Police Have No Duty to Protect You, Federal Court Affirms Yet Again

It’s been said by democracy’s critics that the system is essentially two wolves and a sheep deciding what’s for dinner. But to its defenders, democracy has been described as an ethical ideal and a way of life—these conceptions nearly implying a metaphysical manifestation. While we have no way of knowing whether or not we’re living up to democracy as an ethical ideal, we do have evidence of its effectiveness as an electoral system, or lack thereof. If the goal is to secure good governance, then democracy generally fails. But democracy not only pertains to presidents and congressmen, but also down to the local town hall, school board, and mayor. Each of these political actors possesses power purportedly on behalf of “the people.” But I wouldn’t be the first to point out that when someone whom I didn’t vote for wields political power over me, they are not doing so with my consent; in this case, their exercise of power is not literally on my behalf. Libertarians are trapped in a by now obvious dilemma: vote as often as we can for the most “proliberty candidate,” or generally abstain from voting on the grounds that there’s no good candidates or that we refuse to give any kind of consent to broad political power. There is an illustrative example of this dilemma in an episode of The Office.

Later in the series (S8, EP19), a woman named Nellie declares she is the new manager after the real manager—Andy—leaves for several weeks. Everyone in the office is confused by her claim to authority, especially since she didn’t earn the position and no one consented to her newfound power. The main character, Jim, tries to convince everyone to just act as though she has no authority. Nellie, however, starts doing performance reviews and giving out raises based on who will accept her as the new boss. Once a few workers in the office begin accepting the idea that she has authority to issue raises, everyone else has a choice: continue to reject her authority, or accept it for the potential benefits it brings them. In addition to giving raises, she actually cuts the pay of a few skeptical workers who won’t consent to her new authority as boss. There are some interesting assumptions at play in this episode: the workers are so conditioned to having a boss that if their options are between an absentee manager and Nellie—the latter of whom is offering raises—there seems to be an obvious incentive to prefer Nellie, even though having no boss extends their personal freedom at work. But other than Jim and a few others, most of the workers in the office never consider rejecting the idea of a boss altogether.

This is how democracy works. Firstly, most assume there has to be a government, which represents the will of the people and enforces the law: this could be a local sheriff, state governor, or even the US president. The cost of trying to convince everyone else that this position or source of power shouldn’t exist is prohibitively high, so the next best option is to choose someone who we think will do the least amount of damage. But—and this is the rub of democracy—in so voting, just as some office workers began accepting Nellie’s raises, we imply a tacit endorsement or acceptance of political power. We have no way of indicating that we’re voting out of self-defense or that, all things considered, we wish something like school board seat 7 or county tax assessor didn’t exist in the first place; power is placed over us with no real alternative.

In this episode of The Office, the aspirational Dwight is likewise in a bind: either he accepts what he otherwise deems to be illegitimate authority, or he remains in the minority. In a democracy, we are all like Dwight: we can either “get a raise” (that is, vote for the candidate whose policies promise to benefit us), or be relegated to powerlessness through our inaction, accepting the dictates of the Nellies of the world. For instance, about a third of eligible voters didn’t vote in 2020, and yet Joe Biden is now their president, just as Trump was everyone’s president before him, including his most impassioned political enemies. Plenty of Americans engaged in hashtag activism to say that Trump was #NotMyPresident, but … he was. In a democracy, we all have little recourse against authority after the election is over. And if we don’t participate at all, we really have no say, since we are not factored into the “will of the people.”

But unlike an office manager, a politician could have control over our very life or death, or at the very least, our livelihoods. The state can send us to fight in wars, raise our taxes, and as covid policies have shown, they can force us to shut down our businesses and our very means of existence. Democracy means that if we never vote, or even if we do vote but our candidate never wins, all of these measures over our lives can be controlled by people to whom we never conceded authority. We are all Dwight in The Office, on the precipice of accepting Nellie’s authority or having it imposed on us regardless. She can give us a raise, but she can also reduce our pay. The American state can reduce our taxes or send out “stimulus checks,” but they can also send us to die in the sands of Afghanistan. The stakes are enormous in our modern democracy.

Like many workers in The Office, most people are too conditioned to think we need a boss, and that Nellie, or Joe Biden, is as good as any other. But if the fictitious world of Dunder Mifflin tells us anything, the workers’ most productive period was later in the series when their manager (played by Will Ferrell) was hospitalized after trying to dunk a basketball. After weeks without a boss, Jim says, “So as it turns out, unless you're a young child or a prison inmate, you don't need anyone supervising you. People just come in and do their work on their schedule. Imagine that. People like us allowed to sell paper. Unsupervised. And yet, somehow it works.”

We too might consider a world without arbitrary political power. Imagine that.

A good definition of the tragedy of the commons is that "resources that are unowned and/or unownable will be plundered to extinction." Consider the fish in the seas, especially those that migrate, such as whales, or may be found beyond any nation's territorial waters. No one owns them and it may be impossible to own them. Therefore, fishermen are incentivized to take them before other fishermen take them. Overfishing results. Catches shrink. The size of the fish shrinks. Treaties among fishing nations may mitigate the problem, as long as all sign the treaty and poachers are controlled.

