Lawson for Congress

The terrorists we must fight are not crouched in caves thousands of miles away.

The terrorists we must fight are threatening us with financial weapons of mass destruction that are destroying our economic system.

As described by Warren Buffet in his 2003 letter to Berkshire Hathaway shareholders, the financial industry has created new types of derivatives that he described as “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

As summarized in this BBC article:

Contracts devised by ‘madmen’

“Derivatives generate reported earnings that are often wildly overstated and based on estimates whose inaccuracy may not be exposed for many years” - Warren Buffett

“Large amounts of risk have become concentrated in the hands of relatively few derivatives dealers … which can trigger serious systemic problems.” - Warren Buffett

Derivatives are financial instruments that allow investors to speculate on the future price of, for example, commodities or shares - without buying the underlying investment

Derivates like futures, options and swaps were developed to allow investors hedge risks in financial markets - in effect buy insurance against market movements -, but have quickly become a means of investment in their own right.

Outstanding derivatives contracts - excluding those traded on exchanges such as the International Petroleum Exchange - are worth close to $85 trillion, according to the International Swaps and Derivatives Association.

Some derivatives contracts, Mr Buffett says, appear to have been devised by “madmen”.

He warns that derivatives can push companies onto a “spiral that can lead to a corporate meltdown”, like the demise of the notorious hedge fund Long-Term Capital Management in 1998.

Does any of this sound familiar? It should. We’re living it.

How is Congress reacting to this clear and present danger, which is sitting right across the table from them as it testifies in Washington?

They’re ignorant and scared:

WASHINGTON — It was a room full of people who rarely hold their tongues. But as the Fed chairman, Ben S. Bernanke, laid out the potentially devastating ramifications of the financial crisis before congressional leaders on Thursday night, there was a stunned silence at first.

Mr. Bernanke and Treasury Secretary Henry M. Paulson Jr. had made an urgent and unusual evening visit to Capitol Hill, and they were gathered around a conference table in the offices of House Speaker Nancy Pelosi.

“When you listened to him describe it you gulped,” said Senator Charles E. Schumer, Democrat of New York.

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”

How did we get into this situation? This is the endgame for an inherently unstable system that has been forever destined to fail. As I noted in a previous post:

If asked to pick one word to describe why I’m running for Congress, that word is sustainability. Sustainability doesn’t mean stability, it doesn’t mean safety, and it doesn’t mean protection from life’s inevitable uncertainties. Sustainability does mean recognizing and obeying the natural laws that govern of our world.

Every branch of science has certain laws: Objects in motion tend to stay in motion; force equals mass times acceleration; every action has an equal and opposite reaction; energy in a closed system cannot be created or destroyed but merely changed in form; and closed systems tend towards increased entropy are a few good examples.

These laws of motion and conservation of energy are not limited to high school physics class. Every system in nature must obey these underlying principles — including our financial and monetary systems.

Let’s start with Newton’s laws of motion — it’s a short hop from there to defining leverage as the ability to move a large object a short distance using a small force exerted over a long distance. Leverage is a concept in finance, as well — using borrowed money to increase returns based upon small underlying price movements. Just as the car lifted with a hydraulic jack can hurt you if it falls, a small price movement in an imprudently leveraged investment can wipe out a lifetime of savings.

Next consider conservation of energy and open versus closed systems. Since energy within a closed system cannot be created or destroyed, and since closed systems tend towards increasing entropy, every growing system must be open to an external energy source. In this setting, one can immediately see problems with our debt-based monetary system.

What is debt-based monetary system? It’s where money is debt, and every dollar in circulation exists because a bank created it out of nothing based upon someone’s promise to pay it back, with interest.

Our economy is an open system relative to money, which is created and destroyed by banks. Banks create the money through loans — but they only create the amount you borrow. They don’t create the interest that you also promise to repay. Where do you get the interest? You have to earn it, but first it has to be created — yes, by someone else borrowing more money that they promise to repay with still more interest.

In the end, our monetary system is like a game of musical chairs — the banks create money based upon someone’s willingness to borrow, and the bank’s ability to lend. The constant demand for new money to repay interest on existing money compels growth and new money creation at an accelerating rate.

Refer to the chart of America’s total debt, which raises obvious questions about sustainability. Trees do not grow to the sky — and when banks cannot lend, or people are no longer willing to borrow, the music stops. When the music stops, there are more loans outstanding than money to repay, so everyone left standing loses whatever they pledged in exchange for their loans. Even worse, money that was created out of nothing through borrowing just as easily disappears back into nothing as asset values plummet — so when the music stops, the chairs start disappearing from the room.

Leverage, debt-based money, fractional reserve banking, and interest are fundamental features of our economic system. Our economic history of boom/bust cycles and decisions dominated by short-term gain as opposed to long-term stewardship are fundamental consequences of this underlying system. In short, our system has undesirable consequences and is fundamentally unstable — but it’s working as designed.

Interestingly, now we have the terrorists who created and detonated these weapons holding us hostage. They’re asking us for more power, and to punish us with more debt, only to further enable the corrupt system to which we are hopelessly enslaved in the first place.

In other words, they’ve thrown a massive brick through the window, and are asking us to assume a crippling debt so that we can hire and pay them to “fix” it:

As noted by many, including Kentucky Senator Jim Bunning and Texas Representative Ron Paul, the Federal Reserve and the banking system that controls it are the cause of our systemic risk. Even the Federal Reserve’s own Harvey Rosenblum emphasizes that the Federal Reserve’s job is to create moral hazard, which enables systemic risk:

Rosenblum: The Federal Reserve is in business to create moral hazard. The mere act of being a central banker means that your job description involves creating moral hazard. A central bank is a “lender of last resort,” what more moral hazard can you have than having a lender of last resort that people know, when push can to shove, can be relied upon? The Federal Reserve’s job is to cushion the blow to 300 million American citizens of all the economic shocks that hit out there. What drives me crazy is when I hear people shouting “Moral hazard, moral hazard”… that’s what my job is to do…

Of course, it’s a bit disingenuous to say that the Fed’s job is to “cushion the blow” when the Fed threw the brick that caused the economic shock.

Gary Larson’s classic Far Side cartoon says it all. The Federal Reserve has heaved a gigantic brick through the window of our nation’s economy. Jobs are getting scarce, retirement savings and housing values are declining, and basic necessities are less affordable. Using the current crisis as an opportunity to further empower the Federal Reserve at the expense of the people is not the answer.

We need to restart past conversations, and restore a Constitutional money and banking system that removes moral hazard from the equation entirely. We cannot allow a private monopoly to create money out of nothing to loan to us at interest. The Federal Reserve is welcome to compete in a free market, but accepting private debt-based currency should not be compulsory — it should be voluntary, and other forms of money that facilitate trade and local economic growth should be welcomed.

Alan Greenspan noted that our money system is not a free market — the power over our money is centralized in the hands of the Federal Reserve. That fact, along with the Federal Reserve’s support for the inherently unstable process of fractional reserve banking,  create the bricks that break our windows.

Our founders intended for our money and banking system to be democratized. Our ability to create wealth in our communities is one of our unalienable individual rights. The government is only authorized to establish a level playing field with accurate “weights and measures.” In particular, Congress was given the authority to coin money, and regulate its value — it is not authorized to delegate monopoly authority over our money to a private central bank.

Since 1913, however, our money comes from a monopoly run for the benefit of private banks. The banks have the power to create money through debt, and the people and our governments thus accumulate debt instead of wealth.

So what is Congress going to do? Let’s continue reading about their negotiations with the terrorists:

When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”

“What you heard last evening,” he added, “is one of those rare moments, certainly rare in my experience here, is Democrats and Republicans deciding we need to work together quickly.”

Although Mr. Schumer, Mr. Dodd and other participants declined to repeat precisely what they were told by Mr. Bernanke and Mr. Paulson, they said the two men described the financial system as effectively bound in a knot that was being pulled tighter and tighter by the day.

