Policy Institutes

Cato Institute Scholars Respond to Obama’s Final State of the Union Address

Cato Institute scholars Emma Ashford‎, Trevor Burrus‎, Benjamin Friedman‎, Dan Ikenson,‎ Neal McCluskey‎, Pat Michaels‎, Aaron Powell‎, and Julian Sanchez‎ respond to President Obama’s final State of the Union Address.

Video produced by Caleb O. Brown, Tess Terrible and Cory Cooper.

Presidential candidate Hillary Clinton is proposing to increase taxes on high earners with a four percent surtax on people making more than $5 million.

Imposing such a tax hike would:

  • Encourage more tax avoidance and evasion, the sort of behaviors that Clinton and other politicians bemoan.
  • Increase deadweight losses, or economic damage, of taxation. This damage rises by the square of the tax rate, so for example, a 40 percent rate causes four times the damage of a 20 percent rate. This feature of our tax system means that raising the top rate is the worst way to raise revenue, even if raising more revenue made sense, which it does not.
  • Discourage the work and investment efforts of the most productive people in the economy. Entrepreneurs, executives, angel investors, venture capitalists, and other high earners add enormous value to the economy. Politicians should focus on removing barriers to their efforts, rather than penalizing them. Besides, the income of high earners is more flexible and mobile than the income of other people, so raising their taxes causes the strongest behavioral responses and largest deadweight losses.
  • Raise taxes on the people already paying the highest rates. Average tax rates rise rapidly as income rises. In 2015 those earning more than $1 million paid an average federal tax rate (including income, payroll, and excise taxes) of 33 percent. That is twice the rate of people with middling incomes, and many times the rate of people at the bottom.
  • Push the top U.S. income tax rate substantially higher than our trading partners in the OECD (Table 1.7). The top U.S. federal and average state tax rate is already 46 percent, which compares to the OECD average of 43 percent.
  • Move even further away from the fair and efficient ideal of a proportional, or flat, tax system. The United States already has the most graduated, or progressive, tax system in the OECD.

Perhaps the biggest problem with Clinton’s plan is that the federal government already taxes and spends too much. The American economy and average citizens would be better off if the size and scope of the government were reduced. Clinton’s tax increase would not solve any problems, but rather would add fuel to the fire of rampant bureaucratic failure in Washington.

Last week, the World Bank updated its commodity database, which tracks the price of commodities going back to 1960. Over the last 55 years, the world’s population has increased by 143 percent. Over the same time period, real average annual per capita income in the world rose by 163 percent. What happened to the price of commodities?

Out of the 15 indexes measured by the World Bank, 10 fell below their 1960 levels. The indexes that experienced absolute decline included the entire non-energy commodity group (-20 percent), agricultural index (-26 percent), beverages (-32 percent), food (-22 percent), oils and minerals (-32 percent), grains or cereals (-32 percent), raw materials (-32 percent), “other” raw materials (-56 percent), metals and minerals (-4 percent) and base metals (-3 percent).

Five indexes rose in price between 1960 and 2015.  However, only two indexes, energy and precious metals, increased more than income, appreciating 451 percent and 402 percent respectively. Three indexes increased less than income. They included “other” food (7 percent), timber (7 percent) and fertilizers (38 percent).

Taken together, commodities rose by 43 percent. If energy and precious metals are excluded, they declined by 16 percent. Assuming that an average inhabitant of the world spent exactly the same fraction of her income on the World Bank’s list of commodities in 1960 and in 2015, she would be better off under either scenario, since her income rose by 163 percent over the same time period.

This course of events was predicted by the contrarian economist Julian Simon some 35 years ago. In The Ultimate Resource, Simon noted that humans are intelligent animals, who innovate their way out of scarcity. In some cases, we have become more parsimonious in using natural resources. An aluminum can, for example, weighed about 3 ounces in 1959. Today, it weighs less than half an ounce. In other cases, we have replaced scarce resources with others. Instead of killing whales for lamp oil, for instance, we burn coal, oil and gas.

I will have a paper on this subject soon. In the meantime, please visit www.humanprogress.org.

(P.S.: This post appeared originally here.)

1. Cheaper oil lowers the cost of transporting people and products (including exports), and also the cost of producing energy-intensive goods and services.

For the seventh week in a row, the average price of a gallon of diesel declines, to $2.235 https://t.co/X3Zaq52YSO pic.twitter.com/vYMStMZ2mj

— St. Louis Fed (@stlouisfed) January 2, 2016  

2. Every upward spike in oil prices has been followed by recession, while sustained periods of low oil prices have been associated with relatively brisk growth of the U.S. economy (real GDP).

   

3. Far from being a grave danger (as news reports have frequently speculated), lower inflation since 2013 has significantly increased real wages and real consumer spending.

 

4. Cheaper energy helps explain why the domestic U.S. economy (less trade & inventories) has lately been growing faster than 3% despite the unsettling Obama tax shock of 2013.

   

Why do I keep harping on interest on reserves? Because, IMHO, the Fed’s decision to start paying interest on reserves contributed at least as much as the failure of Lehman Brothers or any previous event did to the liquidity crunch of 2008:Q4, which led to a deepening of the recession that had begun in December 2007.

That the liquidity crunch marked a turning point in the crisis is itself generally accepted. Bernanke himself (The Courage to Act, pp. 399ff.) thinks so, comparing the crunch to the monetary collapse of the early 1930s, while stating that the chief difference between them is that the more recent one involved, not a withdrawal of retail funding by panicking depositors, but the “freezing up” of short-term, wholesale bank funding. Between late 2006 and late 2008, Bernanke observes, such funding fell from $5.6 trillion to $4.5 trillion (p. 403). That banks altogether ceased lending to one another was, he notes, especially significant (p. 405). The decline in lending on the federal funds market alone accounted for about one-eighth of the overall decline in wholesale funding.

For Bernanke, the collapse of interbank lending was proof of a general loss of confidence in the banking system following Lehman Bothers’ failure. That same loss of confidence was still more apparent in the pronounced post-Lehman increase in the TED spread:

The skyrocketing cost of unsecured bank-to-bank loans mirrored the course of the crisis. Usually, a bank borrowing from another bank will pay only a little more (between a fifth and a half of a percentage point) than the U.S. government, the safest of all borrowers, has to pay on short-term Treasury securities. The spread between the interest rate on short-term bank-to-bank lending and the interest rate on comparable Treasury securities (known as the TED spread) remained in the normal range until the summer of 2007, showing that general confidence in banks remained strong despite the bad news about subprime mortgages. However, the spread jumped to nearly 2-1/2 percentage points in mid-August 2007 as the first signs of panic roiled financial markets. It soared again in March (corresponding to the Bear Stearns rescue), declined modestly over the summer, then showed up when Lehman failed, topping out at more than 4-1/2 percentage points in mid-October 2008 (pp. 404-5).

These developments, Bernanke continues, “had direct consequences for Main Street America. … During the last four months of 2008, 2.4 million jobs disappeared, and, during the first half of 2009, an additional 3.8 million were lost.” (406-7)

There you have it, straight from the horse’s mouth: the fourth-quarter, 2008 contraction in wholesale funding, as reflected in the collapse of interbank lending, led to the loss of at least 6.2 million jobs.

But was the collapse of interbank lending really evidence of a panic, brought on by Lehman’s bankruptcy? The timing of that collapse, as indicated in the following graph, tells a much different story.

