How Obama could be the Greatest President Ever

A crisis is an opportunity for revolutionary change. Obama could become the greatest president ever, and fulfill the hopes he inspired, by making radical changes. He could put the economy on track to prosperity, reorient American foreign policy towards harmony, and refresh the American spirit of liberty.

The government could end the recession within three months with "money to the people." Congress would authorize the U.S. Treasury to print thousand-dollar bills, and give every U.S. resident six of them. That would be debt-free and would end the negative-feedback loop of higher unemployment creating ever less demand for goods, which then makes companies shut down and lay off workers. The recession creates economic lockjaw: banks fear to lend because companies are shutting down and workers are losing their jobs. Cash is the ultimate credit and the antidote to credit freeze. "Money to the people" is almost a free lunch, because the recession is causing deflation and fear of further price declines. Monetary expansion is bad medicine except in an economic depression with deflation, when it is a good tonic if given directly to the people, not to the risk-fearing banks.

For long-run prosperity, Obama should promote radical changes in taxation. Don’t tax the rich just because they have wealth. Instead, tax subsidies so that they are no longer subsidies. Polluters are subsidized if they do not pay the social cost of their emissions, so tax pollution. Landowners are subsidized from the increase in their rent and land value due to public works and civic services. Tax land value to eliminate this subsidy. A land value tax will make the economy more productive, as the land-value subsidy promotes inefficient uses of land and the excessive speculation that results in the boom-bust sequence we are suffering from now.

In foreign policy, Obama is confronted by the unsolved conflict over Palestine and the wars in Afghanistan and Iraq. Besides bringing home the US troops, Obama could promote a lasting democracy in Iraq by promoting an equal sharing of the oil profits, decentralized governance and voting, and protection for persecuted minorities. In Afghanistan, pay the farmers to grow alternatives to opium, and decentralize democracy to bring political power to the people.

Restore trade with Cuba. Stop promoting the war on drugs that is tearing Latin America apart with violence. Apologize for having overthrown the government of Iran in 1953. For the Arab-Israeli conflict, recognize an independent Palestinian state in which the Israeli settlers of the West Bank pay rent for the lands they hold. Most important, declare that American foreign policy will henceforth avoid interfering in the domestic affairs of other countries. Declare also that Americans are willing to talk to and negotiate with all adversaries.

Strengthen American freedom by promoting a constitutional liberty amendment: "Congress shall make no law restricting any peaceful and honest adult human action, not involving force or fraud, any state interest to the contrary notwithstanding." A first step would to be to legalize medical marijuana.

Obama has said he would confront the growing underfunded liabilities such as for Medicare and Social Security. A greater government takeover of medical services would compound the problem. The reason folks cannot afford medical care is because the money to pay for it has been take from them in the first place. Obama should separate the poverty problem from the medical problem. Make medical payments tax deductible, to unlock insurance from employment. Reform the legal system to having the loser in medical civil lawsuits pay all the legal costs. Then allow workers to opt out of medicare and provide their own medical care.

Obama could be truly great by getting welfare-state liberals to understand that state socialism cannot improve on the choice and productivity provided by a free market. Allow workers to switch from Social Security to individual accounts funded at first by U.S. Treasury bonds. That would replace the current Ponzi scheme with accounts that finance retirement from the worker’s own wages.

The global economy will recover from the Crash of 2008, but the massive bail outs and greater debt will cause problems far into the future. Where will the money come from for the coming trillion-dollar deficits? If it comes from money creation, the result will be inflation much worse than during the 1970s, and a global flight from the U.S. dollar.

There is a way out, but it requires the greatness of economic enlightenment. Establish sound money with free-market banking: stop the expansion of money by the Federal Reserve, and instead let banks issue private currency redeemable into Federal-Reserve-note money.

The US can reduce its trade deficit and borrowing from abroad with a radical tax shift that reduces the cost of exports, stops economic waste, and induces high economic growth. That is the tax shift described above. Stop taxing labor, goods, production, and investment. Instead, just remove all the subsidies, such as to pollution, to farmers, and to land holding.

Taxing land value and pollution, plus user fees, could provide sufficient revenue while eliminating the need to compensate people for denying them economic opportunity. That implies that there would be no more transfer payments: no more governmental payments for medical care and retirement. That cuts the budget in half while raising wages and reducing the cost of living.

These are the radical steps that could make Obama the greatest US president ever. If not, small change will be ineffective, hope will be lost, and America will continue on the path towards self-destruction. Can Americans make the revolutionary changes needed to avoid disaster? Obama has inspired many us with the answer. Yes we can! However pessimistic we feel, we can yet remain hopeful. That is the real audacity of hope.

I.O.U. an Answer

I.O.U.S.A, a film about the U.S. debts and deficits, has been playing in theaters and on television. I saw it on CNN. The film’s website is http://www.iousathemovie.com. The producer, the Peter G. Peterson foundation, has the web site www.PGPF.org, where you can view 30 minutes of the film. The movie explains how the U.S. government debt has escalated, and also discusses the trade deficit and touched on the savings deficit and the "leadership deficit."