It has been estimated that in nineteenth-century America hunters killed 40 million buffalo and trappers took 200 million beaver. The buffalo were hunted almost to extinction, and some scientists claim that the water shortage and erosion problems of the American West are a result of the overtrapping of beaver, nature's premier water conservationist.

Privately Owned Resources Are Capitalized, Ending Their Plunder

A solution to the problem lies in private ownership of the resource. Private owners manage natural resources to maintain their capital value. Scientists and economists have pointed out that the annual and apparently never-ending forest fires of the American West are partly due to the fact that they occur on government-owned land. But government ownership is not the same as private ownership. Government has little incentive to protect the trees in order to harvest them over long periods of time. Governments' main objective seems to be simply fighting forest fires once they have begun, a policy that doesn't seem to have worked very well. Radical environmentalists would not tolerate selling the land and forests to private companies. A pity, because that is exactly what would stop their destruction.

Notice that the main problem that results from the tragedy of the commons is resource depletion. It is true that the first to grab the resource benefits, but this is a one-time grab. Privately owned forests, fisheries, oil wells, copper mines, fertile farmland, etc. will yield their bounty to perpetuity, whereas a plunderer leaves nothing for the future. In other words, plunderers eat the seed corn.

This describes the state of government today. Through its money-printing monopoly, government has the ability to plunder resources without limit, leaving nothing for future growth. Austrian economists call this high time preference, as opposed to low time preference. Those with high time preference prefer the satisfaction of short-term wants at the expense of long-term wants. The ant versus the grasshopper fable is the perfect illustration of the principle. The ant works hard to save for the future, while the grasshopper plays in the summer sun. But the ant has food and shelter through the coming winter, while the grasshopper freezes and starves. Politicians have high time preference, because they occupy their positions of power for a limited time. They have constituents and supporters to placate. They want action and they want it now. They want free fill in the blank.

The Soviet Union was the poster child of this syndrome. Prior to the Russian Revolution of 1917, Russia was a highly industrialized nation that was a worthy competitor in world markets. After the revolution, it embarked on a one-time grab of all the nation's resources as it attempted to impose a completely socialist, state-directed economic model. Within a few years the Russian people were starving. Only Western aid, the sale of its vast natural resources, and the plunder of Eastern European nations after the Second World War allowed the Soviet Union to survive as long as it did. When asked if the US would help restore the Russian economy after the fall of communism, President George H. W. Bush insightfully said that there was not enough capital in the entire world to do that.

The Solution Is Private Money, but the Temptation for Plunder Is Too Great

Under a gold standard, government cannot spend more than it taxes and borrows honestly in the bond market. Gold is a finite medium of exchange, perfectly suited for trading finite goods and services. But government can manufacture fiat money in unlimited amounts. So we have finite resources exchanged by fiat money with no limit. The temptation for government to use this power to accomplish its high–time preference goals is too great for the politician/grasshoppers to ignore. Thus, all economies are being plundered by the ultimate expression of the tragedy of the commons—fiat money in the hands of profligate governments. There seems to be nothing that can prevent the disaster, since every citizen benefits in some way from government spending and no one is willing to give up his handout. In fact, the demand for handouts keeps increasing.

Conclusion: Consumer Spending Consumes Capital

In conclusion, we may say that the real tragedy of the commons is not that the plundered resources are claimed by a minority, but that the resources can never be capitalized to provide benefits into perpetuity. Government may plunder an economy only once. Western economies have a lot of accumulated capital resources, so it may seem that multitrillion-dollar budgets and deficits are sustainable. But they are not. What Keynesians call a postcovid boom, due primarily to pent-up consumer spending fueled by helicopter money, probably is capital decumulation. We are eating our seed corn. Fun, fun, fun … while it lasts.

The Fed has embarked on a massive expansionary quest in recent years. In 2020, total Reserve Bank assets rose from $4.2 trillion to $7.4 trillion amidst the pandemic and related government lockdown and fiscal “stimulus” policies. That was roughly three times the extraordinary growth in the consolidated balance sheet for the Reserve Banks in the 2008-2009 financial crisis. And in the latest weekly “H.4.1” release, total assets were up to $7.8 trillion – rising about a hundred billions dollars a month so far this year. 

In banking, rapid growth isn’t hard to achieve, if you are willing to assume risk. In fact, rapid growth should always be questioned as a sign of possible undue risk taking. How about the Federal Reserve Banks? How much risk are they taking, and on whose dime? 

To answer these questions, we first have to identify the accounting principles on which the Fed’s balance sheet is based. 

