Power & Market
After a month of “will he, won’t he” drama fitting for reality television, Donald Trump has announced his plans to declare a national emergency in order to get the funding he desires for his border wall. While the wall itself invites debate on subjects such as practical immigration policy, eminent domain, and government contractors – the use of a national emergency has brought a renewed look at executive power.
For weeks Trump has been warned by Republican leadership about the dangers of the precedent being set by such a decision. Nancy Pelosi has already suggested that a Democratic politician could use a “national emergency” to enact gun policy.
While such concerns are justified, it’s amusing to see such objections being raised by conventional beltway-types as the long-standing trend within Washington has been the gradual expansion of the executive branch. What is the practical difference, for example, between a president going around Congress for a border wall and a president going around Congress for military action? Or President Obama’s own immigration-related executive order that granted protection to “Dreamers” after Congress refused to bend to his will?
After all, if we are to buy in to the idea that political action is validated through participation, then it makes sense for the single political office voted on by the entire country to gradually expand its power – particularly given the obstructions to majority rules the Constitution purposefully placed on the legislative branch. The preference for general majority rule at the expense of state-based representation is also what motivates the modern lefts interest in effectively abolishing the senate and Electoral College – both of which act as checks on the imperialism of democratic excess.
While the 20th century set the stage for the modern state, it was Andrew Jackson who was the first American president to understand how the promotion of democracy could directly feed an imperial presidency. While Jackson could be praised for his views on central banking and federal debt, his presidency offered some of the most flagrant examples of hostility towards both states rights and limits to executive power.
In his first address to Congress, he outlined his vision of a truly democratic executive. He called for the abolishment of the Electoral College, and criticized the role of a large legislature in frustrating popular rule. In his view, “the first principle of our system…[is] that the majority is to govern.” As the best representative of what he saw as the will of the people, he placed his own interpretation of the Constitution as equal to all other branches of government – best illustrated by his rejection of John Marshall’s decision regarding the property rights of Native Americans leading to the Trail of Tears.
While Trump has gone the furthest in openly inviting comparisons to “Old Hickory,” Jackson’s view of the democratic presidency has long prevailed. In the words of John Yoo, “Jackson remains one of the greatest Presidents because he reconstructed the office into the direct representative of the American people.”
Unsurprisingly, it was Yoo who provided the legal defense for many of the excesses of the George W. Bush presidency.
[Editors note: Mr. Luddy will be giving the Henry Hazlitt lecture at this year's Austrian Economics Research Conference. Click here to learn more.]
The most important issue facing America today is the national debt and increasing federal deficits. Our national debt now exceeds yearly gross domestic product (GDP).
The U.S is the wealthiest country in the world, but our government has the largest spending deficits and national debt in recorded history.
The budget deficit in FY 2018 was $800 billion, but the debt increased by $1,300 trillion, and is now $21,500 trillion dollars. Government accounting (oxymoron) allows for spending and loans outside of the budget. The practice of underreporting deficits is fraud and is not legal in the private market.
Note the US Debt Clock (here).
In simple terms, the national debt consistently increases more than the federal deficit, which will cause a devaluation of the dollar and eventually, a major financial crisis.
In FY 2019, the federal budget projects the following:
- Total revenue $3,422 trillion or 17% of GDP
- Total spending $4,407 trillion or 21% of GDP
In the best of times, regardless of tax rates, the federal revenue rarely exceeds 18% of GDP. This means based on projected spending, we cannot grow or tax our way out of the deficit because spending is projected at 22% of GDP.
To balance the federal budget in FY 2019, it would be necessary to cut all spending by 22%.
Read the full article at The American Spectator
This month’s Liberty Matters forum is a discussion of the American economist Frank Fetter. Though he is neglected today, Fetter made vital contributions to Austrian economics and was a major force in spreading the ideas of the early Austrians in the United States (see here and here). In my contributions to the discussion, I explain why Fetter’ work is important and how it can continue to provide fresh insights to contemporary economists. So far, the focus of the essays has been on key elements of economics, especially foundational concepts like price, market, equilibrium, capital, and rent. I’m joined in the conversation by Joseph Salerno, Peter Lewin, and Geoffrey Hodgson.
