Government the Destroyer, Part II

The Bush administration recently revealed their stimulus package to help shield our country from a recession. In the conclusion of this two-part essay, Lew Rockwell shows the stimulus package for what it really is.

I ask you to consider the absurd discussion of a stimulus package designed to rescue the economy from recession. The idea is that the government will inject funds into private markets to stimulate them to the point that they will run on their own. Not once in this debate have I heard anyone ask the core question: where is this money going to come from?

It seems that Washington wants us to believe that they have some magic machine that can turn up $150 billion in new assets without anyone having to do anything to make these assets appear. One wonders, then, why we need to wait until a recession to stimulate the economy. Why not magically create hundreds of billions every day, and not just for this country but for the entire world? Why are we holding back?

Now, the ideas of the stimulus package are not 100% awful. Some people are talking about tax cuts, which is a good thing but rather pointless without spending cuts. I’m particularly intrigued by the underlying assumption here that taxes work as a drag on an economy whereas tax cuts fuel expansion. If that is the case, and is indeed true but for different reasons than Washington gives, why wait until the recession to cut taxes? If taking less from us is good for the economy, we should institute this as a universal policy.

One great lesson of political economy, emphasized for centuries, is that the government creates no wealth of its own. Everything it has it has to get from you and me, one way or another. It can tax. It can borrow. And, finally, it can inflate by means of credit market manipulation. This third option is the most disguised. When people hear the words monetary policy, they figure that this is something they will leave to experts. And central bankers have an astonishing talent for obfuscation to the point that no one knows with certainty precisely what they are doing.

The whole show is designed to make us go to sleep and not think about what is really going on. The unvarnished truth is that when the Fed artificially lowers rates, it is creating new money that waters down the value of the existing money stock, yielding a lower purchasing power for the dollar. That’s another way of saying that it creates inflation – perhaps not right away, and perhaps not across all economic sectors, but eventually and certainly.

This, my friends, is a form of breaking windows. It is wealth destruction. It matters not that there will be more dollars to spend, because prices will be higher and wealth has been drained out of the private sector, and redistributed within it. It is Bastiat’s fallacy reinvented in a new form.

New money also distorts production structures. At the very time when the market is pressuring long-term investment to pull back, the lower rates encourage expansion in ways that prolong the crisis. It only delays and worsens the inevitable. The Great Depression taught us that government is capable of doing this to the point that the crisis can last for 17 years. So this is no small matter. A government determined to prevent recession is a government that might end up sustaining one to the point of the collapse of civilization itself.

It is a perverse belief, but pervasive nonetheless. It is believed by both political parties. It is held by the president, the media, and the congress (except for Ron Paul). It is a reflexive belief, one that reflects a failure to think between stages and see the unseen effects of government intervention.

One reason that Bastiat’s example has power is that it applies not just in one area of policy but all areas. If it isn’t true that breaking windows creates wealth, it is not true that government spending and inflating is a boon to the economy. It only ends up draining wealth from the private sector, which is the only source of wealth creation.

It doesn’t matter what the government spends money on. For example, building pyramids with tax dollars is not good for the economy, despite what Keynes claimed. But neither is waging war good for us or the victim country, despite constant claims to the contrary.

It is surely one of the most deadly myths that the Second World War ended the depression. As Robert Higgs has shown, it further prolonged it, all phony data aside. And consider the spending on the war on terror. If government spending were capable of stimulating the economy, we would not have recession right now.

Chris Westley assembled some data on the last seven years of economic conditions, and it is sobering indeed. Since 2000, tax revenues are up 25%. That’s wealth destruction. Government spending is setting records for expansion, with $1 trillion added to the annul budget, with military spending up $250 billion each year over the egregious $400 billion spent annually in 2000. That’s wealth destruction. The national debt is up 59%. That has to be paid. More destruction.

Social security liabilities are up 60%. That too is the promise of future destruction. The money supply is up 72%. More destruction. Inflation itself has risen 20%, so the dollar of 2000 is now worth 80 cents. The gas price alone is up 118%, so that too is wealth destroyed. As an indication of economic trouble, the gold price is up 206%.

