Power & Market
Fifty Years of Environmentalist Lies
First pollution would cause a new ice age unless we destroyed capitalism and replaced it with socialism and central planning.
That didn’t work out, so then we were told that capitalism was causing global warming and therefore must be destroyed and replaced with socialism and central planning.
That didn’t work out either, so then we were told that capitalism is causing climate change and therefore must be destroyed and replaced by socialism and central planning.
That didn’t happen, so now capitalism must be destroyed and replaced by socialism and central planning with a “great reset” known as the “Green New Deal.”
Fifty years of eco-pocalyptic predictions that turned out to be lies.
Happy Earth Day! And to Klaus Schwab, who displays a framed picture of V.I. Lenin on his office wall, Happy Lenin’s Birthday, too!
Fighting Fire With Fire
Let’s say a house is on fire. The fire department shows up, except rather than spraying water on the fire, they spray gasoline. Moments later they are shocked the fire has gotten out of control.
Yet here we are. The central planners are fighting inflation with more inflation.
In Canada, the province of Quebec plans on giving individuals who make less than $100,000 a year a $500 check to:
…help them cope with higher than expected inflation.
An estimated 6.4 million people are expected to receive this money. Doing the math, the government is spending $3.2 billion it doesn’t have. It will do nothing to decrease the cost of living.
Continuing along these lines, if $500 is good, surely $1,000 would be twice as good. It seems no one in power cares to publicly acknowledge these absurdities. According to the government:
Finance Minister Eric Girard defended the decision to give a $500 cheque to the vast majority of taxpayers as the best solution to help households cope with soaring inflation.
As explained:
The measure was "better than anything that was proposed," the minister said.
Canada is not the only nation ignoring concepts Austrians have stressed for over a century. In the USA, despite the highest inflation readings in four decades, the desire for new stimulus measures persists, as CBS Reports:
…almost 3 million people have signed a Change.org petition started last year that calls on lawmakers to pass legislation for recurring $2,000 monthly payments.
The petition is only 1.5 million signatures away from being the number one most signed petition on the website Change.org.
But wait, there’s more! Just last week, out of California:
Governor Newsom Proposes $11 Billion Relief Package for Californians Facing Higher Gas Prices
If enacted, eligible residents will receive $400 per vehicle, at a cost of $9 billion, while $2 billion will go to free public transportation.
According to Representative Mike Thompson of California:
The gas stimulus would "provide middle-class Americans with monthly payments to ease the financial burden of this global crisis."
So much stimulus is slated to come out this year that CBS compiled a list of states that will send out stimulus checks to fight inflation. Literally and unapologetically, the headline reads:
Stimulus checks for inflation: Here are the states planning to send money to residents
Of course, all these state stimulus checks cannot hold a candle to what’s coming down the pipeline:
Biden Pitches $5.8 Trillion Plan With Record Tax Hike
Fighting fire with fire, or fighting inflation with inflation; this is what happens when all of history and economic reality is willfully ignored by the powers that be. Money continues to be plentiful, and so too is the government’s desire to spend that which it does not have.
Normally, it's understood that every action has a consequence. This may be true, but unfortunately those writing the checks, levying new taxation, or borrowing newly created money appear to be immune from any adverse consequences. Not only are central planners and politicians not punished, but they’re rewarded with celebrity-like status, unfathomable salaries, and benefits. These few powerful individuals are not widely viewed as villainous traitors against the country; if anything, they get schools named in their honor, maybe a library, and on the odd occasion grace the cover of TIME magazine.
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Free Markets Are Not Violent "Social Darwinism"
The ideas of “natural selection” or “Darwinism” are familiar to almost everyone who has an elementary understanding of the natural sciences. It invokes the notion of constant struggle for survival and competition. Only those who are strong will stay alive. Might makes right, in the most literal sense of the term. Even though it is the “Law of the Jungle”, it is commonly believed today that mankind lives outside this jungle, and has escaped the clutches of natural selection.
While the animals instinctively tear each other apart for survival’s sake, humans supposedly are far too advanced for such barbarity. Mankind has long since moved beyond this base instinct of the “survival of the fittest”. We do not try to kill one another, and indeed, even cooperate with each other in order to better ensure our survival. Even though we are not perfect, as the existence of murder, theft, and war indicate, the existence of the human race today is removed totally from any ideas of “natural selection,” and as convincing as this narrative may appear, this entire paradigm of thinking is wholly incorrect.
To be sure, it is true that interpersonal cooperation makes individuals much more productive than they would be in autarkic production. Economists have shown for centuries that the division of labor makes people much more productive than would otherwise be. Additionally, it is true that people today generally do not view each other as potential enemies or threats to their own existence, as they would be forced to do in a setting of brutish nature. However, it is not the case that the civility that people enjoy today was originally an outcome of his own moral stature or belief in non-violence. Man was not driven into cooperation because of his desire to reject natural selection, but because of it.