The first of the three vertical lines is for September 15, 2008, when Lehrman went belly-up. Interbank lending on the next reporting date — September 17th — was actually up from the previous week. Thereafter it declined a bit, and then rose some. But these variations weren’t all that unusual. As for the TED spread, although it rose sharply after Lehman’s failure, the rise reflected, not an actual increase in the effective federal funds rate (as the “panic” scenario would suggest), but the fact that that rate, though it actually declined rapidly, did not do so quite as rapidly as the Treasury Bill rate did:

OK, now on to those other vertical lines. They show the dates on which banks first began receiving interest payments on their excess reserves. There are two lines because back then two different sets of banks had different “reserve maintenance periods,” and therefore started getting paid at different dates. (The maintenance periods have since been made uniform.) Those (mostly smaller) banks with one-week reserve maintenance periods began earning interest on October 15th; the rest, with two-week maintenance periods, started getting paid on October 22nd. The collapse in interbank payments volume coincides with the latter date. Notice also that the collapse continues after the TED spread has returned to a level not so different from its levels before Lehman failed.

If you still aren’t convinced that IOR was the main factor behind the collapse in interbank lending, perhaps some more graphs will help. The first shows the progress of interbank lending over a somewhat longer period, along with the 3-month Treasury Bill rate and (starting in October 2008) the interest rate on excess reserves:

To understand this graph, think of the banks’ opportunity cost of holding excess reserves as being equal to the difference between the Treasury Bill rate and the rate of interest on excess reserves. Prior to October 15th, 2008, the opportunity cost, being simply equal to the Treasury Bill rate itself, is necessarily positive. But when IOR is first introduced, it becomes practically zero; and shortly thereafter it becomes, and remains, negative. Mere inspection of the chart should suffice to show that the volume of interbank lending tends to vary directly with this opportunity cost.

Once the interest rate on excess reserves is fixed at 25 basis points after mid-December 2008, things get simpler, as the volume of interbank lending varies directly with the Treasury Bill rate. Here is a chart showing that period, with the opportunity cost itself (that is, the Treasury Bill rate minus 25 basis points) plotted along with the volume of interbank lending:

Now, it would be one thing if Bernanke were merely guilty of misunderstanding the cause of the decline in interbank lending, without having actually been responsible for that decline. But Bernanke was responsible, as was the rest of the Fed gang that took part in the misguided decision to start rewarding banks for holding excess reserves in the middle of a financial crisis.

What’s more, it is hard to see how Bernanke can insist that the Fed’s decision to pay IOR had nothing to do with the drying-up of the federal funds market given the justification he himself offers for that decision earlier in his memoir, which bears quoting once again, this time with emphasis added:

[W]e had been selling Treasury securities we owned to offset the effect of our lending on reserves… . But as our lending increased, that stopgap measure would at some point no longer be possible because we would run out of Treasuries to sell….The ability to pay interest on reserves…would help solve this problem. Banks would have no incentive to lend to each other at an interest rate much below the rate they could earn, risk-free, on their reserves at the Fed (p. 325).

Yet when he turns to explain the causes of the collapse in interbank lending, just eighty pages after this passage, Bernanke never mentions interest on reserves. Instead, he blames the collapse on panicking private-market lenders, while treating the Fed — and, by implication, himself — as a White Knight, galloping to the rescue. “As the government’s policy response took effect,” he writes, “the TED spread declined toward normal levels by mid-2009” (p. 405). What rubbish. We’ve already seen why the TED spread went up and then declined again. And although interbank lending itself revived somewhat during the first half of 2009, it declined steadily thereafter, ultimately falling to lower levels than ever.

And the Fed’s “policy response”? According to Bernanke, it had “four main elements: lower interest rates to support the economy, emergency liquidity lending…and the stress-test disclosures of banks’ conditions” (409). Let Kevin Dowd tell you about those idiotic stress tests. As for “lower interest rates,” they were proof, not that the Fed was taking desirable steps, but that it was failing to do so, for although the Fed did get around to reducing its federal funds rate target, its doing so was a mere charade: the equilibrium federal funds rate had long since fallen well below the Fed’s target, and the subsequent moves merely amounted to a belated recognition of that fact, without making any other difference. Finally, although the Fed’s emergency lending aided the loans’ immediate recipients, as well as their creditors, it contributed not a jot to overall liquidity, the very point of IOR having been — as Bernanke himself admits, and as I explained in my first post on this topic — to prevent it from doing so!

As the next chart shows, IOR, besides contributing to the collapse of interbank lending, also played an important part in the dramatic increase in the banking system reserve ratio. The vertical lines represent the same three dates as those referred to in the very first chart. Although the ratio did rise considerably following Lehmans’ failure, it rose even more dramatically — and, quite unlike the TED spread, never recovered again — after the Fed started paying interest on excess reserves:

To better understand what went on, here is another diagram, this one showing banks’ choice of optimal reserve and liquid asset ratios as a function of the interest paid on bank reserves:

In the diagram, the vertical axis represents the interest rate on reserve balances, in basis points, while the horizontal axis represents the reserve-deposit ratio. The picture shows two upward-sloping schedules. The first is for reserve balances at the Fed, while the second is for liquid assets more generally, here meaning (for simplicity’s sake) reserves plus T-bills. The horizontal line shows the yield on T-bills at the time of implementation of IOR, here assumed to be a constant 20 basis points. The two dots, finally, represent equilibrium ratios, the first (at the lower left) for before the crisis and IOR, the other for afterwards. Note that, the high post-IOR ratio reflects, not just the interest-sensitivity of reserve demand, but that, with IOR set at 25 basis points, reserves dominate T-bills. Thus, although the demand for excess reserves may not be all that interest sensitive so long as the administered interest rate on reserves is less than the rate earned by other liquid assets, that demand can jump considerably if that rate is set above rates on liquid and safe securities.

The last chart I’ll trouble you with today tracks changes in total commercial bank reserves, interbank loans, Treasury and agency securities, and commercial and industrial loans, from mid-2006 through mid-2009, this time with a single vertical line only, for October 22, 2008, when IOR was in full effect:

The chart shows clearly how the beginning of IOR coincided, not only with a substantial decline in interbank lending (green line), but in a leveling-off of other sorts of bank lending, which later becomes a pronounced decline. For illustration’s sake, the chart shows the course of C & I lending only; other sorts of bank lending fell off even more.

Don’t get the wrong idea: I don’t wish to suggest that IOR was responsible for the post-2008 decline in bank lending, apart from overnight lending to other banks. There’s little doubt that that decline mainly reflects the effects of both a declining demand for credit and much stricter regulation of bank lending, especially as Dodd-Frank and Basel III came into play, Nor do I believe that merely eliminating IOR, as opposed to either reducing the regulatory burdens on bank lending, or resorting to negative IOR (as some European central banks have done), or both, would have sufficed to encourage any substantial increase in bank balance sheets, and especially in bank lending, after 2009, when most estimates (including the Fed’s own) have “natural” interest rates sliding into negative territory. But as I noted in my first post in this series, when IOR was first introduced, natural rates were, according to these same estimates, still positive. And one thing IOR certainly did do, both before 2009 and afterwards, was to allow banks, and some banks more than others, to treat trillions in new reserves created by the Fed starting in October 2008, not as an inducement to expand their balance sheets, but as a direct source of risk- and effort-free income. (Note, by the way, how, just before IOR was introduced, but after the Fed stopped sterilizing its emergency loans, bank loans and security holdings did in fact increase along with reserves.)

