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By Anthony J. Evans, on 23 May 11
Consider this diagram showing the billions of euros that each of 8 EU countries owes the other.
Whilst the numbers are far from perfect, they give a clear understanding of the extent to which EU debt obligations are interlinked. But why try to raise money to pay someone off if they owe you even more? Why not cross cancel the debts and be left with the difference?
To see how this might work I recently ran a classroom simulation where students did precisely that. After three trading rounds they had managed to generate the following results:
- The countries can reduce their total debt by 64% through cross cancellation of interlinked debt, taking total debt from 40.47% of GDP to 14.58%
- Six countries – Ireland, Italy, Spain, Britain, France and Germany – can write off more than 50% of their outstanding debt
- Three countries – Ireland, Italy, and Germany – can reduce their obligations such that they owe more than €1bn to only 2 other countries
- Ireland can reduce its debt from almost 130% of GDP to under 20% of GDP
- France can virtually eliminate its debt – reducing it to just 0.06% of GDP
The final picture demonstrates the scope for cross cancellation. It is hard to see how such a policy would be possible, let alone desirable, but as a pedagogical exercise I think it is worth consideration. For those interested in more details I have set up a website: http://www.eudebtwriteoff.com. You can also download the full report: The Great EU Debt Write Off (.pdf)
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By David Howden, on 5 January 11
For over a decade we have heard reports of China’s increasing world dominance. Yet while Beijing has amassed a large war chest of savings over the past decade – $2.5 trillion remain under its control – it has been cautious in waiting for a rainy day to put its savings to use.
The times they are a changing. One day prior to his arrival in Madrid for an official visit, Chinese Vice President Li Keqiang announced that China had the utmost confidence that Spain would recover from its economic malaise. And to put China’s money where his mouth is, Li made an open-ended pledge to “help” (read: “bail”) out Spain in the future.
Citing China’s stance as a “responsible investor” with a long-term view of European financial markets, Li assured investors that purchases of Spanish public debt would continue. Moreover, the man who is widely reckoned to become China’s next premier commented on Chinese support for Spain’s austerity measures, and confirmed the conviction that Spain would achieve a swift economic recovery.
While Spain’s austerity measures are admirable, there is still a long way to go. With a deficit of 9.3 percent of GDP for 2010, and 6 percent forecast for this new year, total debt will grow to 62 percent of Spanish GDP by the time this year becomes bygones. That is, it will be 62 percent of GDP as long as GDP does not collapse further than it already has been. While GDP contracted by over 2.5 percent in 2009, and the final tally for 2010 still to come, the future debt load of Spain is more than a little uncertain.
Meanwhile, Spain’s own Socialist Prime Minister Jose Luis Rodriguez Zapatero noted that the Chinese commitment will “play a key role” in financial stabilization. This seems to be a signal that the stabilization that Zapatero is talking about is different than that which China reckons to be “investing” in.
Real stabilization will not come from having a bailout by different words. The Eurozone economy – of which Spain is a not insubstantial part as the fifth largest economy – is in the midst of a deteriorating debt crisis. Continued bailouts are band aid solutions to the wrong problem. When faced with a crisis of insolvency the solution is not continued doses of more debt. What are needed are drastic cuts to expenditures.
Spaniards, or anyone for that matter, should not be fooled into thinking that Beijing’s generosity will solve any problems. If anything a bailout will exacerbate and prolong the pain which has already been assured by the excesses of the past. When you wake up with a hangover, drinking more does little to numb the pain. More alcohol may get rid of the morning shakes, just as this “bailout” may calm market jitters, but at the cost of a more severe eventual withdrawal.
Philipp Bagus, in his new book “The Tragedy of the Euro”, explains lucidly how the European debt crisis emerged. Southern European countries joined a currency union assumed to be unbreakable. Any eventual signs of trouble with any of the weaker countries – the PIIGS of today – would by necessity be attended to by the strong. Incidentally, with reports of Belgium and even France someday requiring external aid, the list of the strong is quickly shrinking. Adding fresh troubled economies to its scope is not helping this situation either. On January 1st Estonia became the 17th country to enter the Eurozone. While Estonia ran a budget deficit of 8 percent of GDP last year it is only a matter of time before the new addition joins the ranks of the needy.
Unfortunately for Spaniards, what commentators are commonly missing (besides the fact that this bailout will breed more painful adjustments down the road) is that the pain of this bailout will fall mainly on Spaniards.
Guaranteeing a bailout will assure the government that they can continue their spending binge for a little while longer. Necessary cutbacks will not be enacted, as they will not be deemed as necessary. While the punch is still flowing, drink up. Without meaningful budget cuts there will be no improvement in an already tenuous fiscal situation. How long can insolvent countries keep getting bailouts to keep them going?
China has deep pockets, enabling it to keep bailing out troubled Europeans for a long run. But we all know what happens in the long run. Surely such a fate for Spain is worse than some short-term pain today.
