De-Toxify the Beast!

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Gettysburg Address, If He Had Been More Honest

 

 
 

Have you ever
heard this phrase? “Starve the beast!” It refers to starving the
Federal government. It argues that if Congress cuts taxes, spending
cuts will necessarily follow.

The problem
with this metaphor is that it conjures up a mental image of an overweight
person who cannot bring himself to stop eating. He has no inner
Richard Simmons, longing to get out.

The problem
is this: this obese person has an inheritance that he can tap into
whenever money runs short: the Federal Reserve System. He just keeps
getting fatter.

The metaphor
of the obese person is the wrong one. The correct metaphor is a
city council filled with drunks. Only one of them has remained stone
cold sober for 30 years. He keeps telling the voters that his colleagues
can’t sober up on their own. The voters pay no attention. That is
because the council members keep buying free drinks for the party-loving
folks who live in their districts. “Barkeep, another round for my
friends!”

Where does
the city council get the money? From the voters. The voters who
remain sober say they don’t like it when council members keep buying
drinks for their neighbors and then put it on the city’s tab. But,
drink by drink, household by household, most residents are becoming
steadily addicted to booze.

It is always
hard to persuade a lone drunk to head for Alcoholics Anonymous.
It is impossible when they are all together at the bar, with half
a dozen constituents each. “Set ‘em up, barkeep! Put it on my tab!”

POLITICAL
RESENTMENT BY SOBER VOTERS

There is no
possibility that such a city council will ever head for AA as a
group. Why should they? Parties are fun. Everyone loves a good party.
But what’s a party with only lemonade? That would be a Baptist party,
with some Mormons invited, just to be sociable.

But, insist
the fiscal Baptists, one of these days the taxpayers are going to
find themselves incapacitated. The broad mass of taxpayers are going
to find it difficult to remain productive. Revenues will fall. Then
the city council will find that the till is depleted. No more parties!

That sounds
plausible, but there is a problem: bonds. The voters keep passing
bond issues. And why not? When you are dealing with a room full
of drunks who are three hours into the party, you will not find
a lot of concern about the borrowing cost of putting more booze
on the tab. Parties make for short-run thinking. “There’s always
more where that came from! Let the good times roll!”

The bartender
knows that the city council is good for the money. What’s a little
extra debt? The owner of the bar will submit his bill at the end
of the month, and it will be paid. It has always been paid. It’s
easy money for him. He tells the barkeeper, “Keep filling up those
glasses. The city is good for the debt.”

The remnant
of voters who are both sober and productive now see what is going
to happen. The bonds must be paid off. The sober voters will have
to pay the bills. They don’t have the votes to lower taxes. They
can at best hold taxes level. But the tab keeps getting larger.
The tavern owners in the city keep extending credit. The tax base
will not cover this indefinitely.

It is obvious
to the voters who are not participants at the party that, at some
point, the city is going to default on the bonds. The losers will
be the dolts who kept lending money to a city whose council members
were, with one lone exception, drunks. The tavern owners will hit
the skids themselves. The fiscal Baptists prepare for the great
“we told you so” opportunity that is surely coming. “Sorry, guys,
but you knew your customers were a bunch of drunks. You will now
have to go into another line of work. And your customers will all
be suffering from hangovers and depleted bank accounts.”

The problem
is, when the city defaults, there will be a lot of services cut.
The parties will cease, but then money for all of the other services
will be hard to come by. The city council will find it difficult
to collect taxes. It will find it more difficult to attract future
lenders. When it’s “in God we trust; all others pay cash,” there
will not be much cash.

CONGRESS
IS NOT A CITY COUNCIL

Here is where
the analogy breaks down. Yes, they are all drunks: voters and council
members. That part holds up. What doesn’t hold up is the analogy
of the city council. Drunks with an unlimited tab are in Congress.

Unlike a city
council, which faces a potential revolt by bond investors –
the famous vigilantes – Congress has a central bank in reserve.
That’s why it’s called the Federal Reserve. The FED keeps buying
the debt of the U.S. Treasury. Congress, unlike a local city council,
can keep running up the tab. “Another round for my guests, barkeep!”

The Federal
Reserve, unlike a bond vigilante, is not using its own money to
pay Congress for its perpetual party. It creates money out of nothing
to buy the IOUs of the party-goers. It’s a two party system. The
Democrats invite their constituents to the party, and the Republicans
invite theirs. They sit at different ends of the bar. Nobody is
in favor of calling it a night and going home.