Some clarification of terms is useful here. The common conception of “natural selection” views it exclusively in terms of creature-vs-creature. In reality, the mechanism of natural selection is much broader than this. Organisms must not only survive against others, but in must survive in their environment. Ludwig von Mises understood and emphasized this crucial point:
Both schools [referring to Social Darwinism and its critics] misunderstood the Darwinian concept of the struggle for survival. It does not refer merely to combat and blows. It means metaphorically the tenacious impulse of beings to keep alive in spite of all factors detrimental to them. As the means of sustenance are scarce, biological competition prevails among all individuals-whether of the same or different species-which feed on the same stuff. It is immaterial whether or not tigers fight one another. What makes every specimen of an animal species a deadly foe of every other specimen is the mere fact of their life-and-death rivalry in their endeavors to snatch a sufficient amount of food. (Theory and History, pg. 39)
As Mises points out, it is a creature’s environment that he must survive within. Other organisms are certainly elements within that environment, but do not wholly comprise it.
Organisms, through the idiosyncrasies and random movements of nature, will gradually evolve and exhibit different characteristics. These differences between organisms will naturally affect their ability to survive in their environment, with those who are more will-adapted surviving at the expense of those who are less well-adapted. Animals and plants we find living in areas with little rainfall have evolved mechanisms by which they can survive without much precipitation (such as many species of cacti, for instance). The differences that these organisms manifested made them more likely to survive within their environment, and as a result, they survived on while others that were less adapted did not.
For millennia, this was all there was to the world’s biological story. Organisms continued to evolve to changing climates and some lived and some died and so it goes. Natural selection just keeps chugging on. Several thousand years ago, mankind came onto the scene. We as a species started out as hunter-gather nomads, but eventually started to form larger communities and grow. Fast-forward to present day, and the world has been largely conquered and tamed by mankind. The modern world is filled with technological marvels and wonders of engineering. Diseases that once killed millions are all but eradicated. What started off as humble bipedal hunter-gatherers have become a planet-conquering race.
However, this success did not come through a rejection of the mechanism of natural selection, but through working within it. Man is, unlike all other animals, species, and organisms, uniquely gifted with the construct of reason. He is granted a conceptual grasp upon himself and the world greater than any other found in all of nature. It was with this reason that man made a monumental discovery. Instead of competing with others, cooperation with others allows for everyone to achieve a greater ability to survive. Instead of the differentiation within all individuals serving as the basis for competition within our environment, those differences can be the basis of trade and cooperation.
If I have a particularly adept ability to bake bread, and my neighbor has a particularly adept ability to craft shoes, one can see an obvious opportunity for trade here. I am better off baking bread and trading my excess bread for the excess shoes of my neighbor. We both get what we want and are wealthier because of the trade. Undoubtably, the option of violence is always available as well. I could simply kill or threaten to kill my neighbor and receive shoes from him in that way. However, violence is always risky. Perhaps he is actually stronger than me and instead I am the one forced to pay tribute to him. Additionally, violence is disadvantageous in the long-term. If I kill him, then I can no longer receive any furniture from him, and continually threatening him can lead to retribution. Regardless, peaceful transaction is more productive and efficient, so it benefits both me and my neighbor for us to trade cooperatively with each other.
Notice that the motivation for peaceful trade has nothing to do with altruism. It is not through a desire to create a more moral society that I engage in peaceful trade, but through my own desire to survive. This change of attitudes has the secondary effect of promoting and encouraging peace and harmony between individuals, but this is not the primary motivator for their trade. The emergence of the division of labor in society was a result of the mechanism of natural selection, not a desire to escape from it. Mises, again, clearly saw and understood this dynamic in the evolution of human civilization:
Man alone by dint of his reason substituted social cooperation for biological competition. What made social cooperation possible is, of course, a natural phenomenon, the higher productivity of labor accomplished under the principle of the division of labor and specialization of tasks. But it was necessary to discover this principle, to comprehend its bearing upon human affairs, and to employ it consciously as a means in the struggle for existence. (Theory and History, pg. 38-39)
Human civilization, as far as we are aware, is the greatest accomplishment of life and reason. Mankind has a grasp and hold on his world in a way heretofore unseen. This accomplishment represents not the rejection of natural selection and its grip upon the future of the human race, but as the greatest level of success within that system. In a world of “survival of the fittest”, human beings in peaceful cooperation have proved to be the fittest, and thus, have survived and thrived.
As Mises stated above, the Social Darwinists and those of similar schools misunderstood the concept of natural selection. They also erred in its application to the human condition. It makes little sense to ask if the ideas of natural selection “should” be applied in modern society. Nobody asks if the idea of 2+2=4 “should” be accepted in society. Math is composed of positive facts, and is not subject to ethical considerations. Similarly, the mechanism of natural selection is a fact of life. It is the basis on which existence within this universe resides. There is no question of whether or not it “should” apply to society. It applies to society whether we like it to or not, just as 2+2=4 applies regardless of how our personal feelings on the matter.
The emergence of civilized society has the effect of making men less aggressive and more kind to each other. In a nomadic existence, those outside the tribe are always potential threats to your own survival. The domesticated and modern man has no such concerns about strangers whom he encounters. This effect is undeniable, but as we stated above, it is a corollary effect. But even in a morally elevated society, man has not escaped the iron grip of natural selection. He must always work to survive in his environment, and his fellow men are only one part of that environment. Having ethically harmonious relationships with those around him certainly improves this aspect of his environment, but is not enough to remove him from the need to survive altogether. He still must eat, drink, sleep, and have clothing and shelter if he is to live, regardless of the comradery he has with those around him.