By Bruno Prior, on 3 November 10
Can I steal from myself? Of course not. Further, I cannot hold too much of my own stolen property. My future plans to dispose of my stolen property cannot be constrained by the possibility that I will have to restore it to its rightful owner, since I will have to restore it to myself.
Similarly, the world cannot steal from itself and the world economy cannot be deprived of its assets. In the absence of expropriation from Mars or Venus, the claim that “the world economy has too much swag” is a misunderstanding. The growth of demand in 2011, 2012 and later cannot be held back by allegedly excessive “global theft”.
These remarks are surely obvious. Nevertheless, a common argument since the meltdown is that an overhang of excessive booty will hold back acquisition and lead to a prolonged period of weak demand.
Substitute “debt” for “theft”, and this is the opening of Tim Congdon’s latest Marketplace column for Standpoint magazine, arguing that debt is no burden on the economy, since there is always a credit to match the debit. The logic is as true for theft as for debt. For every victim who has lost an asset there is a criminal who has gained an asset. And yet it is obvious that an economy in which theft was rampant would be less well off than an economy in which people acquired property only by voluntary exchange.
Tim is treating the economy as a zero-sum game, and assuming that the value of assets remains proportional to the money that was exchanged for them. In reality, wealth can be created or destroyed through changing ownership and use of property. The pie shrinks or expands accordingly.
In the case of theft, wealth is usually destroyed, because the stolen good is worth less to the criminal than it was to its rightful owner. In the case of voluntary exchange, wealth is usually created, because each participant obtains a good that they value more highly than the good that they exchanged (otherwise they would not have agreed to exchange). In the case of debt, whether wealth is created or destroyed depends on the use to which the borrowed money is put.
I lend money to a borrower on the basis that they are able to make better use of it in the short term than I am. If I am right, they repay me with interest gleaned from the profitable use to which the money was put. We are better off. Wealth has been increased. But I might be wrong. In that case, I will not be paid the full amount due. We are worse off. Wealth has been destroyed.
It is little consolation that, until the point of default, the debit and credit remain in full on our respective books. Nor does it help if we distort monetary values and demand through monetary policy, so that the debt is able to be repaid in full in nominal terms. It is not real. If the money has been badly invested, wealth has been destroyed, and nothing can change that.
As an amateur, I hesitate to criticise one of our leading professional economists and defenders of the free market. But Tim seems to me in this article to have crystallized the monetarist philosophy into a form so pure that the underlying errors can be seen clearly through the cubic zirconium intellectual construct.
By Sean Corrigan, on 1 October 10
Much ink has been spilled (and some even coherently applied) over the vexed subject of ‘deleveraging’ and its likely impact upon the economy-at-large.
For the Keynesian-tainted mainstream, this all comes down, of course, to the fear that individuals and businesses – having succumbed to the illusion that they should expect to enjoy a higher standard of living than their productive capacities could support – might rediscover the Micawberish happiness of living within their incomes and that aggregate spending (and with it prices!) might temporarily fall, while people again found a way to earn what they had formerly charged copiously to their plastic.
In order to avoid this supposed societal evil, Leviathan has been roused from his fitful slumbers to stride forth and do our spending for us on a truly epic scale, while we have been indoctrinated to believe that we would all become instantly richer if only we would respond more eagerly to the Counterfeiter-in-Chief’s valiant efforts to debase the value of what little money we have yet managed to hold on to.
Since the LEH-AIG implosion, household debt has incontrovertibly shrunk, falling some $466bln as mortgage borrowing outstanding (which had run at a scorching 11.9% compounded rate in the seven fat years to end-2007) dropped by $423bln.
To view this as a return to voluntary thrift, however, is a little premature since, for example, the 6% decline in consumer credit extant almost exactly matches the average 5.6% bank charge-off rate for such lending. On the residential side, banking write-downs of a mean 2.3% have so far amounted to around $100bln according to the FDIC – with another $30bln or so to add in on Fannie & Freddie’s account.
But that is not quite the end of the picture for, if we combine the MBA’s quarterly assessment with the Fed’s FOF numbers, we can estimate that the stock of mortgages subject to foreclosure has swollen by around $165bln in this period, with $300bln more having also become delinquent – and this without taking account of multi-residential property, second-liens, or RE now perforce owned by the lenders.
A further indication of the scale of the distress can be seen in the fact that whereas foreclosure usually takes place within 180 days of a loan falling past due, the current average is a mind-boggling 470 days, implying that lenders have been falling over themselves not to recognise the true state of affairs for as long as they could ‘extend and pretend’.
This is no laughing matter, as commercial banks with assets between $100mln and $1bln – of whom there are some 3,800 with a combined $1tln balance sheet – have OREO-inclusive ‘Texas Ratios’ of 32%, a number as bad as all but the worst seen during the late-80s bust. Moreover, they have an average exposure to real estate loans of no less than 525%, a figure which perhaps explains their reluctance to further depress property prices by turning payment-shy mortgagees out into the street.
