It's our money, damnit

The EU's Big Kazoo

As Europe insists on still more socialism as a solution to its ill, the U.S. Fed is doing its best to help out -- in deep secrecy, of course.

By Jed Babbin

Europe has no time for clichés, so Europe's currency crisis has skipped two cycles. Instead of allowing one cycle of history to complete itself before it is repeated -- first as tragedy and then as farce -- the Eurozone nations have decided to pass by the end of the current course, skip tragedy, and go directly to farce.

France's President is pressing hard on the trigger to fire the EU's "big bazooka" but he can't fire because Germany's PM has her finger stuck behind the trigger and isn't budging. Meanwhile, Mr. Radoslaw Sikorski, Poland's Foreign Minister, last week demanded German intervention to save Poland (and the euro). Sikorski said, "I demand of Germany that, for its sake and ours, it help the Eurozone survive and prosper. Nobody else can do it. I will probably be the first Polish foreign minister in history to save this, but here it is: I fear German power less than I am beginning to fear its inactivity."

A week before Sikorski's plea, EU Commission chief Jose Manuel Barroso said that the only way to save the world was to give more power to -- wait for it -- the EU Commission. If there isn't an increase in the EU's power to regulate national economies, Barroso warned, Europe would "hand sovereignty to markets."

Jacques Delors, one of the euro's creators, echoed Barroso's remarks saying that the euro wasn't created on a sound basis. The sound basis, according to Delors, would be centralized economic power in the EU.

There's not a lot to be learned from all this, given the fact that there's nothing but Keynesian economics going on here. But Barroso and Delors do prove redundantly that for socialists, success and failure are one and the same. They have to be because socialism never works. So when it fails, the reason can't be that socialism is a bad idea: it has to be that socialism wasn't tried hard enough.

The second lesson -- dispensed hilariously by Barroso -- is that markets are always sovereign. Dear Jose: read a little history in your spare time (which should be abundant when the euro collapses). Start with the fall of the Roman Empire (resulting in part from the devaluation of its currency), continue through the 1929 stock market crash and proceed to the 2008 banking crisis in which George Bush said we had to break the rules of the free market to save the free market. In those events we -- at least those of us who aren't Keynesians -- learned that financial markets will always respond to government policy. But the response will be on the markets' terms, not on whatever terms the government elites tried to impose.

For Sarko, the problem is that the EU's "big bazooka" can't go "boom." In reality, the "big bazooka" -- the idea that the European Central Bank will just print enough money to bail everyone out -- looks and sounds more like a marching band-sized kazoo. The European Central Bank's creators didn't give it the power to be the European lender of last resort. Merkel has said "nein" to that, because she knows the inflationary impact would disproportionately rob Germany and the euro would quickly become valueless.

On her side, Merkel wants to rewrite the EU treaty to provide unification of power over national budgets and spending, and a means of enforcement through the EU courts. It's a technocratic approach, a ten thousand-page repair manual written in German which, even if Greece and Italy promised solemnly to follow it, they couldn't because their citizens aren't, well, Germans.

What will happen this week is what has happened at every "last chance" summit before it: a lot of window dressing will be peddled without any solutions to the fundamental problems that beset the euro. There will be promises of future action and an attempt to again seduce the markets to not impose the proper penalties that capitalism, in a free market, demands.

This time, however, the markets won't buy it. And they won't buy the Eurozone nations' national bonds because the risks are just too high. Even German bonds proved unsellable in their latest round of offerings. The crisis will build, and will probably blow up in another three months or so when Italy, Spain, and Greece have to sell another major round of bonds.

If that were all we had to worry about, life would be easy. But we do have our Federal Reserve, and at its head Mr. Ben Bernanke. The Fed, under Bernanke and his predecessor -- Henry Paulson -- have had a penchant for lending out our money in trillions of dollars and keeping the loans secret.

A week ago, we learned that the Fed -- in concert with the Eurozone nations' banks and those of Japan, Canada, the UK, and Switzerland -- reduced the cost of borrowing dollars to Eurozone banks. This was, we were assured, just another "credit easing" maneuver. But "credit easing" means providing something to someone at below-market rates. It's a subsidy and someone has to bear the cost. In this case, the biggest "someone" was, apparently, the United States.

