Monday, October 13, 2008

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.