 Fig 1: US Household Liabilities Far less equivocal, however, has been the behaviour of Corporate America, for here there was a decisive move to preserve cash flow – and, more importantly, to boost free cash flow. The cynic will note that this even went so far as to leave enough in the bank to pay dividends (for only the second spell in twenty years) and that there were even two quarters of next domestic equity issuance and credit reduction, a far cry indeed from the record net $375 billion ($310bln ex-FDI) doled out to shareholders and high executives on the eve of the storm, in QIV’2007.
If we put all this together, we find that, in the face of an estimated 15% fall in sales, and a 43% drop in gross income, free cash flow was actually increased steadily from its pre-crisis lows over the winter of 2007-2008 to hit record levels last summer (see below for Fig 1 ).
This was achieved through a drastic pruning of outlays of a rolling 4Q, peak-to-trough magnitude of 32% in below-the-line outlays, consisting of a 20% reduction in fixed capital spending and a chart-topping $137bln slashing of inventory. Reinforcing this, payroll outlays were cut by almost 6%, equivalent to a $250bln a year saving.
While dividend payments were largely maintained intact, equity issuance net of FDI receipts swung from a balance sheet-sapping, ESOP-mainlining $500bln buyback to a $78bln net call on the domestic market. As a consequence, borrowing actually went down modestly in the second half of last year, having hit a peak of $430bln in the summer of 2007 as the first Fed rate cuts led to some very unwise, late-cycle financial engineering.
Of course, this dramatic pullback in corporate discretionary spending has sent shockwaves travelling the productive structure in a manner that the Herd, with its dull obsession with retail outlays, never manages fully to comprehend. In typical fashion, the pain has been focused on the higher order sectors, as well as on those most directly linked to credit-fuelled, exhaustive spending on houses and cars, as the following schematic of normalized sales reveals (Fig.2).
As such, here is where the Bust has wrought its havoc but – at the risk of appearing hard-hearted – this has been a necessary (if not yet sufficient) precondition of the recovery. Dangerous levels of leverage could not have been allowed to mount further; budgets simply had to be recast in order to take account of the post-Boom landscape and new priorities had to be set, accordingly.
 Fig 2: US sales profiles The darker side to this, however, is that little actual ‘deleveraging’ has occurred (outside of the rather more badly impaired non-corporate sector, that is). Indeed, for all the cash accumulated, debt levels still remain very high by historical standards, both as a proportion of net worth and in relation to income.
 Fig 3: US Corporate Debt Ratio All of which means that, on the aggregate, there has been almost no improvement in average creditworthiness, as evidenced by the composite Altman Z-score estimate for the sector as a whole.
 Fig 4: US aggregate Z-score If we once remember that the aggregate hides some wider, individual distribution, it is clear that Ben Graham’s ‘margin of safety’ has been severely pruned in the inflationary finance era ushered when even the pretence of a link to gold was abandoned with the collapse of Bretton Woods.
Arguably then, whatever the Inflationists continue to advocate, more repairs need to be effected to balance sheets, not fewer, and, No!, Mr. Wolf, this does not mean someone else must become a net borrower in order to achieve this; simply that people and companies have to accept a settlement of the past debts owed them.
Your lowered net liabilities can just as easily (and more healthily) be reflected in my lowered net financial assets, not just in my equal-and-opposite increase in the use of credit.
If you previously bought more of my produce than you could pay for, I had to accept your IOU for the difference. Now that you wish to lower your outstanding obligations, I do not have to borrow in your place, but I do have to let you deliver me goods or services to the value of the original loan (or steel myself to a partial write-off of it). Strictly speaking, this does not even impose the necessity of you consuming less or me cutting back production: if you increase your marketable output sufficiently, you can both pay for another consignment of my wares and extinguish your existing liability – after all, is this not the very thing we hope for from all those businesses on which we acquire claims?
Rather than facilitating this, sadly, the State is blindly violating its duty to provide for the greater good by further impairing our balance sheets (since we are the ones who will eventually have to foot the bill for its opposition to our wishes) faster than we are able to mend them.
 Fig 5: US Sectoral Flows – what ‘deleveraging’! Government, indeed, is more than compensating for private credit contraction. Revealing as it is, what the chart above does not flesh out is that there has been substantial Federal borrowing in order to lend, not just to spend – with around $85bln in new loans (some to state & local government), $225bln in GSE support, $50bln in equity acquisitions, and $130bln in student credit since 2007 – so a gross debt contraction, in blunt Keynesian aggregate terms, is not actually being allowed to take place.
The problem with this is that while corporates are trying to heal themselves, they are also painfully aware that (a) the previous overspend (whose dubious fruits they so enjoyed) is not likely to return rapidly; and (b) that this governmental excess will eventually come out of their, or their patrons’, pockets.
Here we are subject to the suspicion that government deficits, being unitary, are much more visible – and, of course, can be dealt with more arbitrarily – than the sum of a myriad private ones and hence excite much more angst. There is no debt clock running to add up the other sectors’ improvidence, as there is with Leviathan.