“You have the credit lines in America, which are the lifeblood of the economy, frozen.” Mr. Schumer said. “That hasn’t happened before. It’s a brave new world. You are in uncharted territory, but the one thing you do know is you can’t leave them frozen or the economy will just head south at a rapid rate.”

As he spoke, Mr. Schumer swooped his hand, to make the gesture of a plummeting bird. “You know we’d be lucky …” he said as his voice trailed off. “Well, I’ll leave it at that.”

Folks, we’re in trouble. When Republicans and Democrats are both ignorant and scared, we do horrible things.

Don’t believe me? Turn off Faux News and read Roubini. Read Denninger. Read Shedlock. This is not a drill, and our elected representatives need to hear our anger at this unprecedented hostage crisis.

In this setting of ignorance and fear, a proposed “fix” is being circulated that will authorize our government to go further into debt to buy toxic debt from failing banks. Note that the “fix” will not work — it will simply push the system further out of equilibrium. Karl Denninger succinctly dissects it here. Key quote:

The claim is that this is intended to “promote confidence and stability” in the financial markets.

It will do no such thing.

It will instead strike terror into the hearts of investors worldwide who hold any sort of paper, whether it be preferred stock, common stock or debt, in any financial entity that happens to be domiciled in the United States, never mind the potential impact on Treasury yields and the United States sovereign credit rating.

What should Congress do? Follow the Constitution: eliminate the money monopoly that is crippling our country. As I noted here:

Return our money to the people, for starters. Do people want to exchange and transact in gold and silver? Great. Do people want to do business in private local currencies that build self-sufficient communities? Great. Affirm that all barter transactions between individuals are tax-free, and let individuals build wealth by helping each other.

Eliminate fractional reserve banking, eliminate legal tender laws, and eliminate our private money monopoly. Our government can use its sovereign power to create currency that is not based upon debt, and based upon how responsibly our government creates that currency, people can choose to accept it or discount it appropriately.

This idea is not new, it’s in fact how we originally grew into a prosperous nation — colonial scrip. Scrip is fine for domestic trade, and specie or other commodities can be used for international trade. Competition between different money systems keeps people honest, and elimination of fractional reserve banking and fraudulent “deposit insurance” keeps banks honest.

Relentlessly seeking another hit of debt will not cure our unsustainable addiction. The poison is not the cure.

It’s time to look around and reassess our national priorities. Republican, Democrat, Libertarian, Constitution, Green, Unaffiliated, Catholic, Protestant, Jewish, Muslim, Hindu, Atheist, Straight, Gay… none of these labels matter. We are all on the same boat. When the boat hits the iceberg, we all sink or swim together.

It’s time to get off the treadmill of a collapsing debt-based currency and empower local economic growth through an honest, Constitutional money system that will strengthen communities by empowering local producers of real goods and services.

Here’s the bottom line: we may or may not be able to prevent a a misguided bailout. Ultimately, however, self-sufficient communities are the only lasting antidote to the current crisis. There is one thing that Congress could do to provide a safety net that would empower individuals to build self-sufficient communities:

Congress must unambiguously affirm that all voluntary barter transactions between individuals are tax-free.

What do I mean by “barter transactions”? They may be transactions exchanging time for time, time for goods, goods for goods, time for dollars or private barter currencies (paper or specie), or goods for dollars or private barter currencies. The key point is that human individuals (not corporations or other creatures of the legal system) need to be free to create wealth in their communities.

Again, If the banks get bailed out, the people need to be bailed out. People must again have the ability to serve each other as individuals to recreate the wealth that is being destroyed all around us.

It’s time to focus on hometown security, instead of homeland security.

Today’s New York Times has an Op-Ed piece by Roger Altman, formerly with Lehman Brorthers, Blackstone Group, and the U.S. Treasury, regarding the role of the Federal Reserve in the current financial crisis. This article deserves critical scrutiny by every American. Here are some key excerpts:

SMALL rallies notwithstanding, we are experiencing the most dangerous financial period since the 1930s. In the year since this crisis erupted, huge losses have threatened the solvency of our largest financial institutions. As a result, the Federal Reserve has been forced into increasingly difficult emergency actions, including the rescues of the investment firm Bear Stearns and the mortgage companies Fannie Mae and Freddie Mac, to prevent the entire system from collapsing.

Our entire regulatory system, conceived long ago for a different financial world, must be rebuilt. The next president will have no choice but to undertake this task next year.

The next president must first create a single framework for the major financial borrowers, administered by the Federal Reserve alone.

It usually takes a severe crisis to bring about systemic change. The upside to the punishing turmoil in our financial system is the growing probability that regulatory overhaul is at hand. And that’s good, because without it the Fed might be unable to save the system next time.

I agree with two of Mr. Altman’s key points: our current position is dangerous and unsustainable, and that the regulation of our monetary and financial system, based upon the Federal Reserve’s monopoly of our debt-based currency, must be rebuilt.

I disagree, however, with the assertion that we need to further centralize power in the Federal Reserve. As noted by many, including Kentucky Senator Jim Bunning and Texas Representative Ron Paul, the Federal Reserve and the banking system that controls it are the cause of our systemic risk. Even the Federal Reserve’s own Harvey Rosenblum emphasizes that the Federal Reserve’s job is to create moral hazard, which enables systemic risk:

Rosenblum: The Federal Reserve is in business to create moral hazard. The mere act of being a central banker means that your job description involves creating moral hazard. A central bank is a “lender of last resort,” what more moral hazard can you have than having a lender of last resort that people know, when push can to shove, can be relied upon? The Federal Reserve’s job is to cushion the blow to 300 million American citizens of all the economic shocks that hit out there. What drives me crazy is when I hear people shouting “Moral hazard, moral hazard”… that’s what my job is to do…

Of course, it’s a bit disingenuous to say that the Fed’s job is to “cushion the blow” when the Fed threw the brick that caused the economic shock.

Gary Larson’s classic Far Side cartoon says it all. The Federal Reserve has heaved a gigantic brick through the window of our nation’s economy. Jobs are getting scarce, retirement savings and housing values are declining, and basic necessities are less affordable. Using the current crisis as an opportunity to further empower the Federal Reserve at the expense of the people is not the answer.

We need to restart past conversations, and restore a Constitutional money and banking system that removes moral hazard from the equation entirely. We cannot allow a private monopoly to create money out of nothing to loan to us at interest. The Federal Reserve is welcome to compete in a free market, but accepting private debt-based currency should not be compulsory — it should be voluntary, and other forms of money that facilitate trade and local economic growth should be welcomed.

Alan Greenspan noted that our money system is not a free market — the power over our money is centralized in the hands of the Federal Reserve. That fact, along with the Federal Reserve’s support for the inherently unstable process of fractional reserve banking,  create the bricks that break our windows.

Our founders intended for our money and banking system to be democratized. Our ability to create wealth in our communities is one of our unalienable individual rights. The government is only authorized to establish a level playing field with accurate “weights and measures.” In particular, Congress was given the authority to coin money, and regulate its value — it is not authorized to delegate monopoly authority over our money to a private central bank.

Since 1913, however, our money comes from a monopoly run for the benefit of private banks. The banks have the power to create money through debt, and the people and our governments thus accumulate debt instead of wealth.

Please help us teach David Price the importance of debt-based versus asset-based money, and the importance of returning the power to create wealth to the people.

I just watched an instructive interview between CNBC’s Steve Liesman and Harvey Rosenblum, a 38-year Federal Reserve veteran who is currently Director of Research at the Dallas Fed. The entire interview is available here, but let’s start with a brief excerpt:

Liesman: One of the concerns out there right now is that actions by the Federal Reserve and the government will increase what we call “moral hazard.” What are your thoughts on that?

