WASHINGTON'S BUSINESS CULTURE

In lieu of the budget debate and abject failure of the Federal Government to slow the rate of government growth, cut spending, and devise a viable solution, Standard and Poor’s has downgraded the Federal Government’s debt from AAA to AA+. The Democrats began tossing around blame like beads at Mardi Gras, with profuse attacks directed at the tea party movement. In reality, the blame stems from Washington and the politicians’ desires to finance their reelection campaigns.

There is something in economics that is called the law of unintended consequences. This law is mainly directed at government action but can also be applied to actions of people. Essentially, the law of unintended consequences is where a law or action happens and unforeseen results occur. Examples of this are abound. The income tax, for example, was initially applied only to the super rich, the top 1% earners in the country. Now, everyone pays income taxes.

There is another aspect of the law of unintended consequences that rarely, if ever, is reported. That is the effect of government policies on the dynamics between politicians and lobbyists. Whenever the government enacts a subsidy to prop one industry (i.e. ethanol), or enact taxes to discourage other industries or actions (i.e. tobacco taxes) produces additional lobbyists to encourage or dissuade these policies. The same applies to government spending. To illustrate, the Federal Government enacts a subsidy program to prop up and make competitive the ethanol industry. This policy will purposefully be harmful to oil companies. The ethanol industry will funnel funds to politicians’ campaigns who support this policy. Equally so, the oil companies will do the same to those politicians who oppose this policy. This happens for every policy Washington enacts that interferes with free market principles. This amounts to a politician receiving thousands to millions of dollars on the basis of what policies they support.

In regards to the law of unintended consequences, there exists almost a market where there is a supply and demand for government policy, and the price is campaign contributions. Consequently, there is not much of an incentive to produce true reforms in government policy. There exists too much of an incentive and too much money for Washington to continue its ways. In reality, the incentive exists for continued and additional government intrusion in economic affairs and continued and additional government spending.

Washington is itself to blame for the debt crisis and resulting reduction in our credit rating by Standard and Poor’s. The only path to true reform regarding the debt is for the Representatives and Senators to peel back their relationship with K Street (lobbyists) and remove any interference of the Federal Government in the free market. Maybe then will our nation truly see reform.

The Debt Ceiling

Last week, members of the Democratic Party in the U.S. Congress spoke about encouraging the President Barrack Obama to unilaterally raise the debt ceiling by invoking the 14th Amendment to the Constitution. Not only that, but there have been academia who have interpreted the 14th Amendment to empower the President to take this action. This course of action is absurd and undoubtedly unconstitutional.

The 14th Amendment contains five different sections. Sections four and five are the only relevant sections to this issue. Section Four states "The validity of the public debt of the United States, authorized by law...shall not be questioned." There's more to this particular section but it is unnecessary to present it all. There is nothing stated in this section that could reasonably be interpreted as empowering the President of the United States to raise a debt limit ceiling. Furthermore, all this section does is legitimize the debt incurred by the Government of the United States.

Section Five of the 14th Amendment puts the nail in the coffin. It states "The Congress shall have power to enforce, by appropriate legislation, the provisions of this article." So how does the President have the power to raise the debt ceiling? He doesn't. It clearly states that Congress is empowered to enforce the 14th Amendment.

Clearly the 14th Amendment does not empower the President to raise the debt ceiling. Thankfully the White House has itself dismissed this course of action stating that it is unconstitutional.

China's Hidden Economic Growth

From 2007 to the present, China has seen a growth rate in GDP as high as 13%, and as low of 6.2%, and an average growth rate in this period of 9.97%. These are extraordinary numbers that no doubt can be attributed to China’s decentralization and liberalization of their economy. This has caused the media to question whether other the American economic model should supersede the Chinese economic model. However, I am not too sure if China’s GDP growth is as good of an indicator as speculated.

Given that China is a communist nation, their regulatory policies pushed a good deal of their economy into a black market. This has been observed in every nation with excessive red tape and costly regulatory policies. The Soviet Union experienced that same issue. Latin American countries have had the same issue. Hernando De Soto’s excellent expose’ in “The Mystery of Capital,” accounts for this. In this book, De Soto shows how excessive red tape moved much of the economy into the illicit black market. This consequently resulted in the GDP of various Latin American countries being underreported. As these countries liberated their economy’s their GDP began to grow as businesses operating under the table began to come out and operate within the legal realm.

I attribute what De Soto displayed and explained in Latin America to what is being experienced in China. Prior to liberalizing, China’s GDP has been underreported due to the very nature of an existing black market. As businesses in China emerge from the black market and are able to operate openly and under legal and property protection, China’s GDP has grown to figures that more truly represent their economy.