The first essays and responses in the discussion have now been published, and the forum will remain open for the rest of the month for short rejoinders by all the participants. I hope you’ll take a few minutes to read through some of the contributions. Here is the abstract for the discussion:
Matthew McCaffrey, assistant professor of enterprise at the University of Manchester, explores the economic and political work of the “forgotten giant” of economics, the Indiana-born Frank Fetter. At the height of his career in the early 20th century, Fetter was one of the most respected, cited, and debated economists in the United States. He taught for over 40 years at prestigious universities, including Stanford, Cornell, and Princeton, and his research appeared in practically every major publication in economics and political science. Yet today he is virtually forgotten outside a small group of Austrian economists. In his opening essay, McCaffrey explores two aspects of his thought in particular: his contributions to theoretical economics and their relationship to Austrian ideas, and his political views as they relate to the philosophy of classical liberalism. He is joined in the discussion by Geoffrey M. Hodgson, Research Professor of Business Studies in the University of Hertfordshire, Peter Lewin is Clinical Professor in the Jindal School of Management, University of Texas, Dallas, and Joseph T. Salerno, professor of economics in the Finance and Graduate Economics Department in the Lubin School of Business of Pace University in New York.
After last week’s explosive congressional hearing, the Senate and the Trump administration agreed to reopen the FBI background check into Supreme Court nominee Brett Kavanaugh. Former FBI chief James Comey wrote Sunday that “the F.B.I. is up for this” because it is “full” of "people who just want to figure out what’s true."
But truth has often been a scarce commodity in FBI investigations. Consider these cases stretching back decades:
Is gun control on its deathbed?
Cody Wilson, founder of the 3D printable gun activist group Defense Distributed, recently won a landmark case against the State Department. Defense Distributed and the Second Amendment Foundation (SAF) reached a settlement with the Department of Justice that now allows for people to 3D print firearms without government interference.
Defense Distributed’s clash with the State Department originated in 2013 , when the State Department demanded that Defense Distributed remove the files for its Liberator pistol. Although Defense Distributed initially complied with the State Department’s demands, they did not go out without a fight. In 2015, Defense Distributed and the Second Amendment Foundation teamed up to fight the State Department’s mandate.
Fast forward to the present and Defense Distributed initially channeled its inner David against the federal government Goliath. However, Defense Distributed could not enjoy a proper victory celebration after federal judge Robert S. Lasnik issued a temporary restraining order on the publication of 3D blueprints.
A Game-Changing Victory
A temporary hiccup, the latest restraining order placed on Defense Distributed may end up being an exercise in futility when it’s all said and done.
In the 21st century, technology is frequently changing the rules of politics, in which traditional forms of political control are slowly being phased out.
Defense Distributed’s initial triumph against the State was a much needed moral victory for gun rights activists.
In present times, gun rights have been under assault at the state and federal level. With blatant calls for the repeal of the Second Amendment and a bipartisan consensus rallying around the need for sweeping gun control legislation, gun rights appeared to be on the chopping block.
Despite the roadbloacks ahead, Defense Distributed has given concerned owners a bit of breathing room and is opening up new avenues for human freedom.
Crypto-Anarchy in Action
Defense Distributed’s endeavors are one of the most poignant expressions of crypto-anarchism, the realization of anarchy in cyberspace.
Timothy May, author of The Crypto Anarchist Manifesto, shares one of the most powerful aspects of crypto-anarchism: “Just as the technology of printing altered and reduced the power of medieval guilds and the social power structure, so too will cryptologic methods fundamentally alter the nature of corporations and of government interference in economic transactions.”
The history of humanity is one of power-hungry individuals using coercive institutions like the State to subjugate people and control their livelihoods. Eventually, certain groups who grew tired of the status quo of oppression rose up and attempted to create new political orders.
But two major junctures in economic history have fundamentally changed citizens’ relationships with their governments—the emergence of industrial capitalism in the 19th century and the Internet’s arrival in the late 20th century. Now, when governments try to curtail a certain activities, the market finds a way meet consumer demands.
Donald Trump has made his second Supreme Court nomination: Judge Brett Kavanaugh of the US Court of Appeals for the District of Columbia.
Relative to the other names that were discussed, Kavanaugh’s selection could be seen as a win for the establishment.