Here is the story so far of the government’s great stimulus. It has led to hard economic times. More of the same will create more of the same and worse. The unemployment rate is rising. Savings are falling. Prices are rising. We are less secure, less prosperous, and we have fewer opportunities than ever to dig our way out of this mess.

Government expansion has actually created the absurd scenario mentioned above. The boy threw the rock, the crowds in Washington believed the sophist, and now they are plotting to raze all homes on the block, in the name of economic recovery.

Have we learned from the Great Depression? Ben Bernanke believes that he has learned something. He believes that the key problem of that period was a failure of the central bank to pump in enough money and credit. He has never absorbed the critical observation of Rothbard that the Fed did attempt to pump up the money supply from 1929-1934. They used every mechanism, but the credit markets found few takers, and without their cooperation, the money supply does not expand.

The real lesson of the Great Depression is that there is nothing that the central bank can do to forestall a recession whose time has come, and nothing government can do to improve the situation once the recession has arrived. Everything it attempts to do – except shrink – only ends up making matters worse.

So it is in our time. We must ask ourselves what Washington is capable of doing this time around. I believe that the answer is anything and everything. Bernanke will attempt to flood the economy with money. Washington is perfectly capable of imposing price and wage controls on the entire economy. It is capable of terrifying levels of protectionist legislation. New taxes are less likely but taxation through debt accumulation is probably inevitable. There might be rationing, spending mandates, anti-hoarding legislation, and more.

The assumption that driving up consumption is the key to prosperity is particularly dangerous, and also pregnant with irony. During good economic times, we are hounded constantly by the intellectual elites for our consumption habits. It is said that we are a greedy nation, buying ever more fripperies and not looking after the long term. The American public is decried by the intellectual elites as materialist, consumerist, and short sighted.

Then recession hits and the tune changes completely. Reliable leftists, fresh from having complained about the egregious spending habits of the American consumer, suddenly turn on a dime and tell us that more consumption is the key to economic growth. They favor policies that would get us to fork over ever more of our money, under the belief that the core problem is a lack of demand!

A recent example is Barack Obama, who said last year that the problem with popular culture is that it "saturates our airwaves with a steady stream of sex, violence and materialism." But only this week, he seemed to endorse one of the three. "If the economy continues to decline in the coming weeks, we should send checks to people," he said. "This is the quickest way to help people pay their bills and get them to start spending."

In fact, less spending and more saving is what is called for during a recession, which is nothing but a market correction writ large. Attempting to coerce spending threatens the value of the dollar itself.

Here we face a very dangerous situation. If the dollar ever ceases to be the international currency of choice, and this could happen, we could face roaring inflation. And with dreadful legislation that prohibits any kind of choice in currency, Americans will be stuck. Here is a problem that could cause near panic in Washington.

The irony here is that after a century of failed interventionism and socialism, Washington is no less likely, and probably far more likely, to take the path of least resistance and accumulate ever more power unto itself, at our expense.

We are in an election season, so of course people ask who would be the least bad person to head the state in the years ahead. The answer here is not at all clear, if it is not Dr. Paul. As with the 1930s we face a choice between militaristic fascism and Keynesian-style socialism combined with environmentalism. These are two very grim choices.

I tell you this not to spread gloom but merely to be realistic about the prospects for the future of American politics. But there is also good news to be considered. The private sector has raced so far ahead of the state, and is so global, that it is far more resilient than before. There are safety valves available in the form of international capital markets.

The government is so much bigger now than in the 1930s, but, paradoxically, that also makes it less effective than it once was, which is very good news. It is a massive, lumbering giant, whereas the markets are a speed racer.

I might also point out that the government enjoys nowhere near the respect it once had. Once the governing elite consisted of the nation’s elite, coming from the best families and the best schools. Today, the governing elite has never been more transparently ridiculous and even freakish. Gone are the aristocratic public servants of yesterday; today, the government is made up of a class of hucksters and gangsters that inspires no confidence.