Moreover, it’s evident that the FOMC itself, rightly or wrongly, sees IOR as continuing to play a crucial part in limiting banks’ willingness to expand credit. Otherwise, how can one possibly understand that bodies’ decision last month to raise the rate of IOR (and, with it, the upper bound of its federal funds rate target range) from 25 to 50 basis points? That decision, recall, was aimed at making sure that bank credit expansion would not progress to the point of causing inflation to exceed the Fed’s 2 percent target:

The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent. The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

Bernanke’s implementation and defense of IOR would be more than bad enough, were it not also for his particular determination to avoid repeating the mistakes the Fed made during the Great Depression. “[M]ost of my colleagues and I were determined,” he says, “not to repeat the blunder the Federal Reserve had committed in the 1930s when it refused to deploy its monetary tools to avoid a sharp deflation that substantially worsened the Great Depression” (p. 409). Among the Fed’s more notorious errors during that calamity were its failure to expand its balance sheet sufficiently, through open-market purchases or otherwise, to offset the dramatic, panic-driven collapse in the money multiplier during the early 1930s, and its recovery-scuttling decision to double reserve requirements in 1936-7.

Of course, Bernanke’s Fed didn’t commit the very same mistakes committed by the Fed of the 1930s. But, as David Beckworth had already recognized by late October 29, 2008, it made remarkably similar ones that also resulted in a collapse of credit. “History,” Bernanke credits Mark Twain with saying, “does not repeat itself, but it rhymes” (p. 400). If you ask me, Bernanke himself was a far better versifier — and a far worse central banker — than he and his many champions realize.

[Cross-posted from Alt-M.org]

In an interview with the New York Times editorial board, Donald Trump said that he would impose a 45% tariff on all goods from China.  That is, to put it mildly, a really bad idea, and a number of commentators have already taken it to task. 

I’d like to focus on what Donald Trump said immediately after he proposed a 45% tax on Americans who buy things that were made in China.  According to the New York Times:

Mr. Trump added that he’s “a free trader,” but that “it’s got to be reasonably fair.”

Unfortunately, Trump is far from the first politician to adopt the “free but fair trade” line.  Many of the other candidates vying for the Republican nomination for President in 2016 have employed the trope in some form this election cycle. (See, for example, Mike Huckabee, Rick Santorum, Bobby Jindal, Carly Fiorina, Jeb Bush, Marco Rubio.)  Some of these candidates, like Trump, are economic nationalists who openly advocate mercantilist economic policy. 

Many of the others are merely politicians.  They probably believe in the value of free trade, but when departing from that principle is politically expedient, they need some way to defend themselves.  Vague appeals to “fairness” are uniquely well-suited to that task.

The alternative to free trade is not “fair trade.”  The choice is between free trade and protectionism.  If you think a small amount of protectionism is good, then you do not support free trade.  This is important because the economic case for free trade is a case for free trade, not partially free trade or mostly free trade. 

Tariffs, quotas, and subsidies are bad economic policy in each instance.  Some trade barriers are more harmful than others, but there is not a correct quantum of protectionism you can support while still being a “free trader.”

Perhaps it’s a good thing that even when espousing protectionism, political candidates feel the need to proclaim their support for economic liberty.  Still, it would be better if their hypocrisy were called to task more often.

Today, the Supreme Court heard oral argument in Friedrichs v. California Teachers Association, a challenge to public-sector unions’ ability to extract forced dues from non-members. As my colleague Ilya Shapiro writes, and Ian Millheiser at Think Progress agrees, the Court seems poised to strike down “fair share” fees for public-sector workers who do not want to join the union. This would essentially mean that “right to work” would be constitutionally mandated for public-sector workers.

Such a ruling would correct a 40-year-old mistake the Court made in Abood v. Detroit Board of Education. There, the Court ruled that public-sector union dues can be meaningfully separated into the “political” and the “non-political,” and that, while the First Amendment forbids forcing people to support political causes with which they disagree, public-sector unions can extract a “fair share” fee for non-political purposes.

From the very beginning, this distinction was under attack. As Justice Lewis Powell wrote in concurrence in Abood:

Collective bargaining in the public sector is “political” in any meaningful sense of the word. This is most obvious when public-sector bargaining extends … to such matters of public policy as the educational philosophy that will inform the high school curriculum. But it is also true when public-sector bargaining focuses on such “bread and butter” issues as wages, hours, vacations, and pensions.

In other words, public-sector unions are just another political special interest that seeks favors from the government, and what they can’t get at the ballot box they’ll get at the bargaining table.

Yet, if public-sector unions are just another special interest group, then why does the government give them the extraordinary privilege of extracting dues from non-members? Parents don’t get this privilege. Trade associations don’t get this privilege. Non-profits don’t get this privilege. In fact, unions are the only special interest group in American society that gets this privilege.

The primary argument in favor of forced agency fees is the “free rider” argument–namely, that those who don’t contribute to the union will be allowed to free ride on those who do. But, as pro-union Professor Clyde Summers once pointed out, this is essentially what happens in all types of private associations:

Why is it not applicable to a wide range of private associations? If a community association engages in a clean-up campaign or opposes encroachments by industrial development, no one suggests that all residents or property owners who benefit be required to contribute. If a parent-teacher association raises money for the school library, assessments are not levied on all parents. If an association of university professors has as a major function bringing pressure on universities to observe standards of tenure and academic freedom, most professors would consider it an outrage to be required to join. If a medical association lobbies against regulation of fees, not all doctors who share in the benefits share in the costs.

The government-thumb-on-the-scale, forced-dues privilege that unions enjoy should give us pause. It seems positively un-democratic for the government to grant such an extraordinary privilege to one group, or possibly just un-republican.

The Guarantee Clause, or the “Republican Form of Government Clause,” can be found in Article IV, Section 3 of the Constitution. It reads: “The United States shall guarantee to every State in this Union a Republican Form of Government…” Writing in the Heritage Guide to the Constitution, Rob Natelson, one of the foremost originalist scholars, writes that a “Republican Form of Government” means three things: 1) “popular rule, broadly understood,” 2) no monarch, and 3) the rule of law.

In practice, the Guarantee Clause is one of those constitutional clauses that is so vague it is rendered essentially unenforceable. On top of this, the Supreme Court, in one of its most interesting cases, ruled that the clause is not justiciable by the courts and is therefore only a political question for Congress. That case, Luther v. Borden, concerned the Dorr Rebellion, a virtual coup in 1840s Rhode Island (really).

So my comments here should be read in light of the fact that the Guarantee Clause is severely under-theorized. Yet, it seems not absurd to argue that, if “republican form of government” means anything, it means that the government cannot privilege one interest group over another. This would broadly accord with Natelson’s concept of “popular rule, broadly understood.”

The Guarantee Clause is mostly dormant. It was recently revived, however, by teachers unions and other organizations seeking to overturn Colorado’s Taxpayer Bill of Rights (TABOR). Kerr v. Hickenlooper, in which Cato has filed two briefs, is a challenge to Colorado’s method of raising taxes only through popular approval by the people. By removing tax hikes from representatives, the argument goes, it is no longer a “republican” form of government.

This seems like a stretch, but so is any argument based on the Guarantee Clause. If the Supreme Court preserves forced agency fees for public-sector unions, however, it may be worth looking into whether a Guarantee Clause argument might be made.

The U.S. is allied with every major industrialized power on the planet. America’s friends in Asia and Europe generally are prosperous and populous. Yet decades after the conflicts which led to Washington’s security guarantees for them, the allied gaggle remains a bunch of “losers,” to paraphrase Donald Trump.

Last week North Korea staged its fourth nuclear test. Naturally, South Korea and Japan reacted in horror. But it was America which acted.

The U.S. sent a Guam-based B-52 wandering across South Korean skies. “This was a demonstration of the ironclad U.S. commitment to our allies in South Korea, in Japan, and to the defense of the American homeland,” opined Adm. Harry B. Harris, Jr., head of Pacific Command.