The peace of modern society is not an incoherent perversion of nature. This peace has emerged in response to the challenges of the natural order. Because man was forced to survive in his environment, he employed his reason to aid him in his quest for survival. His reason led him to production and exchange with others as the best method to aid in his survival. As the marvels of human civilization can show, man’s reason has been amply vindicated. For millennia, the story of human beings was constant violence and distrust towards one another. It was only when this was exchanged for productive peace that the story of human civilization and triumph could begin.
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Frank Chodorov: An Intellectual Warrior against the Omnipotent State
February 15 marks the 1887 birth of Frank Chodorov, who Aaron Steelman described as offering an “unwavering defense of individualism” in the “intellectual war against the omnipotent state.”
Born Fishel Chodorowsky, Chodorov was a “lifelong individualist.” Early in his career, he described his position as “unashamedly accepting the doctrine of natural rights, proclaim[ing] the dignity of the individual and denounce[ing] all forms of Statism as human slavery.” Almost two decades later, in his 1962 Out of Step: The Autobiography of an Individualist, he still steadfastly held that position:
If we assume that the individual has an indisputable right to life, we must concede that he has a similar right to the enjoyment of the products of his labor. This we call a property right. The absolute right to property follows from the original right to life because one without the other is meaningless; the means to life must be identified with life itself…We object to the taking of our property by organized society just as we do when a single unit of society commits the act…Robbery is robbery, and no amount of words can make it anything else.
Chodorov also greatly influenced Murray Rothbard, who wrote that “I shall never forget the profound thrill—a thrill of intellectual liberation—that ran through me when I first encountered the name of Frank Chodorov,” and called his analysis “one of the best, though undoubtedly the most neglected, of the ‘little magazines’ that has ever been published in the United States.”
Chodorov’s hope was to reach young people—“the policymakers of the future”--to revive individualism “by implanting the ideas in the minds of the coming generations.” And an important part of that was as editor of the Foundation for Economic Education’s The Freeman, which Leonard Read chose him for in 1954.
As Steelman put it, Chodorov “approached myriad topics from the same perspective: voluntary, peaceful actions are moral and productive and should be encouraged; coercive actions are immoral and should be condemned.” That is why he deserves discovery, or rediscovery, today, when such immoral, coercive actions are much further developed than when he wrote.
As we pass Chodorov’s birthday, it is worth following at least a bit of his thought for those unfamiliar with it. As a sample, consider an abbreviated version of his “Economics Versus Politics,” the first chapter of his 1959 The Rise and Fall of Society:
Becoming Creatures of the State
- The presumably rational human animal has become so inured to political interventions that he cannot think of the making of a living without them.
- It hardly occurs to us that we might do better operating under our own steam, within the limits put upon us by nature, and without political restraints, controls, or subventions…these interventionary measures are placed in our path…for purposes diametrically opposed to our search for a better living.
The State Doesn’t Over-Rule the Realities of Economics
- Society, Government, and the State are basically economic phenomena…so any inquiry into the mechanism of social integrations cannot bypass economic law.
- That there is a science of economics which covers basic principles that operate in all our occupations, and have nothing to do with legislation, is hardly considered.
- Economic laws are self-operating and carry their own sanctions.
- The intrusion of politics into the field of economics is simply evidence of human ignorance or arrogance…Since the beginning of political institutions, there have been attempts to fix wages, control prices…all resulting in failure…because the only competence of politics is in compelling men to do what they do not want to do or to refrain from doing what they are inclined to do.
- The assumption that economics is subservient to politics stems from a logical fallacy…that in controlling men the State can also bend these laws to its will.
- When the State intervenes in the economy…it always does [so] by way of confiscation.
- The Welfare State is in fact an oligarchy of bureaucrats who, in return for the perquisites and prestige of office, undertake to confiscate and redistribute production.
- All welfarism starts with a program of distribution…and ends up with attempts to manage production…and there too they fail.
Violating Economic Laws Leads to State Collapse
- In the long run every State collapses…in its insatiable lust for power [it] increasingly intensified its encroachments on the economy of the nation, causing a consequent decline of interest in production…It was not economically able to meet the strain of some immediate circumstance, like war, and succumbed.
- There is no way for the State to avoid this consequence…except, of course, to abandon its interventions in the economic life of the people it controls, which its inherent avarice for power will not let it do. There is no way for politics to protect itself from politics.
America as a Case Study
- The American State…[was] midwifed by a coterie of men unusually wise in the history of political institutions and committed to the safeguarding of the infant from the mistakes of its predecessors.
- Every precautionary measure known to political science was taken to prevent the new American State from acquiring the self-destructive habit of every State known to history, that of interfering with man’s pursuit of happiness. The people were to be left alone, to work out their individual destinies with whatever capacities nature had endowed them.
- The State was surrounded with a number of ingenious prohibitions and limitations. Not only were its functions clearly defined, but any inclination to go beyond bounds was presumably restrained by a tripartite division of authority, while most of the interventionary powers which the State employs were reserved for the authorities closer to the governed…it was forever, presumably, deprived of the monopoly position necessary to a State on the rampage. Better yet, it was condemned to get along on a meager purse; its powers of taxation were neatly circumscribed.
- The ink was hardly dry on the Constitution before its authors, now in position of authority, began to rewrite it by interpretation, to the end that its bonds would loosen…to extend the power of the central government.
