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Politicians hate cash.

That may seem an odd assertion given that they love spending money (other people’s money, of course, as illustrated by this cartoon).

But what I’m talking about is the fact that politicians get upset when there’s not 100 percent compliance with tax laws.

They hate tax havens since the option of a fiscal refuge makes confiscatory taxation impractical.

They hate the underground economy because that means hard-to-tax economic activity.

And they hate cash because it gives consumers an anonymous payment mechanism.

Let’s explore the animosity to cash.

It’s basically because a cashless society is an easier-to-tax society, as expressed by an editorial from the U.K.-based Financial Times.

…unlike electronic money, it cannot be tracked. That means cash favours anonymous and often illicit activity; its abolition would make life easier for a government set on squeezing the informal economy out of existence. …Value added tax, for example, could be automatically levied. …Greece, in particular, could make lemonade out of lemons, using the current capital controls to push the country’s cash culture into new habits.

And some countries are actually moving in this direction.

J.D. Tuccille looks at this issue in an article for Reason.

Peter Bofinger of the German Council of Economic Experts…wants to abolish the use of cash… He frets that old-fashioned notes enable undeclared work and black markets… So rather than adjust policy to be more palatable to the public, he’d rather leave no shadows in which the public can hide from his preferred policies. The idea is to make all economic activity visible so that people have to submit to control. Denmark, which has the highest tax rates in Europe and a correspondingly booming shadow economy, is already moving in that direction. …the Danmarks Nationalbank will stop internal printing of banknotes and minting of coins in 2016. After all, why adjust tax and regulatory policy to be acceptable to constitutents when you can nag them and try to reinvent the idea of money instead?

By the way, some have proposed similar policies in the United States, starting with a ban on $100 bills.

Which led me to paraphrase a line from the original version of Planet of the Apes.

Notwithstanding my attempt to be clever, the tide is moving in the wrong direction. Cash is beginning to vanish in Sweden, as reported by the New York Times.

…many of the country’s banks no longer accept or dispense cash. Bills and coins now represent just 2 percent of Sweden’s economy, compared with 7.7 percent in the United States and 10 percent in the euro area. This year, only a fifth of all consumer payments in Sweden have been made in cash, compared with an average of 75 percent in the rest of the world, according to Euromonitor International. …Cash machines, which are controlled by a Swedish bank consortium, are being dismantled by the hundreds

Though the article notes that there is some resistance.

Not everyone is cheering. Sweden’s embrace of electronic payments has alarmed consumer organizations and critics who warn of a rising threat to privacy and increased vulnerability to sophisticated Internet crimes. …The government has not sought to stem the cashless tide. If anything, it has benefited from more efficient tax collection, because electronic transactions leave a trail; in countries like Greece and Italy, where cash is still heavily used, tax evasion remains a big problem. Leif Trogen, an official at the Swedish Bankers’ Association, acknowledged that banks were earning substantial fee income from the cashless revolution.

What matters, by the way, is not the degree to which consumers prefer to use alternatives to cash.

That’s perfectly fine, and it explains much of what we see on this map.

The problem is when governments use coercion to limit and/or abolish cash so that politicians have more power. And this is why the French (gee, what a surprise) are trying to crack down on cash.

Writing for the U.K.-based Telegraph, Matthew Lynn mentions the new policy and France and also explores some worrisome implications of this anti-cash trend.

France is banning the use of cash for transactions worth more than €1,000…part of a growing movement among academics and now governments to gradually ban the use of cash completely. …it is a “barbarous relic”, as some publications loftily dismiss it. The trouble is, cash is also incredibly efficient. And it is a crucial part of a free society. There is no convincing case for abolition. …When it comes to creeping state control, it is no surprise to find the French out in front. …A cashless economy would be far easier to both tax and control. But hold on. …cash is far too valuable to be given up lightly. …While terrorists and criminals may well use cash to buy weapons, or deal in drugs, it is very hard to believe that they would not find some other way of financing their operations if it was abolished. Are there really any cases of potential jihadists being foiled because they couldn’t find two utility bills (less than three months old, of course) in a false name to open an account?

Amen. Banning cash to stop terrorists is about as foolish as thinking that gun control will thwart jihadists.

In any event, we need to consider trade-offs. Chris Giles highlighted that issue in a piece for the Financial Times.

…an unfortunate rhetorical echo of Maoist China. It is illiberal… Some argue there would be beneficial side effects from abolishing notes and coins through the regularisation of illegal activities. Really? …Cash would have to be abolished everywhere and the BoE does not have those powers, thankfully. The anonymity of cash helps to free people from their governments and some criminality is a price worth paying for liberty.

Though I suppose we should grudgingly give politicians credit for cleverly trying exploit fear to expand their power.

But never forget we’re talking about a bad version of clever. If they succeed, that will be bad news for freedom.  J.D. Tuccille of Reason explains in a second article why a growing number of people prefer to use cash.

Many Americans happily and quietly avoid banks and trendy purchasing choices in favor of old-fashioned paper money. Lots of business gets done that way…the Albuquerque Journal pointed out that over a third of households in the city either avoid banks entirely (the “unbanked”) or else keep a checking account but do much of their business through cash, check-cashing shops, pawn shops, money orders, and other “alternative financial products” (the “underbanked”). A few weeks earlier, the Kansas City Star reported a similar local situation… Twenty-six percent cite privacy as a reason for keeping clear of banks – bankers say that increased federal reporting and documentation requirements drive many customers away. “A lot of people are afraid of Uncle Sam,” Greg Levenson, president and CEO of Southwest Capital Bank, told the Albuquerque Journal. …most people aren’t idiots. When they avoid expensive, snoopy financial institutions, it’s because they’ve decided the benefits outweigh the costs.

Very well said, though I’d augment what he wrote by noting that some of these folks probably would like to be banked but are deterred by high costs resulting from foolish government money-laundering laws.

More on that later.

Let’s stay with the issue of whether cash should be preserved. A business writer from the U.K. is very uneasy about the notion of a society with no cash.

…tax authorities have become increasingly keen on tracking everything and everyone to make absolutely certain that no assets slip under their radars. The Greeks have been told that, come 2016, they must begin to declare all cash over €15,000 held in safes or mattresses, and all precious stones, gold and the like worth more than €30,000. Anyone else think there might be a new tax coming on all that stuff? …number-crunchers…are maddened by the fact that even as we are provided with lots of simple digital payment methods we still like to use cash: the demand for £20 and £50 notes has been rising. …They are maddened because “as untraceable bearer instruments, it is not possible to locate where banknotes are being held at any one time”… Without recourse to physical cash, we are all 100% dependent on the state-controlled digital world for our financial security. Worse, the end of cash is also the end of privacy: if you have to pay for everything digitally, every transaction you ever make (and your location when you make it) will be on record. Forever. That’s real repression.

She nails it. If politicians get access to more information, they’ll levy more taxes and impose more control.

And that won’t end well.

Last but not least, the Chairman of Signature Bank, Scott Shay, warns about the totalitarian temptations that would exist in a cash-free world. Here’s some of what he wrote in a column for CNBC.

In 2010, Visa and MasterCard, bowed to government pressure — not even federal or state law — and banned all online-betting payments from their systems. This made it virtually impossible for these gambling sites to continue operating regardless of their jurisdiction or legality. It is not too far-fetched to wonder if the day might come when the health records of an overweight individual would lead to a situation in which they find that any sugary drink purchase they make through a credit or debit card is declined. …there is…a sinister risk…a cashless society would certainly give governments unprecedented access to information and power over citizens.

And, he warns, that information will lead to mischief.

…the U.S. government is already using its snooping prowess and big-data manipulation in some frightening ways. …the U.S. government is becoming very fond of seizing money from citizens first and asking questions later via “civil forfeiture.” Amazingly, the government is permitted by law to do this even if it is only government staff members who have a suspicion, not proof, of wrongdoing. …In recent years, it made it increasingly difficult for companies to operate or individuals to transact by adding compliance hurdles for banks wishing to deal with certain categories of clients. By making it too expensive to deal with certain clients or sending the signal that a bank should not deal with a particular client or type of client, the government can almost assuredly keep that company or person out of the banking system. Banks are so critically dependent on government regulatory approval for their actions… It is easy to imagine a totalitarian regime using these tools to great harm.

Some folks will read Shay’s piece and downplay his concerns. They’ll say he’s making a slippery slope argument.

But there are very good reasons, when dealing with government, to fear that the slope actually is slippery.

Let’s close by sharing my video on the closely related topic of money laundering. These laws and regulations have been imposed supposedly to fight crime.

But we’ve slid down the slope. These policies have been a failure in terms of hindering criminals and terrorists, but they’ve given government a lot of power and information that is being routinely misused.

P.S. The one tiny sliver of good news is that bad money laundering and know-your-customer rules have generated an amusing joke featuring President Obama.

P.P.S. If politicians want to improve tax compliance in a non-totalitarian fashion, there is a very successful recipe for reducing the underground economy.

Most would probably agree that this year’s race has already exceeded expectations in terms of sheer entertainment value, but as we head into January the presidential campaign season will really start to heat up. Foreign policy is poised to play an even bigger than expected role in this election, thanks to the many fires burning across the globe. In particular, of course, every candidate will have to explain how he or she intends to grapple with the mess in the Middle East. Unfortunately, as we heard during the most recent debates, most of the answers so far involve more American military intervention.

Over at the Council on Foreign Relations, Micah Zenko has started keeping track of all the candidates’ calls for the use of force. The Presidential Candidates Use of Force Tracker, as he calls it, is a wonderful public service, providing voters with an easy way to compare the candidates’ proposals for intervening in Iraq, Syria, and elsewhere. What’s missing, however, is an even quicker way to compare just how interventionist one candidate is compared to the others.