This is all to the good, for as Mencken said, it is always great when we do not get all the government we pay for.

On the intellectual level, the teachings of economics in the Austrian School tradition have never been more available to the world, or more frequently cited and discussed. And a recessionary environment guarantees more attention to the Austrian theory of the business cycle simply because this is the only model that makes sense of our current problems.

We should never underestimate the power of ideas to make a difference in the world. During the Great Depression, the resistance to the state was present but weak. Today we have built up a mighty intellectual army that extends across the globe. We are prepared in ways that they were not. We have thousands of students and faculty, and men and women of affairs who know real economics. We have the internet. We have new books that put the whole problem in perspective, such as Jesús Huerta de Soto’s work on business cycles. We have the biography of Mises now, and it illustrates the heroism of political dissidence. The works of Rothbard on the Great Depression and central banking have never been more widely circulated and available. This time our masters in Washington will not go unopposed.

At the Mises Institute, now in our 26th year, we tried to maintain a careful balance between serious and fundamental scholarly work, and public advocacy. We must never lose sight of the need for research and detailed work. It is not enough to merely repeat slogans. At the same time, there are some foundational lessons of economics that must be taught again and again with each new generation. The fallacy of the Broken Window is one of them, and its implications are truly radical.

Both Bastiat and Hazlitt saw that the government is the great window breaker, that destroyer of wealth that drives the economy backwards. The engine of creativity, recovery, and expansion is the private sector, completely unencumbered by state intervention. Ron Paul’s newest book is called Pillars of Prosperity: Free Markets, Sound Money, and Private Property. The title nicely sums up the message of the economics of freedom.

It bears repeating in every age, in all places, for we will never be completely free of the great threat of the window breaker. So long as there are governments with stones ready to throw, there will be a need for someone to point out that destruction is never productive, never beneficial, and never a path to the good life that we all seek.

Regards,

Lew Rockwell
for The Daily Reckoning
February 21, 2008

Llewellyn H. Rockwell, Jr. is founder and president of the Ludwig von Mises Institute in Auburn, Alabama, editor of LewRockwell.com, and author of Speaking of Liberty.

Yesterday, the Dow was up 90 points. But gold hit a new record high. So did the commodity index, the CRB.

What should you do with your money now?

Today, we take a break from our usual cogitations to bring you something useful. A suggestion.

"Sell the U.S.," we have said.

"Sell the U.K.," say our colleagues in London. The English have very similar problems to the United States – too much debt, too little profitable output, high costs, too little energy, too little food. What’s more, the U.K. economy relies far more on the financial industry than America does.

But today we are feeling positive…helpful…almost earnest. We offer some buy-side advice.

Our colleague in Buenos Aires has persuaded us that Latin America is a buy. (Spanish speaking readers are invited to go directly to moneyweekes.com to read his reports unblemished by our bad translations.)

The whole region is booming, says our man in South America. GDP growth is solid to spectacular. Currencies are rising. These economies are relatively unburdened with the high costs and legacy obligations of Britain and America. And they produce what the world seems to want most – food and energy.

"The economy of Peru is gathering momentum," writes Horacio Pozzo. "GDP growth reached 8.99% in 2007, with a strong growth in consumption (rising at a 7% annual rate) and with outstanding growth in capital investment, at around 23.4%.

"Wherever you look, the Peruvian economy is healthy – with a fiscal surplus of 2.6% of GDP and an external surplus of 1.5% of GDP, with record foreign currency reserves of $28 billion, unemployment of 6.9% and an inflation rate, which reached 3.9% last year, under control."

By almost every measure, in other words, Peru has a more solidly growing economy than either Britain or America.

In Brazil, meanwhile, consumer spending is rising too – up 5.5%, compared to an average of only 2.4% in the ’90s. How come consumers are spending more? Simple…there’s more money in the country and they have more jobs. Earnings have gone up 148% in just the last five years – to a per capital level of $2,794 in 2007. Unemployment has been going down too. It ran into the double digits in 2001 and 2003. Since then it’s been coming down, to the lowest level in the last ten years in 2007 – at 7.4%.