- Social power, the centralization which has been going on since 1789 has pushed American Society into that condition of subservience which the Constitution was intended to prevent.
- In 1913 came the amendment that completely unshackled the American State, for with the revenues derived from unlimited income taxation it could henceforth make unlimited forays into the economy of the people. The Sixteenth Amendment…violated the right of the individual to the product of his efforts, the essential ingredient of freedom.
- There is now no phase of economic life in which the State is not a factor…no enterprise or occupation free of its intervention.
- The metamorphosis of the American State from an apparently harmless establishment to an interventionary machine as powerful as that of Rome at its height took place within a century and a half.
Chodorov’s Main Conclusion
- Society…flourishes only under a condition of freedom.
The Ludwig von Mises Institute has described Frank Chodorov as “an advocate of the free market, individualism, and peace.” In an era when precious few fit that job description, his work is worth renewed understanding and emulation. And reading his work can be the first step to blazing further along the trail he spent his life developing.
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Fedcoin Report Issued
Fedcoin is inevitable. Yet many issues surround it while the Federal Reserve continues engaging the public and experts on this matter. The Board of Governors recently issued a report: Money and Payments: The U.S. Dollar in the Age of Digital Information detailing various ideas without definite conclusions.
It starts with the Executive Summary:
This paper is the first step in a public discussion between the Federal Reserve and stakeholders about central bank digital currencies (CBDCs). For the purpose of this paper, a CBDC is defined as a digital liability of a central bank that is widely available to the general public.
They don’t use the word Fedcoin; perhaps CBDC sounds more official. But they’re discussing a Federal Reserve cryptocurrency, created by the Fed functioning exactly like the dollar bills in your wallet.
One hurdle is the transmission process required to get the new coins into circulation. CBDC’s could simply be exchanged for existing dollars, or can used to expand the money supply through new loan arrangements directly to the public.
The potential expansion of the money supply, and the Fed gaining new powers by stepping into the commercial banking/government transferor/collection agency role, is most concerning if not completely terrifying. In the Fed’s own words:
A widely available CBDC would serve as a close—or, in the case of an interest-bearing CBDC, near-perfect—substitute for commercial bank money.
Consider the implications of an interest bearing CBDC. The Fed could grant Fedcoin loans at favorable rates to the entire country or only to those deemed most in need of funds. Consider if someone were to default on a CBDC loan. Would the Fed not be obligated to seize that person’s assets? This is hardly a conspiracy theory as default risk would be an eventuality of issuing Fedcoin loans if repayment of principal and interest is required.
Alternatively, forgivable Fedcoin loans could be granted; much like the Paycheck Protection Program, where, as of January 9, 2022, $680 billion in loans were forgiven across America.
In what could become the ultimate error in monetary policy, next time a financial crisis hits, Fedcoins could be deployed to stimulate demand, meaning citizens could receive an instantaneous stimulus check deposited into their bank account, courtesy of their neighborhood central bank.
A faint hope of averting disaster remains. Earlier this month, legislation was introduced by Congressman Tom Emmer (MN-R), who anticipated the trajectory of Fedcoin. He issued a bill prohibiting CBDC from being issued directly to individuals, saying:
It is important to note that the Fed does not, and should not, have the authority to offer retail bank accounts.
He also had concerns over the Fed having the ability to:
…collect personally identifiable information on users, and track their transactions indefinitely…
History provides many examples showing what the Fed can do as the lender of last resort. The continual boom and bust cycle, a dollar that can only decline in purchasing power, a country never more divided economically while facing a booming stock market are just some of the implications of central banking. A significant amount of economic destruction will be avoided if the Fed is not afforded the opportunity to become the lender of first resort.
For one of the most powerful institutions on the planet, Fedcoin is an idea that Marx himself could only dream of when he asked for:
Centralisation of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.
Concerned citizens may want to alert their state representatives to the potential dangers a CBDC poses, including privacy concerns while having the Fed compete against commercial banks. Additionally, you can fill out the Fed’s feedback form on the matter here. Even if they don’t take your feedback seriously, at least your comments will be made available for public viewing!
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Federal Housing Regulators Have Learned and Forgotten Everything
Should the government subsidize buying houses that cost $1.2 million? The answer is obviously no. But the government is going to do it anyway through Fannie Mae and Freddie Mac. The Federal Housing Finance Authority (FHFA) has just increased the size of mortgage loans Fannie and Freddie can buy (the “conforming loan limit”) to $970,080 in “high cost areas.” With a 20% down payment, that means loans for the purchase of houses with a price up to $1,212,600.
Similarly, the Federal Housing Administration (FHA) will be subsidizing houses costing up to $1,011,250. That’s the house price with a FHA mortgage at its increased “high cost” limit of $970,800 and a 4% down payment.
The regular Fannie and Freddie loan limit will become $647,200, which with a 20% down payment means a house costing $809,000. The median U.S. price sold in June 2021 was $310,000. A house selling for $809,000 is in the top 7% in the country. One selling for $1,212,600 is in the top 3%. To take North Carolina for example, where house prices are less exaggerated, an $809,000 house is in the top 2%. For FHA loans, the regular limit will become $420,680, or a house costing over $438,000 with a 4% down payment—41% above the national median sales price.