Unfortunately, the message might not work as intended. CNN’s Will Ripley reported from Pyongyang that “A lot of North Korean military commanders find U.S. bombers especially threatening, given the destruction here in Pyongyang during the Korean War, when much of the city was flattened.” Which sounds like giving the North another justification for building nuclear weapons.

Worse, though, reported Reuters: “The United States and its ally South Korea are in talks toward sending further strategic U.S assets to the Korean peninsula.” Weapons being considered include an aircraft carrier, B-2 bombers, F-22 stealth fighters, and submarines.

A better response would be for Seoul to announce a major military build-up. The Republic of Korea should boost its military outlays—which accounted for a paltry 2.4 percent of GDP in 2014, about one-tenth the estimated burden borne by the North. The ROK also should expand its armed forces from about 655,000 personnel today to a number much closer to the DPRK’s 1.2 million.

Doing so obviously would be a burden. But if the economic wreck to its north can create such a threatening military, why cannot the ROK, which enjoys a roughly 40-1 economic and 2-1 population advantage, meet the challenge?

South Korea is not alone. Japan has been another long-term defense welfare client of the U.S. Only under Prime Minister Shinzo Abe has Japan begun to do more, mostly because his government is no longer convinced that the U.S. will forever subsidize Japan’s defense.

Alas, the Europeans have not yet come to that conclusion. NATO sets a two percent of GDP standard for military outlays, yet the 2015 European member average was just 1.5 percent. Only four European states hit two percent.

Moscow’s aggressive behavior against Georgia and especially Ukraine set off all sorts of angst throughout Europe. U.S. officials and NATO leaders made their usual calls for members to hike military outlays, but most European states did what they usually do, continued to cut spending.

Under normal circumstances European behavior would be mystifying. The European Union demonstrates the continent’s ability to overcome historic national divisions and collaborate for a common purpose.

Collectively the Europeans enjoy around an 8-1 economic and 3-1 population advantage over Moscow. Even after its recent revival, Russia’s military today is a poor replica of that during the Soviet era.

Yet when Moscow acts against non-NATO members Europe’s eyes turn to Washington for military relief. Instead of acting in their presumed interests, they push for U.S. action.

Washington’s allies generally are a pathetic lot. Benefiting from sizeable and capable populations and enjoying large and advanced economies, they nevertheless can’t be bothered to invest heavily in their own defense.

When troubles arise U.S. friends expect the American cavalry, in the form of a B-52 in Korea this time, to arrive. As a result, I argue on National Interest online, “the U.S. is expected to defend much of the globe. And the bulk of Washington’s over-size military outlays are to project power for the benefit of its ne’er-do-well allies.”

In the years ahead Washington should take a page from the Trump play-book and choose as allies a few “winners,” nations whose friendship actually makes America more secure. The U.S. should stop treating national security as a form of welfare for other states.

Kim Jong-un’s gift to the world is North Korea’s fourth nuclear test. Washington should respond by backing away from a potential conflict that is not its own.

Although Western intelligence widely disbelieves the DPRK’s claim to have tested a thermonuclear device, or H-bomb, Kim Jong-un has clearly demonstrated that nothing will dissuade the regime from expanding and improving its nuclear arsenal.

The North’s action has led to widespread demands for action. Alas, no one has good ideas about what to do.

Pyongyang again ignored “the international community” because “the international community” has no cost-effective means to restrain the DPRK. Although as assistant secretary of defense Ashton Carter advocated military strikes against North Korean nuclear facilities, most people on and off the Korean peninsula don’t believe the answer to a potential war is to start an almost certain war.

Sanctions long have been the West’s go-to answer. Congress already was considering three different enhanced sanctions bills and the UN Security Council is planning new economic penalties.

But the North has never let public hardship get in the way of its political objectives. So far the People’s Republic of China has refused to encourage regime collapse by cutting economic ties and eliminating energy and food support. Moreover, Russia, with a newly revived relationship with the DPRK, insisted that any response be “appropriate” and “proportionate.”

Whether there ever was a chance to negotiate away the North’s nascent nuclear program may be impossible to know. But virtually no one believes the Kim regime is willing to eliminate existing weapons developed at high cost.

So what to do?

  1. Recognize that not every problem is America’s problem. North Korea matters a lot more to its neighbors than to the U.S. Indeed, Pyongyang wouldn’t be constantly tossing imprecations and threats toward Washington, if the U.S. didn’t have troops on its border and abundant air and naval forces pointed the DPRK’s way.
  2. Withdraw American conventional forces from the peninsula. The Republic of 
  3. Korea, with twice the population and upwards of 40 times the economic strength, of the North, is well able to provide for its own defense. U.S. troops act as nuclear hostages, unnecessarily put in harm’s way without constraining North Korean nuclear activities.
  4. Seek to persuade Beijing to pressure the North out of the former’s own interest. Washington’s only chance of enlisting China’s help is by addressing its concerns—impact of potentially violent implosion spurring conflict and refugees across the Yalu, loss of economically advantageous position in the North, creation of united Korea allied with America aiding Washington efforts at containment. This requires negotiating with the PRC.
  5. Offer to establish diplomatic relations with North Korea. Engagement might not change anything, but then, we can be certain that nothing will change if we maintain the same policy toward the North.
  6. Indicate that continuing expansion of Pyongyang’s nuclear arsenal would force Washington to reconsider its position on proliferation. After all, the U.S. does not want to be left extending a nuclear umbrella over South Korea, Japan, Taiwan, Australia, and who knows else against nuclear-armed North Korea, China, and Russia. Better to extricate America from such a miasma and allow its allies to create their own nuclear deterrents. If that prospect bothers the PRC, then it should do more to prevent the DPRK from continuing its present course.

North Korea has become a seemingly insoluble problem for Washington. Nothing the U.S. can do, at least at reasonable cost, is likely to create a democratic, friendly, non-nuclear DPRK.

But as I point out on National Interest: “Washington can share the nightmare, turning South Korea’s defense over to Seoul and nuclear proliferation over to the North’s neighbors, particularly China. Moreover, Washington can diminish North Korean fear and hostility by establishing diplomatic ties, just as America had official relations with the Soviet Union and its Eastern European allies during the Cold War.”

The geopolitics still would be messy. But no longer would it be America’s responsibility to clean up.

The conventional wisdom is that Justice Scalia is the swing vote in Friedrichs v. California Teachers Association, but he gave no indication at this morning’s argument that he was anywhere but on the plaintiffs’ side. Chief Justice Roberts and Justice Kennedy – other potential defectors from the pro-workers, anti-compelled-speech side – were similarly solid. With Justice Alito having written the two recent labor-related opinions, the most likely fifth vote for the unions (supported by California and the United States) becomes Justice Thomas, but only because he said nothing, as is his wont.

Not surprisingly, the biggest issue for the more conservative justices was the matter of compulsion: why should non-unionmembers in the public sector be forced to pay “agency fees” for so-called collective bargaining when (a) all issues that are collectively bargained by public-sector unions are matters of public policy (not simply wages and conditions of labor as in the private sector), and (b) those workers disagree with the supposed “benefits” that the unions want them to pay for (e.g., tenure protections versus merit pay). “Is it even okay to force someone to contribute to a cause you do believe in?”, asked Justice Scalia. “We’re not talking about free riders, but compelled riders,” posited Justice Kennedy.

“Since public employment contracts are submitted for public comment, that suggests this is different than private-sector collective bargaining,” explained Chief Justice Roberts, who was silent during the plaintiffs’ half of the argument and an active questioner of the union and governments (typically a sign of agreement with the former and disagreement with the latter). 