Thus, while companies wait to find out what they or their customers will have to suffer in terms of carbon gabelles, trade restrictions, health-care levies, and all manner of taxes, they are still somewhat loath to put this free cash to work in the form of laying down fixed, specific, physical capital or in taking on more long-term labour commitments, hence the heretofore anaemic nature of the recovery. And now we are in the process of adding a further layer of currency and interest rate uncertainty to the mortar, the wall of disincentives can only tower ever higher above us all.
By Toby Baxendale, on 22 June 10
Alan McCormick of Legatum wrote an excellent article for yesterday’s Wall Street Journal:
Shortly after taking office in May, Britain’s new chief secretary to the Treasury discovered a note from his predecessor, Liam Byrne: “I’m afraid to tell you there’s no money left.”
Tomorrow, to help address that mounting fiscal crisis, Chancellor George Osborne will release an emergency budget. It is expected to include an array of spending cuts and tax hikes to reduce the £156 billion deficit he inherited from the previous government. In all likelihood, it will call for a dramatic increase in the capital-gains tax.
Such a move would be disastrous for the economy. Raising the capital-gains tax would discourage Britons from creating new businesses, and scare off investors. The government should instead focus on leaving money in the hands of entrepreneurs. It is their hard work that’s going to create the jobs and wealth needed for full economic recovery.
(a subscription is required to view the whole article, but a free trial is available)
For readers seeking further analysis of the Capital Gains Tax proposals, I recommend this post by Steve Baker.
By Andy Duncan, on 26 May 10
With what Mr Spock might call the fascinating financial news stories we have all seen in the last week or so, most people are coming around to the idea that we are on the edge of some kind of financial abyss. Is our drop into this abyss inevitable, in the best historicist tradition of the Marxists, or is there some clear route which can steer us away from a fall into a double-dip recession, or even a hyperinflationary depression, which is merely sitting around awaiting our discovery?
We at the Cobden Centre believe in the creation of a good sound currency system based upon honest money. However, the route to that may prove long and hard, and perhaps too long and too hard to get us quickly out of our current mess. Is there a simpler fix we can apply in the meantime?
Floy Lilley of the Mises Institute believes there is. She has been examining some financial reforms of the mid 1980s, in which New Zealand found itself in a remarkably similar position to our own current morass, with massive government debt and a large client state suffocating what remained of a shrinking productive sector.
How did the New Zealand government solve this problem?
Maurice P. McTigue, the former Minister of Works in New Zealand, led the assault. Some of the measures he instigated included reducing the Department of Transportation from 5,600 to 53 and reducing the numbers in the Forest Service from 17,000 to 17. In his own department, Mr McTigue remained the sole employee out of 28,000.
In a lecture he gave in 2004 (reproduced below), Mr McTigue explained how they achieved their remarkable turnaround in New Zealand’s fortunes, and how they escaped their own 1980s debt crevasse.
Alas, Ms Lilley believes our current UK Coalition government is incapable of adopting the bold measures taken by the New Zealand government:
Britain, too, is at a crossroads. Its political leaders cannot bear the thought of not spending, so they have stopped thinking about it. They are falsely convinced that any cuts in public spending would destroy the country’s basic public services and stop any economic recovery from ever beginning. Their economists have this backwards. The British population can look forward to ever-increasing taxation under the thumb of a coercive and costly bureaucracy whose monetary policies serve the state, but do not serve people.
Floy Lilley
But just in case there are any UK politicians out there who want to know how New Zealand did it, here is Mr McTigue’s 2004 lecture, as delivered to the students of Hillsdale College in the United States:
Rolling Back Government: Lessons from New Zealand
If we look back through history, growth in government has been a modern phenomenon. Beginning in the 1850s and lasting until the 1920s or ’30s, the government’s share of GDP in most of the world’s industrialized economies was about six percent. From that period onwards – and particularly since the 1950s – we’ve seen a massive explosion in government share of GDP, in some places as much as 35-45 percent. (In the case of Sweden, of course, it reached 65 percent, and Sweden nearly self-destructed as a result. It is now starting to dismantle some of its social programs to remain economically viable.) Can this situation be halted or even rolled back? My view, based upon personal experience, is that the answer is “yes.” But it requires high levels of transparency and significant consequences for bad decisions – and these are not easy things to bring about.
What we’re seeing around the world at the moment is what I would call a silent revolution, reflected in a change in how people view government accountability. The old idea of accountability simply held that government should spend money in accordance with appropriations. The new accountability is based on asking, “What did we get in public benefits as a result of the expenditure of money?” This is a question that has always been asked in business, but has not been the norm for governments. And those governments today that are struggling valiantly with this question are showing quite extraordinary results. This was certainly the basis of the successful reforms in my own country of New Zealand.