With many visual effects and interviews, the show explained how the unfunded liabilities for Social Security, Medicare, and Medical are the biggest elements of federal debt, and these deficits - promises not backed by funding - threaten the viability of the U.S. economy.
Despite the show featuring prominent economist and past government officials, the film lacks answers to the deficit problems. The only specific remedies are on Social Security, in which the answers suggested were to raise the age for full benefits, reduce the rate of growth of payouts, and increase taxes.

The film does not discuss the alternative of replacing Social Security with private accounts that would hold U.S. treasury bills. Such accounts would provide a greater retirement payout, and since the funds would belong to the individual, he would be able to borrow against it in an emergency. Today’s Social Security account is not your money until you actually receive it, and how much you receive depends on how much Congress wishes you to get.

There were no remedies provided for the biggest entitlement problems, Medicare and Medicaid. As the population ages, the Medicare costs of treating the elderly is escalating, and without changes, will dominate the federal budget. The film also had no answers to the trade deficit and the savings deficit. Maybe the new administration will at least end the leadership deficit.

One can ask, why no answers? Over and over again, the film talks about the problems, but provides no solutions other than for Social Security. The aim of raising awareness of the deficits is good, but the film fails when the viewers are left hanging there with no remedies.

It seems to me that possibly I.O.U.S.A. lacks answers because the producers don’t have them. Another reason for the lack of remedies is that they would be unpopular. To reduce the Medicare deficit, one needs to reduce the benefits, to change it to only insurance for catastrophic expenses. But that would be unpopular with those receiving Medicare benefits, and might result in criticism for the film. So they are silent on the remedies.

The film has been compared to the movie "An Inconvenient Truth" by Al Gore, about climate change. It is a good comparison, because "'An Inconvenient Truth" also lacks meaningful remedies such as pollution charges. Perhaps there too, answers would reduce the popularity of the film.

Of course the general answer to a budget deficit is to reduce spending and raise revenue. But that is not a real answer. We need to analyze which programs would be reduced, and which would be the sources of new revenue. Without specifics, there is no real answer.

The effectiveness of remedies depends on how radical you want to get. The more effective the remedy, the further one needs to go away from the status quo. For example, one can reduce benefits in Medicare, but that leaves the elderly with insufficient medical care. The elderly do not have sufficient funds for care because of the high expenses and lack of savings. They lack savings because taxes have drained their wages of funds that could have been saved. If taxes for Medicare go up, then that leaves even less for savings, and can reduce the incentive to work.

These deficits come from deep flaws in the structure of taxation and government, ultimately from flaws in the constitutions of the federal and state governments. The incentive of government chiefs is to please the voters and the special interests that fund their election campaigns. People like benefits such as medical care, and they don’t like to pay taxes on their wages. So the inexorable incentive is for government to provide benefits and push the cost into the future. The special interests provide needed campaign funds in exchange for favors such as trillions of dollars to bail them out of their failed financial speculations.

The U.S. Constitution endows Congress with the general power to tax and to borrow. That was a big mistake. Congress should have authorized Congress with the power to tax only land value and harms such as pollution. The Constitution should authorize Congress to borrow only for productive investments, not for consumption spending including military expenses.

With no taxes on wages, folks can then save much more, and they would have more incentive to save with no taxes on interest and dividends. Higher wages would enable folks to buy their own medical insurance and retirement insurance. Federal entitlements could then be scrapped. But such remedies are radical, and I.O.U.S.A. did not seek radical answers. Indeed, the film favors keeping Social Security. But status-quo thinking is what got us into the deficit mess.

So, unfortunately, this well-intended film will become part of the problem rather than the solution, because without answers, the film crowds out attention that could have been placed on the remedies. The deficits are deep problems, and only radical remedies can extirpate deep problems.

How to Make the new Year Better

Many economists and financial analysts are making conjectures about when the recession will bottom out and how strong the recovery will be. The speed of recovery depends on the policies of government world wide. With the best policies, the economy could recover within three months. With bad policies, such as occurred during the Great Depression, the economy could stay down for years.

One bad policy that made the depression worse was the erection of trade barriers. The US enacted a high tariff in 1930, and other countries also restricted imports, and world trade broke down. Companies that sold goods abroad could no longer stay in business. Farmers suffered as foreigners could not buy their crops.

Unfortunately, many countries today are repeating this policy error. The German philosopher Hegel was right when he observed that governments do not learn from history. Indonesia is requiring new licenses and taxes for imports. Russia has raised tariffs on imported cars and food. India has levied a tariff on imported soybean oil. The chiefs of each country think that they are protecting their home industries, but they are ignoring the lessons of the Great Depression, as trade limitation is contagious. If political pressure induces them to do something, a money subsidy is preferable to a trade barrier, since that does not distort prices as much.

Another policy failure during the Great Depression was higher taxes. Government revenues are down during the recession, but raising income taxes just makes more companies fail, and then more workers are thrown out of work. Governments stupidly raise their existing income, sales, and value-added taxes, instead of following the economic wisdom of taxing bad things such as pollution.

Governments can make the new year better by enacting optimal supply-side and demand-side policies. Supply side policy seeks to increase the supply of goods by reducing government-imposed costs. Governments can reduce excessive regulations such as the Sarbanes-Oxley law that imposes millions of dollars of costs on company accounting for little benefit. Governments can also reduce marginal tax rates, the tax rate on additional earnings.