Rosenblum: The Federal Reserve is in business to create moral hazard. The mere act of being a central banker means that your job description involves creating moral hazard. A central bank is a “lender of last resort,” what more moral hazard can you have than having a lender of last resort that people know, when push can to shove, can be relied upon? The Federal Reserve’s job is to cushion the blow to 300 million American citizens of all the economic shocks that hit out there. What drives me crazy is when I hear people shouting “Moral hazard, moral hazard”… that’s what my job is to do…

Liesman then asks Rosenblum an interesting question:

Liesman: You’ve been at the Fed thirty eight years. Do you feel as if some of things being discussed and some of the things the Fed has had to do recently have stretched the Federal Reserve too far?

Rosenblum: No. I think it’s stretching the Federal Reserve in the direction that it needs to be stretched, and we just have to get the laws to catch up with where we ultimately have to be if we’re going to be a 21st century Fed deaing with 21st century financial markets. And if you’re going to be a lender of last resort, you have to have the tools to deal with the thing, and you need more regulatory power. Will regulation ever be perfect? Will it solve all the problems? Absolutely not. At best it will be one step behind the market, but even if you’re two steps behind the market, you’re doing pretty darn good.

There you have it. An insider’s description of a system that is perfectly designed to steal from the poor and middle class, to the benefit of those who control the supply of money and credit. Banks who control the supply of money and credit constantly engineer new ways to exploit the system for their benefit. Importantly, they can push the system past its limits knowing that profits will be privatized during the good times, while losses during crises will be socialized.

Cue my favorite banking video (long-time supporters will have seen this already, but it’s always worth reviewing):

Does it make sense to give the Federal Reserve more power, when in fact it is the cause of our systemic instability, and a key ingredient of an economic system that institutionalizes corporatism, poverty, and injustice?

Fortunately, more people in Washington such as Kentucky Senator Jim Bunning are realizing that the Federal Reserve is the problem instead of the solution:

Now the Fed wants to be the systemic risk regulator. But the Fed is the systemic risk. Giving the Fed more power is like giving the neighborhood kid who broke your window playing baseball in the street a bigger bat and thinking that will fix the problem. I am not going to go along with that and will use all my powers as a Senator to stop any new powers going to the Fed.

Indeed, the Federal Reserve has been scrambling over the past year to prevent a collapse of our banking and money system with a variety of “lending facilities” that let various players in the financial markets exchange assets of questionable values for Treasury debt at low interest rates, for an extended period of time. These lending facilities are the reason that the Fed itself is running out of Treasury debt — it’s lending Treasury debt so that banks don’t have to put a value on illiquid and difficult-to-value (read: questionable) assets. Does such a shell game, or a system that encourages it, make any sense at all?

Well, it might make sense, and money, for the banks. Take last week, for instance. Freddie Mac’s shares soared last Monday after a reportedly successful auction of $2 billion in new debt. One might ask who is buying Freddie’s bonds in the current environment — a recent Financial Times article reports that foreigners are scaling back their GSE holdings:

Bank of China this week revealed it had cut its portfolio of securities issued or guaranteed by the two government-sponsored enterprises by a quarter, or $4.6bn, since the end of June. The sale underscored signs of nervousness among foreign buyers of Fannie and Freddie’s debt.

Might domestic banks be picking up the slack? John Carney of Dealbreaker raises an intriguing possibility:

We don’t know who bought the Freddie notes today. But buyers of Freddie notes who have access to borrowing from the Federal Reserve would have found the decision to bid relatively easy. That’s because the ability to exchange the Freddie debt for Fed cash means banks can buy Freddie debt with a huge amount of leverage, dramatically increasing the return on their capital.

Here’s how it works. A bank that bought the six month notes from Freddie this morning could also bid to borrow from the Fed’s Term Facility, which held an $75 billion auction today. As collateral for the borrowing, the bank could offer the newly purchased Freddie notes, for which the Fed would give them credit for 97% of their market value. Recently, the TAF pricing topped out at 2.35 percent for 28-day borrowing. So a bank buying $100 million of Freddie paper yielding 2.858% could flip it to the Fed, borrowing $97 million at around 2.4% (assuming the pricing will be slightly higher this time around).

At the end of the day, a credit desk could buy $100 million of Freddie debt for just $3 million down. On that $3 million, the desk would receive a 17.7% annualized return, or 8.8% over six months, for paper that is thisclose to being explicitly backed by the Treasury Department. Not a bad deal at all.

Ah, the ingenuity of the markets.

Keep in mind that the same banks with access to these borrowing facilities charge usurious interest rates for credit cards, load up customers with penalties and fees, profit by creating money out of nothing to lend to the public with interest, and seize underlying assets when folks can’t pay.

Why can’t we all sign up for a taxpayer-financed carry trade? Thank you, Mr. Chairman:

We had a standing-room crowd at the I.O.U.S.A. premiere in Raleigh, North Carolina this evening. Two auditoriums were sold out — both the one sponsored by our campaign, as well as the regular showing. The movie provided an excellent overview of the “fiscal cancer” that David Walker, former head of the Government Accountability Office (GAO), has been courageously discussing for the past several years. The discussion about addressing these issues, however, is just beginning — and will be much more controversial.

If you missed the movie, there are some key excerpts available on YouTube, such as David Walker’s descriptions of our four deficits:

As an example of leadership deficit, consider how Congress has been abusing the trust of our senior citizens by raiding the Social Security trust fund every year:

So how big is our “fiscal hole”? David Walker explains:

After the movie, we watched a live Town Hall discussion from Omaha, Nebraska, moderated by CNBC’s Becky Quick and featuring panelists Warren Buffett, CEO of Berkshire Hathaway; William Niskanen, chairman of the Cato Institute; Bill Novelli, CEO of AARP; Pete Peterson, senior chairman of The Blackstone Group and chairman of the Peter G. Peterson Foundation; and Dave Walker, president & CEO of the Peter G. Peterson Foundation and former U.S. Comptroller General.

The best part about the event is that we had a solidly bipartisan crowd. As such, there was room for everyone to be offended: For example, some Republicans were offended that the Clinton years were painted with such a glowing brush, as spending restraint coupled with a growing economy caused the federal debt to decrease for a change (unless you count the fact that Congress spent the Social Security surplus, of course). Some Democrats were offended by the movie’s downplaying the effects of allowing the Bush tax cuts to expire — such a step will only deal with 10% of our fiscal hole.

There is, however, bipartisan agreement on two critical points:

• We need change in Congress. The biggest applause in our theater during the Town Hall discussion was after Pete Peterson’s assertion that our founders never intended a government run by career politicians. (David Price, take note. After 22 years in Washington and accumulating a healthy Congressional pension, you are a career politician.) Bill Novelli, CEO of AARP, also received resounding applause for his comment that our two party system is “toxic”, and partisan bickering is one of the biggest impediments to meaningful dialog.
• We cannot keep doing what we are doing. Current trends for public debt, private debt, foreign trade balances, and Medicare/Social Security obligations are unsustainable.

The second point was driven home by the movie, and clearly emphasized by David Walker during the Town Hall discussion. In fact, the oddest moment of the entire evening was when Warren Buffett began his comments by complimenting the movie as well-done, and then stating he was going to provide a more optimistic “Pollyanna” perspective. He then proceeded to make the claim that our overall situation is not that serious, since our massive future obligations can be paid for through “the pie getting bigger.” In other words, we can “grow our way out” of the problem.

At that point, the theater’s cognitive dissonance was so thick you could cut it with a knife, and it was clear that a showdown was just around the corner. David Walker did not disappoint, and adroitly yet diplomatically smacked down Warren Buffett’s erroneous assertions. After noting that he has tremendous respect for Mr. Buffett, Mr. Walker reminded everyone that the projections of looming bankruptcy discussed in the film already take GDP growth into account. Assuming traditional growth rates, we cannot grow our way out of this problem. Of course, if growth does not meet projected expectations, things could be worse, and sooner.