Average citizens who own ordinary houses may think it makes no sense for the government to support people who buy, lenders that lend on, and builders that build such high-priced houses, not to mention the Wall Street firms that deal in the resulting government-backed mortgage securities. They’re right.
Fannie and Freddie, which continue to enjoy an effective guarantee from the U.S. Treasury, will now be putting the taxpayers on the hook for the risks of financing these houses. Through clever financial lawyering, it’s not legally a guarantee, but everyone involved knows it really is a guarantee, and the taxpayers really are on the hook for Fannie and Freddie, whose massive $7 trillion in assets have only 1% capital to back them. FHA, which is fully guaranteed by the Treasury, has in addition well over a trillion dollars in loans it has insured.
By pushing more government-sponsored loans, Fannie, Freddie, its government conservator, the FHFA, and sister agency, the FHA, are feeding the already runaway house price inflation. House prices are now 48% over their 2006 Housing Bubble peak. In October, they were up 15.8% from the year before. As the government helps push house prices up, houses grow less and less affordable for new families, and low-income families in particular, who are trying to climb onto the rungs of the homeownership ladder.
As distinguished housing economist Ernest Fisher pointed out in 1975:
[T]he tendency for costs and prices to absorb the amounts made available to prospective purchasers or renters has plagued government programs since…1934. Close examination of these tendencies indicates that promises of extending the loan-to-value ratio of the mortgage and extending its term so as to make home purchase ‘possible for lower income prospective purchasers’ may bring greater profits and wages to builders, building suppliers, and building labor rather than assisting lower-income households.
The reason the FHFA is raising the Fannie and Freddie loan-size limits by 18%, is that its House Price Index is up 18% over the last year. FHA’s limit automatically goes up in lock step with these changes. These increases are procyclical acts. They feed the house price increases, rather than acting to moderate them, as a countercyclical policy would do. Procyclical government policies by definition make financial cycles worse and hurt low-income families, the originally intended beneficiaries.
The contrasting countercyclical objective was memorably expressed by William McChesney Martin, the longest-serving Chairman of the Federal Reserve Board. In office from 1951 to 1970, under five U.S. presidents, Martin gave us the most famous of all central banking metaphors. The Federal Reserve, he said in 1955, “is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.”
Long after the current housing price party has gotten not only warmed up, but positively tipsy, the Federal Reserve of 2021 has, instead of removing the punch bowl, been spiking the punch. It has done this by, in addition to keeping short term rates at historically low levels, buying hundreds of billions of dollars of mortgage securities, thus keeping mortgage rates abnormally low, and continuing to heat up the party further.
In general, what a robust housing finance system needs is less government subsidy and distortion, not more.
In fact, the government has been spiking the housing party punch in three ways. First is the Federal Reserve’s purchases of mortgage securities, which have bloated its mortgage portfolio to a massive $2.6 trillion, or about 24% of all U.S. residential mortgages outstanding.
Second, the government through Fannie and Freddie runs up the leverage in the housing finance system, making it riskier. This is true of both leverage of income and leverage of the asset price. It is also true of FHA lending. Graph 1 shows how Fannie and Freddie’s large loans have a much higher proportion of high debt-to-income (DTI) ratios than large private sector loans do. In other words, Fannie and Freddie tend to lend more against income, a key risk factor.
Graph 1: Percent of loans over 43% DTI ratio
Fannie and Freddie also make a greater proportion of large loans with low down payments, or high loan-to-value (LTV) ratios, than do corresponding private markets. Graph 2 shows the percent of their large loans with LTVs of 90% or more—that is, with down payments of 10% or less—another key risk factor.
Graph 2: Share of loans with LTV ratios over 90%
Now—on top of all that– the FHFA, by upping the loan sizes for Fannie and Freddie, is bringing to the party a bigger punch bowl. That the size limit for Fannie and Freddie is very important in mortgage loan behavior, we can see from how their large loans bunch right at the limit, as shown by Graph 3.
Graph 3: Distribution of loans relative to limit
Source: Fisher, Lynn M., et al. “Jumbo rates below conforming rates: When did this happen and why?.” Real Estate Economics 49.S2 (2021): 461-489.
The third spiking of the house price punch bowl consists of the government’s huge payments and subsidies in reaction to the pandemic. A portion of this poorly targeted deficit spending money made its way into housing markets to bid up prices.
A key housing finance issue is the differential impact of house price inflation on lower-income households. AEI Housing Center research has demonstrated how the spiked punch bowl has inflated the cost of lower-priced houses more than others. This research shows that rapid price increases crowd out low-income potential home buyers in housing markets. Thus, as Ernest Fisher observed nearly 50 years ago, government policies that make for rapid house price inflation constrain the ability to become homeowners of the very group the government professes to help.
In general, what a robust housing finance system needs is less government subsidy and distortion, not more. The question of upping the size of Fannie and Freddie loans, and correspondingly those of the FHA, is part of a larger picture of what the overall policy for them should be. Should we favor making their subsidized, market distorting, taxpayer guaranteed activities even bigger than the combined $8 trillion they are already? Should they become even more dominant than they are now? Or should the government’s dominance of the sector and its risk be systematically reduced? That would be a movement toward a mortgage sector that is more like a market and less like a political machine.
In short, what about the future of the government mortgage complex, especially Fannie and Freddie: Should they be even bigger or smaller? We vote for smaller.
