Mr. Whalen is a Washington-based writer and consultant.
“The creatures outside looked from pig to man, and from man to pig, and from pig to man again; but already it was impossible to say which was which.”
—George Orwell, Animal Farm
Just when the Cold War ended is a question historians will debate for years to come. The fall of the Berlin Wall is the obvious reference point, a powerful picture of the “collapse of Communism” eagerly seized by the media. Yet the victory in Berlin obscured the high price overturning Communist rule would exact from the unique American political economy, and also exaggerated the extent of the triumph. The battle between entrenched Communist elites and the freed citizenry of Eastern Europe shows that toppling the Wall marked the beginning of a new struggle.
As analysts ponder “the end of Communism,” a more important struggle rages among the industrialized nations. Francis Fukuyama suggested that with geopolitical confrontation between East and West no more, “the end of history” impended, implying that the struggle for freedom ended with Soviet imperialism. Yet just as formerly Communist nations contain factions reluctant to yield power and dismantle Cold War structures, so too the technocrat elite within the Group of Seven (G-7) countries (Canada, France, Germany, Italy, Japan, the United Kingdom, the United States) remain wedded to policies designed to maintain “stability” in private markets during a time of global military and political conflict.
Many economists and politicians in America, themselves products of the Cold War, reject the idea that global conflict has ended, arguing instead that the new contest among nations is economic. Governmental guidance in the form of “industrial policy” is needed to meet the new menace posed by the European Community, Japan, and other ascendant Asian economic powers, they contend. “The issue is no longer whether government should intervene [in the economy],” Dr. Robert Kuttner wrote in The New York Times Magazine, “but when, where and how.”
The Road to Perdition
Kuttner represents a uniquely post-modern, positive liberty strain in American intellectual thought which holds that market economies must inevitably evolve toward a managed, regulated formulation where commercial warfare among nations, not individuals or private concerns, is the most disaggregated form of “competition.” Under this dirigiste, top-down world view, America is pitted in a zero-sum struggle against Europe and Asia, losing rather than gaining benefits from free and open trade. In the world of “industrial policy” and “managed trade,” the functioning of markets is the concern of politicians, not mere business people. Private companies, financial institutions, and individuals are seen as dangerous sources of instability in markets where “market surveillance” and “bank supervision” are common terminology; this is perhaps what Justice Learned Hand had in mind when he referred to “a society governed by platonic guardians.”
But history is not over. The threat of central planning did not end with the fall of Soviet Communism. The great battle yet to be fought is for the soul of the United States as a libertarian society, the country deliberately made in an image different from the regimented states of Europe. The challenge lies in reaffirming and perhaps even reintroducing the principles of limited government, individual liberty, and private property—the necessary conditions for a free-market, pluralistic society. The question is not about degrees of regulation, but of keeping free markets from disappearing entirely. Ideas once taken for granted must be rediscovered: that public debt is intrinsically evil and leads to speculation and inflation; that thrift and personal responsibility are the foundations of individual and national wealth; and that deviation from these principles leads to social ruin, as evidenced by events in Russia and, more recently, by rioting and looting in Beirut and Los Angeles.
“The beginning of the end of capitalism in America, which was also the beginning of the rise of totalitarian Communism, came in 1913,” economist Herbert Stein wrote in The Wall Street Journal on January 9, 1992. “This was about the same time as the beginning of Communism in Russia. But whereas Communism faded away early in the 1990s, it remained a threat in America.”
The liberal American government that broke the “Robber Barons”; that saw the nation through panics, currency runs, and the Great Depression; that defeated Hitler and General Tojo; and that survived global standoff with the Soviet military menace, is not the limited government of our nation’s founders. Washington, governed by politicians, lobbyists, and the carrion swarm we shall simply call “liberal economists,” constitutes the chief threat to prosperity and liberty in America. “The expediencies and exigencies of social machinery,” to paraphrase Hayek, are moving us toward a less libertarian society where “stability” is managed from above—the very same type of society our forebears fought against on forgotten battlefields in Europe and Asia.