In order to simplify the data provided by Zenko and his research associate, Amelia M. Wolf, I have created a scoring system so we can compare the candidates more easily. I call it the “Presidential Candidate Intervention Meter.” The Intervention Meter is based on an analysis of proposals made between August and December 14, 2015 and quantifies each candidate’s interventionist position by scoring each proposal for the use of force according to how expansive, expensive, or entangling it is. A call for the major use of ground force, for example, earns more points than a call for the limited use of Special Forces. Likewise, carpet-bombing proposals score higher than calls for air support of Iraqi troops (the scoring rules follow at the end of this post).

Admittedly, the Intervention Meter is a simple and not entirely scientific tool. Reasonable people will disagree on exactly how many points to assign each type of proposal as well as how to categorize each of the proposals. Nor can a single score encompass all the complexity and consequences of a policy proposal. Nonetheless, by applying the same scoring process to each candidate’s policies the Intervention Meter contributes to the conversation about what level of military intervention each candidate would pursue as president.

So, what do we find when we run the analysis? There have been 67 calls for the use of force to date, an average of four per candidate; 25 for the use of ground forces, 17 for airstrikes, 20 for no fly/safe zones, and 5 for non-specific action to combat terrorism globally. The average candidate score was 181. Unsurprisingly, Senator Graham topped the chart, scoring 360 points in our inaugural edition thanks to his appeal for sending U.S. ground troops to the Middle East. More surprising, perhaps, is the fact that Hillary Clinton took the second spot. This was due in large part to the fact that although Clinton has called for a somewhat less interventionist approach to the Middle East (i.e. no major use of ground troops), she has called for the unlimited global pursuit of terrorists, which earned her an extra 100 points in our scoring system. With Graham out of the race Clinton now leads the field over the not much less hawkish Senator Marco Rubio.

At the other end of the spectrum, Senator Rand Paul unsurprisingly brings up the rear as the least interventionist candidate, along with Governor O’Malley. Governor Christie also scores quite low given the hawkish tone he has struck in all of the Republican debates thus far. It seems likely that as the campaign progresses and he continues to press his case as the counterterrorism expert that we will see his score go up. Senator Sanders, on the other hand, may not deserve quite as high a score as he gets. Although he has called for air support for Iraqi forces in the fight against ISIS, most of his score comes from a half-hearted call to combat terrorism worldwide in response to a question in the last Democratic debate.

Things will shift as the campaign moves forward. It will be interesting to see how the Republican candidates do or don’t shift their interventionist rhetoric as they approach the primaries and then again when the eventual nominee launches into the general election. Meanwhile, Hillary Clinton is already running as the most hawkish and interventionist Democrat in a very long time. Having staked out such a position as she appeals to Democratic primary voters, it is hard to see her becoming any less interventionist in the general election as she begins to appeal more energetically to moderate voters.

2016 Presidential Candidate Intervention Meter


Scoring Rules:

Calls for ground forces

High (i.e. thousands of troops): 100 points
Medium (i.e. embed with Iraqi forces): 50 points
Low (i.e. Special Forces): 25 points

Calls for Air Power

High (i.e. carpet bombing): 50 points
Medium (i.e. air support for Iraqi forces): 25 points
Low (i.e. drone strikes to kill terrorists): 10 points

Calls for No Fly/Safe Zones: 10 points

Calls for global/unlimited action against terrorism: 100 points

Philip Bump of the Washington Post, still in thrall to the labor theory of Congress’s value, declares, “The 112th Congress, you might remember, was the least productive in modern times.” That is to say, it passed fewer bills than other recent Congresses. But all is not lost!

After the first year of this 114th Congress, more bills have been enacted than in the 112th or 113th, according to data compiled by So far, the 114th is tracking more closely with the more-productive 110th and 111th.

So good news for those of you have been worrying that you didn’t have enough new laws to discover, understand, and obey. Bump’s article is full of charts and data, all organized around the theme that a good, “productive” Congress is one that produces bills.

But as I’ve written before, journalists may well believe that passing laws is a good thing, and passing more laws is a better thing. But they would do well to mark that as an opinion. Many of us think that passing more laws – that is more mandates, bans, regulations, taxes, subsidies, boondoggles, transfer programs, and proclamations – is a bad thing. In fact, given that the American people pondered the “least productive Congress ever” twice, and twice kept the government divided between the two parties, it just might be that most Americans are fine with a Congress that passes fewer laws.

Is a judge “less productive” if he imprisons fewer people? Is a policeman less productive if he arrests fewer people? Government involves force, and I would argue that less force in human relationships is a good thing. Indeed I would argue that a society that uses less force is a more civilized society. So maybe we should call the 112th and 113th Congresses the most civilized Congresses since World War II (the period of time actually covered by the claim “least productive ever”), and the first session of the 114th Congress slightly less civilized.

As before, I wonder if congressional reporters would applaud the productivity of such Congresses as

The 31st Congress, which passed the Fugitive Slave Act in 1850

The 5th Congress, which passed the Alien and Sedition Acts in 1798

The 21st Congress, which passed the Indian Removal Act in 1830

The 77th Congress, which passed Public Law 503, codifying President Franklin D. Roosevelt’s Executive Order 9066 authorizing the internment of Japanese, German, and Italian Americans, in 1942

The 65th Congress, which passed the Eighteenth Amendment (Prohibition), the Espionage Act, and the Selective Service Act, and entered World War I, all in 1917

And hey, fans of legislation: If you’re really disconsolate over the passage of barely more than 100 new federal laws a year, take heart: According to my former colleague Ryan Young, now with the Competititive Enterprise Institute, federal regulators are on pace for the most pages in the Federal Register in a single year. They’ll need a strong final week, but Ryan thinks they can break the old record of 81,405 pages of new regulations. Will the Washington Post hail the regulators’ “productive” year? How about the Americans who have to comply with those regulations?

After the Supreme Court blocked Hawaii’s race-based election pending appeal, its organizers—a government contractor named Na’i Aupuni—canceled it and decided instead to seat all the candidates as delegates to a special constitutional convention for the purported new nation of “native Hawaiians.” The plaintiffs have asked the Supreme Court to find the election/convention organizers in contempt of its earlier order. Meanwhile, the appeal of the district court’s earlier denial of an injunction proceeds in the U.S. Court of Appeals for the Ninth Circuit. Cato has joined the American Civil Rights Union on a brief supporting the challengers. We point out that this is the second time that Hawaii has attempted to conduct a discriminatory voter-registration procedure to facilitate a racially exclusionary election. The first time this occurred, the Supreme Court held that such elections violate the Constitution. Rice v. Cayetano (2000). Things are no different this time. The voter qualification requirements here again make eligibility contingent on ancestry and bloodlines, which are nothing more than proxies for race. (There’s a further requirement that voters affirm a belief in the “unrelinquished sovereignty of the Native Hawaiian people,” which is an ahistorical assertion.) Such a discriminatory scheme is per se unconstitutional under the Fifteenth Amendment.

For PR professionals, the holiday season is like one big Friday at 5:00 p.m. That’s when you release information that you don’t want getting too much attention.

So it’s no surprise that we learned yesterday that the Transportation Security Administration has just awarded itself the authority to make airport strip-search machines mandatory. Until now, having a machine create a digital representation of your unclothed body has had a happy alternative: a prison-style pat-down! (That’s my choice. It’s sometimes a little massage-y.)

It takes a lot of gall for the Department of Homeland Security to make this move now, though—not because it’s the holiday season, but because the DHS (of which TSA is a part) is currently under a court order to establish the legality of its strip-search machine policies in toto.

In July 2011, the D.C. Circuit Court of Appeals ruled that the DHS had failed to follow the procedures required by law when it established its policy of using strip-search machines for primary screening. The court ordered the DHS to “promptly” undertake a notice-and-comment rulemaking. Four years later, our friends at the Competitive Enterprise Institute initiated a new lawsuit seeking to compel DHS to finish what was amounting to an endless rulemaking process.

DHS recently told the D.C. Circuit that it would finish the regulation by March 3, 2016. In the meantime, they’re screwing the lid down just a little bit more on air travelers. Chutzpah!

When the regulation is done, it can finally be challenged under the Administrative Procedure Act’s “arbitrary and capricious standard.” Our John Mueller and Mark Stewart have already shown that strip-search machines are a cost-ineffective security measure.

In a similar vein, rumors are swirling that the DHS will soon announce full REAL ID enforcement at airports. The quiet week between Christmas and New Years seems like a ripe time to get that news out.

They’ve said they’d give 120 days’ notice that TSA is going to start rejecting drivers’ licenses and IDs from states that don’t participate in the national ID system. A December announcement means that April would be white-knuckle time for travelers.

There will not be enforcement, of course. The goal is to bluff about enforcement to state legislatures in advance of their 2016 legislative sessions, so that they’ll pass laws implementing the federal national ID mandate. Just yesterday, two DHS bureaucrats issued orders to Minnesota governor Mark Dayton (D) detailing how the law in Minnesota must change to satisfy their demands.

Federal bureaucrats ordering around governors and legislators! Chutzpah!

DHS isn’t dumb enough to do it … I’m sometimes wrong … but actual REAL ID enforcement at airports would be quite a show. Not only would there be howls of protest aimed at TSA in the media, the DHS would catch a delicious lawsuit from some law-abiding American citizen trying to visit family who is denied the right to travel.

The lawsuit would expose that DHS enforcement is entirely arbitrary. REAL ID is unworkable, and the agency has been handing out waivers like they were candy canes since the statutory deadline in 2008. Having selected a pared-down “material compliance checklist” to treat as compliance, DHS bureaucrats have been arbitrarily claiming that some states are in compliance and some states are not, giving waivers to some states and not to others based on internal, self-selected criteria. That is not how law works, and once they try to enforce, they’ll have to square-up their enforcement efforts with the terms of the REAL ID law, equal protection, and due process.