For one, he will uphold the Court’s record of Justices with law degrees from either Harvard or Yale.
Two, he has a very swamp-friendly resume, including a long history of doing legal work for the Republican Party and a particular closeness with the Bush family. Having worked on matters including the Clinton Impeachment, the 2000 Florida Recount, and challenges to Obamacare, he has been described by Senator Dick Durbin as the “Forrest Gump of Republican politics.”
Interestingly, a decision he made regarding the Constitutionality of the Affordable Care Act is what troubles many on the right. Though he dissented to the question of whether the bill was Constitutional under the Commerce Clause, his minority opinion made it clear that it his objection was to the court’s jurisdiction and not the law itself. He viewed the individual mandate as a tax, logic used by Chief Justice John Roberts in upholding the law.
As Christopher Jacobs wrote for The Federalist:
In Kavanaugh’s view, the mandate could fit ‘comfortably’ within Congress’ constitutional powers,” Even as he ‘do[es] not take a position here on whether the statute as currently written is justifiable,’ Kavanaugh concludes that ‘the only potential Taxing Clause shortcoming in the current individual mandate provision appears to be relatively slight.
Attention now will turn to Kavanaugh’s views on Roe vs. Wade and whether his appointment will challenge that decision. On Fox News this morning, Judge Andrew Napolitano thought Kavanaugh’s explicitly pro-life track record as a Justice would make the nomination process more difficult, possibly pushing Trump to nominate someone different. We will now see how moderate Republicans, such as Senator Susanne Collins, react to the decision.
Of course, the fact that the appointment of a single Supreme Court Justice warrants nationwide protests now erupting is simply a reminder of the inherent failures of a system which gives so much power to nine people in black robes.
We've long been told that Cuba's health care system is one of the greatest in the world. In spite of the fact that health usually correlates with wealth in national statistics, we're assured that Cuba's obvious poverty is offset, at least in part, by amazingly low infant mortality rates and life expectancy.
But in a new short article for the journal Health Policy and Planning, Gilbert Berdine, Vincent Geloso, and Benjamin Powell examine some of the ways that the data is being manipulated in Cuba to ensure better-looking health statistics.
For example, on the matter of infant mortality, doctors have been known to redefine dead infants as dead fetuses:
[There is] evidence that physicians likely reclassified early neonatal deaths as late fetal deaths, thus deflating the infant mortality statistics and propping up life expectancy. Cuban doctors were re-categorizing neonatal deaths as late fetal deaths in order for doctors to meet government targets for infant mortality.
Abortions of babies in utero who might die soon after birth is a tactic as well:
Physicians often perform abortions without clear consent of the mother, raising serious issues of medical ethics, when ultrasound reveals fetal abnormalities because ‘otherwise it might raise the infant mortality rate.’ ... At 72.8 abortions per 100 births, Cuba has one of the highest abortion rates in the world.
The focus on infant mortality may have led to increases in other types of mortality:
[T]hese outcomes come at cost to other population segments. The maternal mortality ratio of Cuba in 2015 was higher than in Latin American countries like Barbados, Belize, Chile, Costa Rica, Mexico and Uruguay ( Trends in Maternal Mortality 1990 to 2015, 2015). In terms of healthy life expectancy, Cuba ranked behind Costa Rica, Chile, Peru and Bermuda and marginally surpassed Uruguay, Puerto Rica, Panama, Nicaragua and Colombia
Some factors that have led to a more fit population have nothing at all to do with health care delivery:
[C]ar ownership is heavily restricted in Cuba and as a result the country’s car ownership rate is far below the Latin American average (55.8 per 1000 persons as opposed to 267 per 1000) (Road Safety, 2016). A low rate of automobile ownership results in little traffic congestion and few auto fatalities. In Brazil, where the car ownership rate is 7.3 times above that of Cuba, road fatalities reduce male and female life expectancy at birth by 0.8 and 0.2 years
Forced exercise helps:
[Another factor includes] forcing the population to increase their reliance on more physically demanding forms of transportation (e.g. cycling and walking) (Borowy, 2013). In fact, local physicians attribute a strong role to the massive introduction of bicycles in order to explain the decrease in traffic accidents mortality
So does making the population go hungry:
During the ‘Special Period’ (the prolonged economic crisis caused by the collapse of the Soviet Union), there were ‘sustained shortages in the food-rationing system’ that led to reductions in per capita daily energy intake (Franco et al. 2007). Combined with the increase in the levels of energy expenditures due to the reliance on physically demanding forms of transportation, this led to a reduction in net nutrition...this crisis led to the halving of obesity rates and, although one has to be careful in causal terms, this likely contributed to important reductions of deaths attributed to diabetes, coronary heart diseases and strokes (there were also increases in the number of cases of neuropathy).