Importantly, the Town Hall discussion did attempt to spark some debate about how to fix these problems. Where debate did arise, however, its outcome was entirely too predictable. For example, William Niskanen, chair of the Cato Institute, proposes privatizing a portion of Social Security so that individuals can control their own retirement savings and seek higher returns than our insolvent Social Security system will provide. At the same time, he wisely counsels us to stop government bailouts — the government cannot, and should not, prevent businesses or individuals from making bad investments and losing money.

The counterpoint was provided by Bill Novelli of the AARP. He’s against privatizing Social Security — how do we prevent newly empowered savers from putting their nest egg into Freddie Mac, Fannie Mae, Bear Stearns, and Lehman Brothers stock? While Mr. Niskanen is wisely advising us to stop relying on the government to “bail us out,” how can the average American truly “save” when deposit rates don’t keep up with inflation, and beating inflation requires paying the financial services industry for the privilege of putting our savings at risk in volatile markets that have turned into casinos for the highly-leveraged and well-connected?

So how can we cut the Gordian knot? I can envision three ways to proceed:

First, we could try to address the problems within the confines of our existing money system and expected ongoing budget deficits. As David Walker pointed out, the government has no money. It can take money from you in taxes, only to provide benefits to you somewhere else. It can borrow money, but that condemns us to pay the money back, plus interest. It can print money through the Federal Reserve, but simply printing money to meet obligations didn’t work for the Weimar Republic, and isn’t working for Zimbabwe. Within our current framework, we need to cut spending, cut entitlement benefits, and raise taxes to more punitive levels.

Alternately, we could stop and immediately seek debt counseling: end deficit spending, enforce a balanced budget, and fund our entitlement programs by refinancing our existing federal debt over a longer period of time while being more intelligent about what promises we honor, to whom, and when. You can think of this as a self-imposed and somewhat-negotiated “bankruptcy plan” where we tell our creditors that the rules are changing a bit.

A well-documented plan of this type has been proposed by Texas CPA Davis Jackson. The summary videos below are worth watching:

There is a third path to consider, however, in addition to the above. Given the severity of our situation, it is worth asking some questions about our money system itself, its history, and who benefits from preserving the status quo. I was impressed that the movie provided some education as to the nature of our money system, and the role of the Federal Reserve’s monopoly in “managing” the money supply. Most importantly, the selected clip of John Stewart’s interview with Alan Greenspan provided a rare (if deeply embedded) moment of clarity:

Watch the segment from 2:25 to 4:33. John Stewart asks the key question — if we say we live in a “free market economy”, why do we need a Federal Reserve to set interest rates? Greenspan waxes poetically about the gold standard for a while, and then answers: “To the extent that there is a central bank governing the amount of money in the system, that is not a free market.”

So, then, I ask a rhetorical question that’s often at the heart of the “liberal” versus “conservative”, or “left” versus “right” debate. If our money, which is the foundation of almost every economic transaction, does not exist in a “free market” but is instead managed by a monopoly acting in its own best interest, can we claim that any part of our economy is actually free?

That question, briefly glimpsed during the movie, has been asked before. In fact, a hundred years ago the “money question” was a topic of active discussion. The following quotation is from the book High Cost of Living by Thomas Cushing Daniel, published in 1912:

I urge all voters to apply this crucial test to their representatives before supporting them.

Make them commit squarely and unequivocally to these questions. Do you believe Congress should exercise its sovereign power as provided in the Constitution of the United States to create money and regulate the value thereof and control the circulating medium in the interest of the whole people? Or do you believe this sovereign power should be transferred to Banks of Issue?

Their answers will prove conclusively whether they are with the people or against them.

Or do you believe that Banking Corporations should issue a credit substitute and through it control the money and circulating medium of exchange of the people of the United States in their own interest?

Watch your presidential candidate carefully and see that he commits himself clearly on this vital question. It will be a true test of his honesty and fitness for office. Admitted ignorance on the monetary issue should not excuse him. The subject is as old as our government, and if he does not know enough about it now to answer these test questions, he is not qualified to fill the position he aspires to, and should not ask your votes.

Asking basic questions about our money system opens up additional possibilities to advance prosperity and liberty. Most importantly, it gets us moving in a direction towards following the Constitution, and having a government that honors its commitment to serve the people as opposed to special interests.

Solving this dilemma will not be easy, but it is possible. Pete Peterson noted that despite best intentions and claims of “bipartisanship” and “compromise”, someone will be hurt as we work to address these imbalances. To advance a just and sustainable future, we need principled leaders in Washington who will advance a Constitutional government that levels the playing field, and repairs broken systems that punish average Americans for the benefit of a few.

What are your thoughts on the challenges, and potential solutions?

There has been much discussion about the use of the rebate package passed by Congress and signed by the President to stimulate the economy. B.J. recently covered the topic in his post, “Shiller vs. IMF,” laying out the arguments of those who favor using it and those who oppose it. As with most government initiatives, success is best measured by its unintended consequences:

President Bush Boosts Porn Industry With Economic Stimulus Plan, According to AIMRCo

NEW YORK, July 2 /PRNewswire-USNewswire/ — An unforeseen and surprising beneficiary of the Economic Stimulus Plan, a plan that George Bush contends will “boost our economy and encourage job creation,” has surfaced this week. An independent market-research firm, AIMRCo (Adult Internet Market Research Company), has discovered that many websites focused on adult or erotic material have experienced an upswing in sales in the recent weeks since checks have appeared in millions of Americans’ mailboxes across the country.

According to Kirk Mishkin, Head Research Consultant for AIMRCo, “Many of the sites we surveyed have reported 20-30% growth in membership rates since mid-May when the checks were first sent out, and typically the summer is a slow period for this market.

Jillian Fox, spokeswoman for LSGmodels.com, one of the sites reporting figures to AIMRCo, added, “In a June 15, 2008 survey to our members, thirty two percent of respondents referenced the recent stimulus package as part of their decision to either become a new member, or renew an existing membership.”

The economic stimulus plan, which includes a check for up to $600 for individuals and $1200 for married couples (among other benefits), is the product of an agreement between House leaders and the Bush Administration, focused on reviving a struggling economy in the wake of flagging economy.

Fox also added, “Getting more people to buy porn was probably the last thing Bush had on his mind when he came up with his ’stimulus package,’ but we’ll take it.”

One might reasonably question if the money we borrowed to pay for these “rebates” are going to spur capital investment and wealth creation. Or do these data suggest that we’re simply seeing “Congressmen Gone Wild”?

It appears our incumbent Representative and others in Congress who supported this legislation have succeeded in seeking a short-run economic boost to satisfy their constituents and facilitate their re-election while ignoring — and in fact exacerbating — very serious fundamental and long-run challenges.

Long-run economic growth results from a number of fundamental factors, which include the accumulation of physical capital (which is a function of personal saving in a healthy economy), human capital (which is a function of education), technological advancement, protection of property rights, and a strong legal system. The accumulation of high debt by government necessitates that resources in the future must be redistributed from investment in these productive forces to paying the bills we’re stacking up now, which crushes long-run economic growth.

Furthermore, the building of a large government debt has a number of negative by-products in an international economy. Absorbing private domestic saving necessitates reliance on foreign saving for domestic growth, as well as possibly on foreign purchasing of government bonds to finance deficit spending. When foreign investment decreases and/or leaves the country, which may occur for a number of reasons (market insecurity, a decline of the value of the dollar due to inflationary monetary policy or payment of foreign debt… either of these sound familiar?), then with it goes the source of growth. At this point, interest rates increase with high government borrowing, and the central bank is in a tough spot. It can either inflate to lower interest rates, which will hurt consumers, increase costs for businesses, and decrease returns of investors; or it can do nothing and allow high interest rates to lead to a recession.  In any of these situations, economic growth is either stagnant or significanlty negative in the end. Thus, “stimulus” spending ultimately gives no real economic boost at all.