Should DHS try to show that it has rational criteria for refusing IDs, that may bring in the question of ID security, which, like strip-search machines, is another cost-effectiveness loser. I won’t belabor that point, but my Christmas list includes a TSA and DHS operating under the rule of law, required to defend its programs in light of solid points made by security analysts like this guy Adam.

Learn more than you ever wanted to know about REAL ID from this recent Hill briefing.

The recent Omnibus increased H-2B visas for seasonal non-agricultural workers by not counting some renewals against the annual cap of 66,000.  Numerical estimates of the increase vary widely but the Congressional Budget Office estimated 8,000 additional H-2B visas will be issued in 2016.  This small policy shift is consistent with channeling would-be illegal immigrants onto temporary work visas – a strategy that has succeeded in decreasing unlawful immigration. 

There has been a dramatic decrease in Mexican unlawful immigration over the last decade.  The majority of illegal immigrants apprehended along the border had always been Mexican until 2014.  Beginning in 2006, with the slowdown in the housing boom, fewer Mexicans started coming to the United States illegally which led to fewer apprehensions.  The number fell to 229,178 in 2014, down from 1,073,468 in 2004. 

Mexican illegal immigration did not rebound after the Great Recession because the United States had expanded temporary migration programs that allowed far more Mexicans to enter lawfully.  Mexican migration to the United States didn’t disappear – it just became legal.  The Omnibus’ modest expansion of H-2B visas builds on this successful strategy by widening the legal pathway for lower-skilled migrant workers.

The Omnibus’ H-2B visa reform is an important, albeit small, part of continuing this strategy.  H-2B admissions are up 20 percent from 2002 to 2013 while the percentage of Mexicans getting those visas rose from 64 to 84 percent.  As the H-2B expanded, it also Mexicanized, diverting many would-be Mexican unlawful immigrants and their families onto legal temporary migrant visas. 

Increased Temporary Migration

There has been a tremendous rise in the number of temporary migrants on E, H, O, P, and L visas along with their derivative family members.  Their number of admissions increased by 104 percent from 2002 to 2013, from about 1.5 to 3 million (Chart 1). The number of Mexican temporary migrants admitted increased 512 percent during the same time period, which explains the rapid collapse in Mexican illegal immigration.  Mexican migrants didn’t stop coming after 2006, they just came legally as the temporary migrant programs expanded. 


Source: Yearbook of Immigration Statistics

The share of temporary worker visa admissions that went to Mexicans also increased from 7 percent in 2002 to over 21 percent in 2013 (Chart 2).  Not only were more visas issued but a larger percentage of them went to Mexicans. 

Chart 2

Mexican Share of All Temporary Migrants

Source: Yearbook of Immigration Statistics

Chart 3 combines the gross number of Mexican illegal immigrants (gross) who successfully entered the United States each year with the number of Mexican temporary migrants.  It reveals a line that shows a dip during the Great Recession that soon recovers afterward to the pre-recession migration levels.  The only difference post-recession is that most of them are coming legally.  An average of 929,000 entered each year from 2002 to 2005.  During the post-recession years of 2010 to 2013, an average of 930,000 entered each year.       

Chart 3

Mexican Temporary Workers and Illegal Immigrants

Source: Yearbook of Immigration Statistics

Chart 3 obscures the spectacular decline of Mexican illegal immigration that began in 2006 and the increase in legal temporary Mexican migration that took its place.  Beginning in 2009, an increase in temporary migrant visas funneled Mexicans who would have otherwise entered illegally onto visas (Chart 4).  The number of admissions for Mexican temporary migrants surpassed illegal Mexican entrants in 2008 and every year afterward.  The percent of all Mexicans that entered on temporary visas (excluding green cards) increased from 11 percent in 2002 to 57 percent in 2008 to 71 percent in 2013.  I attribute this shift to both an increase in temporary migrant admissions which decreased the supply illegal Mexican entrants by funneling them in to a legal market.           

Chart 4

Legal Temporary Mexicans and Illegal Mexicans

Source: Pew Research Center, Yearbook of Immigration Statistics, Author’s Calculations

Temporary legal migrants gradually displaced those who came illegally.  From 2002 to 2008, the change in the number of Mexican illegal immigrants each year explains 97.8 percent of the variation in all Mexican entrants.  From 2009 to 2013, the annual change in temporary migrants on visas explains 97.8 percent of the annual variation in all Mexican entrants.  Legal temporary visas are now driving Mexican migration.        

The temporary visas also include the family members of these workers who enter as derivatives.  Family reunification has been an important component of unlawful immigration so allowing them to come reduces the pressure to migrate illegally.

Each visa issued during the 1950s-era Bracero guest worker visa program displaced 3.4 illegal workers.  If anything like that relationship hold today, the expansion in temporary migrants visas and mobility is the only policy preventing a re-ignition of unlawful Mexican migration on a pre-recession scale.    

Increased Enforcement or Increased Legal Migration?

Another explanation for the decrease in Mexican illegal immigration is that border enforcement improved and became an actual deterrent.  The same people who make that argument also paradoxically claim that President Obama left the border wide-open, but no matter. 

The number of Border Patrol agents is negatively correlated with both the gross flow (-0.93) and net change in Mexican illegal immigration (-0.9) from 2002 to 2013.  In other words, more Border Patrol agents seem to deter unlawful immigration.  However, the increase in temporary Mexican migration and the decrease in gross Mexican illegal immigration has a correlation coefficient of (-0.82) while the correlation between apprehensions and temporary migrants is -0.94.  Part of the reason why they’re so similar is that the numbers of Border Patrol agents and temporary Mexican migrants move in the same direction (+0.93).  That’s hardly a slam-dunk for the enforcement cheerleaders. 

If Border Patrol deters Mexican illegal immigrants then it should also deter those from countries other than Mexico (OTM).  Remarkably, the gross flow of illegal OTM migrants is positively correlated with the number of Border Patrol agents (+0.29).  Even the number of OTMs apprehended on the border is positively correlated with the number of Border Patrol agents (+0.06) while the correlation for the selected years of 2009 to 2013 is greater still (+0.50), showing a distinct lack of deterrence for OTMs.  Perhaps those OTM number would be even greater if it weren’t for Border Patrol getting more effective but the proponents of this theory have yet to demonstrate that.    

The number of OTM illegal immigrants has increased as the number of Mexicans has fallen (Chart 5).  If Border Patrol is really responsible for the collapse in Mexican illegal immigration, then why did the apprehensions of OTMs increase along with the number of Border Patrol agents?

Chart 5

Mexicans and OTMs Apprehended and Number of Border Patrol Agents

Source: Customs and Border Protection


Above I use temporary admissions of guest workers and their families on I-94s as a proxy measurement for the increase in temporary migration.  An I-94 is made each time a temporary migrant enters the United States.  Several I-94s could be issued to each migrant as they go back and forth across the border during a given year, so a temporary migrant could rack up several I-94s over the course of his or her work period.  That means there are more I-94s for temporary migrants than there are temporary migrants.  Regardless of the I-94 increase, whether due entirely to a relaxation of mobility restrictions or an increase in the numbers, they are now more substitutable and able to displace illegal migrants.

Billionaire Warren Buffett is campaigning with presidential candidate Hillary Clinton, and he is echoing her class warfare rhetoric. In Nebraska the other day:

As Mr. Buffett introduced Mrs. Clinton, he outlined statistics showing that the richest 400 Americans saw their incomes rise sevenfold between 1992 and 2012, the most recent year IRS data were available. During that period, their average tax rate dropped by about one-third, he said.

Buffett is referring to this data published by the IRS. The sevenfold increase Buffett refers to is not adjusted for inflation. The IRS provides a column with inflation-adjusted income, but Buffett decided not to use that data.

But the main problem with Buffett’s statement is that the one-third tax rate drop is explained by 2012’s lower capital gains and dividend tax rates. Buffett probably wants people to believe that nefarious loopholes caused the drop, but the real reason was a serious policy change widely supported by economists and tax experts.

Under the income tax, dividends and capital gains are generally taxed at both the corporate and individual levels. That double taxation creates serious distortions, such as inducing U.S. corporations to become excessively indebted. The capital gains and dividend tax rate cuts under George W. Bush (now rescinded) partly fixed the double taxation.

In the following table, I roughly recalculate the 1992 and 2012 tax rates for the Top 400 excluding the reduced-rate dividends and capital gains. (Capital gains had a reduced rate both years, and dividends had a reduced rate in 2012).

Without the reduced rates on capital gains and dividends, the average tax rate for the Top 400 was virtually unchanged—25.6 percent in 1992 and 25.4 percent in 2012.

So Buffett’s complaint about the tax rate on top earners is really a complaint about tax reforms for capital gains and dividends. Rather than trying to inflame liberal voters with out-of-context data, Buffett should provide his economic arguments about the proper treatment of capital gains and dividends in the tax code.

I provide the arguments for reduced capital gains tax rates here. Just about every developed country has reduced capital gains tax rates. In 2012 the average tax rate across the OECD was just 16 percent. So Buffett should explain why he thinks all those countries are getting it wrong on capital gains.

There are other interesting things about the IRS data on the Top 400. Buffett, Clinton, Sanders, and the rest would have us believe that this is a permanent group of the wealthy aristocracy. Actually, there is huge turnover in the Top 400, as I discuss here. Most reach this top group for only a single year, often when they are selling their family businesses and realizing a capital gain. The IRS table shows that 68 percent of all income of the Top 400 is capital gains.

Finally, the IRS data show that the share of overall federal taxes paid by the Top 400—even with the reduced capital gains and dividend tax rates in 2012—rose from 1.04 percent in 1992 to 1.89 percent in 2012. Buffett is quoted saying of the Top 400, “the game has been stacked in their direction.” But if the Top 400 are paying a higher share, the game is clearly stacked against them.