Well-intentioned leaders have for decades told America that resisting Soviet imperialism warranted any sacrifice. Debate over running budget deficits or the wisdom of tolerating even modest inflation were easily pushed aside because of the perceived threat of nuclear annihilation, the power of “the crisis.” To question fiscal deficiencies or the use of monetary policy to accommodate projects such as Vietnam, the expansion of welfare expenditures in the 1970s, or the military buildup of the 1980s, was attacked as unpatriotic or even pro-Communist. Deliberately or not, in fighting Communism we have created a home-grown socialist nightmare not fundamentally different from corporativist states proposed by Lenin and Hitler, and realized by Stalin. Both to meet external threats and to satisfy internal needs, America has created an enormous state apparatus that accommodates almost any request, but also limits and regulates ever more aspects of private life, including health care, investing, and the use of private property.
After a presentation by this writer on Social Security, an elderly Bethesda, Maryland, man obliquely highlighted the issue facing Americans when it comes to recognizing limits on government. I had told the audience that SSI and other federal trust funds are an accounting fiction dependent on future generations’ sweat to redeem promissory notes issued by the Treasury. After a heated debate, we finally concluded that, yes, Social Security is a fraud. But then the gray-haired man with military decorations displayed proudly on his jacket declared that while correct, “We should not say bad things about the United States because America is the greatest country in the world.”
America, world policeman, defender of freedom, land of infinite salable assets and endless credit, can do no wrong. No debt is too big, no expenditure too outrageous for the nation that won the three great wars of this century. Since this perception is widely shared internationally, successive governments in Washington have financed the growth of government with public debt denominated in dollars. Investors, at home and abroad, fund federal deficits by exchanging cash for future dollars, plus interest, payable at some date certain. Yet the rules of arithmetic and compounded interest suggest that the scheme may eventually reach a ceding in terms of investor appetite for dollars.
Comstock Partners principal Michael Aronstein characterized America’s fiscal problems from the perspective of the post-war generation’s children in Barron’s on April 27, 1992: “Certainly, there’s something enraging about the sort of casual arrogance with which people in Washington sit down and decide what [the deficit will be], whether it is $300 billion, $400 billion, $500 billion or $600 billion, sure, they can borrow it . . . . There is a limit. And that’s the delusion that we as a society are operating under—that all of this is limitless. There is no natural boundary.”
Debt and Forbearance
Two economic indicators, America’s rising national debt and politically motivated intervention to rescue private companies from market discipline, best illustrate the strangulating effect of big government on the U.S. economy. Far more than the narrow issue of simply regulating markets, the growing burden of government spending and debt, facilitated by periodic bursts of inflation, is gradually blurring the distinction between private and public property, and the separation between that economic activity which is “public” and that which is dearly private.
Federal government borrowing, on net, presently consumes virtually all excess private capital in the U.S. economy. Annual, interest only payments on the outstanding $3 trillion plus in public debt (not including interest accrued by Social Security and other trust funds), totals over $350 billion, now the single largest item in the federal budget. With capital inflows from Europe and Japan down dramatically from the torrential levels of the mid-1980s, foreign money is no longer available to offset federal borrowing.
While often criticized by xenophobic politicians, capital inflows from abroad during the 1980s delayed the consolidation and asset revaluation that inevitably follows sustained inflation—the corollary to public debt expansion. Following the boom years of the 1970s, when government-induced monetary expansion forced banks and investors to lengthen the maturity of—and trade for short term gain—assets to escape inflation, the 1980s represented a plateau, a pause financed by high real interest rates and dollars repatriated from abroad.