As Berdine, et al point out, a key factor here is the unseen opportunity cost of mandating that more and more resrouces be directed toward health care at the expense of other sectors of the economy. Cuban central planners have decided that large amounts of national income be devoted to health care so as to improve (some) national indicators on health. But, given the choice, would Cubans choose to devote so much to health care?
Many advocates for government-directed health spending like to claim that health and longevity are the most important factors. But ordinary human behavior makes it clear this is not actually true. People routinely spend money on non-essentials like non-basic automobiles, large houses, and costly vacations when they could save that money for medical emergencies. Even in countries with so-called socialized medicine often have options for private supplemental health insurance — which would expand and improve quality of care for the purchaser. And yet few elect to use this option. Clearly, living as long as possible is only one value balanced against many others.
In light of this, can we conclude the Cuban government is hitting the "correct" amount of health care spending? Since each person's value ranking differs, this is obviously impossible.
Nevertheless, the Cuban healthcare system is clearly geared toward hitting certain goals arbitrarily set by government officials. This can lead to abuse, of course, and also to unreliable data.
The $85 billion mega-merger of AT&T with Time Warner appears headed for consummation, which will create another big digital media company with telecom underpinnings. But will this endless scramble for eyeballs and clicks, the quest to determine which platforms finicky content consumers will choose in coming years, actually create any value for shareholders? Or will it end up like the AOL/Time Warner merger of 2000, a poster child for unduly optimistic predictions about the value of merging technology platforms?
Beyond digital media companies, questions loom about the booming M&A market in general. Is the world of deals mostly malinvestment, as David Stockman charges, or does at least some transaction activity represent organic and healthy allocations of capital? Are company valuations and purchase prices completely out of whack, due to a Fed-juiced equities market? Do stock buybacks, creative recapitalizations, and listless horizontal mergers attempt to create ersatz "financial" growth in lieu of the real thing?
All of these are open questions, and mises.org readers need no explanation of how central banks and low interest rates create malinvestment. But (cue movie trailer voice) in a monetary world controlled by central banks, the damnable answer is we can never know. That is precisely Stockman's point: because the Fed controls the most important price in the economy — the Fed Funds rate — it's impossible to know the true price of anything.
Value is subjective, and supply and demand drives prices. But both measures are expressed in dollars.
So the brilliant young tech kid who gets $30 million from a VC fund for a great new idea may have created value for society that justifies it — or may be the lucky recipient of cheap shotgun money, spread around by yield-chasing fund managers hoping whiz kid's idea pays 20X or 50X to cover losses elsewhere.
This is true of all speculative markets, to be sure. VC, M&A, and equity markets would have uneven distributions of winners and losers without the Fed. But one of the big problems with central banking generally is this: when you manipulate the cost of money and credit, you necessarily manipulate that distribution. This strengthens the perception that wealth is a rigged game, and in fact actually creates an undeserving class of Fed-connected elites in heavily "financialized" industries.
One company hoping to cash in on easy money is Vice Media, a rough and tumble media platform focused on the advertising cliche known as the "youth market." You may have happened across Vice.com, or seen their ubiquitous videos on airlines or your social media feeds. The slant is decidedly leftwing, which is no surprise, but also fairly interesting — one recent video highlighted the tragic history between Haiti and the Dominican Republic with compelling on-the-ground storytelling.
Still, it's a niche brand at best. So imagine thinking Vice.com is worth several billion dollars, ranking it among the most valuable private companies in America. Imagine thinking it will soon be worth $50 billion, perhaps within a decade. Imagine thinking the company is wildly undervalued, so that you pull $70 million in spare change from your back pocket and invest in something you don't quite understand but imagine represents youth and revolutionary thinking.