Inflation is still running a bit hot in the Amazon. But the authorities are turning on the air conditioners. The key lending rate of Brazil’s central bank is 11.25% and may go up, as officials try to hold down price increases. And unlike the U.S. president, Brazil’s top man is actually becoming more popular – with approval ratings above 50% and rising.

Money is flowing to Brazil because the country is a major supplier of raw materials and soft commodities – the very things whose prices are rising so sharply. Just last week, for example, Brazilian suppliers got South Korean and Japanese buyers to accept a 63% increase in the price of iron ore. Wheat, of course, is off the charts.

But how do you take advantage of the boom in Latin America…and without getting whacked by a downturn in commodities? Here at The Daily Reckoning, we are suspicious of commodity prices. As soon as you notice a big spike up in a commodity – such as wheat, currently – you have to expect a big spike down. Commodity producers – with some major exceptions – react quickly to price increases. They produce enough to meet the demand…and then, typically, a lot more. Bust follows boom, sometimes so quickly that an investor has little time to get into position.

The 1970s, for example, were boom years for commodities, generally. But the price of sugar actually peaked out at 70 cents per pound in 1973 – at the very beginning of the boom. Marc Faber explains:

"Despite accelerating inflation rates, sugar thereafter failed to make a new high in the 1970s. After 1981, when interest rates fell, the price of sugar continued to decline and bottomed out at 2.5 cents per pound in 1985. And although interest rates continued to decline in the 1990s, sugar was still selling for just 5 cents a pound in 1999…very simply because supplies exceeded demand."

A boom in commodities is almost always followed by trouble. That’s why our old friend Rick Rule says, "most people can’t believe how cyclical commodity markets are." He goes on to say that in commodities, "either you are a contrarian or you are a victim."

But Horacio makes a suggestion for how to profit from Brazil’s boom without getting on the wrong side of a commodity cycle.

TAM (NYSE:TAM) is an airline with nearly 50% of the domestic Brazilian market. Air transport in Brazil is rising at 10% per year. Yet, TAM sells at a price that is only 4 times earnings. And it has a price to book value of only 1.14.

Buy TAM, says Horacio.

Latin America is booming. And our colleagues in Buenos Aires, Argentina are well placed to help you profit from the many value opportunities south of the border. They have launched an email report service entitled Informe Moneyweek that covers both Latin American and international investment opportunities. It’s written daily in Spanish by South American market experts, Horacio Pozzo and Paola Pecora. If this is something you would be interested in, I encourage you to click here…and by the way, it’s free!

*** London is a remarkable city.

We took the train out to Luton Airport this morning. Standing on the platform at London Bridge Station we watched the early morning trains come in. Out of them came the working classes, people who wear jeans and watch caps and start work early on construction sites, in restaurants and hotels, and in the few other manual jobs that remain in the city center. Later trains bring in a different class of worker…dressed in suits and ties, who walk across the bridge to the City, London’s equivalent of Wall Street, and spend their days separating clients from their money. Millions of people come into the town center each day… "I did not think death had undone so many," remarked T.S. Eliot, watching them make their way over the Blackfriar’s Bridge.

The center of town has become so expensive that few real Londoners can afford to live there. Instead, there are working foreigners, such as your editor, rich Arabs, Russians, French, Indians – all manner of flotsam and jetsam from the globalized, capitalist economy.

England has a tax rule, dating back some 200 years, that allows these foreigners to live in the U.K. and pay tax only on the money they earn in the country or bring into it. If, for example, a Russian energy billionaire chooses to live in London, his earnings from Russia are tax-free here. Naturally, this little feature…along with London’s financial industry and its civilized, law-abiding society…attracts many of the world’s rich and footloose.