Now, in the 1990s, the proverbial chickens have come home to roost in the form of collapsing asset prices. As high-quality private collateral becomes scarce, well-capitalized financial institutions avoid making loans, preferring the safety of Uncle Sam’s AAA-rated IOUs. And large banks, reeling from accumulated asset-quality problems created by making imprudent loans to developing countries, real estate developers, and corporate raiders (whose appearance is attributable to macro-monetary economic fine-tuning) buy long-dated government debt with monies borrowed in the overnight funds market—liquidity available to them only because of Federal Deposit Insurance Corporation (FDIC) insurance.
The “spread” or difference between yields on 30-year Treasury bonds and Federal Reserve funds illustrates, respectively, expectations for inflation and official manipulation of short-term interest rates in order to rescue “private” banks from the results of poor credit and management decisions. The yield curve now totals some 450 basis points from end to end, the widest spread seen in the post-World War II era, and would be steeper were it not for recent Fed purchases of longer-dated Treasury paper—the ultimate act of inflationism and monetary idiocy.
The force driving hope for a U.S. economic recovery in 1992 is Federal Reserve expansion of high-powered money. In the first quarter of 1992 alone, total bank reserves rose at a near-record 27 percent, measured on a quarter-to-quarter average basis, an example of how Washington, through a servile central bank, uses inflationary monetary policy to create the illusion of economic expansion. By keeping short-term interest rates low, the Bush administration seeks to revive private economic activity without making any fiscal policy adjustments, such as lowering the deficit or tax rates. In fact, the Bush administration hopes to use easy money to salvage banks left insolvent by the latest cyclical correction in asset values. One veteran on the staff of the House Banking Committee calls this process a “managed collapse” of the banking industry.
Too Big to Fail
More than any other indicator, the reluctance to allow market resolution of large bank insolvencies is symptomatic of how a de facto nationalization of private assets is occurring in America via inflation and debt. The doctrine known as “too big to fail,” whereby the taxpayer subsidizes large depositors and other creditors of private banks, epitomizes the larger trend in the U.S. economy toward politically managed stability from above rather than market-based solutions. Too-big-to-fail is especially pernicious on economic grounds since it subsidizes badly managed banks and companies at the expense of well-run concerns, and even worse, does so based on political determinations where transparency and public accountability are lacking.
Look at the financial problems facing larger commercial banks today and it quickly emerges that we are repeating the socialist mistakes of the past. Since the appearance of the twin specters of Third World loans and domestic disinflation, we have headed down a road attended by familiar monstrosities such as the FDIC and the World Bank, and newer gorgons like the Resolution Trust Corporation (RTC), institutions comparable to the state-sector organs found in the authoritarian societies of Europe and Latin America. Worse yet, America’s political leadership seems incapable of rediscovering even the bailout mechanism of the 1930s, the Reconstruction Finance Corporation (RFC), which while flawed was at least a transparent fiscal tool requiring annual appropriations, rather than the off-budget subterfuge now employed to support the ongoing thrift/bank rescue.
The 1987 stock market break accelerated the trend toward greater overt and covert manipulation of markets in the name of preserving short-run “stability.” The process began years earlier, first through creative accounting—known as forbearance—employed to protect insolvent thrifts in the Southwest. These institutions were gradually taken over and the rest is history—except that the government still lacks the money and political will to resolve the situation. Dozens of insolvent thrifts and commercial banks are today open for business under FDIC or RTC ownership, literally government-owned “zombies” operating at a loss and in competition with solvent banks. To make the irony complete, the single largest seller of federal funds in the “private” market is another Depression-era entity, the Federal Home Loan Banks, which issue notes carrying a presumptive U.S. guarantee.
Starting with the RFC, and continuing through the mobilization and centralization of industry during World War II, government’s role in the economy has gone from passive arbiter to active regulator and now participant. Compare the days of Jim Fisk and Jay Gould, for example, when intervention in the gold market in 1869 burst one of history’s great speculative bubbles, to the rescue of Lockheed (1971), New York City (1976), Chrysler (1980), Continental Illinois (1984), First City Bank of Houston (1987), and most recently the nationalization of Crossland Savings of New York.