New Zealand’s per capita income in the period prior to the late 1950s was right around number three in the world, behind the United States and Canada. But by 1984, its per capita income had sunk to 27th in the world, alongside Portugal and Turkey. Not only that, but our unemployment rate was 11.6 percent, we’d had 23 successive years of deficits (sometimes ranging as high as 40 percent of GDP), our debt had grown to 65 percent of GDP, and our credit ratings were continually being downgraded. Government spending was a full 44 percent of GDP, investment capital was exiting in huge quantities, and government controls and micromanagement were pervasive at every level of the economy. We had foreign exchange controls that meant I couldn’t buy a subscription to The Economist magazine without the permission of the Minister of Finance. I couldn’t buy shares in a foreign company without surrendering my citizenship. There were price controls on all goods and services, on all shops and on all service industries. There were wage controls and wage freezes. I couldn’t pay my employees more – or pay them bonuses – if I wanted to. There were import controls on the goods that I could bring into the country. There were massive levels of subsidies on industries in order to keep them viable. Young people were leaving in droves.
Spending and Taxes
When a reform government was elected in 1984, it identified three problems: too much spending, too much taxing and too much government. The question was how to cut spending and taxes and diminish government’s role in the economy. Well, the first thing you have to do in this situation is to figure out what you’re getting for dollars spent. Towards this end, we implemented a new policy whereby money wouldn’t simply be allocated to government agencies; instead, there would be a purchase contract with the senior executives of those agencies that clearly delineated what was expected in return for the money. Those who headed up government agencies were now chosen on the basis of a worldwide search and received term contracts – five years with a possible extension of another three years. The only ground for their removal was non-performance, so a newly-elected government couldn’t simply throw them out as had happened with civil servants under the old system. And of course, with those kinds of incentives, agency heads – like CEOs in the private sector – made certain that the next tier of people had very clear objectives that they were expected to achieve as well.
The first purchase that we made from every agency was policy advice. That policy advice was meant to produce a vigorous debate between the government and the agency heads about how to achieve goals like reducing hunger and homelessness. This didn’t mean, by the way, how government could feed or house more people – that’s not important. What’s important is the extent to which hunger and homelessness are actually reduced. In other words, we made it clear that what’s important is not how many people are on welfare, but how many people get off welfare and into independent living.
As we started to work through this process, we also asked some fundamental questions of the agencies. The first question was, “What are you doing?” The second question was, “What should you be doing?” Based on the answers, we then said, “Eliminate what you shouldn’t be doing” – that is, if you are doing something that clearly is not a responsibility of the government, stop doing it. Then we asked the final question: “Who should be paying – the taxpayer, the user, the consumer, or the industry?” We asked this because, in many instances, the taxpayers were subsidizing things that did not benefit them. And if you take the cost of services away from actual consumers and users, you promote overuse and devalue whatever it is that you’re doing.
When we started this process with the Department of Transportation, it had 5,600 employees. When we finished, it had 53. When we started with the Forest Service, it had 17,000 employees. When we finished, it had 17. When we applied it to the Ministry of Works, it had 28,000 employees. I used to be Minister of Works, and ended up being the only employee. In the latter case, most of what the department did was construction and engineering, and there are plenty of people who can do that without government involvement. And if you say to me, “But you killed all those jobs!” – well, that’s just not true. The government stopped employing people in those jobs, but the need for the jobs didn’t disappear. I visited some of the forestry workers some months after they’d lost their government jobs, and they were quite happy. They told me that they were now earning about three times what they used to earn – on top of which, they were surprised to learn that they could do about 60 percent more than they used to! The same lesson applies to the other jobs I mentioned.
Some of the things that government was doing simply didn’t belong in the government. So we sold off telecommunications, airlines, irrigation schemes, computing services, government printing offices, insurance companies, banks, securities, mortgages, railways, bus services, hotels, shipping lines, agricultural advisory services, etc. In the main, when we sold those things off, their productivity went up and the cost of their services went down, translating into major gains for the economy. Furthermore, we decided that other agencies should be run as profit-making and tax-paying enterprises by government. For instance, the air traffic control system was made into a stand-alone company, given instructions that it had to make an acceptable rate of return and pay taxes, and told that it couldn’t get any investment capital from its owner (the government). We did that with about 35 agencies. Together, these used to cost us about one billion dollars per year; now they produced about one billion dollars per year in revenues and taxes.
We achieved an overall reduction of 66 percent in the size of government, measured by the number of employees. The government’s share of GDP dropped from 44 to 27 percent. We were now running surpluses, and we established a policy never to leave dollars on the table: We knew that if we didn’t get rid of this money, some clown would spend it. So we used most of the surplus to pay off debt, and debt went from 63 percent down to 17 percent of GDP. We used the remainder of the surplus each year for tax relief. We reduced income tax rates by half and eliminated incidental taxes. As a result of these policies, revenue increased by 20 percent. Yes, Ronald Reagan was right: lower tax rates do produce more revenue.
Subsidies, Education, and Competitiveness
What about invasive government in the form of subsidies? First, we need to recognize that the main problem with subsidies is that they make people dependent; and when you make people dependent, they lose their innovation and their creativity and become even more dependent.