In Obama’s presidential campaign, he sought to tax the rich more. Those with higher incomes do much of the investing and hiring of workers. Such tax increases should be avoided, and the tax cuts of the early decade should be made permanent. Aside from pollution taxes, if government chiefs seek more revenue, they can levy a tax on land value. The tapping of land rent for public revenue would, contrary to other taxes, push the economy towards greater production, since an underused plot of land would pay taxes based on its most productive use. A tax on land value is the ultimate in supply-side policy, especially when combined with a reduction of taxes on wages, goods, trade, and value added.

Critics say that since a tax on land value would make the price of land fall, this would make the real estate crash even worse. Many more properties would be worth less than the mortgage. But the best time to do this is when land values have already fallen, not when they are rising and peaking. During a boom, real estate interests oppose a land value tax spoiling the party. So there is nothing to gain by waiting for land values to rise before levying a tax. Do it now.

In an efficiency tax shift, eliminating taxes on wages, profits, sales, and value added, replacing them with taxes on pollution and land value, most folks would have net gains. The greater tax on the land value of a typical house would be less than the eliminated tax on the building, wages, and income from savings and investments. Those with net losses could be compensated with either money or bonds. The bond would be repaid by the volcano explosion of output as the unshackled economy would sprout up at rates we cannot imagine today. It would make the recent growth of China look like a snail’s trek.

But economic emergencies may well also warrant demand-side policies. The usual policy of money expansion does not work in a depressed economy. The central bank buys bonds and creates the money to pay for them, but the money just sits in the banks as reserves or government bonds, as the risk of lending is high. The usual policy of government spending also does not work well. Public works such as highways bridges take time to plan and only employ particular types of labor, often at the expense of other projects. The best demand-side policy is "money to the people." Print currency and distribute it equally to everybody. People will then buy stuff, pay off debts, and add capital to banks. Moreover, printing the money would be debt free.

As to monetary policy, enough already! When will central bankers understand that their policies are futile and create more trouble down the road? There is no scientific way to know the precise optimal money supply or interest rate. The manipulations of central banks and governments do not allow interest rates to do their job of allocating funds between consumption and investment, between the future and the present, between savings and borrowing. Central banks should freeze the national currency and let private banks and other institutions expand the money supply in the future, with bank notes and deposits convertible into the national currency.

Car makers are losing billions of dollars, and seek subsidies so that they can continue to loose money rather than recognize their bankruptcy. This may seem shocking to free-market guys, but better than pouring unlimited money down the drain, better than loans that cannot possibly be paid back, would be to nationalize the automobile firms. Folks would then not be scared off from buying cars, and millions of workers would stay at their jobs. Let the value of the shares and bonds fall to zero. Then the government could restructure the companies and sell them off. These companies and unions committed deception in the past by promising pensions that were not funded. Nationalization would be their well-deserved punishment.

To make the new year much better would require radical changes. Now is the time when people want and expect change. The question is whether the new administration will offer small and ineffective change, or the bold, radical, volcanic changes that would quickly turn the economy around and provide not just hope but the reality of prosperity, social peace, and economic justice.

How to Extirpate Poverty

To “extirpate” means to complete eliminate, from the Latin word meaning to pull out by stem and root. To extirpate poverty means to eliminate its cause, so that it does not come back. Fundamentally, poverty comes from a low wage level, so we need to examine what makes a wage level low.

The wage level of an economy can be thought of as the wages paid to unskilled people. Those with greater skill and talent get higher wages, so some think that the solution to poverty is better education. But a stagnant economy also depresses the return to human capital, the extra wage for those who are more productive. In a thriving productive economy, even those with few skills are better off than skilled labor in a depressed economy. Indeed, in an unproductive economy, those with skills often find little market for their human capital.

The wage level of an economy is set by marginal labor, those who work at the least productive land in use. The classical “law of wages” says that when workers are mobile, the wage at the margin of production will set the wage level for the rest of the economy.

The margin of production has several edges. There is the horizontal extensive margin of land that is just barely worth using, land so unproductive it fetches no rent. There is the vertical extensive margin of the space above a city, into which taller buildings can rise, without increasing the site rent. There is also the intensive margin of adding more workers to land already being used. The wage at the intensive margin will equalize to that of the extensive margin. Workers are paid what they add to production, which is called their marginal product.

As explained by the economist Henry George in his book Progress and Poverty, the margin of production moves out farther and faster to less productive land when people can hold land even if they don’t use it. Those who want to use land must then push the margin to less productive land, which lowers the wage and increases the rent. After paying for labor and capital goods, what is left is land rent. As the margin of production moves to ever less productive land, wages fall and rent rises.

We can raise wages and reduce rent by avoiding the under-use of land, moving the workers back to more productive land. Land is used most productively when the rent is collected for public revenue or for distribution among the residents. Land is then not worth holding unless one uses it in its most productive use, since the rent paid to the community is based on the highest and best use of the land.

This would involve a tax shift, in which taxes that come from wages are replaced by public revenue from land rent, or from voluntary payments by folks who receive an equal share of the rent. Workers would get a double gain: higher wages from putting land to its most productive use, and the gain from keeping one’s full wage.