While President Ulysses Grant sought to calm markets by selling government gold (albeit after nearly being duped by the wily Gould), the Lockheed rescue and the nationalization of Crossland were deliberate efforts to avoid market-based solutions. With the collapse of the Bank of New England in early 1991, the Treasury used billions of dollars in public money to keep the insolvent institution alive. Even after providing a multi-billion dollar subsidy for uninsured depositors in order to facilitate a purchase, the Treasury still refuses to admit its central (and arguably illegal) role in a bailout that ultimately could cost the taxpayer in excess of $4 billion (the officially admitted figure is $2.5 billion).
In the case of banks rescued (and the dozens closed with public subsidies), the United States has accelerated its guarantee of apparently private liabilities in the form of uninsured bank deposits (foreign deposits and those over the $100,000 legal limit) and even non-deposit liabilities of larger banks, as in the case of the parent of Continental Bank. This direct government subsidy for private investors occurred without Congressional approval, being conducted de facto by federal regulators in the name of limiting what is called “systemic risk,” which regulators refuse to define or address by limiting interbank exposure.
The Invisible Hand
More disturbing than overt bailouts of certain classes of private creditors are instances where supposedly “private” companies, in particular big banks and defense contractors, have been rescued covertly, without the prior knowledge or consent of Congress. The most notable examples of this new approach are found among the New York money-center banks—Citicorp, Chase Manhattan, Manufacturers Hanover, and Chemical Bank—which all suffered in recent years from deteriorating asset quality and substandard earnings.
In the case of Citicorp and Chase Manhattan, for example, it is clear that both have been in a slow, government-supervised liquidation for the past several years, whereby forbearance with respect to impaired assets and other special dispensations allow these institutions to avoid closure or mergers. During the period of November-December 1990 and again at the end of March 1991, Chase was reportedly rescued by a combination of discount window loans from the Federal Reserve Bank of New York and covert loans from other New York banks, acting upon oral guarantees made by senior Federal Reserve officials. Similar reports have been made with respect to Citicorp, but little hard evidence exists beyond anecdotal reports and extraordinary discount window activity when these banks had difficulty borrowing from private markets.
Another recent example involves McDonnell Douglas, the aircraft manufacturer and defense contractor that experienced serious financial difficulties last year. In April The New York Times reported two payments totaling hundreds of millions of dollars ostensibly made for the moribund C-17 program “at a time when the company faced a severe financial crisis.” By shifting payments from one account to another, the federal government provided funding to the company when it could not raise funds from private markets. “The Congressional investigators said that the effect of the two [payments] was to give McDonnell Douglas immediate payments that it would otherwise have had to wait months or years for,” according to The Times.
And we are not alone in this folly—indeed, we learned it from the British, who are still trying to bail out Olympia & York’s exposure on the Canary Wharf project, an office complex located on a narrow, isolated peninsula in East London that lacks no amenity save adequate transportation to convey eager tenants in and out. Vanessa Houlder wrote in the Financial Times on June 5, 1992: “The losses incurred by Canary Wharf’s developers, Olympia & York, raise the question of why the project was thought viable in the first place: how did O & Y persuade its bankers to fund the scheme?”
Just as decisions about interest rates or whether enterprises of a certain size will succeed or fail are increasingly a function of political considerations, in the international arena manipulation of markets and entire economies is now accepted practice. The 1985 G-7 Plaza Accord, for example, formalized a process whereby central banks manipulated the price of the dollar and “coordinated” interest rate movements to achieve politically designated economic goals.
All G-7 countries manipulate their domestic interest rates, and central bank intervention in the currency market is executed without apology or explanation. And as the increase of government debt dominates the evolution of the “independent” Federal Reserve, in the international realm the efforts by other members of the G-7 to monetize a certain portion of American inflation likewise distorts the economies of Germany and Japan.