By creating more debt to “stimulate” the economy, Congress is attempting to rebalance a house of cards and delay its eventual collapse, even at the cost of potentially worsening it. We are delaying action on making hard choices that must be made today to shore up the country’s financial future and are making the these choices much harder for ourselves down the road. A $9.4 trillion national debt — with more hundred-billion deficits and skyrocketing interest payments expected down the road — and $53 trillion in present value of unfunded liabilities are absolutely nothing to ignore. These are phenomena that will wreck the economy much more powerfully than any near-term recession that may come, and they will not go away on their own nor by creating a significant amount of new debt.

Finally, we should note that the “stimulus packages” being in the form of rebates implies somehow a lessened burden of taxation for now to achieve a change in some economic variable. Real tax cuts are cuts in the burden of government on the taxpayers, and as such, they are long-term commitments that allow us and our communities to keep more of their resources.

Cutting taxes in the short-term and continuing deficit spending in no way represent a tax cut, as the government has one of two options to finance remaining spending. It can borrow and accumulate debt, which necessitates either a future tax increase to pay off the debt or a stalling of long-term growth and decline in opportunities available to the future. Or, the government can print money to finance deficits, which causes price inflation that squeezes consumers. As Milton Friedman would say (paraphrasing), “A tax cut is not a tax cut at all without a spending cut.”

Paige Michael-Shetley is the Volunteer Coordinator and Youth Coodinator for Lawson for Congress. He is a Senior at the University of North Carolina at Chapel Hill and is majoring in Economics and Math.

Slowly, our government is catching on to the fact that the Federal Reserve is the cause of our slow-motion train wreck. Senator Jim Bunning from Kentucky appropriately questioned increasing the Federal Reserve’s power in today’s hearing:

Now the Fed wants to be the systemic risk regulator. But the Fed is the systemic risk. Giving the Fed more power is like giving the neighborhood kid who broke your window playing baseball in the street a bigger bat and thinking that will fix the problem. I am not going to go along with that and will use all my powers as a Senator to stop any new powers going to the Fed. Instead, we should give them less to do so they can do it right, either by taking away their monetary policy responsibility or by requiring them to focus only on inflation.

While I don’t understand specifically what he means by “taking away their monetary policy responsibility”, or even “requiring them to focus on on inflation”, another dissenting voice is a good start.

As Mike Shedlock noted, “In an unusual but encouraging development, someone besides Ron Paul is calling Bernanke on his hogwash.”

Encouragingly, bipartisan opposition to the Treasury’s ill-advised “confidence game” is apparently growing.

As mentioned in our press release, the most appropriate approach to the Freddie/Fannie problem is a decisive restructuring of the GSE’s debt at the expense of the bondholders, as outlined by Nouriel Roubini:

First, notice that the hit that bondholders will take will be limited in the absence of their bailout. With a debt/liabilities of about $5 trillion and expected insolvency – as of now and in the worst scenario of $200 to $300 billion – the necessary haircut is relatively modest: either a reduction in the face value of the claims of the order of 5% (if the mid-point hole is $250 billion) or – for unchanged face value – a very modest reduction in the interest rate on their debt after it has been forcibly restructured.

Second, a 5% haircut is much smaller than the 75% haircut that the holders of Argentine sovereign bonds suffered in 2001-2005, much smaller than the haircuts that holders or Russian and Ecuadorean debt suffered after those sovereign defaults, and much smaller than the 30% haircut that holders of corporate bonds suffer on average when a corporation goes into Chapter 11 and its debt is restructured. So why should Uncle Sam – i.e. eventually the U.S. taxpayer – pay that $250 billion bill when investors in the U.S. and around the world can afford it? The same investors are getting a fat subsidy of $50 billion a year (whose NPV is much bigger than $250 billion) for holding claims that now provide a 100bps spread above Treasuries and are under the implicit guarantee of a full bailout.

For those who study our financial system, the past few weeks have been interesting, and concerning. I don’t know if it’s possible to overstate my concern for our future — both as citizens as the United States of America, and as inhabitants of a world that is increasingly interconnected yet dependent on a fundamentally flawed financial and monetary system.

If asked to pick one word to describe why I’m running for Congress, that word is sustainability. Sustainability doesn’t mean stability, it doesn’t mean safety, and it doesn’t mean protection from life’s inevitable uncertainties. Sustainability does mean recognizing and obeying the natural laws that govern of our world.

Every branch of science has certain laws: Objects in motion tend to stay in motion; force equals mass times acceleration; every action has an equal and opposite reaction; energy in a closed system cannot be created or destroyed but merely changed in form; and closed systems tend towards increased entropy are a few good examples.

These laws of motion and conservation of energy are not limited to high school physics class. Every system in nature must obey these underlying principles — including our financial and monetary systems.

Let’s start with Newton’s laws of motion — it’s a short hop from there to defining leverage as the ability to move a large object a short distance using a small force exerted over a long distance. Leverage is a concept in finance, as well — using borrowed money to increase returns based upon small underlying price movements. Just as the car lifted with a hydraulic jack can hurt you if it falls, a small price movement in an imprudently leveraged investment can wipe out a lifetime of savings.

Next consider conservation of energy and open versus closed systems. Since energy within a closed system cannot be created or destroyed, and since closed systems tend towards increasing entropy, every growing system must be open to an external energy source. In this setting, one can immediately see problems with our debt-based monetary system.

What is debt-based monetary system? It’s where money is debt, and every dollar in circulation exists because a bank created it out of nothing based upon someone’s promise to pay it back, with interest.

Our economy is an open system relative to money, which is created and destroyed by banks. Banks create the money through loans — but they only create the amount you borrow. They don’t create the interest that you also promise to repay. Where do you get the interest? You have to earn it, but first it has to be created — yes, by someone else borrowing more money that they promise to repay with still more interest.

In the end, our monetary system is like a game of musical chairs — the banks create money based upon someone’s willingness to borrow, and the bank’s ability to lend. The constant demand for new money to repay interest on existing money compels growth and new money creation at an accelerating rate.

Refer to the chart of America’s total debt, which raises obvious questions about sustainability. Trees do not grow to the sky — and when banks cannot lend, or people are no longer willing to borrow, the music stops. When the music stops, there are more loans outstanding than money to repay, so everyone left standing loses whatever they pledged in exchange for their loans. Even worse, money that was created out of nothing through borrowing just as easily disappears back into nothing as asset values plummet — so when the music stops, the chairs start disappearing from the room.

Leverage, debt-based money, fractional reserve banking, and interest are fundamental features of our economic system. Our economic history of boom/bust cycles and decisions dominated by short-term gain as opposed to long-term stewardship are fundamental consequences of this underlying system. In short, our system has undesirable consequences and is fundamentally unstable — but it’s working as designed.

What we are experiencing today is a perfect storm of rising demand for natural resources in the setting of  global growth, a declining domestic currency due to decades of unsustainable debt (= money) creation and spending, coupled with an unfolding credit crisis that has crippled the debt (= money) creation system. What happens next?

I don’t know. Economists and analysts are searching for an analogy to our current position. Are we in the 1970s? Are we Japan in the 1990s? Are we entering the 1930s? Each situation is unique, and this one is no exception. There is evidence that we have experienced “peak credit“, and are popping a credit bubble that has been forming for over 20 years. That is reminiscent of Japan in the 1990s, or the 1930s. We’re also suffering from high energy prices, like the 1970s, although in this case we’re facing global tight supplies in the setting of rising demand.

Today’s news capped off several weeks of concerning developments. Illustrating the danger of leverage, our largest mortgage companies, Freddie Mac and Fannie Mae, are fighting rumors of insolvency:

The companies, Fannie Mae and Freddie Mac, have been hit hard by the mortgage foreclosure crisis. Their shares are plummeting and their borrowing costs are rising as investors worry that the companies will suffer losses far larger than the $11 billion they have already lost in recent months. Now, as housing prices decline further and foreclosures grow, the markets are worried that Fannie and Freddie themselves may default on their debt.