While the progressive justices focused on the importance of stare decisis – respecting precedent and the reliance interests built up around it – that didn’t appear to be a major concern for anyone else, regardless of the age of the ruling that’s now under attack (Abood v. Detroit Board of Education from 1977). “Everything that’s collectively bargained [in the public sector] is necessarily a political question,” thundered Justice Scalia in describing why a ruling to strike down agency fees would even comport with Abood’s statement that states can’t force workers “to contribute to the support of an ideological cause [they] may oppose as a condition of holding a job.”

In other words, to the extent we can predict anything based solely on oral argument – take this with a mine of salt – I’d much rather be us (those who support the teachers) than them (those who support the teachers’ union and state and federal governments). If that’s how the case goes, it would be a huge victory for workers’ rights, the First Amendment, and educational freedom – and probably the most important ruling this term. 

We’ll find out by the end of June.

For background and commentary about the case, see this two-minute primerCato’s brief, my two recent op-eds, and this podcast.

When China joined the World Trade Organization in 2001, it agreed that other members would be allowed to apply “nonmarket economy methodology” in antidumping cases against Chinese goods for 15 years.  That deadline will soon pass in December 2016, but the Financial Times reported recently that U.S. officials are actively pressuring their European counterparts to continue using NME methodology indefinitely.  The report is disappointing but not at all surprising.

Given Washington’s long history of actively and intentionally violating WTO antidumping rules, most experts have guessed that the United States would not change its practices at the end of 2016 to comply with WTO rules.

It’s important to realize at the offset that the U.S. antidumping law is bad policy that exists to protect a handful of politically powerful U.S. industries from legitimate competition.  My colleague Dan Ikenson has thoroughly catalogued the numerous fallacies used to support antidumping in general, the myriad abuses of the U.S. government, and the particularly nonsensical nature of nonmarket economy treatment.

I wrote a Cato Policy Analysis in October 2014 explaining the history of NME status as an excuse for lawless protectionism.  I also spelled out some of the possible paths the United States could take following the 2016 expiration of China’s NME status at the WTO and what the legal consequences would be of each.  At the time, I thought the most likely outcome would be no change in practice resulting in years of embarrassing trade litigation at the WTO where the United States will be continually called out for violating trade rules.  According to the Financial Times, that’s exactly what they’re planning to do:

The Obama administration … is advocating a policy of inaction, which would force China to bring a challenge in the WTO and thus put the onus on Beijing to prove that its state-heavy economic model has met all the criteria for [market economy status].

Unfortunately, the article perpetuates a frustrating myth that advocates of the status quo use to misdirect the debate.  Whether China’s economic model meets the criteria laid out in U.S. or EU law for market economy or nonmarket economy treatment is irrelevant.  Those criteria are not part of WTO law. 

The WTO Antidumping Agreement lays out detailed rules for how members can implement antidumping measures, and the use of NME methodology is plainly inconsistent with those rules.  China’s accession protocol to the WTO exempts members from some of those rules until December 2016.  After that, United States, European Union, or any other WTO member that uses NME methodology against Chinese goods will be violating global trade rules.

To be blunt, the United States uses NME methodology against Chinese imports because it provides for more protectionist outcomes, not because China doesn’t have a market economy. Whether China qualifies as a market economy under any set of criteria will have no impact on WTO rules or U.S. practice.

What’s more, it’s clear that China considers resolving the NME issue to be an important international economic goal this year.  Ending NME treatment on time would smooth over relations and enable the United States to work on more important bilateral issues. 

Antidumping duties on imports from China harm American consumers and businesses by making the things we buy more expensive while privileging inefficient, rent-seeking domestic industries.  Rather than kowtowing to special interests, the U.S. government should promote economic growth and international peace by ending the NME charade as soon as possible.

In less than an hour, the U.S. Supreme Court will hear oral arguments in one of the most important cases of the year, Friedrichs v. California Teachers Association. The plaintiffs in Friedrichs are ten California teachers who are suing their union because they believe that laws forcing government employees to join a union or pay them “agency fees” as a condition of employment violate their First Amendment right to free speech, which includes the freedom not to speak, and not to be compelled to subsidize the speech of others.

SCOTUS has previously held that the agency fees may cover collective bargaining activities but not the unions’ political activities. However, as the plaintiffs argue, public-sector collective bargaining is inherently political. For example, more funding for teachers means higher taxes or less money for public parks, etc. The Cato Institute has filed an amicus brief in support of the plaintiffs, and several Cato legal eagles, such as Ilya Shapiro, Andrew Grossman, and Trevor Burrus, have already weighed in. 

Much of the constitutional analysis floating around the interwebs has focused on whether or not overcoming the supposed “free rider” problem constitutes sufficient grounds for states to grant unions the right to expropriate funds from non-members to cover collective bargaining activities that supposedly benefit them. Champions of free speech have generally attacked the other side’s strongest case, therefore their arguments assume that all teachers do, in fact, benefit from that collective bargaining, but that freedom of speech entails the freedom not to be forced to pay for someone else to advocate even on your supposed behalf. In an op-ed for the Orange County Register, however, Ilya Shapiro and I explain how collective bargaining can actually come at the expense of some teachers:

[E]ven if collective bargaining weren’t inherently political, it’s easy to see how workers could object to the supposed “benefits” negotiated on their behalf. For example, a teacher might prefer higher pay to tenure protections, or a defined-contribution pension plan – such as a 401(k) – to one that has defined benefits.

There are countless ways in which union-negotiated contracts or laws that the unions lobbied to enact can actually harm the interests of individual teachers. For example, “last-in, first-out” laws protect long-serving teachers regardless of ability at the expense of talented, young teachers. Worse, as we explain, such contracts and laws can harm the interests of the very children our education system is supposed to be designed to serve:

Collective bargaining also can come at the expense of students. When schools lack high-quality math teachers because the union contract requires they be paid the same amount as gym teachers, kids lose out. And when that contract has “last in, first out” (LIFO) rules that force a district to lay off a talented young teacher before a low-performing teacher with seniority, students suffer.

Last year, a judge in California struck down such tenure and LIFO rules after finding “compelling” evidence that making it hard to fire low-performing teachers had a negative impact on students, especially low-income and minority students. The judge pointed to research by Harvard professor Thomas Kane showing that Los Angeles Unified School District students who were taught by an English teacher in the bottom 5 percent of competence lose the equivalent of several days of learning in a single year relative to students with average teachers.

“Indeed,” the judge concluded, “it shocks the conscience.”

Sadly, the deleterious effects of collectively bargained tenure rules can be serious and long-lasting. In a 2012 study of more than 2.5 million students, Harvard professors Raj Chetty and John Friedman and Columbia professor Jonah Rockoff found that students who had just a single year in a classroom with a teacher in the bottom 5 percent of effectiveness lose approximately $50,000 in potential lifetime earnings relative to students assigned to average teachers.

If the Friedrichs plaintiffs win, it won’t solve all these problems. Some states will still have LIFO rules, teacher salary and benefits schedules, or related matters in enshrined in statute. Nevertheless, if the Friedrichs plaintiffs prevail, it will mean that district school teachers will no longer be forced to support advocacy that they believe works against their interests or the interests of their students. In the long run, less funding for such advocacy may well translate into fewer policies that come at the expense of some teachers and students.   Ultimately, a win for the plaintiffs in Friedrichs would be a victory for teachers and their students.