Essentially, we cannot simply attribute China’s model to its excellent production capabilities. If we were to follow anything from China, it is that our regulatory framework needs loosening.

The Benefits of Federalism and States' Rights

After a brief and failed experiment with the Articles of Confederation, our Nation’s Founding Fathers created a unique and ingenious system of governance called federalism. This system produced an additional checks and balance system and separation of powers between the national government and the states’ governments, while recognizing the difference in interests between the 13 states. The most important aspect of Federalism can be seen in the 10th Amendment to the Constitution, which states “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.” This is a paramount system that is more evident and important today as it was 200 years ago. It is the foundation that has allowed economic prosperity when respected, all while allowing for economic collapse when violated.

The largest benefit of federalism is that it has provided for a system of competition between the states. One state’s policies can not only affect it, but can affect another state. For example, recently, Illinois, in dealing with its budget crises, chose to raise income taxes. This negatively affects residents and small businesses of Illinois. At the same time, Wisconsin, Illinois’ neighbor to the north, has introduced a climate friendlier to businesses and individuals. The effect of this will be movement of individuals and businesses from Illinois to the north, and to surrounding states with similar legislation to Wisconsin’s. In other words, there is competition. In essence, this system allows for policy experimentation, 50 different experiments to be exact, to best suit their needs.

This further becomes essential when the states learn from each other and begin to model policies after each other. When Wisconsin’s Governor Walker signed the public employee collective bargaining bill, Indiana soon followed suit. As the benefits to Governor Walker’s bill have been realized, more states have begun to introduce similar legislation seeking similar results. We see similarities with Right to Work States. Those states, such as South Carolina, are attracting more business, allowing for job creation. If the federal government dictated these policies, it would be difficult to find the best, most efficient policy.

The benefits of this system cannot be seen if the federal government dictates a national economic policy. Essentially, what works in one state will not necessarily work in another state. What works in one region, may not necessarily work in another region. The best federal economic policy is to allow the states to determine their destination, to compete with each other for the most beneficial policies.

QUANTITATIVE EASING

As the economy continues to produce dismal results, Board of Governors Chairman Ben Bernanke is considering implementing round three of quantitative easing (QE). Aside the fact that quantitative easing failed miserably in Japan, and failed two previous times in America, the Federal Reserve might try this tactic again to try to stimulate an economy that honestly, can no longer be stimulated. Other than the fact that this effort is going to fail, there are three reasons why this Congress needs to step in and regulate this independent government body called the Board of Governors.

Quantitative easing is the process where the Federal Reserve buys bonds from the market. These bonds are purchased ex nihilo, or out of nothing. This results in increasing the money supply. Any study of economics and the money supply shows that this policy will be inflationary. Other than continued government spending, this is the last thing our economy needs. With 9.2% unemployment and many more dropping out of the labor market, an inflationary policy is the last thing needed for our economy. Making consumer expenditures more expensive is the last thing this economy needs.

Inflation has the effect of weakening the dollar. This leads to another impact QE will have on the economy. Because inflation will devalue the dollar, the exchange rate for the dollar will become weaker. It will take more dollars to buy foreign currency which makes foreign products more expensive. At the same time, however, this will make American goods exported cheaper and more competitive abroad. However, because the U.S. imports the majority of petroleum, a weak dollar will result in an increase in gas prices, exacting additional budgetary pressures on Americans.

Lastly, QE is unconstitutional. Article I, Section 8 of the Constitution directs Congress to regulate the value of the money it creates. Essentially, because QE is inflationary by its very nature, the Federal Reserve’s policy is unconstitutional in that it subverts the ability of Congress to control the value of the dollar. The Constitution does not empower the Federal Reserve to affect the value of the dollar. In fact, from the Federal Reserve’s own website, the Federal Reserve Act mandates the Federal Reserve to maximize employment and to stabilize prices. Well, inflationary policies do not stabilize prices. We need to only look at South America to see how unstabilized prices become as result of reckless money printing.

In Conclusion, the Federal Reserve’s QE policy undermines a constitutionally explicit power of Congress. QE results in an increase of the money supply, which contributes to inflation. In a time when many Americans are out of work, and many American’s facing pressure on their budgets, an inflationary policy like QE cannot be good for our current economy. Additionally, inflation weakens the dollar, causing important imported commodities such as petroleum to be more expensive. The Board of Governors needs to seek a different approach.

PRIVATIZING DEPOSIT INSURANCE

The Federal Deposit Insurance Corporation (FDIC) was established under President Franklin D. Roosevelt during the Great Depression. Its established purpose was to prevent or limit the effects of bank failures. Bank failures have historically led to a run on the deposits of various banks, sparked by fears that additional banks would fail, causing additional banks to fail. At a quick glance, the FDIC is a great idea, and it is. However, I contend that it is prudent and much more favorable to privatize deposit insurance (D.I.).