Under a conservatorship, the shares of Fannie and Freddie would be worth little or nothing, and any losses on mortgages they own or guarantee — which could be staggering — would be paid by taxpayers.

The government officials said that the administration had also considered calling for legislation that would offer an explicit government guarantee on the $5 trillion of debt owned or guaranteed by the companies. But that is a far less attractive option, they said, because it would effectively double the size of the public debt.

These companies funded 80% of the mortgages issued in the first half of 2008, and are thus almost fully responsible for supporting the housing market at its current levels. Ready to talk about leverage? In May, Fannie and Freddie had $83 billion in capital supporting over $5 trillion in debt and other obligations. That’s leverage — every dollar in debt is supported by less than two cents.

Here are some excellent commentaries on the dangers of these quasi-federal companies (read: we’re all going to take the hit) that inflate housing prices and define moral hazard:

Former St. Louis Fed President Poole Calls Freddie, Fannie “Insolvent”

Disaster Planning for Freddie and Fannie

Freddie and Fannie: Conservatorship as Endgame?

Fannie and Freddie Waterfalls Are Too Big to Bail

Fannie and Freddie are just the most recent problem to flare up, however. A contraction in the mortgage market was only the beginning — losses are spilling over throughout the economy. As Nouriel Roubini notes, total loss estimates from the credit crisis across all sectors of the economy are up to $1.6 trillion:

As I argued in writings last February such credit losses would be at least $1 trillion and could be as high as $2 trillion, well above the $300 billion of subprime writedowns that have been recognized so far. At that time the $1 trillion estimate was considered as lunatic but by now the IMF estimates these losses at $945 billion, George Magnus of UBS estimated them at $1 trillion; Goldman Sachs put them at $1.1 trillion, the legendary hedge fund manager John Paulson (who made last year $3.5 billion of income on shorting subprime) put them at $1.3 trillion; and a couple of days ago Bridgewater Associates estimated such losses at $1.6 trillion. Thus, as I argued then $1 trillion would be floor, not a ceiling, to such credit losses.

Of course such losses have been in part transferred from US banks to capital market investors and to foreign investors via securitization. But with the entire capital of the US financial system at $1.3 trillion such staggering losses will lead to a systemic banking crisis and systemic financial crisis. No wonder that Bernanke is now telling non-bank primary brokers that the Fed exceptional liquidity support (TAF, TSLF and especially PDCF) will be extended into 2009. And no wonder that Geithner, Paulson and Bernanke have now all three spoken of the need to find orderly ways to let even large and systemically important institutions go bankrupt if they are insolvent.

The consequences of this credit unwinding and a hard landing in the United States have damaging global consequences, as well. This article, again by Nouriel Roubini, outlines why the current international monetary regime known as Bretton Woods 2 could collapse in the wake of an expanding global credit crisis, and our current trade imbalances:

Will the Bretton Wood 2 Regime of fixed and/or heavily managed exchange rates in many emerging market economies collapse in the same way as the Bretton Woods 1 regime (the “dollar standard” regime that ruled after 1945 in the global economy) collapsed in the early 1970s? What are the similarities and differences between those two regimes? It is interesting to note that the same factors – U.S twin deficit, U.S. loose monetary policies and fixed pegs to the U.S. in the dollar standard regime of Bretton Woods (1945-1971) - that led to the commodity inflation and goods inflation in the early 1970s and thus to the demise of the Bretton Woods 1 regime (in the 1971-73 period) are also partially the same factors that are leading now to the rise in commodity and goods inflation in emerging markets that are pegging to the U.S. dollar and/or heavily managing their exchange rates.

Thus, like the rise of commodity and goods inflation led to the demise of BW1 the current rise in commodity and goods inflation in emerging market economies may be the trigger that will lead – as argued in my 2005 BW2 paper with Brad Setser and a more recent 2007 paper of mine – to the demise of BW2. It is true that BW2 is still alive as the massive ongoing reserve accumulation by BRICs, GCC and other emerging markets suggests. But the rise in inflation that these exchange rate policies are causing may soon lead to its demise: abandoning pegs and/or letting currencies appreciate at a faster rate will be the necessary step to control inflation in such emerging market economies.

Every country is between a rock and a hard place:

By now inflation has become so high in so many emerging market economies that – in some dimensions – it is almost too allow these currencies to appreciate: inflation is so high that only an abandonment of pegs or of heavily managed rates and a very sharp nominal exchange rate appreciation would be able to control inflation Even in that case nominal appreciation would not be enough to control expected inflation: a much tighter monetary and credit policy – that is feasible only if enough exchange rate flexibility is allowed – would be necessary to control actual and expected inflation. But now the global economic outlook has much worsened with the US recession and the sharp economic slowdown in most advanced economies. The need to control inflation with a stronger currency and much tighter monetary policy in emerging markets is happening at a time when downside risks to growth are emerging in these countries because of the US recession and the slowdown in the advanced economies growth rate. Thus, emerging market policy makers face a serious dilemma: controlling inflation requires exchange rate flexibility and much tighter monetary and credit policy. But such policy may exacerbate the growth landing of these economies at the time when global conditions are leading to a sharp slowdown of growth in advanced economies that – in due time – will slow down exports and growth of the emerging market economies.

Thus, it is not obvious that the members of BW2 will decide to phase out this regime and move to greater currency flexibility and tighter monetary and credit conditions. Rising oil, energy and food inflation in these economies is already leading to popular unrest, riots and – in some cases – ruling governments being toppled. Thus, the last thing that these economies need is a sharp growth slowdown on top of socially unpopular rising inflation. That is why – while the rational choice would be phasing out BW2, allow greater exchange rate flexibility, regain monetary autonomy, allow currencies to appreciate and tighten monetary/credit conditions – many of these BW2 may be reluctant to follow this painful policy path.

But again, these problems, consequences, and suboptimal “solutions” are simply the result of a suboptimal and unstable system working as designed.

Finally, we must consider these financial instabilities in a world where the fundamental life-giving resources such as food and energy are becoming increasingly precious:

Every Barrel Now Counts: What Prospects for More Oil Supplies?

IEA Medium-Term Outlook

While we complain about high food prices, other countries — some to whom we owe a great deal of money — are seeing riots and social unrest. The bottom line is that food and energy prices are not separate from this economic crisis. They are intimately related, for two reasons.

First, food and energy are fundamentally equivalent even beyond irrational corn ethanol subsidies. By some estimates, our unsustainable system of industrial agriculture requires 10 calories of fossil fuels for each one food calorie produced. What happens as fossil fuels become more expensive based upon growing global demand against finite supplies?

Second, many countries with food and fuel inflation high enough to spark riots and social unrest, and to whom we owe a lot of money, are keeping their currency artificially low against our dollar to stimulate exports. What happens if the pain of social unrest in China is great enough for them to abruptly let their currency float?

A rapid strengthening of China’s currency would reduce the value of their $1.4 trillion in dollar holdings. On the other hand, such a rapid appreciation would give them an instant discount on their dollar-denominated commodities such as fuel and fertilizer, and is the ultimate solution to their price inflation.  What would be the consequence for us, however, as high prices causing riots and social instability abroad transfer to our shores?

Mutually assured destruction did not end with the Cold War — our position in the global economy can also be described as mutually assured economic destruction.

We need principled leadership that recognizes the root causes behind the threats we face, and we need a government that empowers us to build a sustainable society. Such sustainability has not, and cannot, come from a federal government that consolidates power, exceeds its Constitutional authority, and serves corporate and special interests.

Critically, we must recognize that our economic, energy, environmental, and agricultural policies do not operate in isolation — they are all related, and they all exist on the foundation of an unstable monetary system that bring us to this precarious situation. We live in interesting times.