A complete efficiency tax shift would also eliminate taxes on interest, business profits, dividends, and value added. The increase in investment would make the economy grow faster, raising the wage level until poverty is extinguished.

The reason why poverty does not disappear today is that much of the gain from an economic expansion ends up increasing land rent rather than wages. If the rent is used for common benefits or distributed equally, then the public would benefit from both higher wages and a share of the greater rent. The elimination of wage taxes would also stimulate investment in human capital, since the reward would be higher. There would be more self-employment and more entrepreneurship.

The collection of the land rent would also eliminate economic depressions. The capture of economic expansion gains by land rent and land value spurs land speculation that carries the price of land so high it is no longer affordable. Investment slows down, causing a recession. This is what we witnessed during the past few years. The abolition of depressions would eliminate the cyclical poverty of hard times in depressed economies.

Governments today do not extirpate poverty. They treat the symptoms with assistance for food, shelter, and medicine. The poor fall into a poverty trap, since getting a job implies a loss of the welfare benefits. The highest tax rates are on the poor seeking to escape poverty, since they have to pay taxes, pay to take care of children, pay for transit, and they lose the free benefits. There then develops a culture of poverty, where children are brought up to see themselves as victims who can at best just beg for more welfare favors.

Only the efficiency tax shift, replacing taxes on wages with taxes on land rent, will go to the root cause of poverty, and pull out those roots. Anything else just makes the poor feel better, but they remain poor. As Henry George write in his book Social Problems, “There is in nature no reason for poverty.” There is no poverty in heaven because everyone there has an equal share of the heavenly places, and their activities are not hampered with taxes. To extirpate poverty, let us do on earth what is done in heaven.

Free Banking Explained

by Fred Foldvary

Free Banking is free-market banking. In pure free banking, the money supply and interest rates are handled by private enterprise, there is no restriction on peaceful and honest banking services, and there is no tax on interest, dividends, wages, goods, and entrepreneurial profits. Free banking provides a stable and flexible supply of money, and allows the natural rate of interest to do its job of allocating funds among consumption and investment, thereby preventing inflation, recessions, and financial panics.

To understand free banking, we first need to understand the relationship between capital goods and interest rates. Capital goods, having been produced but not yet consumed, have a time structure. Think of it as a stack of pancakes. The bottom pancake is circulating capital goods, which turnover in a few days, such as perishable inventory in a store. The higher levels take ever longer to turn over. The highest pancake level consists of capital goods with a period of production of many years, the most important type being real estate construction.

Lower interest rates make the pancake stack taller, while higher interest rates make it flatter. Think of trees that take 20 years to mature. Suppose the trees are growing in value at a rate of three percent per year. If bonds pay a real interest rate of four percent, and the interest rate is not expected to change, then the trees will not be planted, since savers will put their funds into bonds instead. But if bonds pay a rate of two percent, then the trees get planted. So the lower interest rate induces an investment in long-lived trees and steepen the capital-goods pancake stack.

In a pure free market, the time structure is in economic harmony, because investment comes from savings. If more folks save, the banks lower the interest rate to lend out the extra money, and the greater investment from borrowed funds is offset by the lower consumption of those saving their income instead of spending for consumption.

But with central banking, such as with the Federal Reserve system, an injection of money has the temporary effect of greater savings. Banks lower the interest rate to lend out the extra money. But folks have not changed their intended consumption, so the new investment battles with planned consumption for resources, and prices go up.

The fundamental problem with central banking is that the optimal money supply and rate of interest are unknowable. Another problem is that despite the technical independence of central banks from the rest of the government, in practice when the economy is down, there is political pressure for central banks to stimulate the economy with money expansion.

The key problem is that the artificially lower rate of interest induces greater investment in the higher order capital goods such as real estate construction, and also associated goods such as wood for construction and durable goods such as furniture. The pancake stack has been made steeper, but that is not sustainable. Funds that would have gone to circulating capital instead get locked up and then wasted in excessive investment in higher-order capital goods such as real estate. We have seen in 2008 a glut of empty houses, some of which get looted.

The central bank later stops the great expansion of money in order to avoid too high inflation, but that then halts the real estate investments. Workers get laid off, the firms suffer losses, and the economy goes into recession.

The expansion caused by the injection of money feels economically good for a while, but it is like a drug that wears off, causes addiction, and ruins the health of the economic body. With the artificial rate of interest below the natural free-market rate, land speculators also borrow funds. Speculators buy real estate expecting the land value to rise. The economy gets a real estate bubble caused by money expansion and land-value subsidy. Public goods such as streets, transit, schooling, security, and various subsidies all make neighborhoods more productive and attractive. These benefits boost land rent and land values.

Site values capture much of the benefit from an economic expansion because the governmental works and services are paid for mostly from taxes on labor, enterprise, and trade. This is a huge implicit redistribution of wealth from workers and entrepreneurs to landowners. During an economic boom, the demand for land by overly optimistic speculators pulls up the prices of land beyond that warranted for current use. Those who actually want to use land for residences and business stop buying, which combines with higher interest rates and higher prices to reduce investment.

Investment drives the business cycle. As investment falls, the economy follows into recession. Land values fall, companies go bankrupt, unemployment rises, and property owners can’t or won’t pay their mortgage interest. With mounting losses, banks fail, and the value of speculative derivatives, based on land values that are now falling, collapse. The financial waterfall brings down insurance firms, banks, hedge funds, and brokerage firms which had bad investments and failed speculations.