We might call such a person a fool, someone suffering from historical amnesia when it comes to the dot.com and housing bubbles, who forgets the importance of fundamentals and real earnings in overvalued companies. We might call them a sucker who deserves to lose money. Or we might call them a genius, if it all works out. In fact that $70 million investor back in 2012 was no less than Rupert Murdoch — by all accounts a brilliant and shrewd media mogul, not to mention hard nosed investor. And he's not alone, as a very serious private equity player — TPG — invested $450 million just a year ago.
Fast forward to today, and Vice Media is reeling from a combination of lagging revenue, a confusing array of platforms, and the struggle to figure out millennial TV habits. So the next round of Murdochs and TPGs might not be easily identified.
Vice, mind you, produces "content" rather than tangible goods or services. And not just any content, but edgy content, which requires an almost preternatural understanding of the shifting social media and hipster landscapes. Edgy is amorphous, and quickly lost. Worse yet is the risk of a stale company imagining it's still edgy, i.e., lacking self-awareness. Now-shuttered Rare comes to mind, as does the struggling Buzzfeed.
All of this suggests Vice needs the right people, and a constant new stream of them, to stay relevant. This is a tall order even in the older, slower print world, as anyone familiar with Rolling Stone or Spin can attest. So investing in Vice truly means investing in people, like its wild man founder Shane Smith, not management, products, brands, processes, or systems. And people are notoriously unreliable.
Rupert Murdoch and TPG should be worried.
Addendum: the deal world today is not just a large-cap, headline-making phenomenon. Deal activity across company sizes is robust, both in terms of volume and value, despite cooling somewhat from a recent 2015 peak. M&A buyers spend nearly $5 trillion annually, more than $1.5 trillion of it in the US.
The two primary categories of M&A distinguishes between "strategic" and "financial" buyers.
Strategic acquisitions involve existing corporations scooping up competitors, new service lines, new brands, or new technology, with the goal of greater vertical integration and the economies of scale and management such integration makes possible. "Synergy" is the awful buzzword frequently used to describe big corporations either merging with a similarly sized company, snapping up smaller bolt-on businesses as subsidiaries, or absorbing established companies to fill holes in their product and service offerings.
Vertical integration, however, comes at a potential price. As Rothbard posits in Man, Economy, and State, corporations that become too large and dominant in a field risk losing perspective on profit and loss with regard to their intra-subsidiary transfer pricing, the amount each subsidiary "charges" the others for goods and services. Corporate executives who buy up too many similar companies might find themselves with imperfect information about internal profits and losses, and thus (like Soviet planners) become unable to allocate resources and price end goods/services effectively.
As a general rule strategic buyers are less sensitive to interest rates and central bank signals, because big existing corporations often bring cash to the table or swap their own valuable stock. When Amazon simply plunks down $13.7 billion in cash to buy Whole Foods, it's not doing so to make a quick buck or even take advantage of low interest rates (though it did issue corporate debt to raise some of the money). It's not openly engaging in the kind of financial engineering David Stockman decries, although he does frequently criticize Amazon's lack of profits and dividends relative to its sky-high P/E ratio. In essence, strategic buyers (especially public corporations) often have the luxury of long-range decision-making.
Financial buyers, however, generally consist of private equity or venture funds whose investors want to buy a company and sell it within a three to five year window. As Peter Thiel describes in Zero to One, for every investment that hits, most will fizzle. So the goal is to avoid too much downside risk while biding time to unearth the big winning investment — a story Thiel knows well from his experience with PayPal, Ebay, and Facebook (note that private equity firms often invest in large public companies; the strategic vs. financial distinction is based on the identity of the buyer rather than the target entity).
During the heady go-go years of private equity M&A, from the mid-1990s until the Crash of 2008, Alan Greenspan and Ben Bernanke demonstrated their commitment to making credit cheap and easy, and to making sure stock markets didn't crash. So private equity players responded rationally, buying up companies with 1 part equity to 6, 7, 8, or more parts debt. Often the 1 part debt was divided into tranches and split between various funds, isolating the risk of losing equity even further.