Envy is a more potent emotion than the desire for wealth itself. Many people in the United Kingdom are annoyed that so many rich people live in their midst without paying taxes. "It’s not fair," they say, "that we have to pay thousands in taxes on our meager salaries, while they earn billions and pay nothing." They have a point. It’s not fair. But it might be smart. Clearly, the rich spread their money around. They fill the fancy restaurants…buy the expensive cars…go to the theatre. They buy property too…lifting the ceiling on the London housing market to the highest level in the world. They also spend enormous amounts of money in England’s equivalent of Wall Street – the City.

They have money to manage and invest…they do mergers and acquisitions…the keep the clerks busy. They keep the high-priced lawyers busy…the dress-shop girls on alert…and the jewelry companies hoping for a big sale. (Last year, celebrating an important birthday, we bought Elizabeth a very little bauble at Tiffany’s on Sloan Square. Now we are on the mailing list and treated as though we were an oil prince.)

Americans, of course, are in a class by themselves. Unlike the world’s other peoples, the land of the free taxes its own on their worldwide wealth – no matter where they live or how long they’ve lived there. We have lived outside the United States for the last 12 years. Yet, every one of those years we filed our U.S. tax return and paid our taxes to the U.S. government – just as if we got something for it.

Curiously, this regime often works to Americans’ interest. An American in Paris, for example, who earns his money in the United States, probably pays less in tax than any other group in the city. A special treaty between the United States and France permits U.S. citizens – and only U.S. citizens – to discharge their entire French tax obligation on U.S. source income simply by paying IRS what is owed.

But the non-U.S., "non-dom" foreigners in London have an even sweeter deal. ("Non doms" they are called…meaning, they are resident in the United Kingdom, but not domiciliary of Great Britain.) It was probably too good to last. Recently, the Labor government buckled to pressure from the voters and introduced a new tax on the "non-doms." Henceforth, the non-doms will have to pay an annual tax of 30,000 pounds – or about $55,000 – per year, for the privilege of living in the United Kingdom.

This amount is peanuts to the Russian billionaires, of course. But there are thousands of ‘non-doms’ to whom it is real money. The City has attracted analysts, fund managers, actuaries and mathematicians from all over the world. There are also large groups of foreigners who have made London their home because it is safer and nicer than where they came from. Whole industries have lodged themselves in London – largely because of the tax feature. A big part of the Greek shipping industry, for example, calls London home.

Now, many of these people say they are leaving. The Greeks say they are going back to Athens. The financial industry says it’s going to Geneva. And all of a sudden, there’s a gush of interest in Dubai.

We don’t know how much effect this new tax will have. But it, along with a decline in the financial industry, makes it a poor time to buy property in London.

*** Speaking of Dubai, a full-page ad in a London newspaper announces a remarkable opportunity. "Dubai Property Investment Weekend," it proclaims.

"Learn about off-plan UAE property and return 40% to 50% of your investment per annum."

Hmmm…a yield of 40% – 50%? How is it possible? We don’t know, but the ad tells us that we can invest 69,000 pounds and we’ll get an annual return of 33,000.

Ha…ha…ha…ha…ha…

It’s nice to see the markets functioning as they should, separating fools from their money. The actual return from an investment in Dubai property is more likely to be preceded by a minus sign. Colleague Kevin Kerr explains why:

"I haven’t been there [to Dubai] before, and know very little about the country. I saw a special on "60 Minutes" a few weeks ago while trapped on an airplane and saw how that Palm Island is completely sold out but there isn’t a soul living there, it’s almost deserted.

"I don’t think I really grasped how insane it is until I saw some of these pictures and read about plans for a spaceport, yes a spaceport and a 100,000 employee Dubailand. I know this may seem stupid…But where do they get the water (hello, it’s a desert), electricity, and everything else to support an infrastructure this big? Again, I know we are all aware of the building craze there, but I just didn’t realize the scope until now."

Colleague Ronan MacMahan says there are ads in the Dublin airport offering a free Bentley if you buy a penthouse in Dubai.

"Apparently, they give you a Mini Cooper if you buy anything at all," says Ronan. "But watch out. There are some 1 million apartments in the pipeline in Dubai."

Until tomorrow,

Bill Bonner
The Daily Reckoning