Let me give you an example: By 1984, New Zealand sheep farming was receiving about 44 percent of its income from government subsidies. Its major product was lamb, and lamb in the international marketplace was selling for about $12.50 (with the government providing another $12.50)per carcass. Well, we did away with all sheep farming subsidies within one year. And of course the sheep farmers were unhappy. But once they accepted the fact that the subsidies weren’t coming back, they put together a team of people charged with figuring out how they could get $30 per lamb carcass. The team reported back that this would be difficult, but not impossible. It required producing an entirely different product, processing it in a different way and selling it in different markets. And within two years, by 1989, they had succeeded in converting their $12.50 product into something worth $30. By 1991, it was worth $42; by 1994 it was worth $74; and by 1999 it was worth $115. In other words, the New Zealand sheep industry went out into the marketplace and found people who would pay higher prices for its product. You can now go into the best restaurants in the U.S. and buy New Zealand lamb, and you’ll be paying somewhere between $35 and $60 per pound.
Needless to say, as we took government support away from industry, it was widely predicted that there would be a massive exodus of people. But that didn’t happen. To give you one example, we lost only about three-quarters of one percent of the farming enterprises – and these were people who shouldn’t have been farming in the first place. In addition, some predicted a major move towards corporate as opposed to family farming. But we’ve seen exactly the reverse. Corporate farming moved out and family farming expanded, probably because families are prepared to work for less than corporations. In the end, it was the best thing that possibly could have happened. And it demonstrated that if you give people no choice but to be creative and innovative, they will find solutions.
New Zealand had an education system that was failing as well. It was failing about 30 percent of its children – especially those in lower socio-economic areas. We had put more and more money into education for 20 years, and achieved worse and worse results.
It cost us twice as much to get a poorer result than we did 20 years previously with much less money. So we decided to rethink what we were doing here as well. The first thing we did was to identify where the dollars were going that we were pouring into education. We hired international consultants (because we didn’t trust our own departments to do it), and they reported that for every dollar we were spending on education, 70 cents was being swallowed up by administration. Once we heard this, we immediately eliminated all of the Boards of Education in the country. Every single school came under the control of a board of trustees elected by the parents of the children at that school, and by nobody else. We gave schools a block of money based on the number of students that went to them, with no strings attached. At the same time, we told the parents that they had an absolute right to choose where their children would go to school. It is absolutely obnoxious to me that anybody would tell parents that they must send their children to a bad school. We converted 4,500 schools to this new system all on the same day.
But we went even further: We made it possible for privately owned schools to be funded in exactly the same way as publicly owned schools, giving parents the ability to spend their education dollars wherever they chose. Again, everybody predicted that there would be a major exodus of students from the public to the private schools, because the private schools showed an academic advantage of 14 to 15 percent. It didn’t happen, however, because the differential between schools disappeared in about 18-24 months. Why? Because all of a sudden teachers realized that if they lost their students, they would lose their funding; and if they lost their funding, they would lose their jobs. Eighty-five percent of our students went to public schools at the beginning of this process. That fell to only about 84 percent over the first year or so of our reforms. But three years later, 87 percent of the students were going to public schools. More importantly, we moved from being about 14 or 15 percent below our international peers to being about 14 or 15 percent above our international peers in terms of educational attainment.
Now consider taxation and competitiveness: What many in the public sector today fail to recognize is that the challenge of competitiveness is worldwide. Capital and labor can move so freely and rapidly from place to place that the only way to stop business from leaving is to make certain that your business climate is better than anybody else’s. Along these lines, there was a very interesting circumstance in Ireland just two years ago. The European Union, led by France, was highly critical of Irish tax policy – particularly on corporations – because the Irish had reduced their tax on corporations from 48 percent to 12 percent and business was flooding into Ireland. The European Union wanted to impose a penalty on Ireland in the form of a 17 percent corporate tax hike to bring them into line with other European countries. Needless to say, the Irish didn’t buy that. The European community responded by saying that what the Irish were doing was unfair and uncompetitive. The Irish Minister of Finance agreed: He pointed out that Ireland was charging corporations 12 percent, while charging its citizens only 10 percent. So Ireland reduced the tax rate to 10 percent for corporations as well.
There’s another one the French lost!
When we in New Zealand looked at our revenue gathering process, we found the system extremely complicated in a way that distorted business as well as private decisions. So we asked ourselves some questions: Was our tax system concerned with collecting revenue? Was it concerned with collecting revenue and also delivering social services? Or was it concerned with collecting revenue, delivering social services and changing behavior, all three? We decided that the social services and behavioral components didn’t have any place in a rational system of taxation. So we resolved that we would have only two mechanisms for gathering revenue – a tax on income and a tax on consumption – and that we would simplify those mechanisms and lower the rates as much as we possibly could. We lowered the high income tax rate from 66 to 33 percent, and set that flat rate for high-income earners. In addition, we brought the low end down from 38 to 19 percent, which became the flat rate for low-income earners. We then set a consumption tax rate of 10 percent and eliminated all other taxes – capital gains taxes, property taxes, etc. We carefully designed this system to produce exactly the same revenue as we were getting before and presented it to the public as a zero sum game. But what actually happened was that we received 20 percent more revenue than before. Why? We hadn’t allowed for the increase in voluntary compliance. If tax rates are low, taxpayers won’t employ high priced lawyers and accountants to find loopholes. Indeed, every country that I’ve looked at in the world that has dramatically simplified and lowered its tax rates has ended up with more revenue, not less.