How might this be done? As a good example, Senator Patrick Toomey, the Ranking Member of the Senate Banking Committee, has introduced a bill that would eliminate Fannie and Freddie’s ability to subsidize loans on investment properties, a very apt proposal. It will not advance with the current configuration of the Congress, but it’s the right idea. Similarly, it would make sense to stop Fannie and Freddie from subsidizing cash-out refis, mortgages that increase the debt on the house. Another basic idea, often proposed historically, but of course never implemented, would be to reduce, not increase, the maximum size of the loans Fannie and Freddie can buy, and by extension, FHA can insure.
In the meantime, the house price party rolls on. How will it end after all the spiked punch? Doubtless with a hangover.
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Friedman, Freedom, and The Road to Serfdom
I just came across and article which reminded me that this November 16 was the 15th anniversary of the death of Milton Friedman, one of the past century’s greatest advocates of freedom. As someone who has followed his writing for most of my adult life, I can barely believe he has been gone that long. On the other hand, the abyss between the freedom he advocated and the world we now inhabit is so vast, I can barely believe he has only been gone that long.
That great gap makes me believe that now would be a good time to think back to some of Friedman’s insightful words. But his prolific output makes it hard to choose (rather than Free to Choose) among them when faced with limited space. How much further we have moved along what Friedrich Hayek called The Road to Serfdom since then, however, suggests one good source—Friedman’s “Introduction” to the University of Chicago Press’s 50th Anniversary edition of the book.
The promotion of collectivism is combined with the profession of individualist values.
Individualism…can be achieved only in a liberal order in which government activity is limited primarily to establishing the framework within which individuals are free to pursue their own objectives.
The free market is the only mechanism that has ever been discovering for achieving participatory democracy.
Unfortunately, the relation between the ends and the means remains widely misunderstood. Many of those who profess the most individualistic objectives support collectivist means without recognizing the contradiction.
To understand why it is that “good” men in positions of power will produce evil, while the ordinary many without power but able to engage in voluntary cooperation with his neighbors will produce good, requires analysis and thought, subordinating the emotions to the rational faculty.
The argument for collectivism is simple, if false; it is an immediate emotional argument. The argument for individualism is subtle and sophisticated; it is an indirect rational argument.
Experience…has strongly confirmed Hayek’s central insight--that coordination of men’s activities through central direction and through voluntary cooperation are roads going in very different directions: the first to serfdom, the second to freedom. That experience has also strongly reinforced a secondary theme--central direction is also a road to poverty for the ordinary man; voluntary cooperation, a road to plenty.
The battle for freedom must be won over and over again. The socialists in all parties to whom Hayek dedicated his book must once again be persuaded or defeated if they and we are to remain free men.
The bulk of the intellectual community almost automatically favors any expansion of government power so long as it is advertised as a way to protect individuals from big bad corporations, relieve poverty, protect the environment, or promote “equality.”
It is only a little overstated to say that we preach individualism and competitive capitalism, and practice socialism.
It is amazing how dead-on both Friedrich Hayek’s The Road to Serfdom and Milton Friedman’s appreciative and insightful “Introduction” remain about Americans’ current situation, unfortunately moving back down the wrong road in many ways. But I find the last two quotations particularly ominous. Many today have moved to the point, in their confused understanding, that they want to not only practice socialism, particularly when they think its selective application will benefit them, but preach it as well. But that “progressive” regression into utopian thinking which actually produces dystopian results also means that the benefits from renewed attention to the lessons for liberty to both Hayek and Friedman are greater, as well.
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From the Nixon Shock to Biden-flation
This month marks fifty years since President Richard Nixon closed the “gold window” that had allowed foreign governments to exchange US dollars for gold. Nixon’s action severed the last link between the dollar and gold, transforming the dollar into pure fiat currency.
Since the “Nixon shock” of 1971, the dollar’s value — and the average American’s living standard — has continuously declined, while income inequality and the size, scope, and cost of government have risen.
Since the beginning of this year, price inflation has increased much, and it could continue onward to exceed the 1970s-era price spikes. Understandably, Republicans are trying to blame President Joe Biden for the price increases. However, a major cause of the current price inflation is the unprecedented money creation the Federal Reserve has engaged in since the 2008 market meltdown. This, though, does not mean Biden and most US politicians of both parties do not bear some responsibility for rising prices. Their support for the Fed and massive government spending contributes to the problem.
The main way the Fed pumps money into the economy is by monthly purchases of 120 billion dollars of Treasury and mortgage-backed securities. Even many Keynesian economists agree that rising price inflation means the Fed should stop pumping money into the economy. Yet, this year the Fed is likely, at most, to only slightly reduce its purchases of Treasury securities. It will almost certainly keep interest rates at near-zero levels.
A reason the Fed will not stop or significantly reduce its purchases of Treasuries and allow interest rates to increase is that doing so would increase federal debt payments to unsustainable levels. Even with interest rates at historic lows, interest payments remain a significant portion of federal spending, and recent indications are that the US government is not about to start being frugal. Consider, for example, Congress' six trillion dollars “Covid relief and economic stimulus” spending spree and the Senate passage of the trillion dollars “traditional infrastructure” bill and a budget “outline” of a 3.5 trillion dollars “human infrastructure” bill.