In his 1999 book The Age of Spiritual Machines, the famed futurist Ray Kurzweil proposed “The Law of Accelerating Returns.” According to Kurzweil’s law, “the rate of change in a wide variety of evolutionary systems (including but not limited to the growth of technologies) tends to increase exponentially.” I mention Kurzweil’s observation, because it is sure beginning to feel like we are entering an age of colossal and rapid change. Consider the following:

According to The Telegraph, “Genes which make people intelligent have been discovered [by researchers at the Imperial College London] and scientists believe they could be manipulated to boost brain power.” This could usher in an era of super-smart humans and accelerate the already fast process of scientific discovery.

Elon Musk’s SpaceX Falcon 9 rocket has successfully “blasted off from Cape Canaveral, delivered communications satellites to orbit before its main-stage booster returned to a landing pad.” Put differently, space flight has just become much cheaper since main-stage booster rockets, which were previously non-reusable, are also very expensive.

The CEO of Merck has announced a major breakthrough in the fight against lung cancer. Keytruda “is a new category of drugs that stimulates the body’s immune system.” “Using Keytruda,” Kenneth Frazier said, “will extend [the life of lung cancer sufferers] … by approximately 13 months on average. We know that it will reduce the risk of death by 30-40 percent for people who had failed on standard chemo-therapy.”

Also, there has been massive progress in the development of “edible electronics.” New technology developed by Bristol Robotics Laboratory “will allow the doctor to feel inside your body without making a single incision, effectively taking the tips of the doctor’s fingers and transplant them onto the exterior of the [edible] robotic pill. When the robot presses against the interior of the intestinal tract, the doctor will feel the sensation as if her own fingers were pressing the flesh.”

Congress rejected the Forest Service plan to give the agency access to up to $2.9 billion a year to suppress wildfires. In response, Secretary of Agriculture threatened to let fires burn up the West unless Congress gives his department more money. In a letter to key members of Congress, Vilsack warned, “I will not authorize transfers from restoration and resilience funding” to suppress fires. If the Forest Service runs out of appropriated funds to fight fires, it will stop fighting them until Congress appropriates additional funds.

This is a stunning example of brinksmanship on the part of an agency once known for its easygoing nature. Since about 1990, Congress has given the Forest Service the average of its previous ten years of fire suppression funds. If the agency has to spend more than that amount during a severe fire year, Congress authorized it to borrow funds from its other programs, with the promise that Congress would reimburse those funds later. In other words, during severe fire years, some projects might be delayed for a year–hardly a crisis.

Yet Vilsack and the Forest Service are intent on turning it into a crisis. In a report prominently posted on the Forest Service’s web site, the agency whines about “the rising costs of wildfire operations”–that cost not being the dollar cost but the “effects on the Forest Service’s non-fire work.”

Numerous graphs in the report show declines in inflation-adjusted funding for various line items–but, deceptively, none of the graphs have the Y-axis set to zero, thus exaggerating those declines. Moreover, many of those line items are ridiculous anyway: who cares of land-management planning budgets have declined? The Supreme Court decided in 1998 that land-management planning was a waste of time, so why are they still spending any money at all on it? In any case, most of the items tracked by the charts aren’t programs the Forest Service borrows against for fire, so creating the proposed $2.9 billion emergency fund would do nothing to stop the funding declines.

The question Vilsack should ask is not “Why won’t Congress give his agency a blank check?” but “Why does the Forest Service spend so much on fire anyway?” The answer to that question is complex but comes down to one simple thing: the Forest Service has no incentive to control costs as long as Congress keeps reimbursing them.

As wildfire historian Stephen Pyne wrote in 1995, Forest Service fire managers have long been known for “creative accounting,” transferring “as many costs as possible” to the emergency fire funds. One of these is the “presuppression fund” that becomes available when fire danger is high; the other is the suppression fund that becomes available when a fire isn’t controlled by the first responders. When either of these conditions takes place, Pyne notes, “everything imaginable is charged to fires.” This situation has only gotten worse in the last two decades.

So it’s not surprising that many Forest-Service-fed news articles have reported that 2015 was the costliest fire year ever, citing Forest Service costs of $1.7 billion. But none of the articles mention costs to the Department of the Interior, and while I can’t find that number anywhere, I suspect it was not a lot more than half a billion dollars, as the most it has ever spent in the past was around $470 million.

The reason why this is important is that most fires this year were on Interior lands, not national forests. The Forest Service and its parent, the Department of Agriculture point to the near-record number of acres burned in 2015, about 9.8 million. But less than 20 percent of those acres were on national forest lands, while 54 percent were on Interior lands. 

Firefighting Costs Per Acre Burned   Forest Service Interior 2010 2,834 177 2011 818 200 2012 564 105 2013 983 252 2014 1,371 264 2015 922 ? Average 916 171

As the table above shows, the Forest Service habitually spends more than five times as much as the Department of the Interior per acre burned on their respective lands. Unlike the Forest Service, Interior agencies have never had a blank check for suppressing fire, so they have had little incentive to wildly overspend. 

Worse, Congress’ policy of giving the Forest Service the average of its previous ten years’ of fire suppression costs gives the agency an incentive to spend more each year so that its ten-year average spirals upwards. Meanwhile, in mild fire years, Congress says that the appropriated fire suppression funds that the agency doesn’t need “may be transferred to the National Forest System, and Forest and Rangeland Research accounts to fund forest and rangeland research, the Joint Fire Science Program, vegetation and watershed management, heritage site rehabilitation, and wildlife and fish habitat management and restoration.” 

Thus, it’s heads the Forest Service wins; tails the taxpayers lose. When fire years are mild, the agency gets a windfall to spend on non-fire programs. When fire years are severe, it gets to borrow from those non-fire programs to spend all it wants on fire suppression, knowing it will be reimbursed–and then complains that its non-fire programs are hurt by the borrowings.

One of the reasons why the administration and some environmental groups are behind the Forest Service proposal to give it $2.9 billion a year to draw upon is that increasing fire costs fit neatly into their global climate apocalypse. Yet the data don’t show that the United States is suffering worse droughts today than in the past. According to the National Oceanic and Atmospheric Administration, the percentage of the nation that was severely or extremely dry during summer months (July-September) averaged about 15 percent in 2015. That’s high, but hardly a record.

In recent years, this percentage has ranged as low as 3 percent in 1992 to as high as 24 percent in 1953. It was 20 percent in 2012 and 22 percent in 2000. There was a six-year period in the 1950s when it was 15 percent or more in all but one year (when it was 13 percent), and reached as high as 24 percent. So far, both the 1930s and the 1950s were dryer than the 2010s. This suggests that droughts are cyclical, not growing.

What is growing is the Forest Service’s spending on fire. It will continue to grow until Congress gives the agency incentives to contain its costs rather than incentives to spend more each year.

On December 3, Congress passed a new highway and transit bill allocating $305 billion over the next five years.  Part of the funding, allegedly $35.8 billion, will be taken from the Federal Reserve’s capital account.  Further details on the maneuvering between the Senate and House versions, and Fed objections, are here, here, and here.  Under the final compromise bill, about 8 percent of the Fed’s $35.8 billion contribution will involve a diversion of dividends from commercial banks, but the remainder is just a silly and deceptive gimmick for covering future federal expenditures.  Both the banks and the Fed failed in their last-minute efforts to curtail these provisions during the debate over the omnibus spending bill that Congress passed last week.

To appreciate exactly what these provisions will do, we need to examine more closely the nature of the Fed’s capital account.  The Fed is only nominally owned by its member banks, which comprise all nationally chartered banks and eligible state-chartered banks that choose to join.  Member banks are required to hold an amount equal to 6 percent of their own capital and surplus in the “shares” of their respective district Federal Reserve Banks.  Half of this amount is paid in; the other half is subject to call by the Fed’s Board of Governors.  As member banks increase or decrease in size, their holdings must be adjusted accordingly.  Obviously these “shares” are not like ordinary shares.  They cannot be bought or sold on a secondary market, nor are they in any sense residual claims to the Fed’s earnings.

In exchange for these “shares,” member banks get a few limited privileges.  Prior to 1980, the Fed’s check clearing and discount window was confined to member banks, but since then all banks and other depositories have access to both of these, with a market fee now imposed for check clearing.  Member banks still get to choose six of the nine directors of their respective district Fed Banks, but only with severe constraints, which have gotten more severe with the passage of the Dodd-Frank Act.  This gives banks some slight formal and circuitous influence over Fed policy.

But the main benefit of these “shares” is the dividend they pay, until now fixed by law at exactly 6 percent of the paid-in portion of a member bank’s capital.  This is a bad deal for banks whenever inflation and nominal interest rates are high but a very good deal since the financial crisis.  These “shares” therefore are financially more like debt than equity, in which member banks pass on funds to the Fed, which in turn buys Treasury securities (almost exclusively in the past) and now mortgage-backed securities.  The member banks are in effect indirectly loaning money to the government in exchange for a fixed 6-percent return.

The Senate version of the highway bill would have reduced the members dividends to 1.5 percent, with the remaining 4.5 percent payable by the Fed to the U.S. Treasury.  When member banks unsurprisingly and strongly objected, the House struck out this provision to replace it with a second way of tapping into Fed capital explained below.  The bill’s final compromise ties the dividend for member banks with more than $10 billion in assets to the interest rate on 10-year Treasury bonds, currently 2.2 percent, up to a maximum of 6 percent.  This will release for payment to the Treasury an estimated $2.8 billion over the next five years.  In essence, it constitutes a trivial reduction in the interest cost of government borrowing, annually about a quarter of a percent of the government’s current interest costs of over $200 billion (and this is net of existing Fed remittances to the Treasury).

This feature of the bill also makes more obvious the fact that the so-called “ownership” of the Fed by private banks is little more than a requirement to fund the Treasury.  The reduced dividend over the long run may decrease the attractiveness of Fed membership for state-chartered banks.  Given that the Fed power over non-member banks is now almost as extensive as over member banks, that hardly seems to matter much.  The one attractive aspect of this way of funding is that, rather than increasing the total level of government spending, it merely redirects outlays from banks to transportation.