I have just read a policy brief submitted by the Congressional Budget Office (CBO) to Rep. Paul Ryan, the Ranking Member of the House Budget Committee. The brief, written by CBO Director Peter Orszag and prepared by his staff, discusses projects of our current fiscal path, its impact on our economy if left unresolved, the impact of slowing the growth of the deficit, and the impact of financing the deficit completely with tax increases. Here are some significant points in this very sobering brief.

On the rise of the amount of spending and the federal debt (not the total national debt) as a percentage of GDP:

In December 2007, the Congressional Budget Office (CBO) published The Long- Term Budget Outlook, which presented a long-term projection of the budget under an alternative fiscal scenario,” representing one interpretation of what continuing today’s underlying fiscal policy would mean. CBO projected that, under that scenario, spending on Medicare, Medicaid, and Social Security would rise rapidly, and federal outlays excluding interest (primary spending) would climb from about 18 percent of GDP in 2007 to 28 percent in 2050 and to 35 percent in 2082 (see Table 1).2 Because the scenario also assumes that revenues as a share of GDP would not increase much over the 75-year period, CBO projected that the federal budget deficit and federal debt held by the public would rise sharply. By CBO’s reckoning, federal debt under that scenario would climb from about 37 percent of GDP in fiscal year 2007 to more than 290 percent in 2050—a large figure by any standard (see Figure 1). Since the founding of the United States, federal debt surpassed 100 percent of GDP only for a brief period during and just after World War II (see Figure 2 on page 4).

On the economic impact of staying this course:

According to CBO’s simulations using that model, the rising federal budget deficits under this scenario would cause real gross national product (GNP) per person to stop growing and then to begin to contract in the late 2040s (see Figure 3).4 By 2060, real GNP per person would be about 17 percent below its peak in the late 2040s and would be declining at a rapid pace. Beyond 2060, projected deficits would become so large and unsustainable that the model cannot calculate their effects.

Despite the substantial economic costs generated by deficits under this model, such estimates greatly understate the potential loss to economic growth under this scenario. In particular, they are based on a model in which people do not anticipate future changes in debt; as a result, the model predicts a gradual change in the economy as federal debt rises. In reality, the economic effects of rapidly growing debt would probably be much more disorderly and could occur well before the time frame indicated in the scenario. If foreign investors began to expect a crisis, they might significantly reduce their purchases of U.S. securities, causing the exchange value of the dollar to plunge, interest rates to climb, consumer prices to shoot up, and the economy to contract sharply. Amid the anticipation of declining profits and rising inflation and interest rates, stock prices might fall and consumers might sharply reduce their purchases. In such circumstances, the economic problems in this country would probably spill over to the rest of the world and seriously weaken the economies of the United States’ trading partners.

On slowing the growth of the deficit:

Under the target path, federal outlays excluding interest (that is, primary spending) would rise from 18 percent of GDP in 2007 to 20 percent in 2030 and then decline to 19 percent in 2050 and 13 percent in 2082. For almost all years, revenues would remain at 18.5 percent of GDP. Under those assumptions, the budget deficit would gradually increase to about 6 percent of GDP in 2040 but then would decline to almost zero in 2075. By 2082, the target path would generate a budget surplus of about 2 percent of GDP. The primary budget (that is, the budget excluding interest on the public debt) would reach balance around 2050. With possible economic feedbacks not included, federal debt held by the public would increase to a peak of 120 percent of GDP around 2060 and then would decline to 64 percent in 2082. Thus, compared with the alternative fiscal scenario, the target path would substantially reduce future budget deficits and federal debt.

The target path provided by the Committee staff would be economically sustainable. Under that target, real GNP per person (in 2007 dollars) would continue to grow over the entire projection period, rising from about $45,000 in 2007 to about $165,000 in 2082 (see Figure 4). The economy would be considerably stronger under the target path than it would be under the alternative fiscal scenario. By 2060 (the last year for which it is possible to simulate the effects of the alternative fiscal policy using the textbook growth model), real GNP per person under the target path would be about 85 percent higher than that under the alternative fiscal scenario.

On the impact of raising taxes to finance all projected spending:

… tax rates would have to be raised by substantial amounts to finance the level of spending projected for 2082 under CBO’s alternative fiscal scenario. With no economic feedbacks taken into account and under an assumption that raising marginal tax rates was the only mechanism used to balance the budget, tax rates would have to more than double. The tax rate for the lowest tax bracket would have to be increased from 10 percent to 25 percent; the tax rate on incomes in the current 25 percent bracket would have to be increased to 63 percent; and the tax rate of the highest bracket would have to be raised from 35 percent to 88 percent. The top corporate income tax rate would also increase from 35 percent to 88 percent. Such tax rates would significantly reduce economic activity and would create serious problems with tax avoidance and tax evasion. Revenues would probably fall significantly short of the amount needed to finance the growth of spending; therefore, tax rates at such levels would probably not be economically feasible.

If federal outlays excluding interest did not rise to their 2082 share of GDP (35 percent), but instead were stabilized at the share of GDP projected for 2050 (28 percent), simulations can provide some guidance about the possible economic effects of financing additional spending with a proportional across-the-board increase in all personal and corporate tax rates.6 (The increase would apply to the regular rate schedule, the rates under the alternative minimum tax, and the preferential tax rates on dividends and capital gains.) To carry out the analysis, CBO used two different models of economic behavior—the textbook growth model and what is termed a stochastic overlapping generations model—to reflect the range of opinion among economists about how people respond to taxes. Both models take into account the dynamic effects of
higher tax rates on the economy and how those changes in the economy would in turn affect revenues. However, both models are simplified representations of the economy and therefore provide only a rough guide to the potential effects of the tax scenarios on the economy.

In the textbook growth model, economic output depends on the number of hours of work supplied by workers, the size of the capital stock, and total factor productivity (in simple terms, the state of technological know-how). The labor supply response is projected by CBO’s tax microsimulation model, which, for a sample of taxpayers, provides a detailed representation of individual income taxes. The textbook growth model assumes that households do not explicitly consider expected future policies when they make plans—that is, the model incorporates no forward-looking behavior. Moreover, the model does not account for the way that changes in marginal tax rates on capital income might influence investment, though it does account for the effects of budget deficits on investment.

In the stochastic overlapping generations model, households are forward-looking and their members decide how much to work and save in order to make themselves as well off as possible over their lifetime.9 They face uncertainty about future wages and the length of their life and may be subject to borrowing constraints.

Before accounting for economic feedbacks through the models, CBO estimates that individual income tax rates would have to be raised by about 90 percent to finance the projected increase in spending between 2007 and 2050. The lowest tax rate on individual income would have to be increased from 10 percent to 19 percent; the tax rate on incomes in the current 25 percent bracket would have to be increased to 47 percent; and the highest statutory rate would have to be raised from 35 percent to 66 percent. The top corporate income tax rate would also have to increase from 35 percent to 66 percent. Those estimates of tax rate changes are meant to be illustrative; official estimates of tax rate and revenue changes for any specific proposal would be prepared by the Joint Committee on Taxation.

Under this scenario, real GNP per person in 2050 could be between 5 percent and 20 percent less than what it would be if revenues and spending in 2050 were the same shares of GDP as in 2007. Those economic effects could be substantially reduced if the tax policies used to finance the additional spending did not distort economic behavior as much as increases in income tax rates would. In particular, tax policies that relied less on proportional increases in marginal income tax rates could have substantially smaller effects on the economy. For example, raising revenues by broadening the income tax base and eliminating various tax preferences (such as the deductions for mortgage interest, state and local taxes, and health insurance) would have a smaller effect on real GNP than would a proportional increase in tax rates.