With free banking, all this is avoided. The rate of interest is not distorted by injections of money from a central bank or government, but is set by the market for loanable funds. The supply of funds comes from savings, and the net demand (subtracting borrowing for consumption from savings) comes from those who seek funds for investment. The natural rate of interest is based on time preference, the general preference to have goods such as cars sooner rather than later. With free banking, the natural rate does not get distorted by the manipulations of a central bank.

If the United States shifted to free banking, the current supply of paper dollars, of Federal Reserve note currency, would be frozen. The future supply of money would come from the paper currency issued by private banks and from new coins. There could be a monetary role for government in minting coins: accepting metals from the public and making coins out of them.
The government could also convert its gold hoard into coins sold to the public.

If someone withdraws money from a bank’s ATM, the money would be inscribed with the name of the bank rather than that of the central bank. But anyone could go to the bank and get Federal Reserve notes in exchange for the notes of the central bank. Legal tender laws, which require us to accept federal money in payment of debts, and other laws that make government currency a monopoly, would be abolished. The Federal Reserve Bank would also cease to exist.

Businesses often need to borrow funds for a short while to finance their operations. The loans are paid back from the sale of goods. With free banking, firms could also pay for labor and supplies with bills of exchange. These would be tradeable IOU notes payable within 90 days. A firm that sells wood to a furniture maker could accept payment for the wood in bills of exchange, which it could then use to buy lumber, or it could deposit the bill in a bank. The furniture maker could obtain funds from a bank in order to pay wages, using a bill of exchange which the bank would discount, e.g. it would accept a one million dollar IOU in exchange for $990,000 in cash. Within 90 days, the furniture company would repay the bill of exchange with the cash it gets from the sales of the goods. Alternatively, the firm could issue commercial paper, very short term loans that get sold to money market funds, whose liquid funds also serve as money substitutes.

Reflux, the convertibility of money substitutes into real money, would prevent a bank from an excessive issuing of its notes. The supply of private bank notes would be limited by the demand by the public to hold them. The real money would be federal reserve notes in the hands of the public, and private bank notes and funds in accounts would be money substitutes, acting like money but always convertible into real money.

With free banking, there is no governmental restriction on branches. There is no governmental deposit insurance. There is no reserve requirement, the legal requirement to have some fraction of deposits held in cash. There are no legal limits to other businesses a bank can engage in, so that a bank could also offer insurance or a retail store could also offer banking. There would be no restrictions on interest rates. There would also be no explicit or implicit governmental loan guarantees, such as for the government-sponsored enterprise Fannie Mae. Any secondary market in mortgages or other loans would be purely private.

Also, in pure free banking, there would not be any taxes on interest income. Taxation, as well as the deductibility of mortgage interest payments from taxable income, distorts the incentives of savers and borrowers, which also shifts the rates of interest away from their natural rates. But if interest is tax free while wages and profits are taxed, that also distorts the natural interest rate as resources shift to tax-free sources of income.

To have a pure natural rate of interest, government has to also avoid subsidies, which distort resources towards the subsidy. In pure free banking, public revenue must be based on sources that would otherwise be subsidized, namely pollution charges and land value. The tapping of site values for public revenue prevents the subsidy of the higher rent and site value from governmental public works and services.

With free banking, the natural rate of interest would not be obliterated, since money supply would be set by the public’s demand to hold money rather than an artificial injection by a central bank. Money would not be a government monopoly, but would be provided by competing private banks. But there would be a common unit of account such as the U.S. dollar. The currencies of the banks would all be in the same dollar units and be accepted at stores and by all banks. Only the notes of the largest banks with good reputations would circulate widely, although it would also be possible for there to be local currencies from trusted issuers.
There would also be supplements and alternatives to banking, such as LETS, local exchange trading system, where users could trade with debits and credits to accounts.

Every historic economic boom, at least in the USA, has been accompanied with excessive credit creation, and every financial crisis and depression has been plagued with excessive credit constraints. Free banking avoids the credit bubble and thus also the credit collapse. But the complete elimination of the boom-bust sequence requires the elimination of land-value subsidies, since otherwise even market-based economic expansion would induce land speculation, as that would offer higher gains from leverage than the production of goods, and rising land values would induce derivatives.

Eventually, if most of the economies of the world practiced free banking, there would be a demand for a global currency, and the most likely candidate is gold, which was the global currency before World War I. With gold as the real money, the private bank notes as well as funds in accounts and also bills of exchange would be money substitutes. One could convert paper currency or account funds into gold coins on demand. A small amount of gold would back up the value of purchasing media, and most purchases would use electronic media, not physical gold.

In free banking, the banks and other financial institutions would join together in mutual aid organizations. If one bank ran out of gold or paper notes, it would be able to borrow from other banks. One would not need a central bank as a lender of last resort, since banks would be able to borrow from the mutual aid association.

The natural expansion of money with increasing wealth and population creates a gain called "seigniorage," the difference between the revenue and the cost of the expansion. With central banking, some of the gains go to the central bank, and the rest of the gains are shared by lenders and borrowers as the gains attract more funds that then lower the natural rate of interest. The private banks do not gain if the system is competitive, since any temporary profits would induce an increase supply of lenders that would drive the gain back down.