The paid-in portion of member bank “shares,” however, is only one of two components of the Fed’s capital account.  The other component, labeled “surplus,” comprises residual Fed earnings from interest on its assets.[1]  The House version of the bill, instead of diverting dividends, proposed employing this surplus capital, which today amounts to $29.3 billion, to cover new expenditures on highways and transit.  Congress in the past has imposed levies on the Fed’s surplus, starting in 1933, when it took half to fill the coffers of the new Federal Deposit Insurance Corporation.  In 1997 and again in 1998, Congress pulled out $100 million, and in 2000 it extracted $3.7 billion.  Yet in each of these cases, the Fed replenished the surplus out of subsequent earnings.  The House, in contrast, intended to empty the account permanently.  The compromise version of the bill that passed both houses caps the Fed’s surplus capital at $10 million, with the remaining being passed to the Treasury, supposedly providing $33 billion of extra revenue over the next five years.

Until now, the Fed has almost always kept the value of surplus capital equal to the value of the other, paid-in component of the Fed’s capital, a mere reflection of that half of member bank “shares” that have not been paid in.  Only briefly have Federal Reserve district banks ever drawn down their capital surplus, at least 158 times according to 2002 study by the General Accounting Office (since renamed the Government Accountability Office).  This step was taken so as to absorb losses the Fed had incurred, mainly through its foreign-exchange operations, between 1989 to 2001.

But since the Fed creates money, the surplus capital is basically an accounting mirage.  There  is no idle pot of cash sitting in the account.[2]  Any money that has been paid into the Fed — either through the sale of assets, through repayment of loans made by the Fed, or even through interest the Fed has earned on its assets — is not counted in the monetary base.  When the receipts come from private banks or the general public, the money is withdrawn from circulation at the moment the Fed receives it, temporarily vanishing.  Only if the Fed again pays out that money, does the monetary base go back up.  Of course, much of it is immediately paid back out, as the Fed rolls over its asset portfolio or covers its operating expenses, so there is a constant flow of base money in out.  Yet otherwise, these Fed receipts merely create an accounting entry on the Fed’s balance sheet labeled either as “accrued dividends and other liabilities” or “surplus capital.”

Much of the Fed’s revenue, however, comes not from the private sector but directly from the Treasury, as interest on the Fed’s portfolio of Treasury securities.  Prior to the financial crisis, this was indeed the primary source of Fed income, but now it accounts for just a bit more than half of the total ($63 billion out of total earnings of $116 billion for calendar year 2014), with nearly all of the remainder from interest on mortgage-backed securities.  The effect of these Treasury interest payments on the monetary base is a bit convoluted, but broadly it works out the same as for other Fed earnings.  The difference is that the money has already been pulled out of circulation by the Treasury.[3]  Still, when the Treasury initially pays interest to the Fed, the net amount not paid out again appears on the Fed’s balance sheet as “accrued dividends and other liabilities” or “surplus capital.”

In other words, the surplus capital is merely an entry on one side of the Fed’s balance sheet matching assets on the other side.  To be sure, those assets do earn interest.  So one way of thinking about the Fed’s surplus capital is that it permits the Fed to hold interest earning assets without increasing the monetary base.  But after covering its expenses, the Fed remits most of its earnings to the Treasury on a monthly basis.  (Out of $116 billion in Fed interest earnings from all sources during 2014, $97 billion was remitted to the Treasury.)  Thus, to the extent that surplus capital increases the size of the Fed’s balance sheet, any additional earnings are ultimately funneled back to the Treasury already.[4]

With no actual money in the surplus capital account to begin with, the Fed can only reduce the account in one of three possible ways.  The most straightforward would be for the Fed to create $19.3 billion of new base money for the Treasury to spend.  In the first year, surplus capital would be run down to $10 billion, with $19.3 billion of Fed deposits and currency on the same side of the balance sheet ultimately replacing this fall in capital.[5]  The total on each side of the balance sheet would remain unchanged.  The Congressional Budget Office estimates that future increases in the capital of member banks will require the Fed to continue funneling between $2 and $3 billion of “surplus capital” per year to the Treasury.  Because this method increases the money supply and is mildly inflationary, the Fed will more likely sterilize the transfer in two other ways discussed by Ben Bernanke in a blog post criticizing the House plan.

One of these alternatives would involve the Fed immediately selling off $19.3 billion of Treasury securities and transferring the proceeds from those sales to the Treasury.  This would reduce the Fed’s total balance sheet on both sides by the same amount, but keep the monetary base roughly unchanged, sterilizing the transfer.  But since the Treasury securities sold are now owned by the general public rather than the Fed, the Treasury no longer receives Fed remittances for the interest paid on this portion of its debt.  What the Treasury has gained in one lump sum it now looses in the form of future income from the Fed, with the present value of both approximately the same.  In short, with no new revenue or increased taxation, the Treasury’s new transportation expenditures will merely increase government deficits.

The Fed could instead cover its payment of $19.3 billion to the Treasury by directly reducing its regular Treasury remittances.  In effect, the Fed would still only be giving back to the Treasury what it has first received from the Treasury in the form of interest payments.  Again, the Treasury will lose approximately as much as it gains.  Recall that in 2014, total Fed remittances to the Treasury came to $97 billion.  So all the Fed would have to do is reclassify $19.3 billion of its future excess earnings as a payment from the surplus capital.  To simultaneously reduce the surplus account to $10 billion without selling off any assets, all the Fed needs to do is move $19.3 billion into “other liabilities and accrued dividends.”  Ceteris paribus, the balance sheet totals and the monetary base remains unchanged.  The additional highway spending will still increase current and future budget deficits.

The Fed will probably use some judicious mix of all three methods to comply with the new requirement.  Admittely, reducing the surplus capital from $19.3 to $10 billion also reduces the amount subject to call by the Fed Board from member banks.  But since the Fed creates money, it has no need to exercise this call.  This reduction in capital on call could decrease the extent to which the Fed can impose on bank shareholders any losses from a bank failure.  Given how many other capital controls are placed on banks through the Fed, FDIC, and other federal agencies, it is hard to imagine that this will really have noticeable consequences.

In the final analysis, the only significant change for the Fed brought about by the highway bill is the adjustment in dividends paid to member banks, probably a desirable reform.  The reduction in the Fed’s surplus capital, on the other hand, is an ineffectual cosmetic change, which the Fed can easily offset, raising the question of why Janet Yellen and other Fed officials have objected at all.  The most insidious and misleading aspect of this attempted raid on the Fed is Congress’s ridiculous pretense that it will finance a spending hike without increasing taxes, increasing the deficit, or having the Fed print money.  In reality, there are no other options.


[1] Prior to January 1, 2011, the Fed’s capital account included a third component, labelled “other capital,” which consisted of additional Fed earnings that had not yet been remitted on a monthly basis to the Treasury or paid out as dividends.  Since then, this component has been removed from the capital account and relabeled as “other liabilities and accrued dividends.”  But in practice, it works out the same as the surplus capital, except its total value, which is much lower, is more volatile.

[2] There is one minor exception. The Fed does hold as an asset some Treasury created base money in the form of coins, currently about $1.9 billion.

[3] I’ve abbreviated what happens for clarity.  Most tax and other payments from the public to the Treasury are initially deposited in tax and loan accounts at assorted depositories.  Since these Treasury bank deposits are not counted in the broader monetary measures, tax payments reduce the total money stock, ceteris paribus, but have no initial impact on the base.  Before the Treasury makes expenditures, it transfers these deposits from the banks to the Fed, sometimes within a day or less.  At that point, these transfers do reduce the monetary base.  On the Fed’s balance sheet, bank reserves fall by the amount by which Treasury deposits at the Fed go up.  The exact reverse occurs when the Treasury makes expenditures, except for when it pays interest to the Fed.

[4] Milton Friedman and Anna Jacobson Schwartz were well aware of the quasi-fictitious nature of the Fed’s capital accounts when in Appendix B, “Proximate Determinants of the Nominal Stock of Money,” of A Monetary History of the United States, 1867-1960 (Princeton, NJ: Princeton University Press, 1963), pp. 797-798, they consolidated the Fed and Treasury monetary accounts by subtracting Fed capital from U.S. government securities on the asset side.

[5] Again I’ve abbreviated.  Treasury deposits at the Fed will most likely go up with the initial fall in surplus capital, and the base will only increase as the Treasury draws down its deposits to spend the money.

[Cross-posted from]

Senator Bernie Sanders recently tweeted the following.

Fortunately, the gruelingly long workweek described by Sanders is not the norm. In fact, leisure time has been on the rise. In 1950, an average U.S. worker worked 1,984 hours a year, or about 38 hours a week. In 2015, an average American worker worked 1,767 hours, or about 34 hours a week.

That means that the average U.S. worker had 217 more hours for leisure or other pursuits in 2015 than in 1950. That is about 9 days of extra time.

The 50-hour workweek described by Sanders is more common in China, where the average worker worked 2,432 hours in 2015, or around 47 hours a week. Compare other countries using’s interactive dataset.

North Korean dictator Kim Jong-un has scheduled North Korea’s first communist party congress in decades in May. The U.S. should encourage reform by proposing talks on drafting a peace treaty and normalizing relations.

Dealing with the Democratic People’s Republic of Korea has taken on an air of futility in Washington. The Obama administration refuses to talk with North Korea unless the latter first “takes irreversible steps toward denuclearization.” Yet expecting Pyongyang to yield its most important security assets in return for conversation ensures continued failure.

The first party congress since 1980, when Kim’s grandfather, Kim Il-sung, ruled, portends significant policy changes. Kim Jong-un likely will formalize both consolidation of power and new economic initiatives.

