Of Dishonest Money and a Poorer Future

Interest rates in the United States are low, far lower than they would normally be. The Federal Reserve has been pumping hundreds of billions of dollars into the economy to keep them low. Is that a good thing? For the federal government it might be—in the short run—but for savers it is bad. One percent back on your savings is pretty low. The persistent, artificially low interest rate policy of the Federal Reserve Board has become a major transfer of wealth from private savers to the federal government. Low interest paid by the Treasury means low interest earned by savers. Measured against inflation, you may be letting the federal government use your money for less than nothing.

Perhaps even worse, the low interest rate policy of the Federal Reserve is supporting the colossal spending binge of the federal government. The federal government can spend trillions of dollars it does not have, because the cost of government borrowing is so cheap.

It is not naturally cheap. Normal markets would not support the continued massive deficits from Washington. When the government spends more than it takes in it has to borrow from you and me, or more particularly from our pension plans and insurance programs, as well as from banks (and foreigners, a subject for another day). Savers and banks do not, however, have an unlimited appetite for lending to the government, especially at the low rates that the government offers. In past decades, persistent federal deficits would result in rising interest rates, as investors would demand a higher return to keep them willing to buy more government bonds.

Some months ago, when the ballooning federal deficit showed no signs of easing, the Federal Reserve stepped in and started buying up hundreds of billions of dollars of government debt just as investors were backing away. Interest rates on government borrowing would have gone up, but the Federal Reserve bought up the oversupply of debt and pushed interest rates down. Interest rates on government borrowing today remain at historically low levels, six-month Treasury securities going for about one-tenth of one percent. That is way below the rising rate of inflation, which lately is at about 2.5% and going north. That means that many investors in government debt are actually losing money, the return on their government debt falling behind the rate of inflation, the government paying back the money it borrowed with dollars that buy less than the ones that they took in. Federal Reserve policies are helping this go on.

Speaking of inflation, the Federal Reserve announced this past week that it is O.K. with inflation of 2.5%, that in fact the Federal Reserve sees inflation trending toward 3% for the coming years. Some of us who remember back to the Jimmy Carter days when inflation approached closer to 20% than 10% might be tempted to think that 3% inflation sounds pretty good. Keep in mind, though, what inflation means.

Remember what money is. Money is an exchange of promises. I promise that I will give you, say, $100 worth of value, whether my goods, my time, or my services, in exchange for which you give me a certificate—money—that can be exchanged for $100 worth of goods, time, or services with someone else. Money lets me take that promise and put it in my pocket and carry it around to where I think that it will be of most use to me. Money is enormously efficient. I do not work for the grocery store. I work at my job and get paid and then take my money to the grocery store and exchange it for groceries. The store exchanges that money, in turn, for more goods, as well as to pay the salaries of the people who work there. They in turn take that money and use it for what they want.

Inflation makes all of that dishonest. I get paid the $100. If I wait a year to spend it, and there is a 3% inflation rate, that $100 dollars will then only by me what about $97 would have bought when I got paid. Of course, that is an even bigger deal if the inflation rate is 10%, my $100 only being worth some $90 of goods and services in my example. But even 3% can be a very big deal, a far bigger deal than the Federal Reserve seemed to acknowledge this past week.

Consider retirement. Not enough people do, but you should. Perhaps you are an average couple saving and investing and hoping to have a retirement income of say $80,000 per year. You have figured that you can live on that. With an inflation rate of 3%, you had better think again. Your $80,000 retirement income will only be able to buy what $40,000 or less buys today. Setting aside adequate money to save and invest for retirement is hard enough. Inflation makes it all much harder.

Massive government deficits are already driving the Federal Reserve to cheapen the return on your investments (in order to keep the federal deficit from snuffing out the weak recovery). The inflationary pressures that they are building up inside the federal volcano will undermine your retirement even further. The longer we wait to solve the deficit problem, and the interest rate and inflation dangers it spawns, the worse it all gets. Government may not be able to create wealth, but it can surely take it away.

Of Crony Capitalism and Free Enterprise

In 1991, after the fall of the Berlin Wall and as the Soviet Union was disintegrating, the current editor of The Wall Street Journal editorial page, Paul Gigot, warned,

Freedom’s main enemy now is the corporate state, private business harnessed to the coercive power of government.
(Paul A. Gigot, “Trade’s Hamlet: Will Gephardt Do The Right Thing?” The Wall Street Journal, March 8, 1991)

If that was true in1991, it is far more of a danger twenty years later. As a result of recent legislation, including the Dodd-Frank Act, the massive stimulus program, and the huge healthcare overhaul, involvement of government bureaucrats in private enterprise has never been greater in the United States, not even close. Federal officials are being endowed with enormous power in ways large and small to reward favored businesses and punish those that are not so favored, all hidden under the camouflage of acting for the “public good.”