What this
means is that the party can go on a lot longer in Washington than
it can locally. The presence of the Federal Reserve makes the tavern-owners
happy. The revelry will go on indefinitely.

Or can it?
As they say, “drunks are drunks.” The behavior has the same debilitating
effects, whether locally or in Washington, D.C. The revelers stagger
home at dawn, only to start up again in the evening.

Good time
Charlie Wilson is the model. So is Carl Albert, who was Speaker
of the House from 1971 to 1977. He was an alcoholic. The public
did not know or care. His colleagues knew, but a lot of them suffered
from the same affliction. (http://bit.ly/DCbooze) It is “don’t ask,
don’t tell.” People who live in dirty glass houses don’t hire window
washers, let alone throw stones.

When you are
dealing with people who are long-term alcoholics, you need to intervene
to get them to stop. The problem is, almost everyone seems to be
at the party, allowing Congress to run up a huge tab at the bar.
The vast majority of voters do not want intervention. They may complain
about too much beer being consumed by teenagers and other uninvited
guests whose IDs are never checked by the bartender, but the hard
stuff – Medicare, Social Security, and the Department of Defense
– is untouchable. “Let’s party!”

The dwindling
number of sober voters look at this and conclude: “Something’s got
to give.” They are correct. This raises several questions.
1.
What?
2. When?
3. With what consequences?
4. For whom?
5. In what order?

And, of course,
the big one:
6.
How can I get out of the way?

The last time
that the Federal Government had no debt was in 1836. That was the
only fiscal year in American history when the condition of cold
turkey sobriety prevailed. This tells us that the problem of irresponsible
drinking is not going to be solved at fiscal AA meetings: no booze
at all.

Americans are
not fiscal Baptists. We are, at best, sneakin’ deacons.

LAFFER’S
SOLUTION

For 35 years,
conservatives have witnessed a continuing debate that has raged
on the sidelines of the conservative movement.
Should
the Federal government balance the budget by (1) raising taxes or
(2) cutting spending, so that economic growth can replace the forfeited
revenues?

This is the
debate over the Laffer Curve. Arthur Laffer presented his famous
curve to Dick Cheney and Donald Rumsfeld on a napkin. That was in
1974. He argued that, when taxes are too high, people will find
ways of cutting back on their official, easily taxable production.
The government will not collect all of the tax revenues that Keynesian
economists had promised.

The solution,
Laffer argued, is to cut taxes: especially high marginal income
tax rates. Then production will increase and tax revenues will rise.
Presto: Less is more! Less taxation on the books brings more revenue.
That will balance the budget.

Wikipedia
has a cogent article on the Laffer Curve.

The argument
is formally correct, but it rests on an assumption: the marginal
tax rates really are on the far side of the curve. This assumption
is true most of the time.

The argument
makes another assumption, which is never true for long: “Congress
will not spend more money than is collected from any increased revenues.”
This assumption is not correct politically. (When Laffer drew his
curve, it was not politically correct, either.) Here is what it
misses.
No
matter how much revenue is collected, Congress will always pass
more spending bills, so that the deficit will inevitably reappear,
assuming that it ever goes away.

Put succinctly:
“Federal government deficits are inevitable.” This law has remained
unbreakable ever since 1837.

Mainstream
economists make false assumptions. There is only one assumption
with respect to taxation that is in fact a law of politics: “Assume
the position.” Politics determines only who will assume which position
and for how long.

DAVID
STOCKMAN’S SOLUTION

Stockman was
Ronald Reagan’s budget director from 1981 to 1985. He did not believe
that Laffer’s solution would work. He said so in cabinet meetings.
Reagan had promised to pressure Congress to pass a law lowering
marginal tax rates. He also promised to increase military spending.
He did both.

Stockman kept
saying that the increased revenues would not be sufficient to overcome
the increase in expenditures. He was correct. Reagan vetoed no big
spending bills that Congress got to his desk for a signature. Spending
kept rising.

Meanwhile,
Volcker’s policy of dramatically reduced rate of growth in the monetary
base produced back-to-back recessions: one under Carter in 1980,
which lost the election for him, and one under Reagan in 1981-82,
which cut revenues. In 1983, the Federal Deficit went over $200
billion. I had predicted this figure in my newsletter and my book
on price controls in 1977, at the beginning of Carter’s Administration.
I had said it would hit in 1984. I missed.