What about regulations? The regulatory power is customarily delegated to non-elected officials who then constrain the people’s liberties with little or no accountability. These regulations are extremely difficult to eliminate once they are in place. But we found a way: We simply rewrote the statutes on which they were based. For instance, we rewrote the environmental laws, transforming them into the Resource Management Act – reducing a law that was 25 inches thick to 348 pages. We rewrote the tax code, all of the farm acts, and the occupational safety and health acts. To do this, we brought our brightest brains together and told them to pretend that there was no pre-existing law and that they should create for us the best possible environment for industry to thrive. We then marketed it in terms of what it would save in taxes. These new laws, in effect, repealed the old, which meant that all existing regulations died – the whole lot, every single one.
Thinking Differently About Government
What I have been discussing is really just a new way of thinking about government. Let me tell you how we solved our deer problem: Our country had no large indigenous animals until the English imported deer for hunting. These deer proceeded to escape into the wild and become obnoxious pests. We then spent 120 years trying to eliminate them, until one day someone suggested that we just let people farm them. So we told the farming community that they could catch and farm the deer, as long as they would keep them inside eight-foot high fences. And we haven’t spent a dollar on deer eradication from that day onwards. Not one. And New Zealand now supplies 40 percent of the world market in venison. By applying simple common sense, we turned a liability into an asset.
Let me share with you one last story: The Department of Transportation came to us one day and said they needed to increase the fees for driver’s licenses. When we asked why, they said that the cost of relicensing wasn’t being fully recovered at the current fee levels. Then we asked why we should be doing this sort of thing at all. The transportation people clearly thought that was a very stupid question: Everybody needs a driver’s license, they said. I then pointed out that I received mine when I was fifteen and asked them: “What is it about relicensing that in any way tests driver competency?” We gave them ten days to think this over. At one point they suggested to us that the police need driver’s licenses for identification purposes. We responded that this was the purpose of an identity card, not a driver’s license. Finally they admitted that they could think of no good reason for what they were doing – so we abolished the whole process! Now a driver’s license is good until a person is 74 years old, after which he must get an annual medical test to ensure he is still competent to drive. So not only did we not need new fees, we abolished a whole department. That’s what I mean by thinking differently.
There are some great things happening along these lines in the United States today. You might not know it, but back in 1993 Congress passed a law called the Government Performance and Results Act. This law orders government departments to identify in a strategic plan what it is that they intend to achieve, and to report each year what they actually did achieve in terms of public benefits. Following on this, two years ago President Bush brought to the table something called the President’s Management Agenda, which sifts through the information in these reports and decides how to respond. These mechanisms are promising if they are used properly. Consider this: There are currently 178 federal programs designed to help people get back to work. They cost $8.4 billion, and 2.4 million people are employed as a result of them. But if we took the most effective three programs out of those 178 and put the $8.4 billion into them alone, the result would likely be that 14.7 million people would find jobs. The status quo costs America over 11 million jobs. The kind of new thinking I am talking about would build into the system a consequence for the administrator who is responsible for this failure of sound stewardship of taxpayer dollars. It is in this direction that the government needs to move.
Reprinted by permission from IMPRIMIS, the monthly journal of Hillsdale College
By Toby Baxendale, on 6 May 10
The latest Material Evidence from Sean Corrigan:
What seems to escape every one of these fatuous macromancers is that, for years now, Greece has been the very essence of Keynesian folly: that the heavy hand of the state, by distributing a corrupting largesse derived from the government-supported evil of fractional reserve banking and constituted of laughably mispriced, fiat-money lending, had so successfully ‘stimulated’ the country and artificially boosted the shibboleth of its GDP that it is now reduced to a state of penury so extreme — and is plagued with a false sense of entitlement so engrained — that all conceivable solutions to its woes now seem like bad ones.
 Material Evidence, 7 May 2010 Download the report here.
By James Tyler, on 3 March 10
Some people doodle pictures, but I’m the type who mucks around random bits of historical price data just to see where it goes. For example, I love charts of the Dow Jones Stock index in the 1920s – it me it tells a vivid story of hopes and dreams and pain mixed with desperation. The wild fluctuations in the early 20’s, the solid gains of the mid 20’s then the euphoria and ensuing panic, well.. you know the rest.