Under Dodd-Frank, for example, federal regulatory czars are given authority to decide what lines of business financial firms can or cannot engage in, what services they can offer to customers, how much they can pay their employees, which firms will be bailed out if they get into trouble, what information private firms must provide to federal operatives, and who gets to foot the bill for all of this federal intrusion. Similarly, under the stimulus plan, hundreds of billions of dollars in federal contracts are up for award under the skimpiest of criteria, while under the new healthcare system myriads of government boards will decide who can receive what medical services at what cost and under which conditions.

It gets worse. Because these government benefits or penalties can be exercised with broad discretion by government officials, staying on the good side of the federal task masters becomes very important. Paying attention to the views and interests of government officials in other matters, even those not directly related to the legislation, can become the key to success or failure for a firm. Certainly complaints about the exercise of government discretion will not be well received. This is not hypothetical. Already it is the rare bank that will publicly complain about a decision by the FDIC, and securities firms are noticeably shy about taking issue with decisions of the Securities and Exchange Commission.

This ability of government authorities to employ the force of government to help friends and penalize perceived enemies, and to use economic levers to do so, is called crony capitalism. Crony capitalism unfairly gives capitalism a bad name. It is Third World-like. It is also old fashioned; it is pretty much the way that kings and czars ran their economies. Free enterprise and free markets will always be at war with crony capitalism.

Under crony capitalism, ownership of business may remain in private hands, but private owners share control with influential public officials. It can pay off big time for a business to get and stay on the good side of these people—whose permission and authority are keys to the success of the business. With government favor, a firm not only can win government business, but rules and regulations can be written in ways that favor the firm and disadvantage competition in the private sector. A new upstart in an industry can find trouble getting licenses, experience delays in regulatory approvals, be subject to heavy paperwork demands, face onerous financial fees and requirements, and through a myriad of techniques find his business handicapped in ways not experienced by firms in favor with federal officials.

Crony capitalism not only corrupts the relationship between businesses and the government; it corrupts the relationship between businesses and their customers. Under free capitalism and free enterprise the marketplace is the arbiter of which products and businesses succeed or fail. The multitude of individual people in the marketplace, through their multitude of individual purchases and other economic decisions, are the ultimate judges of economic success. That is to say, that customers have the ultimate say over which firms are the winners and losers, which in turn makes them, the customers, the winners from a vigorous competition among businesses to please them. It takes protection provided by the government to shield an inefficient business from the discipline of customers and markets, and that is what crony capitalism provides.

Under crony capitalism, judging winning and losing is taken away from the market place. With success derived from the ability of businesses to curry favor with government leaders whose hands are on the economic controls, it is no surprise, then, that the growth of government interference has stimulated a dramatic growth in the need for businesses to have representatives in Washington to plead their cause. Fortunately, that right of representation is enshrined in the Constitution. But it would be a good idea to reduce its necessity by re-enthroning markets and the consumers behind them as the final judges in the economy and return our government to preserving life, liberty, and the pursuit of happiness.

Of Incentives and Jobs

Weird things happen when we decide by law who should have jobs and who should not and we order how people and businesses should spend money. I am not referring to the legality of telling people who receive money from the government how to live their lives and run their businesses. I am referring to the wisdom of it. And by "weird" I really mean "bad."

On Friday a press release came across my desk, issued by seven travel-meeting-event industry trade associations. Their basic message was that the public beating up of companies over the meetings they hold and the incentive programs that they have for employees is killing the travel, tourism, and meeting industry and the people who work in it. They estimate that 200,000 jobs were lost in that industry in 2008, and a larger number of job losses are predicted for 2009.

Even the old communist governments figured out that workers respond to incentives. Under the power of incentives people work harder, smarter, and more creatively. They may even enjoy their work more. Sometimes incentives that take the employee out of the normal routine can be very powerful. If left to their own devices, businesses will experiment with different packages of incentives to guide their employees into the most efficient ways to accomplish company goals and objectives. Will they get it right? Often they will not. When they get it wrong, they try something else.

What is the best set of incentives, and should the incentives include travel and recreation programs? I do not know, and neither do you. No one has enough information, smarts, or involvement to know. You may know what works for you, but are you willing to say that others should be offered the same rewards or that you should be given the same incentive program designed by someone somewhere else or in some other line of work? Everyone meeting company goals gets a set of golf clubs. That may work fine for Harry, but how about for you?

While it may be lots of fun to rant about businesses sending employees to Florida for a weekend, do we have any idea how that might figure into the incentive programs in those businesses? If you take that option away, what other option will work as well or as efficiently? Again, I do not know, and neither do you.

Up until recently, I did not have to know or pretend to know. We left it for businesses and their employees to figure out. In view of the efficiency of our businesses--which efficiency continued to improve and lead the world even in 2008--American businesses have been getting the incentives much more right than wrong. When we decide to make those decisions for other people, especially when we try do so through government force, we can be pretty sure we will get it wrong. Who wants to explain to the 200,000 travel and tourism industry people who are in danger of losing their jobs why businesses should not be holding meetings in Williamsburg or San Antonio or Nashville? Step up now; a frozen turkey if you get it right.

