Reserve Board will strive mightily to prevent these things from occurring at least until the next election is safely behind us. FUTURECASTS will take another look at the timing of these events in its February "Near Futurecast" issue. FUTURECASTS at that time will also review the variety of other "bubble factors" it has been keeping an eye on in its Near Futurecasts since its inception more than five years ago.
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A change mechanism that depends on crisis:

  At least democracies do have some mechanisms that induce needed changes. Unfortunately, these mechanisms are far from perfect - and frequently require the development of crisis situations before they can function. History is replete with such examples.
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When the U.S. government is involved, government by crisis can be a worldwide catastrophe.

  Republican policy stupidities during the 1920s contributed significantly to the calamity of the Great Depression. Unfortunately, initial New Deal remedies simply made matters worse and extended the Depression through the entire decade of the 1930s.
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  WW-I transformed the U.S. into the world's primary creditor nation. Trade war levels of protectionism made it impossible for the world's debtor nations to earn enough dollars to repay their dollar debts. Ultimately, worldwide financial collapse and collapse of world commodities markets - including those for U.S. agricultural exports - ruined world commerce and brought on the Great Depression. See the Depression Chronology series of articles, beginning with "The Crash of '29."
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  Protectionist policies played a major role in bringing on the Great Depression - paving the way for the rise of Hitler - and the onset of WW-II. For this vast transgression, the Republican Party paid with the loss of its status as the nation's majority party - and deservedly remained in minority limbo for half a century.
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  Even seventy years ago, it was evident that when the U.S. government is involved, government by crisis can be a worldwide catastrophe.
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  The New Deal initially - stupidly - retained the trade war protectionist policies and adopted redistributionist policies based on the left wing "mature capitalism" fallacy. It tried monetary inflation and redistributionist and industrial planning remedies - with predictably catastrophic results.
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  Keynes to the contrary notwithstanding, governments can't spend their way out of such crises. You have to confront the policy stupidities that have caused the crises - and enact sufficient reforms to permit recovery.
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  Under a liberal Democratic Congress, the U.S. economy in the 1970s was driven into a period of financial weakness and economic volatility and increasing inflation and unemployment by persistent resort to disastrous Keynesian policies. For this transgression, the Democratic Party was deservedly deprived of enough public support to end their status as the nation's majority party, and the Republican Party was restored to approximate parity with the Democrats.
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Inflation always causes unemployment by loosing a variety of noxious financial and economic forces.

 

The austerity needed to end inflation has always caused a nasty period of economic decline prior to resumption of normal economic growth.

  Keynesian economists had promised that stagflation was impossible, but economic history told a different story. After a period of time that might last for as long as a couple of decades for a nation as rich in financial reserves as was the U.S. after WW-II, the policies recommended by Keynesians ALWAYS lead to both inflation and unemployment at the same time. Inflation always CAUSES unemployment by loosing a variety of noxious financial and economic forces.
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  The nasty thing about inflation is that it has never been easy to reverse - Keynesian assurances to the contrary notwithstanding. Recovery  never follows directly after the end of inflation as it does after the end of deflation. As a matter of economic history, the austerity needed to end inflation has always caused a nasty period of economic decline prior to resumption of normal economic growth.
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  In short, once you permit inflation to take hold, the best you have to look forward to is a recession or depression prior to recovery. This - in fact - is what happened when Paul Volcker, appointed by a desperate Jimmy Carter and then supported by the Reagan administration, brought the 1970s period of stagflation to a crashing halt in the early 1980s. The U.S. economy continued to experience below average performance until the mid 1990s, as three presidential administrations doggedly supported the high real interest rates and other policies needed to squeeze out the last of the 1970s inflation.
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  New York City has a fairly regular cycle of demagogic governance - generally by liberal mayors of either political party - that periodically manage to bankrupt the  inherently most wealthy city on Earth. This is ultimately followed by election of reform mayors who demonstrate how easy it is to provide governance that is responsible enough to restore the city to prosperity. Similar cycles have recently been played out in Los Angeles and  Massachusetts.
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California has become a very business-unfriendly state - currently suffering a plague of lawyers who have been granted hunting licenses to extract vast sums from the state's economy.

 

All of a sudden, California liberals have decided that they don't like popular democracy after all, and are singing the praises of representative government.

  California is the current poster child for governance by crisis. The legislature - a liberal Democratic legislature - is composed of politicians who can't say "no" - and the governor was not man enough to impose discipline. Refusing to spend political capital to properly confront the state's problems, he instead preferred to throw money at them - until even the vast revenues and substantial financial reserves of the state of California were exhausted.
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  Aside from its huge budget crisis, California now boasts high tax rates and skyrocketing regulation costs. Energy costs have moved sharply higher. California lawyers have been given a hunting license to extract vast sums from the economy. Health care, unemployment, liability and Workman's Compensation insurance rates have risen explosively - driving businesses out of state or out of business.
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  California has become a very business-unfriendly state. It has become increasingly difficult to be an employer. California is suffering a plague of lawyers. California law schools report vast increases in student enrollments - while health care facilities close their doors and the shortage of nurses worsens.
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  In California - with its initiatives and recalls
- the liberals have gotten what they always claimed they wanted - more popular democracy and public involvement in politics. All of a sudden, however, they have been singing the praises of representative government.
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  The people of California have now in desperation and exasperation recalled their governor in favor of a political outsider - a well known actor - who promises to finally confront these problems. He confronts mounting budgetary problems and a legislature still dominated by a liberal Democratic Party. Now, instead of a feature film, Arnold Schwarzenegger is playing in an old fashioned "Perils of Pauline" serial.

  • Will The Terminator be man enough to restrain the legislature's spending proclivities?

  • Will he be able to protect the public interest against rapacious trial lawyers?

  • Will he be capable of saying "NO" to some of the infinite "needs" that support cries for enlarged and more numerous government benefits?

  • Will he be able to say "NO" to a state civil service that currently enjoys pay scales and benefits considerably above market levels? Saying "no" to the state's powerful civil service was something even the sainted Ronald Reagan never did while California governor. The purpose of the civil service is to serve the public. However - with unionization and growth as a voting bloc - it is the public that serves the civil service.

  If Schwarzenegger fails, the people will just have to try somebody else. They will have to find some other hero.
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Many Latin American democracies have made an art form of failed demagogic democracy.

  The arrival of skilled reform leadership is not a sure thing. It may take a decade - perhaps longer - for the electorate to accept leadership that will vigorously say "NO" to its desires for benefits from the public treasury. The leaders initially chosen may fail. Japan has gone well into its second decade without success - although things are finally looking a bit better there at present. Many Latin American democracies have made an art form of failed demagogic democracy.
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  Unfortunately, crises also provide fertile grounds for demagogues from the idiot right and the idiot left. In the past, the electorates of the U.S. and other Anglo Saxon democracies have always rejected such enticements - but the electorates in more fragile democracies have often succumbed.
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  These dangers are real. But an economics profession that persistently and convincingly informs the public of developments - good and bad - in their economic system will prevent surprise and thus can reinforce the essential political center against the extremist wings. It is essential that the public be fully and repeatedly informed of its economic perils - no matter how much it may not want to hear about them.

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Copyright 2003 Dan Blatt