Right now, we don't know what the cost was, or how much it may grow if it's not repaid. And, even more dangerously, we don't know what else the Fed is doing.

A November 27 Bloomberg News report told us that the Fed -- acting without congressional knowledge -- gave endangered banks loans and guarantees that may have amounted to over $7.7 trillion in the last four years. In comparison, the now-infamous TARP program dispensed "only" about $700 billion.

Think about those numbers. In 2008, the United States gross domestic product -- all the wealth created and earned in the year by the entire nation -- was about $14.6 trillion. So without our knowledge, acting on its own, the Fed gave guarantees and loans in an amount of 53 percent of our GDP.

So now the Fed is in the process of "easing" European access to the dollar. Which means it is subsidizing the EUnuchs to keep doing what they do. Not even their own markets -- or their putative partner, Germany -- is willing to do that.

What's to prevent the Fed from throwing a TARP over Europe? At this point, not much.

Let's not dash out into the fever swamps of Ron Paulism. We need the Fed to be independent, and not subjected to the whims of the White House or Congress. But it needs to be trustworthy. When it gives loans and guarantees equaling 53 percent of our GDP to certain banks without disclosing them, it cannot be trusted. If it is designing a bailout for the Eurozone on our credit, it cannot be trusted.

Let's not seize the Fed or turn it into another vassal of the president or of Congress. But it needs to be entirely open and above board about what it is doing. Let's shine a bright spotlight into the Fed's darkest corners. We need to know what's going on. It's our money, damnit.

Find dark glasses that go black in the case of a crisis and a towel to suck on.

The Sovereign Debt Plane Wreck

Excerpt from the book 

“The Sovereign Debt Train Wreck – US Debt Is Still A Problem” 