The G-7 central banks other than the Federal Reserve now hold over $300 billion in U.S. debt (which requires that they sell or create an equal amount of their own currency). Washington’s profligacy is straining this arrangement, however, as manifested by recent sharp exchanges between Washington and Bonn over monetary and fiscal policy in the newly unified Germany. With the Bundesbank seemingly committed to price stability by maintaining high real interest rates, and the U.S. headed in the opposite direction, the G-7 process of market stabilization is degenerating because Germans and Japanese alike question the need to continue importing American inflation through dollar purchases.
Until the fall of the Berlin Wall, the Bundesbank was willing to counterbalance American fiscal and trade deficits by purchasing dollars, a policy encouraged by exporters and manufacturers in Germany who depend on sustaining the level of the dollar, both to preserve export revenues and the value of direct investments in the U.S. Likewise, Japanese exporters and banks, who generally write contracts or loans in dollar terms, fear a weaker greenback because of the impact on profits and asset values. The scramble by Tokyo banks to meet the revised Basel capital guidelines is caused, in part, because dollar weakness generates lower revenues and valuation losses in yen terms.
One area of G-7 cooperation where there remains general agreement, however, is in dealing with debt issued by developing countries and now by the disintegrating Soviet Union. In much the same way that dollar stabilization efforts by Europe and Japan seek to maintain the value of exports to the United States, the endeavors of Washington in Latin America, and of the Europeans in central and eastern Europe, are designed to prevent a repeat of the 1982 Mexican loan default. And just as Germany, for example, seeks to prop up the dollar through sales of marks, “managing” the less-developed countries’ debt crisis is meant at least partially to preserve the fiction that countries with large external debts, low per capita income levels, and socialist economies constitute a market for exports from developed nations.
Olympia & York of Canada has tried to bully creditors into accepting a “rollover” of existing debt (and, incredibly, new loans). Banks tentatively agreed to a rollover only after the United Kingdom guaranteed a minimum level of occupancy by civil servants. The Russians likewise gave the G-7 a blunt ultimatum: provide new money or face default. No doubt Russian President Boris Yeltsin learned this trick from his advisers, New York Federal Reserve Bank President Gerald Corrigan and former Federal Reserve Board Chairman Paul Volcker. The latter, who is reported to be a formal consultant to Yeltsin, can claim considerable credit for teaching Mexico how the implicit threat of “instability” could be used to coerce new loans and subsidies from Washington.
Frantic efforts to give Russia both debt relief and access to new credit from the International Monetary Fund and the World Bank closely parallel arrangements made with respect to Mexico, culminating in the abortive Brady debt reduction plan in 1989 and, most recently, the political facade of “free trade.” Just as new loans from the World Bank, IMF, and other international lending and export-credit agencies are “recycled” to help Mexico make payments on private foreign loans, the G-7 are contemplating a similar “stabilization” arrangement for Moscow to protect already weakened banks and commercial companies in Europe, Japan, and the U.S. from a full-scale Soviet financial collapse. Whereas Mexico requires a modest $5-10 billion per year in new multilateral loans (total service on its now $107 billion foreign debt was $16 billion in 1991, up 43 percent from 1990), new loans required to keep Russian credits current and pay for imports will soar into the tens of billions of dollars, and this does not include the $20 billion or so to meet the proclaimed cash needs of other former Soviet republics. If Moscow’s accumulated foreign debt is not to collapse, the flow of new money, consistent with the Mexican “stability” model, must grow every year.
As with the example of domestic debt issuance in the U.S., new multilateral debt, authorized for political reasons, is employed to simulate bona fide income in developing nations to pay interest on private debts and to purchase goods and services from the G-7 countries. The Russian bailout is just the latest evolution of this “crisis management.” Starting in the 1970s by recycling Arab petro-dollars to developing nations in the form of private bank loans, the process of managing Third World debt continued in the 1980s with first the Baker Plan (status quo and new loans) and the Brady Plan (debt forgiveness and new loans). Now the process ratchets up several big notches with the start of an open-ended, $30 billion-plus a year G-7 program to float the latest authoritarian government to reside in the great fortress that is Moscow.