Of Plumber Joe and Community Organizer Barry

It took a real life example to give life to the key difference between the two candidates for president. When Plumber Joe met Barack Obama campaigning in his neighborhood, Joe asked the would-be president, why do you want to tax my small business? Actually, more precisely, Joe wants to buy the plumbing business he has worked at, and Obama wants to raise taxes on it, and Joe asked Obama, why? At first, Obama equivocated and mumbled something about getting some tax breaks to offset the tax hikes. When Joe refused to buy into that sleight of hand trick, Obama fessed up. Obama admitted that he wanted to spread the wealth around. In other words, he said that Joe would be making too much money, so Obama wanted to take from him and give to someone else.

Why would Obama want to do that? Because, unlike Plumber Joe, who has a real job, Obama’s career experience came as a “community organizer” (when he was known in Chicago as Barry). Taking money from people and giving it to others is what community organizers do. Barry the Community Organizer now wants to organize a big community, of over 300 million people, and he wants to keep spreading the wealth around. Community organizers like to do that, because they like to get the credit for being compassionate and generous, compassionate and generous handing out other people’s money.

Joe has worked hard as a plumber. Joe has saved and prospered. Now Joe wants to own his own business and provide work for other employees. The employees, these plumbers, would provide plumbing services and get paid by their customers. Barack Obama wants to take some of that money—O.K., a lot of that money—and spread it around to people who would get their money from Barack, people who have not been as “lucky” as Plumber Joe.

Lucky? My guess is that it was not luck that made Joe work hard over the years and save his money to be in a position to own a business and provide real jobs to other people. Under a President Obama, Joe and others like him would become unlucky.

John McCain has been trying to point out for weeks that the change offered by Barack Obama is a big time return to the tired old tax and spend politics of the big government politicians. John McCain is not the most eloquent campaigner, and the mass media has been doing its best to bury his message anyway. McCain finally found a real life example, and that is the most eloquent statement of all. At the last national debate, on a stage that the mass media could not ignore, McCain introduced us to Joe the Plumber (who by the way did not ask for all the attention and is a bit embarrassed by it), and McCain asked, why raise his taxes? Why raise anybody’s taxes going into an economic downturn?

If you do not raise the taxes, you cannot keep spending other people’s money and winning praise for your compassion and generosity. And that is the point of this election.

Of Borrowing and Saving

The basic rule is, if you are not already saving, then you are not ready to borrow. This may sound paradoxical, but it is the only safe way to approach borrowing.

You may wonder, if I have savings, then why would I borrow? That question may be answered in any number of ways. Asking it suggests some lack of understanding of the proper purpose of borrowing.

The proper purpose of borrowing is to manage your income. You should never borrow to spend beyond your income.

Most people receive income in lumps, like once a month or twice a month. Expenses do not always behave themselves that way. First, there are the every day expenses, such as for food, transportation, and a wide range of miscellaneous minor expenditures that quickly add up. Then there are other expenses that occur monthly and may more or less happen at about the same time as your income. A third category is the big expenditure, that may come once or twice a year, such as tuition, taxes, major purchases, insurance premiums. Since the timing of our income and outgo often do not line up, we use borrowing to help bring the two into line.

For example, the tuition is due in September, but you plan to pay for college by working through the school year. A student loan or other borrowing arrangement with the college can line your income up with the expense.

Another example might involve a big appliance. Your refrigerator breaks down and you need a new one. You may not usually have several hundred dollars of unallocated income available in any one month to pay for the new refrigerator, but you likely will over the course of a year. Borrowing lets you draw that income from the course of the year into your current month and match it against this large purchase needed today.

Here is a bigger example. You need a new car, both for family transportation and perhaps even for travel to work. Very few people have enough ready income to buy the new car with what will be received in any one month. Most people, though, can draw upon funds available from their income over the course of a few years to pay for the car, and borrowing is the tool that they can use to do that.

Of course, this borrowing from the future to pay for something today can be abused. There is a natural temptation common to man to seek gratification today and worry about tomorrow’s problems tomorrow, even while causing them today. Two things can help counter this potential for abuse. One is interest, and the other is saving.

Interest is what we pay for borrowing. While rewarding the lender, it is a penalty against anyone who borrows in order to spend beyond his income. As you spend beyond your income, the interest mounts. In the end, it will bring down the abuser once the abuse has gone too far and gets out of hand.

Saving is a more benign and effective check on the impulse to borrow in order to spend beyond income. If you are regularly saving, you are doing something even more important than preparing for the future and reaping the rewards from lending to other borrowers. By definition, if you are saving, you are living within your income. You are taking part of your income and putting it aside. That discipline is what is needed to prevent you from using borrowing to exceed your income. You have a proven practice of spending less than you earn.

That is why I say that if you are saving, then you are prepared to borrow, and if you are not saving, then you are either living right on the edge—spending your income as fast as it is received—or you are going beyond, borrowing to spend beyond what you earn, and that leads to trouble. Then you will be spending to consume something that you did not earn and do not deserve. The eventual price for that is loss of freedom, as you must in the future consume much less than you earn in order to satisfy the debts.