The government has been pushing creation of a “knowledge economy.” Private enterprise is expanding. In this way, argued analyst Michael Bassett, Kim is “liberating” the DPRK.

A de facto property market has arisen in this once most tightly controlled society. Private financing has developed. North Korean and foreign banks are providing cash cards.

The number of official open-air private markets has more than doubled since 2010 to 406; another 1000 unofficial markets are thought to be operating. Eight of ten North Koreans have shopped at private markets.

Noted the Guardian, “Unlike most aspects of life in North Korea, one’s ability to shoot up through the company ranks is less contingent on background: even those with poor songbun, a caste system delineated by family background and political loyalty, can be a boss.”

As a result, a more prosperous, brightly dressed middle class has taken root. Jang Jin-sung, a psychological warfare officer who defected in 2004, wrote: “The key to change lies outside the sway of the regime—in the flourishing underground economy.”

Of course, economic reforms so far are modest, and have not yielded a fully private economy. Moreover, such changes can go only so far in transforming North Korean society.

As I wrote for Forbes: “China demonstrates that autocracy can coexist with free enterprise. In this regard the North has very far to go. But the PRC also shows rising economic liberty to offer the best hope yet for positive evolution over time.”

There are no serious alternatives. War would have devastating consequences.

Enhanced sanctions are a panacea oft-proposed in the U.S. However, there’s no guarantee that increased hardship would cause Pyongyang to capitulate. Moreover, despite Beijing’s evident displeasure with its troublesome neighbor, China remains unwilling to cut its economic lifeline to the North.

Nor would a North Korean implosion be pretty. Pyongyang could choose to strike out militarily. Collapse could send violence and refugees across the DPRK’s borders and loose nuclear materials even further. China might occupy the North and install a friendly regime.

The only other option is engagement, with a conscious attempt to moderate the threat environment facing both Koreas. But eliminating nuclear weapons cannot be the starting point. The possibility of bribing or coercing the North to abandon its nukes disappeared long ago.

Instead, Washington should begin where the North has suggested: negotiate a peace treaty. The best reason to talk may be the simplest: nothing else has worked.

Responding to North Korea’s initiative would offer two practical benefits irrespective of the outcome. First, the North tends to eschew provocative military actions when engaged in negotiations. Second, Beijing long has urged the U.S. to address Pyongyang’s security concerns. Taking the PRC’s advice might make the latter more likely to cooperate with Washington.

However, the most important reason to negotiate remains to encourage the DPRK to move further and faster along the reform path. Such a result might be a long-shot, but Kim Jong-un is dismantling the North Korean status quo.

Of course, discussions should be conducted without illusion. But refusing to engage ensures future failure.

North Korea’s upcoming party congress offers a possible opportunity to dampen hostilities. It’s time for the U.S. to attempt to finally end the Korean War.

On Friday, European Union envoys agreed to extend sanctions on Russia, continuing the restrictions placed on Russian businesses and citizens following Russia’s 2014 invasion of Crimea and aggression in Eastern Ukraine. The sanctions prevent some of Russia’s largest companies from raising capital in the West, restrict the export of technology and technical services for unconventional oil and gas drilling, and freeze the assets and travel of Russian elites.

Unfortunately, as I show in a study published in the January/February edition of Foreign Affairs, sanctions on Russia have been largely unsuccessful. The Russian economy is certainly hurting, but most of this damage was done by the extraordinary drop in oil prices over the last year:

The ruble’s exchange rate has tracked global oil prices more closely than any new sanctions, and many of the actions taken by the Russian government, including the slashing of the state budget, are similar to those it took when oil prices fell during the 2008 financial crisis.

And economic damage itself isn’t necessarily the best measure for sanctions success. Ultimately, sanctions are a tool of economic coercion and statecraft. If they do not cause a policy change, they are failing:

After the initial round of sanctions, the Kremlin’s aggression only grew: Russia formally absorbed Crimea and upped its financial and military support for pro-Russian rebels in eastern Ukraine (including those who most likely shot down the Malaysia Airlines flight).

The performance of modern targeted sanctions –which promise that damage will be narrowly focused on elites rather than the population in general – is also questionable in the Russian case, where the Kremlin has effectively redirected the economic burden of sanctions onto the population:

By restricting access to international financing during a recession, the sanctions have compounded the fall in oil prices, requiring Moscow to slash spending on health care, infrastructure, and government salaries, which has created economic hardship for ordinary Russians. The crash of the ruble, meanwhile, has not only destroyed savings but also increased the monthly payments of those who hold mortgages denominated in foreign currencies.

Perhaps worst of all, the sanctions are costing US and European companies billions of dollars in compliance costs, lost business and broken contracts:

The brunt is being borne by Europe, where the European Commission has estimated that the sanctions cut growth by 0.3 percent of GDP in 2015. According to the Austrian Institute of Economic Research, continuing the sanctions on Russia could cost over 90 billion euros in export revenue and more than two million jobs over the next few years. The sanctions are proving especially painful for countries with strong trade ties to Russia. Germany, Russia’s largest European partner, stands to lose almost 400,000 jobs. 

Ultimately, as I argue in the article, the success of sanctions can be judged by a variety of standards. Yet by virtually all of them, they are failing. This is a blow for those – myself included – who seek restrained policy options to resolve the crisis in Ukraine. Yet given the costs to U.S. businesses, it’s probably time for policymakers to consider whether continuing sanctions on Russia is really the best option, or whether there are more effective diplomatic or economic policy tools we can use instead.

You can read the whole article, with more data and policy recommendations, over at Foreign Affairs

It’s alas old news when the government couples an imposition on liberty with an exercise in futility—security theater, anyone?—but it’s still finding inventive ways to do so in a nifty case that combines the First Amendment, the Second Amendment, and 3D printing.

Defense Distributed, a nonprofit organization that promotes popular access to constitutionally protected firearms, generates and disseminates information over the Internet for a variety of scientific, artistic, and political reasons. The State Department has ordered the company to stop online publication of certain CAD (Computer-Aided Drafting) files—complex three-dimensional printing specifications with no intellectual-property protection—even domestically. These files can be used to 3D-print the Liberator, a single-shot handgun. The government believes that the files that could be used to print the Liberator are subject to the International Trafficking in Arms Regulations, because they could be downloaded by foreigners and thus are “exports” of arms information that could cause unlawful acts.

When Defense Distributed, ably represented by Alan Gura and Josh Blackman, challenged this restriction of its right to disseminate information to Americans—which the State Department’s own guidance says is protected by the First Amendment—the federal district court ruled for the government. Cato has now filed an amicus brief in the U.S. Court of Appeals for the Fifth Circuit, urging it to defend the First Amendment right of Americans to share open-source technical information.

Defense Distributed is not in the business of distributing arms. What it distributes, as properly recognized by the district court, is computer code in the form of CAD and other files. Code and digital files are speech for purposes of the First Amendment, as several federal appellate courts have recognized. Most importantly, simply because speech may be used for unlawful purposes by third parties doesn’t mean it loses constitutional protection.

Since the 1930s, the Supreme Court has consistently held that “the mere tendency of speech to encourage unlawful acts is not a sufficient reason for banning it,” and that “[p]rotected speech does not become unprotected merely because it resembles the latter. The Constitution requires the reverse.” Ashcroft v. Free Speech Coalition (2002). In the seminal case of Brandenburg v. Ohio (1969), the Court provided a baseline for judging statutes that ban protected speech because of the chance it could enable crime. Unless such encouragement is “inciting or producing imminent lawless action and is likely to incite or produce such action,” it’s protected by the First Amendment.

Moreover, the First Amendment requires “precision of regulation” in cases like this to survive even “rational basis” review—the lowest form of judicial scrutiny. But blanket restraints on methods of mass dissemination aren’t precise; the Supreme Court has said that such actions “burn the house to roast the pig.” Butler v. Michigan (1957).

To add practical insult to constitutional injury, attempting to shut down all Internet transfers of these files is an exercise in futility. The State Department would be better served by a more targeted approach that doesn’t infringe on the right to disseminate and receive information. The Fifth Circuit should reverse the lower court when it hears Defense Distributed v. U.S. Dep’t of State.

People have lots of ways to save for retirement. Most employers offer some sort of retirement plan, of course, and people whose employers don’t can set up their own retirement account and get the same tax benefits, albeit without any employer contribution.  Low-income workers at a job without a benefit plan can now participate in Treasury’s new MyRA program, which creates a retirement account for the worker and provides a match for their contributions.

And Social Security, which totals to 15.3% of the first $118,500 of a worker’s income, constitutes a big chunk of most people’s retirement income.

Should we do more to help retirees? Given that the poverty rate of senior citizens is well below that of the rest of society it’s sort of hard to say yes to that question, but the states are having none of it.

Several of them are now creating savings programs of their own,  bolstered by recent Department of Labor regulations that makes it easier for states to do such a thing.

Is this an example of the 50 laboratories of democracy experimenting to come up with a better way to do something? Of course not–it’s akin to each state setting up its own separate post office.

Payroll taxes already constitute 4.5% of GDP, and the government misses out on another $100 billion of tax revenue from the breaks given to encourage retirement saving. Given the enormous effort we already put forth to encourage (or force) people to save for retirement, arguing that we need yet more incentive plans on this front is a tough brief to prosecute, but even if the answer is yes it’s hard to see why the appropriate response would be for this to be done by the states.

The states already run their own college savings programs, and if we go by that record they’re not very good at this.  My wife and I have one of these (two, actually, since the District of Columbia essentially forces each parent to open up their own separate account) and the first few years of parenthood we put a few grand each in these.

Our money is invested in a stock index fund. Index funds are advantageous because they simply follow the aggregate stock market and don’t require any management team to make investment decisions. As a result, the management fee is very low–at places like Vanguard and TIAA-CREF it’s less than .09% of each dollar invested.