The Supreme Court said in Hobby Lobby that, under the Religious Freedom Restoration Act (RFRA), the Department of Health and Human Services (HHS) could not apply its contraceptive mandate to closely held for-profit corporations when doing so would violate the owners’ sincere religious beliefs. Around the time of that decision, the Court stayed the application of the mandate to a group of nuns known as the Little Sisters of the Poor. The Little Sisters—like the plaintiffs in six other cases that have now been consolidated under the name Zubik v. Burwell—object to the “accommodation” that HHS crafted for their religious beliefs and the Supreme Court will now be evaluating their claims.

Here’s the deal: The Affordable Care Act tasked HHS with developing guidelines to ensure that health insurance plans provided women with “preventive care” (a term undefined in the statute’s text). Although the ACA said nothing about accommodating or exempting religious organizations from that “preventive care” requirement, which HHS interpreted to include various contraceptives (four of which Hobby Lobby had objected to), HHS established a rule that exempted churches and their “integrated auxiliaries” from the mandate altogether but required other religious organizations to submit a self-certification that would lead insurance providers or third-party administrators to cover the costs of the objectionable contraceptives.

The Little Sisters, Reverend David Zubik, and the other plaintiffs believe that filing this self-certification makes them complicit in sin, in violation of their sincerely held religious beliefs. The Court granted cert. to determine whether the contraceptive mandate and the accommodation indeed violate RFRA.

But a preliminary question is whether the executive departments responsible for creating the accommodation (HHS, Labor, and Treasury) had the authority to do so. The short answer is that they did not, as Cato and the Independent Women’s Forum argue in our amicus brief.

The departments claim that the source of their authority is the instruction that they interpret what “preventive care” employers must provide to their employees. The departments accordingly tried to balance religious liberty and access to contraceptives by exempting churches and merely accommodating other religious employers. They justified this distinction by saying that non-church religious employers were more likely to employ people who did not share their faith or adhere to the same objection. That distinction does not hold up, however, as the case of the Little Sisters—nuns who have vowed obedience to the Pope!—demonstrates.

Furthermore, there is no indication in the vast amount of ACA text delegating authority to the departments that Congress intended for them to make religion-related judgment calls, as the word “religion” does not appear anywhere in those statutes. It is particularly unlikely that Congress would have delegated, without any statutory guidance, this sort of authority given that the departments have no expertise in crafting religious accommodations. Executive agencies simply cannot impose arbitrary burdens on religious non-profits that they guesstimate to be “less” religious than churches.

In the analogous area of tax exemptions, for example, an organization need only indicate on a form that it is religious—it need not prove or even claim some level of religiosity—and once exempt, it receives the same treatment as a church. That’s a good model for this case: The departments, which lack the “expertise” to answer this “major question” of social, “economic and political consequence,” to quote King v. Burwell, are simply not entitled make religious-liberty policy or receive judicial deference when they do.

Although administrative law’s Chevron doctrine allows agencies to fill in the gaps where a statute’s language is ambiguous, that power does not entitle agencies to make major decisions that alter the fundamental aspects of religious free exercise when the only potential source of that power is the term “preventive care.” Finally, where there is a lack of clear indication of congressional delegation, the Court must avoid constitutional questions that could lead to church-state entanglement, as even the government has argued elsewhere.

The Supreme Court will hear oral argument in Zubik v. Burwell this spring, with a decision expected by the end of June.

Over at Cato’s Police Misconduct web site, we have identified the worst case for the month of December.  It involved the shooting of a man in Paradise, California.

According to news reports, here’s what happened:  Andrew Thomas was seen leaving the parking lot of a bar and his vehicle didn’t have its lights on – even though it was late at night.  Officer Patrick Feaster suspected the driver (Thomas) might be intoxicated and so pursued Thomas to pull him over and investigate further.

No problem so far.  We want police to be alert for impaired drivers who may endanger other people.

Next, Thomas did not pull over after Feaster was behind him with his police lights flashing.

Moments later, Thomas’s SUV crashed and his wife was ejected from the vehicle.  She died.

Next, things get even worse.  Officer Feaster is seen on dash-cam video walking toward the crashed SUV.  The video shows Thomas trying to climb out of the overturned SUV.  Feaster draws his sidearm and shoots Thomas in the neck and he falls back into his SUV.

After the shooting, Officer Feaster gets on his radio to report that the driver is refusing his commands to get out of the vehicle.  He does not mention that he shot the driver.  Feaster also reports that a injured woman is unresponsive, but the video shows that he is not checking on her condition or rendering aid.

Other police and responders get to the scene, but ten minutes go by before Feaster says he fired his weapon.  It is very unclear what could be the justification for shooting a man after a vehicle crash in these circumstances.  Officer Feaster says he was not threatened, but that his gun went off accidentally.

On a police body camera, Feaster is heard telling the watch commander that his gun went off, but he didn’t think the driver was hit because he wasn’t aiming his weapon in the driver’s direction.  Thomas initially survived the shot to his neck, but was paralyzed.  He died weeks later.

Despite community outrage, the local prosecutor, Mike Ramsey, declined to file any criminal charges against Officer Feaster because he said he lacked sufficient evidence to prove a crime in court.  That’s very odd.  Prosecutors would typically be relieved to know that the incident was captured on videotape.

View the video for yourself here:

After menacing states across the country this fall, the Department of Homeland Security has once again caved on threats to enforce REAL ID by denying Americans their right to travel.

This afternoon, DHS Secretary Jeh Johnson put out a press release backtracking on agency claims that the Transportation Security Administration would turn away air travelers from states that don’t comply with the U.S. national ID law in 2016.

The new deadline, according to Secretary Johnson’s statement, is January 22, 2018. That’s sure not 2016. That’s more than two years away.

The date is significant for more than just proving the Department of Homeland Security’s bluff. January 22, 2018 is more than a year into the next into the next presidential administration. Secretary Johnson will be gone. The new president, whoever he or she is, will have a Homeland Security Secretary whose underlings will probably have driven the issue too hard for DHS and Congress to tolerate. And the 2018 REAL ID deadline will get pushed back again, by that group of federal bureaucrats.

It’s why I’ve said time and time again that REAL ID deadlines aren’t real.

Secretary Johnson’s press release breaks some new and interesting ground. Starting on October 1, 2020, it says, “every air traveler will need a REAL ID-compliant license, or another acceptable form of identification, for domestic air travel.”

The claim is not true. If Congress has still failed to repeal the law, DHS will once again cave on this deadline. But it makes clear where the REAL ID Act takes us. Every American is supposed to carry a national ID card. With luck and a little bit of advocacy by state leaders like Neal Kurk (R-NH) and Warren Limmer (R-MN), that will never happen.

Earlier this week, NBER released the first random-assignment study ever to find a negative impact from a school voucher program. Previous gold standard studies had almost unanimously found modest positive effects from school choice, which raises the obvious question: what makes the Louisiana Scholarship Program (LSP) so different?

In an article for Education Next, I argued that, “although not conclusive, there is considerable evidence that the problem stemmed from poor program design.” The LSP is one of the most heavily regulated school choice programs in the nation, and that burden has led to a very low rate of private school participation.  Only about one-third of Louisiana private schools accept voucher students, a considerably lower rate than in most other states. From a survey of private school leaders conducted by Brian Kisida, Patrick J. Wolf, and Evan Rhinesmith for the American Enterprise Institute, we know that the primary reason private schools opted out of the voucher program was their concerns over the regulatory burden, particularly those regulations that threatened their character and identity. For example, voucher-accepting schools in Louisiana may not set their own admissions criteria, cannot charge families more than the value of the voucher (a meager $5,311 on average in 2012), and must administer the state test.

We also know from the NBER study that the participating and non-participating private schools differ in at least one important respect. Whereas the non-participating schools experienced modest growth over the decade before the voucher program was expanded statewide (about 3 percent, on average), the participating schools had been experiencing a significant decline in enrollment (about 13 percent, on average). In other words, schools that were able to attract students tended to reject the vouchers while voucher schools tended to be those where enrollment had been dropping.