Privatizing D.I. will lead to an improvement in bank operations through the increase availability of information. Consumers will be able to discern the reliability and the level of risk a bank takes. This is reflected through the rates a bank pays for D.I. As it is with automobile insurance where high risk groups (i.e. teens, unmarried males, etc.) pay higher premiums due to being a higher risk category, high risk-taking and unstable or unreliable banks would face higher D.I. rates. This would be evident in the interest rates a bank charges for loans or the rates a bank pays for savings. Due to the higher costs it will see, a high-risk bank will charge higher interest rates for loans, and pay out lower interest rates for savings as compared to a low-risk bank. Consumers will be attracted to the low-risk banks without even knowing it.

Along with the previous point, privatizing D.I. will encourage high risk-taking banks to stop or reduce their risky ventures. This will be due those banks losing customers to the low-risk banks who have competitive interest rates for loans and savings. The high risk banks, in order to stay in business, will have to reduce the risk they are facing in order to reduce costs.

The benefits of privatizing D.I. cannot be seen through the FDIC. The FDIC charges a fee to member banks (Federal Deposit Insurance Act, Sec 5 (d)). There are seven factors that are considered when the FDIC admits a new bank Sec 6), one of which is the risk presented by the bank (subset 5). However, this only involves banks seeking to become an FDIC member institution. This does not stop banks who are already FDIC members from engaging in risky areas. This can be seen in the recent sub-prime mortgage crisis. The laws and regulations of the FDIC could not prevent this issue from arising. Privatized D.I. would have.

Privatized deposit insurance has many benefits that the United States and the world need to adopt. Through deregulation, incentives will be created to inhibit banks from engaging in high-risk ventures. Those incentives are seen through higher business costs through higher premiums paid for higher risks. These higher costs will encourage consumers to seek low-risk banks, which carry higher interest rates for savings and lower interest rates for loans. Through this system, the United States would have adverted the sub-prime mortgage crisis.

A Response To The Skeptical Economist

I am currently reading the book "The Skeptical Economist," authored by Jonathon Aldred. So far I've discovered numerous errors in his various arguments, on which I will make responses.

The first error that caught my eye can be found on page 57. Mr. Aldred cites a survey of Harvard students. In this survey, the students were asked two choose between two economies in which to chose to live. In economy A, you have an income of $50,000 whilst the average income is $25,000. In economy B, you have an income of $100,000 while the average is $250,000. Majority of the Harvard students selected economy A. Mr. Aldred contends that this is do to a rivalry situation where people will have a tendency to want to be in a better relative position that others. This looks like a sufficient argument at the superficial level. However, if we delve into the situations presented in economy A and economy B we can find a different response.

In economy B, you are making 2.5 times less than the average income. This is in contrast the Economy A where you are making twice than the average income. Basically, in economy A you are wealthy, and in economy B you are in poverty. Rationality dictates selecting economy A. Furthermore, the $100,000 you would make in economy B is more than likely worth less than the $50,000 you would be in economy A. Economy B is a wealthier economy than A, as dictated by average incomes. Therefore, prices in B will more than like be higher than those in A. Therefore, you purchasing power in B, with the $100,000, would more than likely be less than that of the $50,000 in A.

Opportunity Cost

In economics, there is this notion of opportunity cost, which, as Wikipedia defines it, "the cost of something in terms of an opportunity forgone" (http://en.wikipedia.org/wiki/Opportunity_cost). What this means is that, given two choices (A and B), the cost of choosing A is that of choice B. In other words, you have two choices, studying or watching television. The cost of studying is not watching televesion. Consequently, it is opportunity cost that states the nothing is actually free, because the cost of the free item is not doing something else. In this essay, I am going to contend this notion that this is not always the case.

To illustrate, Johny has been given two choices (A and B). Both choices are free in terms of there is no dollar value for either choice. In other words, Johny does not have to forgo any money to obtain either choice. However, choice A represents anything that can be considered non-fatal. On the other hand choice B represents a choice that will be fatal (such as taking cyanide). A rational human being would no doubt chose A. Johny, being a rational human being choses A. Now, in terms of the conventional view of opportunity cost, the cost of Johny's decision is that of choice B. This is where my issue arises.
How can choice A have a cost to it in the situation presented? The very definition of rationality, which is basically sanity, would steer a person away from choice B. Consequently, choice B cannot be construed as being a cost upon choice A. Ergo, choice A does not have a cost upon it.

What does this all mean? This means that in a world as simple as the one presented, that there may be actually things considered free in all aspects, whether economic or accounting. However, in a real world situation, there would be other choices presented to Johny (or any one else) so that there would actually be an opportunity cost enacted upon choice A.