It is interesting to note that the U.S. Treasury will lend money (most or all of which will be borrowed) to Russia, and that money will then be used to clear arrears on private loans to banks and commercial companies largely but not entirely from western Europe and Japan. It is unlikely that investors who buy Treasury debt issued to fund this operation will waive interest or principal payments. But the same cannot be said of the U.S. loans to Moscow, which history suggests will never be repaid. Inevitably, taxpayers in the G-7 countries must redeem these loans through increased levies necessary to “replenish” the capital of institutions such as the World Bank and IMF, or indirectly via higher levels of domestic debt and inflation. The investors who own AAA-rated World Bank bonds are, after all, the real shareholders.
Price Stability and Freedom
The accumulation of public sector debt in America is the root of many of the problems now facing the U.S. economy. If the other, off-balance-sheet liabilities of the federal government such as Social Security, private pension guarantees, and commitments to multilateral international institutions are added to the cost of resolving the thrift and commercial bank bailouts, it quickly becomes clear that the size of public sector liabilities is growing very rapidly relative to the total value of real private assets (roughly $35 trillion). This trend holds ominous implications for the “free market,” not to mention the long-term prospects for American democracy.
First, in an environment where the government is forced to finance half a trillion dollars’ worth of new debt annually, and “roll” the interest on $3.5 trillion in old debt, the question arises as to whether there is any capital left over for private borrowers. So long as the government refuses to curtail expenditures, efforts to alleviate the “credit crunch” or other manifestations of crowding out are exercises in futility at best, and a political swindle at worst.
Second, as the size of the federal debt increases relative to “private” assets and obligations, the issue of repayment ultimately begs the question as to when and how the government will use its coercive power to expropriate private wealth to pay public debts. It is not a question of federal officials actually seizing private property, but rather creating money, much the same way that Messrs. Fisk and Gould printed new shares of Erie Railroad stock when they needed liquidity. Both examples pertain to criminal expropriation of private property, but only one is sanctioned by the coercive power of the state.
The institutionalized crisis affecting financial markets and the government’s fiscal situation is inexorably moving the United States toward a more centralized and less democratic form of government, no matter which of the three candidates wins the November election. Unless some future leader convinces Americans to cut current spending, higher public debt implies rising inflation, falling real wages, and incremental increases in discord among the public at large. While many factors can explain the riots in Los Angeles, the steady erosion of the purchasing power of the dollar is a cause that has received little attention from a financially illiterate media. The age of money politics demands a press conversant in monetary alchemy.
Without a change in the fiscal and monetary regimes of the United States, government will be the central player in the economy, surrounded by a heavily regulated “private” market. Individual liberties and opportunities will become increasingly a function of administrative mechanisms, and decisions about major business transactions will be concentrated far beyond what was even thought possible two decades ago.
This growth in the role of the coercive and redistributive power of the state, perhaps disguised as managerial and funding partnerships between government and private business, will be sold as part of the solution, or at worst a necessary evil. This fundamental economic evolution, which has its roots in the birth of Communism in Russia, the Great Depression, and World War II, will occur within the world’s greatest democracy without an informed public debate over the rights of property or government’s prerogative to incur new indebtedness without congressional authorization.
As with any other clear choice between good and evil, the way out of the darkening cave of socialism and debt is to turn around and walk the other way. This involves first committing the nation to monetary freedom; and second, balancing the federal budget by cutting tax rates and spending, and establishing a surplus above current interest payments, in order to begin the orderly retirement of the national debt. Any other choice is not only economically unworkable, but immoral. If we do not make this choice, we will have truly lost the Cold War.