Some would-be reformers advocate that the government directly issue currency and gain from the seigniorage, but that would involve the problems of knowledge and incentive. There would be a political incentive to issue too much currency, causing price inflation. There is also the inevitable knowledge problem: there is no way for a monetary authority to know the optimal money supply and interest rate. So any creation of money by a government as a monopoly would distort the interest rate and create instability and waste.

Free banking is not just hypothetical, as it had been practiced in many economies prior to the Great Depression. One well-researched example is the free banking practiced in Scotland until 1844, when the Bank of England took over, described in the book Free Banking in Britain, by Lawrence White. Books explaining free banking include George Selgin’s The Theory of Free Banking and Free Banking by Larry Sechrest.

Land-value taxation alone would greatly reduce but not eliminate the business cycle, since the manipulation of lower interest rates by central banks would still induce excessive real estate construction and purchase, and the interest rate would not be allowed to do its job of harmonizing investment and consumption. But without public revenue from land rent, pure free banking is impossible, since taxes and land-value subsidies would distort interest rates. We therefore need to solve both the money and the land problems. The solution is free banking combined with public revenue from land rent.

Why the Crash of 2008 is not a Market Failure

Why the Crash of 2008 was not a Market Failure

by Fred E. Foldvary

All national economies today are mixed economies, a combination of markets and governmental intervention. In a pure market economy, all activity is voluntary, with no restriction on peaceful and honest human action. A governmental intervention changes what people would otherwise voluntarily do. Government policy can be either market enhancing, such as by penalizing theft, or market hampering, such as by taxing human action.

For any outcome such as a recession, we need to carefully analyze whether the cause is the market or whether it is intervention. Yet nowadays there is a chorus of politicians, journalists, and even economists who have leaped to the conclusion that the Crash of 2008 was a market failure. They say there was too little regulation, and that the lesson from the global financial crisis is that government needs to closely supervise the economy and correct market failures.
Such conclusions are made with no economic analysis. Blaming deregulation ignores the heavy hand of governmental institutions such as the Federal Reserve, the Securities and Exchange Commission, Fannie Mae and Freddie Mac, and the FDIC. More importantly, the focus on regulation is too narrow. The broader issue is intervention, which includes taxation and subsidies along with regulation.

First of all, the USA as well as all major countries practice state socialism and central planning with their central banks issuing and controlling the money supply and manipulating interest rates. Secondly, all countries tax and subsidize human action. Third, all governments restrict trade.

A tax on voluntary activity restricts human action. We would not really have free speech if one had to pay a tax when one gave a speech. When government imposes a cost on human action, there is less of it, by the law of demand, by which higher costs reduce activity. A subsidy is a negative tax, and also distorts outcomes, since with a lower price, those who value the activity at less than the real cost do it, which reduces the amount of higher-valued goods.

There is what is called the “first fundamental theorem of welfare economics,” which states that a pure free market maximizes economic efficiency. The second fundamental theorem states that an efficient allocation can be achieved by the equilibrium of a free market. The theorems are framed with specific conditions about competition, but the concept applies generally. A pure free market maximizes productivity, and no intervention can improve the outcome.

Most economists ignore these fundamental theorems, because they think these only apply to so-called “perfect competition,” to many tiny firms producing an identical product. But the reason markets maximize well being goes way beyond these fundamental theorems. Only free markets can perform the economic calculations needed to maximize productivity and avoid economic waste.

Prices are not just what people pay for stuff. Prices, including wages and interest rates, have a vital job to do in an economy. Human desires are unlimited, but many resources are scarce. A market price effectively adjusts desire to scarcity. It is the job of the interest rate to equalize savings and borrowing, and thus also net savings and investment. The natural rate of interest ensures that all income is allocated to consumption and investment. The market wage ensures that all who seek work become employed. Market prices prevent shortages and surpluses. Market-based profits signal that more of the profitable stuff be made and that losing products and enterprises cease to exist.

Entrepreneurs drive the economy, bringing new products and methods to the market. Tax them, and we get too little innovation, risk taking, and growth. Subsidize entrepreneurs and speculators, and we get too much risk and a misallocation towards goods of lower social value. Any arbitrary restriction, not to prevent force and fraud, distorts well being by preventing folks from getting what they want and, more importantly, because the chiefs of government lack the knowledge of how to run an economy, and their incentive is to please those who finance their power.

Contrary to critics who think that markets are inherently unstable, it is the interventions that cause the economic roller coaster. Every recession is caused by the previous boom, and every economic boom has been accelerated by government subsidies. Artificially low interest rates, expansionary policies, and guarantees for loans and deposits, all pull resources into unsustainable speculative bubbles.

The biggest governmental distortion is the implicit subsidy to land value. These are generated by special tax deductions and exemptions for real estate, by loan guarantees, by the subsidized secondary market for mortgages bought and securitized by Fannie Mae and Freddie Mac, by regulations pushing risky loans for low-income buyers, by allowing deception or negligence in bond ratings, and the moral hazard of encouraging risk with bailouts.