The “human infrastructure” bill represents an expansion of government along the lines of the Great Society. Among its initiatives are universal pre-kindergarten; two “free” years of community college; increased government control of health care via expansions of Obamacare, Medicare, and Medicaid; and a raft of new government mandates and spending aimed at reshaping the US economy to fight “climate change.”
The need to gain support of “moderate” Democrats will likely mean the final “human infrastructure” bill will costs less than 3.5 trillion dollars. However, no Democrat is objecting to the bill's programs; the objectors just want cheaper tolls on the road to serfdom. While progressives will likely accept reduced spending levels in order to get their wish list into law, they will then work to increase funding and expand the programs. As the programs become more entrenched, even many “conservatives” will support increasing their funding.
The expansion of government will increase pressure on the Fed to keep the money spigots open. This will lead to a major economic crisis. The good news is the crisis may mark the beginning of the end of the fiat monetary system and the welfare-warfare state, along with the dawn of a new era of free markets, sound money, and limited government.
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Financial Transaction Taxes Are a Terrible Idea
Plenty has been written about financial transaction taxes (FTTs), mostly arguing over the politically charged issue of who pays: Main Street or Wall Street. Largely absent from the conversation have been the risk transfer (RT) markets—futures1 and options.2 RT is a massive, largely unappreciated economic phenomenon that could be severely impacted by any FTT, even microscopic-sounding ones relative to the face value of the instruments being traded.
FTT proponents seem to think an FTT would hardly be felt by users of the markets while falling heavily on the supposedly obscene profits of cyberpirate middlemen. These perceptions are simply wrong. First, end user activities in the RT markets are complex and far more exposed to an FTT than tax advocates appreciate. And second, the much-maligned middlemen provide absolutely crucial, low-cost-per-trade services of market making and “shared liquidity.”
Shared Liquidity
Whole families of instruments have been developed to provide ever more precise RT. One consequence of this proliferation is that all but the most established markets have trouble attracting enough trading interest/liquidity to serve hedgers efficiently. The solution is shared liquidity, which means that a bid in one market can quickly result in bids in partly related markets. The key to this is having middlemen specializing in the relationships between different instruments and markets.
Shared liquidity is transaction intense, with the middlemen needing to do a minimum of four transactions—buy A, sell B, and later do the reverse. In doing this they have to earn their profit, not from how far A or B moves, but how far these closely related instruments move relative to each other. These services would be greatly impacted by an FTT or unprofitable to offer at all.
The End Users
Hedging is nowhere near the same thing as buying a long-term productive asset with a face value equal to that of the instrument being traded. These instruments aren’t the underlying assets, just limited slices of risk. (And options on futures are slices of slices of risk.) Also, hedges are rarely “one and done,” but are often combinations of instruments needing frequent adjustment.
An FTT would be especially damaging to industries that use futures for more than just hedging simple price risk. Futures can be used to offer pricing flexibility to customers and also to eliminate credit risk between contracting parties. Being able to do the latter means a business can contract with almost anyone rather than with just a limited number of carefully vetted customers.
As an example, when I worked for a bullion dealer, every inventory purchase was immediately hedged, and price quotes throughout the industry were generally in the form of point differences above or below futures. Our trader and a customer would agree on a differential to futures rather than on a specific price; the customer was then free to fix his price at a time of his choosing by purchasing futures.
When the time came for goods to change hands, the customers would do an “exchange for physicals” with us where their long futures position liquidated our short futures hedges. They would then pay us cash equal to the then existing futures price plus the agreed-upon differential and receive the goods. Note that if either party defaulted, nobody got seriously hurt since each was fully hedged right up until the goods changed hands.
An FTT could upend whole industry-wide ways of doing business, even apart from the disastrous impact on vital middleman services.
Risk Premiums
If businesses are unable to hedge, they must take unwanted risks themselves, which they don’t do voluntarily unless they are compensated, i.e., can charge a “risk premium.”
For example, a chocolate manufacturer with a hedge would not fear a spike in cocoa prices and could offer retailers year-long contracts for candy bars at, say, $0.50 each. But without a hedge he could be clobbered by a price spike and would only want the business if he were compensated for taking that risk, say by inserting a $0.10 risk premium and only offering bars at $0.60.
Whole supply chains take a hit when any link insists on a risk premium. At $0.60, the manufacturer will sell fewer bars to retailers, who will charge customers more. Shippers get less business and less beans are demanded from growers. The manufacturer will then make smaller, less efficient production runs, hiring fewer workers, etc. And in something of a double whammy, companies hurt by upside price surprises and those vulnerable to downside ones each impose risk premiums on the same supply chain, whereas with hedging in the RT markets, they could have effectively offset each other’s risks.
One might ask: What about that $0.10 risk premium? Isn’t it being paid to someone in the supply chain, so not a big deal economically? No, the supply chain has a new expense, effectively hiring one of its members to do something additional, but something with zero economic value. The manufacturer is being paid for worrying. Worrying is about as useful as digging and refilling holes. It is a pure burden on the supply chain and roughly break even for the manufacturer. He would just as soon give up the risk premium and not have to worry. The risk premium is like a welfare payment to the manufacturer extracted from the supply chain.
If an FTT impairs the RT markets, a mass of risk premiums that had been avoided through hedging will flood supply chains throughout the economy.