In my index fund the management fee is five times higher, at nearly .5%.  Why the difference? Part of it is because the District expropriates .15% to cover their costs of administering the program. The company that has the contract to run the funds for the program has a management fee for my index fund of .31, which is precisely 15 basis points the management fees on their regular index fund that I could buy if with my money that’s not in the college savings fund.  Apparently the city and the investment company are merely splitting surplus fees being charged to the participants.

Oh, and if a person who’s not a resident of the District of Columbia wants to open a college savings account with DC, he has a 5% fee up front taken out of his account.  5% is little more than the District fleecing people not paying attention, but the .3% adds up over time as well–over $6,000 for a family that sets aside $10,000 a year for a child’s 18 years before attending college.

The federal government thinks that excess fees are injurious–it recently issued new fiduciary rules governing investment advisers with the express goal of helping investors get into accounts with lower management fees. For it to turn around and sanction the states to get into this game is just nonsensical.

Believing in the precepts of federalism doesn’t mean we should countenance the states to try all sorts of new things that the federal government is doing. Things that the government is inherently not good at doing–and setting up new retirement accounts is arguably one of them–shouldn’t be done by the states or the feds. Retirement accounts fall comfortably into that category.

It’s late December, so that means it’s time for members of Congress to join together and celebrate around their own massive, legislative Christmas tree–the notorious omnibus–with earmark ornaments for nearly every congressional district. Reason’s Peter Suderman explains:

The deal is made of two different elements—a 2,009-page omnibus that folds in 12 appropriations bills and calls for $1.1 trillion in spending, and a separate 233-page tax “extenders” bill that continues about $650 billion worth of supposedly-but-not-really temporary tax cuts. All together, the package is worth about $1.8 trillion. 

Many of the tax breaks in the extenders bill are the sorts of tax “cuts” that are the sort of targeted, incentives-and-behavior altering tax cuts and deductions that are best thought of as spending laundered through the tax code. (This includes the child tax credit, various business expensing provisions, and a credit to help people under 40 pay for tuition expenses, as well as credits for wind and solar power.)

Broadly speaking, that’s the sort of spending that Republicans tend to like. The other part of the package, meanwhile, contains the sort of spending that Democrats tend to like.

There is perhaps no greater annual example of how concentrated benefits and dispersed costs conspire to increase Congressional spending. Moreover, as Jim Harper noted yesterday, the omnibus is also an opportunity to slip in highly controversial policies, like domestic surveillance. And yet conspicuously absent from the awful omnibus was one of the few programs that Congress has the constitutional authority to enact and actually benefits low-income students living in Washington, D.C.: the Opportunity Scholarship Program (OSP). In a sharp editorial yesterday, Wall Street Journal excoriated Congressional GOP leadership: 

The omnibus funds the program for fiscal year 2016 but fails to reauthorize it. This means that 20 years after the program was first debated, 10 years after it started, four years after Mr. Boehner revived it after President Obama had killed it, and a few months after the House passed a bill to reauthorize it, we’ll have to fight the battle all over again.

Worse, no one will explain how Nancy Pelosi prevailed despite Republican majorities in both houses.

Done right, the OSP could have saved money while improving student outcomes. Despite spending nearly $30,000 per pupil in recent years, D.C.’s district schools are consistently ranked among the worst in the nation. By contrast, the OSP’s vouchers are less than $9,000 on average and a random-assignment study found that OSP students were 21 percentage points more likely to graduate from high school than the control group. Had Congress allowed the funding to follow the child rather than funding the OSP and district schools out of two separate funds, as they do now, the OSP could have saved more than $20,000 per pupil while still producing better outcomes. And that doesn’t even count the significant savings from the increased graduation rate that researchers Patrick Wolf and Michael McShane calculated:

Because a high-school diploma makes an individual less likely to commit crimes, it therefore decreases both the costs incurred by victims of crimes and those borne by the public in administering the justice system. Coupled with the increased tax revenue made on the increased income, this yields an extra benefit for society of over $87,000 per high-school graduate.

Multiplying the number of additional graduates by the value of a high-school diploma yields a total benefit of over $183 million. Over the time of our study, the OSP cost taxpayers $70 million, so dividing the benefits by the cost yields an overall benefit-to-cost ratio of 2.62, or $2.62 for every dollar that was spent.

The omnibus spending bill is a terrible way to do business, and it would be better if the OSP could stand on its own (and even better if Congress transformed it from a voucher into an education savings account). Unfortunately, there is reasonable doubt whether the GOP will be able to persuade the president to sign a standalone bill reauthorizing the OSP. In other words, leaving the OSP out of the omnibus is a big gamble. That is especially concerning because thousands of kids depend on it and it needs stability to run effectively.

So yes, Congress should change the omnibus practice, but they shouldn’t make the OSP a test case.

Happy Star Wars launch day! As the newest film in the Star Wars franchise is exciting fans around the globe, it’s also offering a unique opportunity for foreign policy scholars: attempting to shoehorn Star Wars parallels and metaphors into foreign policy debates.

It’s certainly easy to do. Over at Foreign Policy, authors examine why the rebel victory at Endor may not have been the decisive battle it initially appeared:

Much of the chaos following the Rebel Alliance’s victory was predictable. Its wartime leaders were overwhelmingly focused on avoiding missteps and destroying their vastly more powerful enemy while ignoring the problems of violence, factionalism, and criminality that plague post-conflict environments across the universe.

You don’t have to work hard to see the clumsy historical metaphor here: the rebellion’s victory gave way to a ‘failed democratic transition,’ with the Rebel Alliance unable to turn their victory into a durable political settlement. In a post-Arab Spring world, the parallels are obvious.

Others examine Luke’s path to radicalization from his first encounter with Obi-Wan (a charismatic mentor with a strange new religion), to his return home to find his family killed by the Empire (presumably by drone strike), to his decision to join the rebels and overthrow the government. When the movie was initially released at the height of the Cold War, a decision to join the rebellion and fight the ‘evil empire’ was heroic. Today, with parallels to ISIS, it can seem less clear-cut.

Some commentators have gone even further, asking whether the Empire was really so bad. Neoconservative icon Bill Kristol noted on twitter that the Empire was a liberal regime with meritocracy and upward mobility. The post-Arab Spring Middle East certainly lends some credence to the idea that even a dictator might be better than chaos, though it requires us to overlook the Empire’s many war crimes.

But what each of these accounts gets wrong is their assumption that Star Wars should be interpreted as a representation of today’s world. Sure, the zeitgeist influences writers, directors, and musicians. Yet the great strength of the science fiction and fantasy genres has always been the ability to explore complex political issues, including foreign policy, in a setting distinct from today’s world.

HBO’s Game of Thrones presents a fantastical world with dragons and wights. But at heart, the story is about power, territory, and what people are willing to do for it. It’s hard to describe author George R.R. Martin as anything other than a pure Hobbesian realist, exploring the consequences of the anarchy that follows the demise of state authority.

Recent dystopian films illustrate the workings of non-democratic societies - The Hunger Games is fundamentally about the ways in which authoritarian regimes keep their population in line – while shows like Battlestar Galactica illustrate the unpleasant compromises societies at war often make within themselves and with the enemy.

With greater space, science fiction books can explore these issues more effectively. Robert Heinlein’s classic works focus on issues as diverse as Starship Troopers’ military-dominated society, and the asymmetric warfare required of a small colony (the moon) trying to escape a larger empire. Despite its futuristic mileu, Joe Haldeman’s Forever War is one of the best fictional explorations of the difficulties veterans face when returning home from war. And in Iain M. Banks’ culture novels, we find both a utopian socialist society, and the disturbing implication that its existence relies on a willingness to engage in covert, morally questionable actions.

The point is: don’t read too much into pundits’ claims that Star Wars is a metaphor for today’s politics. Science fiction’s strength is its ability to explore different governance structures, wars, societies, and political trade-offs in context. So if you want to understand politics, you shouldn’t just read philosophers and theorists. Start with Machiavelli, Hobbes, Locke, Kant, or Morgenthau. Continue with Heinlein, Herbert, Orwell, Asimov, Banks, Stephenson, and Gibson.  

And may the force be with you. 

“1. We must do something. 2. This is something. 3. Therefore, we must do this.” That’s not just a famous line from the BBC’s old comedy Yes, Minister, it might serve as a philosophy of government for about 90 Democrats on Capitol Hill led by Rep. David Cicilline (D-R.I.), who are seeking to revive a failed Clinton-era ban on so-called assault weapons that Congress let lapse a decade ago. (Gun homicide rates have plunged since the Clinton era.) 

The lawmakers’ timing could hardly be worse, with both the New York Times/CBS and ABC News/Washington Post polls showing American public opinion has turned against such bans, which once drew support at levels of 80% or higher. In the latest ABC poll, a 53-45 percent majority of Americans are opposed to such a ban.

That trend in opinion has been in progress for years, since well before this year’s shocking round of mass shootings in Charleston, San Bernardino, and elsewhere. And it owes much to the steady accumulation of evidence on such laws and their effect. Cato has long made gun control one of its topics of interest, with at least three recent publications shedding light on the assault-weapons controversy: David Kopel’s magisterial overview (summary) of the poor track record of supposed common-sense reforms, Jonathan Blanks’s distinction between the actual incidents that dominate gun crime statistics and the outlier episodes that are seized on as symbolic, and Trevor Burrus’s response to the New York Times’s recent overwrought front-page editorial. 

At the Volokh Conspiracy blog, UCLA law professor Eugene Volokh has been doing a series of posts (first, second, third, fourth so far) on why even a liberal gun-control advocate like Prof. Adam Winkler has come to see assault weapons bans as “largely ineffectual…bad policy and bad politics,” and why gun rights advocates are not unreasonable to see such bans as strengthening (desirably, for some proponents) the likelihood of future bans on conventional handguns. I’ve also covered the topic a couple of times at my Cato blog Overlawyered, including here (noting columnist Steve Chapman’s description of the ban as part of a “Potemkin Village” array of reforms with no discernible effect) and more recently here (noting false claims in circulation about mass shootings).