A while a go, I came across a quote;
With an ounce of Gold, a man could buy a fine suit of clothes in the time of Shakespeare, in that of Beethoven and Jefferson…
What does a ‘fine suit’ cost today? Well, an ounce of Gold is just short of £700. If you went into Harrods, and asked for a fine suit, would that see you into an Armani or Zegna number? I think so.
So, the maxim seems to ring as true today as it ever did.
So my mind got to thinking – if an ounce of gold seems to buy the same stuff over the centuries as it does today, then it would seem to be a great proxy for true purchasing power.
The problem with looking at historical charts of stock movements, especially if you are trying to learn the lessons of history, is that the picture is muddied by the fact that the unit of account – i.e. money, does not do a very good job. It is rapidly decaying so when you compare over time, it just gives the wrong impression of what is going on.
For example, look at the stock market over the whole of the 70’s, and you think that equities didn’t do too badly. But adjust for inflation, and you soon realize that stocks lost over three quarters of their value in the first half of the 70′s!
So, the idea dawned on me: the price of stocks and shares are only represented in terms of money. What if you priced them in Gold instead of pounds and dollars?
Firstly: what data? Well, I stuck to the UK, and I chose the FTSE all share index. I took the index value for each day, going back a few decades. I then converted them into ounces of gold. The chart gave me a pretty shocking picture.
But then I realised I’d missed something pretty important. Stocks pay dividends. So, I added a 5% annual dividend return, and then reinvested it into my index. Surely that’d make my chart look less ridiculous? Erm, a bit… but not by very much.
What I was left with was a completely different view of history, and some pretty worrying revelations.
Firstly, my chart had nothing to say until the 70’s. This is because until then, money was gold – therefore priced in money or gold – it didn’t make a difference. In essence, the chart had no surprises.
But in the 1970’s, money was cut loose from gold, with some pretty shocking results.
 FTSE All Share in terms of in oz of Gold (click to enlarge) Some salient observations.
1. The mayhem of the early 70′s had some pretty catastrophic consequences for the world, and recovery only came in the 1980′s. From over 12 ounces of gold, down to nearly 1 ounce of gold is a pretty insane move.
2. Real growth took off in the 80′s, but something happened in the mid 90′s – the internet. This was a period of real economic growth, that morphed into a bubble, thanks to some pretty silly policy mistakes by Greenspan et al.
3. What happened in the 00′s? Wasn’t that supposed to be the ‘NICE’ decade? Wasn’t the stock market supposed to have risen back to its peaks?
My answer to this is that the noughties were a period of stagnation, economic misalignment, and we were all swamped by a money fraud.
The authorities were in such a blind funk in 2001, with the overriding perception that we were facing a 1929 style collapse, that they turned on the money gusher, and flooded the whole world with liquidity. This found its way into the greatest worldwide property bubble the world has ever seen.
But… this was not true growth – at least for the Western economies. Sure, great advances were made in some sectors of their economies, but huge misalignments of capital were occurring, and this decade of false signals to producers, but especially to Western consumers, is why we had the economic crisis of 2008.
Look where we stand now. In ruinous debt. Shackled to low interest rates and nervously watching retail sales and property prices. This is a direct consequence of our societies living the high life for ten years, without actually realising we were in decline.
We have been living like cannibals. Hollowing out ourselves out, yet living the high life. And this is all down to a pseudo neo-Keynesian/monetarist aggregate kabala fetish.
I feel a sense of panic looking at this chart, so what is the solution?
Free markets built on the bedrock of honest money.
By Toby Baxendale, on 18 November 09
Via Reclogging the US credit system, Caitlin Long warns us that there is another impending credit fuelled bubble that is due to be created to accommodate the commercial property market renewals in the next few years. Either a new bubble will emerge as this large level of re-issuance is financed by new bank credit creation, or there will be another bust of epic proportions should this not happen.
Either-way, if it gets funded, this will cause more mis-allocation of capital to this and associated sectors postponing the recovery. If it does not get funded, then we could be back with another Lehman style “event” with all its terrible consequences.
The US financial system faces a daunting challenge in the next five years: $4,200bn of debt that is largely of speculative quality comes due in the commercial real estate and non-investment grade debt markets. At best, this wall of maturing US debt will strain credit capacity. At worst, it will prolong the credit crunch and restrain economic growth.
The next two years are crucial, since delay by banks and other lenders in recognising losses on commercial real estate loans could lead to a pile-up of debt maturities in the credit system in 2012 as this is when loans to highly leveraged corporate borrowers begin to mature en masse.
Such a 2012 reclogging of the credit system, if it happens, could force businesses to liquidate bad investments or pressure the Fed to re-open the monetary and credit spigots, potentially complicating the Fed’s exit from its existing stimulus programs.
The biggest risk to refinancing capacity for this wall of maturing debt, though, is the Fed raising interest rates to control inflationary pressures and dollar depreciation, if necessary. Higher interest rates would preclude marginal borrowers from qualifying for refinancing, regardless of whether credit capacity exists.
Read more.
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