Those interventions, however, are swamped by the colossal subsidy to land value of governmental works. Highways, streets, parks, security, schooling, and all the other government services and subsidies all increase the demand for the lands serviced by these works. If landowners directly paid for these, the payments would capitalize land values back down. But since taxes are almost all on labor, business profits, goods, and trade, worker-tenants get double billed, paying both taxes and higher rents, while landowners get subsidized.

Land values capture much of the gain from economic expansion, and then rising land values induce speculation that adds to the demand and pushes land values to such a high level that those who want to buy land to use it get squeezed out. Land values then stop rising, and the previous construction becomes a “malinvestment,” vacant properties.

We have seen land values plunge, and since most of that value is mortgaged, the real estate crash brings down the whole financial system. The securitized mortgages and derivatives on these loans collapse, creating colossal losses for banks and other financial firms. With loan assets wiped out, banks stop lending, and enterprises dependent on credit fail and employees lose their jobs. That became the situation in 2008.

The key intervention is the land-value subsidy, which makes land value capture the economic expansion, which then attracts the speculators and fools the builders into thinking they can profit from construction as the land appreciates. Warnings of a real estate bubble go unheeded as these actors get blinded by the huge profits and bonuses, and the chiefs forget their fiduciary duty to their shareholders, as with their golden parachutes they can jump off the nose-diving firms. There is indeed massive corruption and greed, and regulations should penalize negligence and fraud, but the greed was stimulated by the land-value subsidy.

Yet both critics and defenders of markets ignore the role of the land-value subsidy. Often this is willful ignorance and deliberate rejection. Conventional economics ignores land and the capitalization of public works into site values -- you will not find this in any commercial economics textbook. Moreover, both pro-market and anti-market think tanks that supposedly educate the public institutes are funded by landed interests, so their publications have to reject any article that hints at the land-value subsidy.

The landed interests -- big landowners, real estate firms, developers, oil companies, and the financial firms that service them -- not only fund political campaigns, but they have also corrupted economic thought, blinded all the free-market institutes to the role of land, and promoted the statist bias against markets. Any bad outcome such as recession, unemployment, poverty, and pollution is ascribed to market failure, and government is always cheered on as the benevolent and competent fixer. The landed interests promote statism because that enhances their land subsidy.

The 2008 bailouts and government takeovers of banks, bad loans, insurance firms, Fannie and Freddie, and the massive injection of funds into the financial system all have one overriding goal: to maintain the subsidy to land values. If the goal instead was to stop the economic collapse, it would be more effective, simpler, debt-free, and less interventionist to just give every person several thousand dollars in currency. Economies are crashing because of credit constraints, and cash is the ultimate credit.

Statist doctrines misled economists and government chiefs to blame the Great Depression of the 1930s on markets instead of interventions. The US government responded by ending the gold-money standard, greatly increasing regulation, and creating institutions such as Fannie Mae to subsidize mortgages. These governmental institutions, guarantees, and subsidies all failed to prevent the Crash of 2008, and the Federal Reserve also failed to prevent it. Yet instead of concluding that regulation has failed, people say that the market has failed. But nobody has explained how something that does not exist -- a pure free market -- can possibly cause anything.

Money to the People!

by Fred E. Foldvary

As this article is being written on Sunday morning, Sept. 28, 2008, Congress will soon pass the $700 billion bad-mortgage bailout requested by the executive branch. With a majority that includes both of the establishment political parties, the bailout will not become a partisan issue. Congress and the administration sought to finish an agreement before the Asian financial markets opened on Monday, as a crash there would again infect the US.

The purchase of mortgages by the government-sponsored enterprises, Fannie Mae and Freddie Mac, and their packaging and sale to financial firms, was supposed to provide safety via diversification, but when the whole real estate market crashes and many mortgages go into default, the slicing and packaging of bad mortgages instead becomes a financial waterfall.
With a real estate crash, financial insurance also fails. One type of debt insurance is called “credit default swaps.” Insurance companies, hedge funds, and others sold insurance for defaults, but did not have sufficient funds to back up that insurance against large losses. When the losses occurred, the firms collapsed.

American voters and taxpayers are angry about this biggest bailout in world history. Somebody who pays much of his income to a mortgage is justified in being outraged at the prospect of the government bailing out irresponsible financial companies while they struggle to make the payments. In response, Congress modified the proposal so that the government will obtain stock warrants, giving the federal government a share of the gains when the stock prices of the firms rise. There will also be an oversight board to supervise the program and some help for homeowners.

It is not clear whether there would be a financial catastrophe if the bailout were not passed. Credit is still available; millions of people are still using their credit cards. Businesses are still getting loans. However, it is true that many firms can’t obtain funds except at quite high risk premiums, or not at all. The credit markets are somewhat stuck, but maybe that is because lenders are waiting for the government to act.

Any plan that bails out banks and mortgages is going to favor some at the expense of others. Many who have been dutifully paying their mortgage payments, or fully own their homes, will not get any aid. If there is a major liquidity problem, and if government has to step in to prevent financial chaos, the egalitarian solution would be to provide money to everyone equally. Money to the people!

The US Treasury Department would print $1000 bills and give each American national (citizen or permanent resident) 6 of those bills, so $6000 in currency to each person. With 300 million Americans, the total would be $1.8 trillion. The egalitarian bailout would avoid more government debt, as it would be paid for by printing money rather than borrowing.