This is a very sobering account of our nation’s financial status prepared by one of the most well-respected public finance economists around in Orszag, who could hardly be considered a free market libertarian/conservative alarmist given his previous history with the Brookings Institute, a left-leaning think tank. While Dr. Orszag implores that we must slow the growth of deficits, which is surely true, he also states that the damage due to deficits is likely underestimated because the model used does not account for forward-looking and panicky behavior of agents that is unquantifiable and would likely lead to more disastrous consequences. As Orszag’s report demonstrates, we cannot simply tax our way out of this problem, as the tax increases necessary to fund these increases in spending will certainly cause disastrous economic effects and likely wouldn’t even generate enough revenue to fund th spending, given the negative revenue impacts of the economic crash that apparently are not dealt with by the model.

For an additional sobering account of our nation’s long-term finances, I invite all of you to view these two videos by David Walker, the just recently retired Comptroller of the Currency.

As an economics and math major at UNC, and someone with an interest in, well, working and making money in the future, these assessments by respected financial analysts scare me. The bottom line is that if we want to ensure that this absolutely crushing financial burden of our government does not come to pass, we must do the work now to cut spending, eliminate the deficits quickly, and greatly restrain the long-term growth of entitlement programs. We cannot tax our way out, and we cannot grow our way out.

To do this work, we need to have a responsible Representative of the 4th District in Washington who demonstrates a thorough concern for and understanding of this problem and who will is willing to exercise courage in telling the truth about an issue when it may not be politically expedient to do so. Voting for a Concurrent Budget Resolution that plans to add $2 trillion in debt over the next five fiscal years, and then calls the Resolution “fiscally responsible,” does not demonstrate the type of responsible representation that is needed to tackle this problem. Clearly, based on this alone, David Price cannot be trusted in representing our district to address this issue.

It is time for a true Revolution. It is time for a change in Washington and in the seat held by the people of the 4th District of North Carolina. To address this issue, we need a Representative who has the experience of starting, owning, and operating a business from scratch and growing it into a financial success that allowed he and his family to emerge out of their own hefty burden of debt. We need a doctor who has made a career in the medical sector who understands why costs in health care, a major contributor to the projected financial burden of the federal government, are increasing so sharply and how we can abate them. If we as a district want to tackle this grand challenge head on and preserve a bright economic future for our country and for future generations, we must elect Dr. William “B.J.” Lawson to be the next Representative of the 4th U.S. House District of North Carolina.

For more insight into our nation’s fiscal troubles, I would like to recommend two books to all of you. The first is Running on Empty by Pete Peterson, a former U.S. Secretary of Commerce and co-founder of the Concord Coalition, an organization advocating fiscal responsibility and spending restraint in Washington. This is the book I read that really opened my eyes to how bad our fiscal situation, explaining well we got into the mess, the consequences of maintaining the course, and why both Democrats and Republicans are to blame.

The second book is The Coming Generational Storm by Lawrence Kotlikoff, a very well-renowned and respected public finance economist at Boston University. This book is newer and a bit more updated, and the tone is more academic, but it is equally as sobering and powerful.

Yesterday afternoon I had a great discussion with Jim Babka, host of the weekly DownsizeDC Conference Call. Jim and DownsizeDC are on the forefront of the fight for good government, and I became an enthusiastic supporter after studying three of their common sense trans-partisan good government solutions (is that too many adjectives?):

• The Read the Bills Act
• The Write the Laws Act
• The One Subject at a Time Act

Here’s a quick snippet from a caller’s question on one of my favorite topics: the “royalty” we elect into government:

Click here to listen.

Here’s our full conversation (about 30 minutes):

Click here to listen.

It’s time for a little exercise. I’m going to cite a recent article from a couple of months ago, and I’m going to have you all guess the name of the author. Let’s see just how good you guys are. Ready? Go!

Nearly 16 years ago in these very pages, I wrote that “‘one-size-fits all’ rules for business ignore the reality of the market place.” Today I’m watching some broad rules evolve on individual decisions that are even worse.

Under the guise of protecting us from ourselves, the right and the left are becoming ever more aggressive in regulating behavior. Much paternalist scrutiny has recently centered on personal economics, including calls to regulate subprime mortgages.

With liberalized credit rules, many people with limited income could access a mortgage and choose, for the first time, if they wanted to own a home. And most of those who chose to do so are hanging on to their mortgages. According to the national delinquency survey released yesterday, the vast majority of subprime, adjustable-rate mortgages are in good condition, their holders neither delinquent nor in default.

There’s no question, however, that delinquency and default rates are far too high. But some of this is due to bad investment decisions by real-estate speculators. These losses are not unlike the risks taken every day in the stock market.

The real question for policy makers is how to protect those worthy borrowers who are struggling, without throwing out a system that works fine for the majority of its users (all of whom have freely chosen to use it). If the tub is more baby than bathwater, we should think twice about dumping everything out.

Health-care paternalism creates another problem that’s rarely mentioned: Many people can’t afford the gold-plated health plans that are the only options available in their states.

Buying health insurance on the Internet and across state lines, where less expensive plans may be available, is prohibited by many state insurance commissions. Despite being able to buy car or home insurance with a mouse click, some state governments require their approved plans for purchase or none at all. It’s as if states dictated that you had to buy a Mercedes or no car at all.

Economic paternalism takes its newest form with the campaign against short-term small loans, commonly known as “payday lending.”

With payday lending, people in need of immediate money can borrow against their future paychecks, allowing emergency purchases or bill payments they could not otherwise make. The service comes at the cost of a significant fee — usually $15 for every $100 borrowed for two weeks. But the cost seems reasonable when all your other options, such as bounced checks or skipped credit-card payments, are obviously more expensive and play havoc with your credit rating.

Anguished at the fact that payday lending isn’t perfect, some people would outlaw the service entirely, or cap fees at such low levels that no lender will provide the service. Anyone who’s familiar with the law of unintended consequences should be able to guess what happens next.

Researchers from the Federal Reserve Bank of New York went one step further and laid the data out: Payday lending bans simply push low-income borrowers into less pleasant options, including increased rates of bankruptcy. Net result: After a lending ban, the consumer has the same amount of debt but fewer ways to manage it.

Since leaving office I’ve written about public policy from a new perspective: outside looking in. I’ve come to realize that protecting freedom of choice in our everyday lives is essential to maintaining a healthy civil society.

Why do we think we are helping adult consumers by taking away their options? We don’t take away cars because we don’t like some people speeding. We allow state lotteries despite knowing some people are betting their grocery money. Everyone is exposed to economic risks of some kind. But we don’t operate mindlessly in trying to smooth out every theoretical wrinkle in life.

The nature of freedom of choice is that some people will misuse their responsibility and hurt themselves in the process. We should do our best to educate them, but without diminishing choice for everyone else.

So, who wrote this article? I’ll give you guys three guesses.

John Stossel, perhaps the most visible libertarian media personality in America? Wrong.

How about Ron Paul? Good thought, but not this time.

How about (insert third guess)? (Most likely) Wrong.

This article, titled “Freedom Means Responsibility” and appearing in the Wall Street Journal on March 7, was written by none other than George McGovern, former Democratic Senator from South Dakota and 1972 Democratic Presidential Nominee. Obviously, this does not quite sound like the same guy who, in his ‘72 acceptance speech, called for Nationalized Health Insurance, enforcing laws against drugs, and guaranteed income for everyone. It certainly appears as though Senator McGovern has had a change of mind on many issues, if not a sea change in philosophy. This is quite welcome from my vantage point, and I of course completely agree with everything that he states in his article.

Senator McGovern’s column, more broadly speaking, demonstrates that the concept of individual liberty isn’t just a libertarian idea, as I’m sure that Senator McGovern would not define himself as a libertarian (he did support Hillary Clinton for President, after all). Freedom is a desire that we all have as individuals and, as such, is the concept that unites us all across the boundaries of political affiliation, religion, race, and sexual orientation. It’s the principle that united