Stockman looked
at the politics of budget-cutting and concluded, “No way.” He was
correct. There was no way that Reagan would reduce spending sufficiently
to bring the budget into balance.

The question
was this: “Could he have cut spending?” That was the most important
domestic policy question in the entire post-War world.

The thrust
of bipartisan Keynesian politics, 1946 to today, has been to resist
all attempts to cut spending, or even hold it steady. Reaganites
promised a Reagan revolution. “Let Reagan be Reagan.” But Reagan
was a big spender. He never lost his taste for the New Deal, which
he favored domestically all of his life. He was never in the camp
of the Taft Republicans.

Reagan had
the votes to get marginal tax rates cut. He had the votes to build
up the Defense Department. But he never bothered to test the political
waters on the question of domestic spending.

In 1983, Social
Security technically went bankrupt. That was Reagan’s moment of
truth in domestic politics. Would he let the thing go under, or
would he implement the Greenspan’s Commission’s recommendation to
hike taxes? He did not hesitate. He backed Greenspan.

Then in 1986
he signed TEFRA into law: a major tax increase.

There was
no Reagan revolution. There was only a Laffer revolution, and then
only on the taxing side.

Stockman wanted
a balanced budget. He saw that Reagan would not provide it by vetoing
spending for domestic programs. So, he opposed tax cuts. He opposed
the Laffer revolution. Conservatives never gave Stockman credit
for having warned Reagan that this would happen. When he resigned,
there were no cries of “Good show, Dave!”

Had I been
Stockman, I would have resigned. But I would have resigned over
Reagan’s refusal to cut spending, not his decision to cut taxes.
My motto is this: “If you’re going to commit political suicide,
do it on behalf of cutting spending.”

“ALL
HAIL THE DEFICIT!”

Here are the
political choices available in a national political system that
is based on this slogan: “Another round for my friends, barkeep.”

1.
Cut taxes (deficit rises).
2. Leave taxes alone (deficit rises)
3. Raise taxes (deficit rises)

This means
that the deficit will rise. Now the debate shifts. From the point
of view of American voters, who should buy Treasury debt?
1.
Private investors
2. Foreign private investors
3. Foreign central banks
4. The Federal Reserve

There is no
question which I am in favor of: #3. Let foreign central banks buy
all of it – every last dime of it. Why? Because American voters
will accept this slogan: “Stiff China!”

Somebody is
going to get stiffed. There is no way out. This can be American
investors. It can be Asian central banks. It can be American citizens,
who will be wiped out because of

1.
Piecemeal default by hyperinflation
2. Piecemeal default by mass inflation and price controls
3. Immediate default by open declaration of Federal bankruptcy
4. Piecemeal default by means-testing of benefits
5. Piecemeal default by the boom-bust cycle, repeated forever

The deception
can go on and will go on. But the question of who bears most of
the costs of the default is a political question.

CONCLUSION

Raising taxes
will not help. Congress will spend every dime and borrow against
the future.

Cutting spending
is not politically possible. Reagan had his chance. He never considered
it.

The deficit
will delay the day of sobriety.

The day will
come when Congress will not have any more credit. The bar’s owner
will send a note to the bartender: “Don’t let these guys run up
the tab. It’s cash on the line.”

If the FED
inflates, prices will rise, until the bar’s owner tells the bartender:
“Silver coins or gold coins only.”

Congress will
then sober up.

Tens of millions
of Americans will then go through forced de-tox at that point. It
will be pink elephants on parade.

Pink
elephants are the inevitable result of red ink.

So, my goal
is to increase the supply of red ink. I want to keep more of my
income, so that I can invest in asset categories that will protect
me from the drunks, both when they are drunk and when they have
the DT’s. This means lower taxes now, capital accumulation now,
and buying up the distressed property of drunks after they finally
sober up. Cut taxes and cut spending. But if it’s one or the other
– and it surely is – cut taxes.

I wish to be
remembered by this poem:

North marched
up the Laffer curve,
And said to all his men:
“Let’s cut the rates till income falls,
And then let’s cut again.”

December
1, 2010

Gary
North [send him mail]
is the author of Mises
on Money
. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible
.

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Best of Gary North

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