In my last post regarding Ben Bernanke’s memoir, I took Bernanke’s Fed to task for electing to sterilize its pre-AIG emergency lending, thereby making sure that, while it was rescuing a small number of troubled firms, it was also reducing the liquid reserves available to others. It was doing this, moreover, at a time when increasingly worrisome economic conditions were giving rise to exceptional liquidity demands. The predictable result was an overall shortage of liquidity, which manifested itself in a collapse of bank lending and spending.

I now turn to an even more mind-bogglingly wrongheaded step taken by Bernanke’s Fed in the course of the financial crisis: it’s decision to pay interest on banks’ excess reserves.

The Fed began paying interest on reserves (IOR) in mid-October 2008, just after ending its program of sterilized lending. That these steps coincided was no accident, for interest on reserves was meant to be a substitute for sterilization, aimed at the same result, namely: that of making sure that the Fed’s gross asset purchases did not give rise to any corresponding increase in bank lending.

The Fed resorted to IOR because, by the time of Lehman’s failure, it had reduced its Treasury holdings to their practical minimum. Consequently, when it came to bailing-out AIG, the Fed found itself in a quandary: the bailout would mean an increase in the overall size of the Fed’s balance sheet, and a like increase in the monetary base. Other things equal, the increase would mean a loosening of monetary policy. Yet the Fed was determined to avoid such a loosening.

It was to escape from this quandary that the Fed came up with the oh-so-clever idea of rewarding banks for not lending their otherwise unneeded reserves in the middle of one of the twentieth-century’s most severe economic contractions. You needn’t take my word for it. Here it is from the horse’s mouth:

We had initially asked to pay interest [in 2006] on reserves for technical reasons. But in 2008, we needed the authority to solve an increasingly serious problem: the risk that our emergency lending, which had the side effect of increasing bank reserves, would lead short-term interest rates to fall below our federal funds target and thereby cause us to lose control of monetary policy. When banks have lots of reserves, they have less need to borrow from each other, which pushes down the interest rate on that borrowing — the federal funds rate.

Until this point we had been selling Treasury securities we owned to offset the effect of our [emergency] lending on reserves (the process called sterilization). But as our lending increased, that stopgap response would at some point no longer be possible because we would run out of Treasuries to sell. At that point, without legislative action, we would be forced to either limit the size of our interventions…or lose the ability to control the federal funds rate, the main instrument of monetary policy…[By] setting the interest rate we paid on reserves high enough, we could prevent the federal funds rate from falling too low, no matter how much [emergency] lending we did (Courage to Act, pp. 325-6).

Nor does Bernanke’s understanding of the Fed’s action differ from that of other Federal Reserve authorities. In December 2009, for example, Richmond Fed economists John R. Walter and Renee Courtois offered an almost identical account. The Fed’s emergency credit injections, they wrote,

had the potential to push the fed funds rate below its target, increasing the overall supply of credit to the economy beyond a level consistent with the Fed’s macroeconomic policy goals, particularly concerning price stability.

For a while sterilization solved the problem. But

following the failure of Lehman Brothers and the rescue of American International Group in September 2008, credit market dislocations intensified and lending through the Fed’s new lending facilities ballooned. The Fed no longer held enough Treasury securities to
sterilize the lending.

This led the Fed to request authority to accelerate implementation of the IOR policy that had been approved in 2006. Once banks began earning interest on the excess reserves they held, they would be more willing to hold on to excess reserves instead of attempting to purge them from their balance sheets via loans made in the fed funds market, which would drive the fed funds rate below the Fed’s target for that rate.

There you have it. The Fed paid banks to hold excess reserves, so that they would quit lending them, in order to make sure that the “overall supply of credit” did not exceed levels “consistent with the Fed’s macroeconomic policy.”

And what level of credit supply was it that the Fed was so anxious to not “exceed”? Perhaps the following chart will give you some idea:

If you are starting to forgive me for using the term “wrongheaded,” I have made my point.

When the Fed first started paying interest on reserves, it did so at a rate exceeding the rate at which banks were prepared to borrow from one another in the overnight (“federal funds”) market. Because this was the case, banks more-or-less withdrew from that market, leaving only some GSE’s, which had reserve accounts at the Fed but were not eligible for IOR, to participate in it. The observed average overnight rate for transactions among these institutions — the so-called “effective” federal funds rate — has been consistently below the interest rate on excess reserves:

Needless to say, after most banks withdrew from the overnight market, the overall volume of overnight loans declined substantially. Remember all that talk about how Lehman’s failure led to heightened concerns about counterparty risk, which caused the interbank market to seize-up? Well, that’s not what happened. Although some large banks had to cut-back on overnight borrowing in response to Lehman’s failure, small banks actually borrowed more. A Liberty Street Economics post, from which the following image is taken, supplies details.

It’s possible, of course, that the banks that were flush with excess reserves wouldn’t have lent those reserves even if they didn’t bear interest, because those banks were also short of capital. The thesis is at least plausible, since the Fed supplied fresh reserves to capital-starved firms by swapping them for mortgage debt and other illiquid assets. The exchange reduced the cash recipients’ (risk-adjusted) capital requirements, but did so only if they held on to the cash. As an alternative to having to raise new capital, the swaps were a bargain — and especially so once reserves bore a modest return.

According to Huberto M. Ennis and Alexander L. Wolman, capital shortages did at first discourage banks that held excess reserves from lending them. But already by late 2009 some “would have been able to use reserves to accommodate a significant increase in loan demand without facing binding capital constraints.” Two years later, the same authors report, “a significant proportion of the reserves held by large banks…could have been quickly used to fund loans without pushing these banks against their minimum regulatory capital levels.”

The reserves “could have been” used. But they weren’t. Why not? Ennis and Wolman conclude that, for banks that were no longer capital constrained, limited “loan demand was likely the main driving force behind banks’ lending behavior.” But that is just another way of saying that the anticipated return on loans was low compared to the return from not lending — that is, compared to the return on holding reserves.

It remains possible nonetheless that IOR made little difference, because the return on loans would have been below the return on reserves even if the latter bore no interest. That at least some “natural” interest rates, including the natural overnight rate, became negative during the crisis, and that a few may still be negative today, is the belief of more than a few economists. That includes authorities in charge of several European central banks. What’s more, it includes Janet Yellen, who in a recent paper observes that “the natural real rate fell sharply with the onset of the crisis and has recovered only partially,” and supplies the following chart summarizing extant estimates of the natural ffr:

If these estimates, or at least some of them, are correct, banks would have withdrawn from the federal funds market by early 2009 even without IOR.

But several caveats are in order. First, note that the natural ffr estimates turn decisively negative only in late 2008. This suggests that, if, instead of introducing IOR in the first place, the Fed had allowed its post-Lehman asset purchases to translate into increased bank lending, and especially if it had not sterilized its asset purchases before then, the natural funds rate might never have gone negative. As I pointed out in my post on sterilization, a collapse in aggregate demand means, among other things, a collapse in the nominal demand for all sorts of credit, and a corresponding decline in market-clearing nominal interest rates.

Second, and no less importantly, while overnight lending rates may have turned negative, not all lending rates did so. Returning the interest rate on reserves to zero would therefore have encouraged bank lending, even if it failed to encourage overnight lending. The one caveat is that, because the supply of overnight funds itself would have remained constrained, banks would still have had a greater than usual need for excess reserves to meet their settlement needs.

Finally, even allowing that nothing short of negative interest on excess reserves would have inspired banks to lend those reserves, it remains the case that IOR was a bad policy, in the sense that abandoning it would at least have been a step in the right direction.

For my part, I do not doubt that, whether negative IOR would have been ideal or not, positive IOR played an essential part in the vast post-2008 accumulation of bank excess reserves — an accumulation that proceeded in lock-step with the Fed’s large-scale asset purchases, thereby allowing the Fed to add trillions to its balance sheet, without contributing a jot to bank lending:

Here is where I must part company with some of my Market Monetarist friends. For while those friends hold, as I do, that IOR was counterproductive, and that Fed asset purchases might have been far more effective in boosting recovery without it, they have tended nonetheless to defend the Fed’s large scale asset purchases (“quantitative easing”). I think this was a mistake, both because it meant accepting the Fed’s own dubious (and hardly “monetarist”) theories about how LSAPs were supposed to aid recovery despite the non-lending of added reserves, and because it overlooked the very real adverse effects of those purchases, including the sacrifice of ordinary means for monetary control that they entailed.

There are, I realize, some who argue that IOR isn’t really equivalent to paying banks not to lend, and that it is therefore not to blame for their having accumulated so many excess reserves. Their arguments are, if anything, even more screwy than the logic — which those arguments manifestly contradict — underlying the Fed’s decision to resort to IOR in the first place. But this post is long enough, so I’ll turn to these arguments in Part II.


As it happens, just as I am completing this post, Janet Yellen is holding a press conference announcing what she regards as the Fed’s first steps toward the “normalization” of monetary policy that has become a policy desideratum in the wake of the Fed’s highly abnormal marriage of IOR and large-scale asset purchases. Of what do these steps consist? First, the Fed will raise its federal funds rate target by a quarter of a percentage point — a meaningless gesture, given (as Yellen herself understands) that the target was already above the “natural” funds rate before the hike.

Second, the Fed plans to double the rate of interest on excess reserves.


[Cross-posted from]

Those are the words of Paul Ryan (R-WI) in October, ahead of his elevation to Speaker of the House. He was objecting to a budget deal being rammed through the House, and he went on to say, “This is not the way to do the people’s business, and under new management we are not going to do the people’s business this way.”

Today, the House is scheduled to debate an omnibus spending bill that has highly controversial cybersecurity surveillance legislation slipped into it.

Well. That didn’t take long.