The difference in enrollment trends suggests that the LSP’s regulatory burden had the opposite of its intended effect: discouraging higher-performing schools from participating, leaving only the lower-performing schools that were so desperate to reverse their declining enrollment and increase their funding that they were willing to do whatever the voucher program required.

Several other researchers and education reform advocates reached similar conclusions, including Matthew Ladner, Adam Peshek, Michael McShane, Lindsey Burke, and Jonathan Butcher. However, others expressed skepticism about what I shall call the Overregulation Theory, and proposed alternative explanations for the LSP’s poor results. 

Writing at Education Week, Douglas Harris of the Education Research Alliance for New Orleans concedes that “regulation probably does reduce the number of private schools, especially the number of higher-performing private schools,” but he still believes the Overregulation Theory is “premature.” Harris instead offers two potential alternatives: 1) the improved public/charter school performance in New Orleans made the performance of the private sector look relatively worse; and 2) the curriculum at most private schools may not have been aligned to the state test, so the poor performance merely reflects that lack of alignment rather than poor performance. 

Harris’s first theory is explicitly rejected by the NBER study. On the third page of the study, the authors write: “Negative voucher effects are not explained by the quality of public fallback options for LSP applicants: achievement levels at public schools attended by students lotteried out of the program are below the Louisiana average and comparable to scores in low- performing districts like New Orleans.” In other words, the public school alternatives are not so great and the performance of the participating private schools is considerably worse.

That said, Harris’s second theory, which Jason Richwine also suggested, is plausible as a contributing factor. However, it is no more plausible than the Overregulation Theory. Indeed, whereas the differences in enrollment trends between voucher and non-voucher private schools provide some suggestive evidence for the Overregulation Theory, Harris provides no evidence to support the Nonaligned Test Theory. How many voucher schools were already aligned with the state curriculum and/or administered the state test? At this point, we do not know. Moreover, to the extent that testing nonalignment explains some of the very large 0.4 standard deviation difference in math scores, it is unlikely that it explains all or even most of that difference. Then again, Harris stated that he will be releasing the results of his own research on the LSP, so it’s likely he knows something that I do not.

Harris also notes that the NBER study only examined the results of one year of one program. He is certainly correct that we need more data over time to draw firmer conclusions, which is one reason I presented my interpretation as “not conclusive” and wrote that “the regulations may have had the opposite of their intended effect” (emphasis added). And, indeed, there is some evidence that voucher schools improved slightly in the third year since the statewide expansion (although if the voucher schools were their own district, they’d still be the fifth-worst of 76 in the state).

Nevertheless, such strongly negative results should give reform advocates great pause about the regulatory strategies employed in Louisiana. We know the regulatory burden chased away most private schools, and we have evidence that the voucher-accepting schools had been struggling with declining enrollment. If we want to better understand the LSP’s atypically disastrous performance, its program design is the logical place to start. 

The history of China’s banking system in the first half of the 20th century offers powerful insights into the conduct of monetary policy and the consequences of government intrusion into banking and monetary institutions that are well worth considering today. Monetary economists and monetary historians would do well to study China’s example, and, in particular, Chang Kia Ngau’s 1958 book, The Inflationary Spiral: The Experience in China, 1939-1950. As you’ll see, sound money and sound banking matter a great deal in creating a harmonious and prosperous society.

In 1905, during the final years of the Qing Dynasty, the first government bank, the Hupu Bank, opened in Peking. It was established by the Imperial Ministry of Revenues when China was still on the silver standard to help finance government deficits by issuing paper currency (see specimen above). In 1908, the bank was renamed the Ta Ching Government Bank (Great Qing Bank), and in 1912, under a new charter, the bank became known as the Bank of China. Another government bank of issue, the Bank of Communications, was established in 1908.

The constant pressure for central and provincial governments to increase spending beyond revenues led to attempts to suspend convertibility. For example, in 1916, President Yuan Shih-kai of the Republic of China ordered the Bank of China and the Bank of Communications to halt convertibility of their bank notes, and the public was instructed to accept those irredeemable notes at par. The largest note-issuing bank, the Shanghai Branch of the Bank of China, refused to comply with the president’s order and was able to defend its notes against a bank run. The Peking Branch of the Bank of China, however, complied with the order, as did the Bank of Communications (Chang: p. 5).

In Manchuria, officials imposed the death sentence on individuals who exchanged irredeemable bank notes at less than par. Despite this severity, there were heavy discounts on provincial government bank notes “which placed a very real limit on the extent to which these issues could be increased.” By 1922 all irredeemable notes from the Bank of China and the Bank of Communications were withdrawn (Chang: p. 5). The public then slowly regained confidence in paper currency as banks recommitted to redeem their notes in silver.

Institutional Limits on the Quantity of Money

In March 1928, the Bank of China sought to enhance the credibility of its currency by embarking on institutional reform to limit note issue. The bank established a “Supervisory Committee” in Shanghai, comprised of members from the Chamber of Commerce, the Bankers’ Association and the Native Bankers’ Association, designed to ensure that the bank had sufficient silver backing for its notes. The Committee published quarterly reports on the bank’s reserve position that were certified by a public accountant (Chang: p. 6).

This institutional check on the credibility of the bank’s promise to honor its commitment to maintain a convertible currency was also adopted by the newly created Central Bank of China, as well as by the Bank of Communications and private banks. To quote Chang (p. 6), “The public became less wary of holding bank notes, and note circulation increased rapidly in the years after 1928. Sound currency gradually drove the unsound notes of the provincial banks out of circulation except in Manchuria and Canton” (emphasis added).

Currency Reform

The silver backing of bank notes was relaxed by the rule change that allowed banks to back up to 40 percent of their note issues with government bonds, and, in November 1935, the central government replaced the silver standard with a foreign exchange standard. The currency reform provided that only notes issued by the Central Bank of China, the Bank of China, and the Bank of Communications would be acceptable as legal tender, and would henceforth be called “the Chinese National Currency” (CNC). Silver could no longer be used to back bank notes, and the public would have to return all monetary silver to a government appointed Currency Reserve Board or to its agents in exchange for CNC (Chang: p. 7).

Those who drafted the new currency plan had recommended additional measures to safeguard the value of money: (1) make the Central Bank of China independent of the Ministry of Finance; (2) establish a Supervisory Committee to limit note issue and avoid inflation; and (3) rationalize government financing to minimize deficit spending and debt monetization. However, those sensible measures were never instituted and instead bank notes in circulation were increased from CNC $453 million in 1935 to nearly CNC $1.5 billion by mid-1937 (Chang: p. 8).

Fiscal Dominance, Inflation, and Repression

Demands on the fisc increased during the Second Sino-Japanese War (1937–1945). The lack of central bank independence and the lack of any hard anchor for the price level under a pure government fiat money system led to an inflationary spiral. During the early war years, from 1937–39, inflation in “Free China” (areas not held by the Japanese) averaged 40–50 percent per year; inflation then accelerated to 160 percent per year until the end of 1941, and during the last four years of the war averaged more than 300 percent per year (Chang: p. 12).

Following the war, the Nationalist government continued to rely on the printing press to finance deficits, inflation spiraled upward, and the government imposed wage and price controls to suppress inflation.[1] Direct measures were also used and “economic instability finally led to a general loss of confidence in the Nationalist government, and total collapse of political and social morals followed” (Chang: p. 367).