In the United States, there are “Generally Accepted Accounting Principles” (GAAP) – but there are different strokes for different folks. Private sector companies follow accounting standards set by the FASB – the Financial Accounting Standards Board. State and local governments follow a different set of “generally accepted” rules that are set by the GASB – the Governmental Accounting Standards Board. The federal government of the United States follows yet another set of “generally accepted” principles, set by the FASAB – the Federal Accounting Standards Advisory Board.

Put aside for now the question whether “generally accepted accounting principles” can even exist in a world where there are more than three sets of them, including international accounting standards. Who sets the accounting standards for the Federal Reserve?

There are two main parts of the “Federal Reserve.” The Federal Reserve Board of Governors is an independent regulatory commission, a government agency, and it follows the standards for the federal government set by the FASAB. But the Federal Reserve Banks are another story: they follow accounting standards set by the Federal Reserve Board of Governors! Those standards are not GAAP.  

One way the Fed’s principles for the Reserve Banks differ from GAAP matters for understanding material risks facing the Reserve Banks, and in turn, the U.S. Treasury.

The Reserve Banks’ assets include trillions of dollars of bonds, most of them government or government-backed bonds. Like any bond portfolio, those investments are subject to interest rate risk. When interest rates go up, bond prices go down (and vice versa).

Under the Board of Governors’ accounting standards for the Reserve Banks, “unrealized” losses in bond investment value do not immediately find their way into the financial statements. Only when losses are “realized” (for example, when the bonds are sold) does loss enter the financial statements.

Today, short and long-term interest rates on government bonds rest near historic lows, important in part because the Fed massively expanded its purchases of government bonds. But low interest rates can’t be taken for granted, particularly if we get significantly higher inflationary expectations -- which appear to have begun to sprout in recent weeks.  

If we get significantly higher interest rates for that reason, the Reserve Bank balance sheet impact from losses on securities assets would arrive if the losses become “realized” – a realistic prospect if the Federal Reserve  reverses course and starts selling off securities as a means of conducting monetary policy amidst higher inflationary expectations.

This impact, and risk, is higher for entities with significant financial leverage. And the Reserve Banks are some of the highest-leveraged banks on the planet. On the 2020 balance sheet, which reported $7.4 trillion in assets, Reserve Banks reported “only” $40 billion in total capital – a capital/asset ratio of one-half of one-percent.

For a given percentage change in the value of assets, highly leveraged entities will see a greater percentage decline in the value of capital. In this case, Reserve Banks would begin reporting negative capital after losses amounting to just one-half of one percent of their total assets.

That is, if they were required to post the losses. Under current standards set by the Board of Governors, they won’t begin to do that until the losses are realized in sales on the open market. And even then, the Reserve Banks won’t show a negative capital amount because the Fed sets its own accounting standards, a least for the Reserve Banks, and changes them as it sees fit.

Back in 2011, after the first spike upward in Reserve Banks’ balance sheet with the financial crisis, the Federal Reserve Board of Governors changed the accounting standards for the Federal Reserve Banks. These changes limited  the possibility that the Reserve Banks’ capital account could ever turn negative. And more recently, some have argued that the Fed’s control over its own accounting principles could allow for even more creative ways of cushioning the blow from any investment losses.

But a free lunch for the Fed isn’t necessarily a free lunch for the rest of us.

The problem (and risk) facing the Treasury (and the rest of us) is compounded by the Fed’s legally dubious new practice of paying interest on reserves that banks maintain with the Reserve Banks. If short-term interest rates rise amidst heightened concern about inflation, under current policy, the Fed would pay higher interest on the massive multi-trillion dollars worth of reserve balances currently at the Reserve Banks.

Introducing its own balance sheet, a balance sheet with about $6 trillion in assets against nearly $33 trillion in (understated) liabilities, the federal government gives us the following comforting words:

There are, however, other significant resources available to the government that extend beyond the assets presented in these Balance Sheets. Those resources include stewardship PP&E in addition to the government’s sovereign powers to tax and set monetary policy.

In other words, we should be comforted that our government will be able to take our money away, or inflate the value of the dollar away, to pay off its debts. 

Maybe we shouldn’t be comforted by these assertions, especially because they arrive in a document theoretically providing  accountability of the government to the real sovereign in the United States – the people.

The Federal Reserve has returned earnings regularly to the Treasury for decades. And the government appears to see the Fed and monetary policy as its ace in the hole. But this is not  necessarily an ace in the hole for the people.

When justifying the fact that the Fed sets its own accounting standards, Fed leaders regularly assert that the value of central bank independence warrants this state of affairs. But how independent is the Fed, really, under current law and policy?

Back in 2010, the opinion of the Government Accountability Office (GAO) on the financial statements of the U.S. Government began including a cautionary note about the risks of the Fed’s ballooning balance sheet to the Treasury. The GAO opinion letters stopped including these notes in 2015. Now that the Fed’s balance sheet is ballooning again, these issues deserve greater scrutiny.

In a 30 minute lecture for the Research Platform on Economic Thought, Dr. Per Bylund looks at the history of the Austrian School and its future prospects in academia and beyond.