Everybody would report to their local post office and get six crisp $1000 bills after recording their names and IDs. Most folks would then deposit the funds into their bank accounts, and poof, the banks now have more money to lend out. People would use the funds to pay debts, buy stuff, and possibly invest in stocks. The stock markets would zoom up, and we would not be rewarding irresponsible financial chiefs.

Of course this would be inflationary, but that would have a benefit of reducing the real value of all debt denominated in US dollars. Lenders would lose some of the purchasing power of the loan payments they receive, but that is better than defaults.

It would require several weeks to set up the egalitarian bailout, as the government would need a data base of all US nationals, and it would take a few weeks to design and print the currency. But the anticipation of everyone getting $6000 could itself already unfreeze the credit markets.
However, this will not happen, as the mortgage bailout seems imminent. Once again, the real estate interests and their financial symbiants will get rescued from the folly of ignoring the inevitable real estate cycle. The real estate cycle is caused by government and gets rescued by government. This indicates the real purpose of government: to protect and subsidize the landed interests, including lenders who use land as collateral. Since land values periodically crash, the real interests need to be bailed out if they are to keep being protected. Meanwhile, worker-tenants pay not only taxes but higher rents to the landed royalty.

A government of the people rather than of the landed royalty would require either anarchism, so that all state subsidies to landed interests cease, or else the public collection of all the economic rent, and its equal distribution to the people as cash or as civic services. That rent would replace all punitive taxation, would eliminate recessions and depressions and poverty, and would remove the suffocation of enterprise now taking place. But the very system of land royalty also controls education, so few will learn the right lesson from the great real estate crash of 2008.

Gold, Interest, and Land
by Fred E. Foldvary,

Three seemingly unrelated variables are in fact deeply connected. Gold has been the most widely used money, and in a pure free market, gold would most likely come back as the real money. Free-market banking would mostly use money substitutes such as bank notes and bank deposits, but these could be exchanged for gold at a fixed rate. Free banking would combine price stability with money flexibility.

Interest is ultimately based on time preference, the tendency of most people to prefer present-day goods to future goods, due to our limited lifespan and the uncertainty of the future. In a free market, the rate of pure interest would be based on the interplay of savings and borrowing. Interest is not just income and payment, but has a vital job in the market economy. The job of the interest is to equilibrate or make equal the amounts of savings and borrowing. This also equalizes net savings (subtracting borrowing for consumption) and investment. Investment comes from savings, and the job of the interest rate is to make sure that net savings is invested.

Economic land, meaning all natural resources, is related to interest, since land is usually bought with borrowed funds. The buildings and other capital goods in land are also often produced using borrowed funds. Thus the vital connection is credit. Developers borrow money at some rate of interest to buy land and construct buildings, and then households borrow to buy the real estate. With equity finance, such as with partnerships and shares of stock, the rate of return on the assets are related to the rate of interest. The interest rate also capitalizes rent into land value, as the price of land rises as interest rates fall.

In a pure free market, gold, interest, and land are in harmony. The pure market interest rate is set by the equilibrium of savings and borrowing. Income not saved is used for consumption, and savings goes to investment, so all income is spent. Landowners pay for territorial services such as streets, parks, and security, and with no subsidy, there is no excessive land buying and construction, and no holding of land out of use in anticipation of future subsidies.

In a pure free market, there is no real estate boom-bust, and no business cycle. There is full employment, because workers keep their full wage, and the cost of labor is not artificially increased by taxation and restrictions. There is no credit crisis, because with no subsidies, land prices would be very low, and borrowing would be for capital goods and enterprise, not for land.

In today’s economy, we use fiat money, not based on any commodity. Money is centrally planned by the monetary authority. Since the correct money supply is unknowable and can only be determined by a pure free market, the central bankers will often create instability in their attempt to either stimulate or “cool off” an economy. The interest rate is unable to do its job, since it is manipulated by the changing money supply, and inflation masks the real interest rate. Markets cannot properly conduct economic calculation, because the observed interest rate involves both inflation and the artificial rates targeted by the central banks.

In today’s economy, land values are grossly inflated by subsidies, mostly implicit. Low interest rates caused by money expansion promotes real estate construction and purchasing, inflating land values. Not only do landowners get the implicit subsidy of services paid for by taxing workers and business, but real estate gets special tax breaks: tax deductions for interest and property taxes, capital gains exemptions and postponements, multiple depreciations, and low capital gains taxes. Housing guarantees and government-sponsored secondary mortgage markets further puff up land values.

Fiat money rather than gold; manipulation and inflation rather than the natural interest rate; and land-value subsidies, all skew and distort prices and profits. An unsustainable land boom financed by artificial credit has to collapse, and the financial crash then further brings down the economy.

And then politicians, commentators, and even economists blame the non-existent free market. Why are they blind to the interventions? There is a cult called “statism” that most people suffer from. Curing it is almost impossible, since the state also controls education. Even when statists are given the explanation, they don’t believe it. Logic and evidence cannot penetrate a deeply held bias. Perhaps the remedy will be the creation of new countries on floating platforms in the ocean, islands of economic sanity in a world of economic madness.