Keep in mind most corporate interest payments are deductible for tax purposes, while dividend payments are not. So it made sense to load up a company with cheap debt, and use revenue to pay off that debt quickly (while deducting the interest portion) rather than funding non-deductible capital expenditures to improve future productivity. Why worry about capex, product development, or improving factories when you plan to sell the company in three years anyway? Load it up with debt, fire existing management, install overseers, put every available dollar toward debt service, and get out before any long-term cracks began to show. After all, there was always another private equity firm (or IPO) waiting to buy.
This model is what propelled Mitt Romney from being merely a rich man to being a very rich one.
It's hardly surprising that fund managers and corporate CEOs developed a short-term mindset: monetary policy almost demanded it. And it's hardly surprising that enterprise values rose to crazy heights, with many financial deals closing for a purchase price of 10 or 12X earnings.
It was all driven by cheap credit, and it all came crashing down in 2008. But if M&A volume is any indicator, we haven't learned a thing.
Our friend Daniel Lacalle was interviewed recently by BBC to discuss recent developments between trade negotiations between the US and China.
On his blog, he goes on to further explain why a trade war would be particularly devastating for China.
What the Trump administration was doing was a negotiation tactic. Aggressive, bulldozer-type and, of course, questionable. But a tactic to address the massive trade deficit with China, the largest in the world, at $375 billion. The negotiation tactic is clear, as proven by the tariff moratorium on the European Union, Canada, Mexico and South Korea.
China needs the U.S. surplus more than the U.S. needs China’s trade and finances. And that is why the trade war will not happen. Because China has already lost it.
This is a duel at dawn in which it is most likely that no one will shoot … Because the pistols are loaded with debt, not with gunpowder.
The trade war will not happen for various reasons:
- China badly needs the surplus with the United States to keep its extremely indebted growth model, way more than the United States needs China’s purchases of debt of goods. China added more debt in the first quarter of 2018 than the U.S., Japan and the EU combined, and it has reached an estimated 257% of GDP. If it does not grow exports to its main customer, the U.S., its problem of overcapacity and debt soars, and the economy crumbles.
- China cannot win a trade war with high debt, capital controls and US exports’ dependence. A massive Yuan devaluation and domino defaults would cripple the economy. The U.S. dollar is the most traded currency in the world, and growing according to the Bank of International Settlement. The Yuan is 4% of currency trade.
- China’s currency is not backed by either global use nor gold. At all. It is as unsupported as any fiat currency, like the U.S. dollar, but much less traded and used as a store of value. China’s gold reserves are an insignificant fraction of its money supply. Its biggest weakness comes from capital controls and intervention. However, even with capital controls, capital flight has continued. $51bn outflows in the first quarter of 2018, according to Natixis.
- China does not have a nuclear option on the U.S. debt. For once, it is not the main owner of U.S, bonds, not even close (China is less than 8.6% of U.S. bonds outstanding). The United States can guarantee the demand for its debt issues even if China sells. But, in addition, China has increased its purchase of U.S. bonds by $168 billion dollars since the U.S. elections. If China sells its Treasury holdings, its own currency would massively appreciate and the domestic risks, lower exports, lower growth, outweigh the threat. Even if it sold, the demand for U.S. bonds has increased and when China has reduced Treasury holdings, Treasury yields have fallen. The Federal Reserve and the main U.S. Fixed Income funds could buy the bonds in a very short period of time, a week at most. Remember that 2018 has seen a record pace of inflows to U.S. Treasuries. $3.4 billion inflows in one week, with year-to-date inflows of $18.6 billion (data April 14th, 2018).
- China cannot maintain its growth – based on a huge debt bubble – if its exports fall. And its trade surplus with the United States has been growing while its trade surplus with the rest of the world shrunk. A drop in the growth of China’s exports would mean a collapse of foreign currency reserves. These reserves have been recovering a bit recently, but have fallen 21% since the 2014 highs.
A collapse in the reserves of foreign currency would accentuate the capital flight that is already taking place, which would lead to increasing the already disastrous capital controls in China, and with it, three effects. Lower growth, higher debt and the risk of a very important devaluation of the yuan.
For China, a trade war would be devastating.
Of course, there are important negatives for the U.S. but not as dramatic.
The United States exports very little (12% of GDP), so any threat that leads to a positive agreement is an exponential improvement. But the duel is loaded with wet gunpowder.