Lessons

Several lessons emerge from China’s experiences prior to the Communist Party takeover in 1949. The first lesson is that long-run economic growth and prosperity depend on “respect for the soundness of private enterprise and banking.” When the government engages in massive debt monetization, the resulting inflation destroys “popular confidence in banking institutions” (Chang: p. 368).

Second, allocating capital to state-owned enterprises crowds out private investment. “Overzealousness in forcing the pace of economic development [by supporting state-owned enterprises] often results in little more than the destruction of private capital formation, thus defeating the very purpose of development” (Chang: p. 368).

Third, the inclination of underdeveloped countries to inflate means that “the establishment of an institutional framework for budget control and the independence of the central bank are of paramount importance for the long-term welfare of the population” (Chang: p. 368).

Fourth, “once inflation is under way, the government is perforce led to the path of increasing intervention and direct control.” Thus, inflation inevitably leads to the loss of economic and personal freedom as the government imposes wage and price controls and allocates resources. Corruption becomes endemic (Chang: pp. 368–69).

Fifth, the experience of Nationalist China shows “without equivocation that the complexity of modern economic life defies the grasp of any single individual” (Chang: p. 369). This point may seem trivial but is one that Nobel laureate economist F. A. Hayek often emphasized in such works as “The Use of Knowledge in Society” and The Fatal Conceit. Central bankers who favor pure discretion in the conduct of monetary policy — as opposed to rules — are prone to think that their intricate macroeconomic models capture the complexity of the real economy and that they can accurately forecast the path of the economy. In contrast a rules-based regime recognizes the difficulty of monetary planning and the benefits of what legal scholar Richard Epstein calls “simple rules for a complex world.”

The most important lesson, perhaps, is that “inflation is no less an enemy of the free society than Communism and, as we have seen in China, may be a harbinger of a Communist triumph” (Chang: 369).

Conclusion

China’s economic experiences during the first half of the 20th century reinforce fundamental principles about the importance of sound money and banking, fiscal rectitude and economic freedom for creating a harmonious society. It also suggests that the adoption of a rules-based monetary regime, which limits money creation and allows competing currencies, also deserves further attention.

____________

[1] This was the second time the Nationalist government resorted to wage and price controls; the first use was in December 1938. However, enforcement was difficult because as Chang (p. 343) notes, “The public … was antagonistic to all forms of government controls on the economy; still prevalent was the laissez faire view that market problems would best solve themselves if only the government would not interfere.”

[Cross-posted from Alt-M.org]

Some of you may have seen my December 2 post showing an “isochronic” map of the world. The map visualized the length of time it took to get from London to anywhere else in the world in 1914. More recently, the good folks at The Telegraph have updated the original 1914 map with 2016 data. To give just one example, it took five days to reach the East Coast of the United States in 1914. Today, it takes half-a-day.

The recent “occupation” of government-owned lands in Eastern Oregon by disgruntled ranchers’ motivated Quoctrung Bui and Margot Sanger-Katz of the New York Times (NYT) to produce an edifying essay on January 6th. It was aptly titled “Why the Government Owns So Much Land in the West.” Curiously, the NYT essay fails to mention one of the most significant, recent, and contentious attempts to “dispose” of federal public lands.

When Ronald Reagan was elected president for his first term in 1980, he received strong support from the so-called Sagebrush Rebels. The Rebels wanted lands owned by the federal government to be transferred to state governments.Their champion was James Watt, a self-proclaimed Sagebrush Rebel who became the Secretary of the U.S. Department of the Interior.

When I was operating as one of President Reagan’s economic advisers, an early assignment was to analyze the federal government’s landholdings and make recommendations about what to do with them. This was a big job. These lands are vast, covering an area six times that of France.

These public lands represent a huge socialist anomaly in America’s capitalist system. As is the case with all socialist enterprises, they are mismanaged by politicians and bureaucrats dancing to the tunes of narrow interest groups. Indeed, the U.S. nationalized lands represent assets that are worth trillions of dollars, yet they generate negative net cash flows for the government. I first presented my findings and recommendations publically at the annual Public Lands Council meeting of September 1981 in Reno, Nevada. The title of my speech was “Privatize Those Lands”—privatize being a word Mrs. Hanke, a Parisian, had imported from France.

My Reno speech caused a stir. James Watt, the Secretary of the Interior, was furious because he wanted to hand over the lands to the state governments—exchanging one form of socialism for another. Needless to say, I thought I was in deep trouble. Hoping to avoid political immolation, I rapidly sent my analysis to the President.

Reagan instantly responded, taking my side. Better yet, he swiftly made my proposals the Administration’s policy. The president endorsed privatizing federal lands in his budget message for the 1983 fiscal year: “Some of this property is not in use and would be of greater value to society if transferred to the private sector. In the next three years we would save $9 billion by shedding these unnecessary properties while fully protecting and preserving our national parks, forests, wilderness and scenic areas.”

It turned out that Reagan had already thought about this issue. The book Reagan, In His Own Hand (2001) makes that clear. This volume contains 259 essays Reagan wrote in his own hand, mainly scripts for his five minute, five-day-a-week syndicated radio broadcasts in the late 1970s. Reagan, In His Own Hand contains several essays on the subject that clearly foreshadowed his policy statement on privatizing public lands. His 1970s musings on public lands echo the writings of Adam Smith. While Reagan never cited Smith, he employed similar reasoning.

Indeed, Smith concluded in The Wealth of Nations (1776) that “no two characters seem more inconsistent than those of the trader and the sovereign,” as people are more prodigal with the wealth of others than with their own. In that vein, Smith estimated that lands owned by the state were only about 25% as productive as comparable private holdings. Smith believed Europe’s great tracts of crown lands to be “a mere waste and loss of country in respect both of produce and population.”

Unfortunately, political opposition—largely from ill-informed environmentalists and some Sagebrush Rebels, too—stopped Reagan from privatizing. U.S. nationalized lands remain ill-used and a constant source of dispute.

Your odds of “making it to the top” might be better than you think, although it’s tough to stay on top once you get there.

According to research from Cornell University, over 50 percent of Americans find themselves among the top 10 percent of income-earners for at least one year during their working lives. Over 11 percent of Americans will be counted among the top 1 percent of income-earners (i.e., people making at minimum $332,000 per annum) for at least one year.

How is this possible? Simple: the rate of turnover in these groups is extremely high.

Just how high? Some 94 percent of Americans who reach “top 1 percent” income status will enjoy it for only a single year. Approximately 99 percent will lose their “top 1 percent” status within a decade.

Now consider the top 400 U.S. income-earners—a far more exclusive club than the top 1 percent. Between 1992 and 2013, 72 percent of the top 400 retained that title for no more than a year. Over 97 percent retained it for no more than a decade.

HumanProgress.org advisory board member Mark Perry put it well in his recent blog post on this subject:

Whenever we hear commentary about the top or bottom income quintiles, or the top or bottom X% of Americans by income (or the Top 400 taxpayers), a common assumption is that those are static, closed, private clubs with very little dynamic turnover … But economic reality is very different—people move up and down the income quintiles and percentile groups throughout their careers and lives

What if we look at economic mobility in terms of accumulated wealth, instead of just annual income (the latter tends to fluctuate more)?

The Forbes 400 lists the wealthiest Americans by total estimated net worth, regardless of their income during any given year. Over 71 percent of Forbes 400 listees and their heirs lost their top 400 status between 1982 and 2014.

So, the next time you find yourself discussing the very richest Americans, whether by wealth or income, keep in mind the extraordinarily high rate of turnover among them.

And even if you never become one of the 11.1 percent of Americans who fleetingly find themselves in the “top 1 percent” of U.S. income-earners, you’re still quite possibly part of the global top 1 percent.

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