An FTT Is a Terrible Way to Tax
The RT markets perform their magic by providing forums to lay off risks through an ever-increasing assortment of specialized instruments and by disassembling and recombining risks to enable those with varying degrees of overlap to be offset against each other. The process is transaction intense, which multiplies the impact of any per-trade expenses, such as an FTT.
Taking on the price risk inherent in a large asset for a brief time is not the same as buying it to consume it or acquiring it as a long-term investment. If this distinction is ignored in an FTT, a seemingly microscopic tax relative to “face values” could devastate the whole RT industry. However, even a lesser FTT could prove massively disruptive. Trading volumes would be reduced and could collapse, resulting in shrinking collections, while the impact on other tax receipts throughout the economy would be hefty. An FTT is likely to be a net tax loser.
The ideal way to tax is to allow the economy to optimize output and then skim some off the top, as with income and sales taxes. An FTT, in contrast, reaches deep into production processes throughout the economy, impairing or eliminating important services while unleashing a flood of costly risk premiums.
A financial transaction tax in the risk transfer markets is a terrible idea!
- 1. Futures are standardized exchange-traded commercial contracts for various commodities, financial instruments, currencies, etc., intended primarily for hedging risk rather than acquiring the underlying asset. They may specify delivery of the asset or be tied to a published price index, but this is done to guarantee that the future's price tracks real-world values. Few users expect to hold their contracts until expiration; they are in and out in a week, a month, or however long they have price exposure.
- 2. Options (puts and calls) are the right to buy or sell something (but not the obligation to do so) at a certain price (strike price) until a stated expiration date. The buyer pays a “premium” in cash (anonymously via the exchange) to the seller (grantor) and is entitled to the value of any movement beyond the strike price. Options enable someone to buy very specific bits of risk protection. By buying and selling combinations of options, he can also swap risks he doesn’t mind taking for ones he needs protection from.
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Fear the Repo, Man
Effective July 29, 2021, the Federal Reserve directed the New York Federal Reserve’s Trading Desk (the Desk), to:
Conduct overnight repurchase agreement operations with a minimum bid rate of 0.25 percent and with an aggregate operation limit of $500 billion; the aggregate operation limit can be temporarily increased at the discretion of the Chair.
What does this mean?
Per the Desk:
In a repo transaction, the Desk purchases securities from a counterparty subject to an agreement to resell the securities at a later date.
As the Fed announced, through the domestic Standing Repo Facility (SRF), they are willing to create up to $500 billion in order to buy securities such as US Treasurys or mortgage-backed securities (MBS) from primary dealers like JP Morgan Securities. The following day, the primary dealers will buy the security back, but at a higher price, which equates to an interest rate of 0.25 percent.
Whether it's for emergency purposes or so the institution can think of a creative way to use the loan has yet to be seen. “Over time,” the facility is expected to be available to depository institutions.
It doesn’t end there! A second facility was announced under similar terms, but offered to “Foreign and International Monetary Authorities” (FIMA), which encompasses “foreign central bank and international accounts maintained at a Federal Reserve Bank.” The limit for each counterparty who takes the Fed’s offer is $60 billion, whereas no cap per counterparty was specified for the SRF.
The newly announced SRF and FIMA repo facilities are not to be confused with reverse repos, which are similar but follow the opposite arrangement, as the Desk explains:
the Desk sells securities to a counterparty subject to an agreement to repurchase the securities at a later date.
In a reverse repo (RRP), firms are in effect lending money to the Fed and currently making 0.05 percent for their service. The volume of RRPs that primary dealers are currently utilizing has now surpassed $1 trillion.
There are various explanations for why the Fed might want to engage in repo transactions, but the explanation offered in the press release was:
These facilities will serve as backstops in money markets to support the effective implementation of monetary policy and smooth market functioning.
Chair Jerome Powell echoed the statement when asked about the new facilities in his latest address:
So it really is a backstop … it's there to help address pressures in money markets—money markets that could impede the effective implementation of monetary policy. So, really, it's to support the function of—functioning of monetary policy and its effectiveness.
The repetitive nature of Powell’s speech as he echoed the press release doesn’t offer much comfort. Given the recession has long passed, and anything cataclysmic like a bank failure doesn’t seem to be on the Fed’s radar, it’s unfortunate they’ve given the public little more than the “smooth market function” rationale. Hollow phrases have the ability to permit every action by the Fed, but in no way do they constitute an explanation based on economic theory.
As for the reverse repo facilities of $1 trillion a day, these overnight, nearly risk-free and lucrative trades deserve some reflection. But can anyone blame an institution for making what practically amounts to “free money” by lending to the Fed? Of course, they’ll never explain it as such. Rather, Powell says:
[S]o we think it's doing what it's supposed to do, what we expect of it to do, which is to help provide a floor for money market rates and help ensure that the federal funds rate stays within the target range.
Therefore, it’s important the wealthiest institutions in the world lend $1 trillion to the central bank for overnight lending, quite possibly with money they created out of thin air itself, in order to keep rates in the appropriate range, says the Fed.
Domestic repos, international repos, and reverse repos; once the financial schemes are invented, they have a habit of never going away. On top of that, they continually reinvent themselves in new and interesting ways, while the dollar amounts continue to increase ever so steadily … As of this writing, no plan of winding down these facilities has been noted.
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