by Satyajit Das

~~~

Greece and the other debt burdened European countries are merely the first carriages in the derailment of the “Sovereign Debt” Express train service.

The failure of the congressional super-committee to reach agreement on $1.2 trillion in budget cuts means that addressing the problem of US public finances is unlikely in the near term. The failure also casts doubts on the ability of US policy makers to overcome political differences to take actions to stabilise US government debt with potential consequences for the US and global economy

At Debt’s Door…

Ralph Waldo Emerson wrote: “The World owes more than the world can pay.” The US certainly owes more than it can repay. US government debt currently totals over $14 trillion.

The US Treasury estimates that this debt will rise to around $20 trillion by 2015, over 100% of America’s Gross Domestic Product (“GDP”). Even these dire forecasts rely on extremely robust assumption about US growth around 5-5.5% per annum. Lower growth will translate into higher debt levels.

There are other current and contingent commitments not explicitly included in the debt figures reported by the government. Since July 2008, the US government has supported Freddie Mac and Fannie Mae (known as government sponsored enterprises (GSEs)). This totals over $5 trillion in additional on or off-balance sheet obligations.

The debt statistics do not include a number of unfunded obligations – the current value of mandatory payments for programs such as Medicare ($23 trillion), Medicaid ($35 trillion) and Social Security ($8 trillion). Projections show that payouts for these programs will significantly exceed tax revenues over the next 75 years and require funding from other tax sources or borrowing.

In addition to Federal debt, US State governments and municipalities have debt of around $3 trillion.

US public finances deteriorated significantly over recent years. Pimco’s Bill Gross observed: “What a good country or a good squirrel should be doing is stashing away nuts for the winter. The United States is not only not saving nuts, it’s eating the ones left over from the last winter.”

In 2001, the Congressional Budget Office (“CBO”) forecast average annual surpluses of approximately $850 billion from 2009–2012. Instead, the US government has run large budget deficits of approximately $1 trillion per annum in recent years. The major drivers of this turnaround include: tax revenue declines due to recessions (28%); tax cuts (21%); increased defence spending (15%); non-defence spending (12%) higher interest costs (11%); and the 2009 stimulus package (6%). German finance minister Wolfgang Schäuble told the Wall Street Journal on 8 November 2010 that: “The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base.”

Drowning by Debt…

No borrower can incur debt on this scale without the complicity of its lenders.

The US government holds around 40% of the debt through the Federal Reserve ($1.6 trillion), Social Security Trust Fund ($2.7 trillion) and other government trust funds ($1.9 trillion). Individuals, corporations, banks, insurance companies, pension funds, mutual funds, state or local governments, hold $3.6 trillion. Foreigner investors hold the remainder including China ($1.2 trillion), Japan ($0.9 trillion) and “other”, principally oil exporting nations, Asian central banks or sovereign wealth funds ($2.4 trillion).

Until the global financial crisis, foreign lenders, especially central banks with large foreign exchange reserves, led by the Chinese, increased their purchases of US government debt..

These reserves arose from dollars received from exports and foreign investment that had to be exchanged into local currency. In order to avoid increases in the value of the currency that would affect the competitive position of their exporters, the exporting nations invested the reserves in dollar denominated investment, primarily US Treasury bonds and other high quality securities. By the middle 2000s, foreign buyers were purchasing around 50% of US government bonds.

During this period, emerging countries, such as China fuelled American growth, both supplying cheap goods and providing cheap funding to finance the purchase of these goods. It was a mutually convenient addiction – China financed customers creating demand for exports and America received the money to buy cheap Chinese goods. Asked whether America hanged itself with an Asian rope, a Chinese official told a reporter: “No. It drowned itself in Asian liquidity.”

Following the global financial crisis, foreign purchases have decreased to around 30% of new issuance. Around 70% of US government bonds (US$ 0.9 trillion) have been purchased by the Federal Reserve, as part of successive rounds of quantitative easing.

Foreign Alms…

Historically, America has been able to run large budget and balance of payments deficits because it had no problems in finding investors in US treasury securities. The unquestioned credit quality of the US, the unparalleled size and liquidity of its government bond market ensured investor support. Given its reserve currency and safe haven status, US dollars and US government bonds remained a cornerstone of investment portfolios.

The US dollar’s share of world trade and investment is extraordinary and out of proportion to its economic role. The dollar remains the principal currency for invoicing and settling trade. 85% of foreign exchange transactions involve the dollar. 50% of stock of international securities is denominated in US dollars. Central banks hold 60% of their foreign exchange reserves in dollars. All this is despite the fact that the US’s share of global exports is only 13% and foreign direct investment is 20%.

The US financing strategy is based on the “balance of financial terror”.

China, the major investor in US government bond investors, finds itself in the position that John Maynard Keynes identified: “Owe your banker £1000 and you are at his mercy; owe him £1 million and the position is reversed.” Over recent years, Chinese concerns about the US debt position has become increasingly shrill.

In 2010, Yu Yongding, a former adviser to China’s central bank, mused: “I do not think U.S. Treasuries are safe in the medium-and long-run…Only God knows how much value that China has stored in the U.S. government securities will be left in the future when China needs to run down its reserves.” In 2011, a Chinese government spokesperson could only “hope the US government will earnestly adopt responsible policies to strengthen international market confidence, and to respect and protect the interests of investors.” In 2010, US Treasury Secretary told a gathering of Chinese students that US government bonds were “safe” investments, eliciting derisive laughter.

But China has America right where America wants China!

Existing investors, like China, must continue to purchase US dollars and government bonds to avoid a precipitous drop in the value of existing investments. This allows America time to correct its deteriorating public finances and reduce its borrowing requirements. It also allows increases in domestic savings to reduce reliance on foreign investors. The US Federal Reserve remains a buyer of last resort, although the long term consequences of this “printing money” strategy remains uncertain.

For the moment, this tenuous strategy appears to be holding. Demand for Treasury securities from investors and other governments has continued. Domestic investment, primarily from banks who are not lending but parking cash in government securities, has been strong. US government rates remain low. The government’s average interest rate on new borrowing is around 1%, with one-month Treasury bills paying less than 0.10% per annum. This has allowed the US to keep its interest bill manageable despite increases in debt levels.

In effect, the US requires artificially low interest rates to able to service its debt. Federal Reserve Chairman Ben Bernanke told the House Financial Services Committee that the US faces a debt crisis: “It’s not something that is 10 years away. It affects the markets currently…It is possible that the bond market will become worried about the sustainability [of deficits over $1 trillion] and we may find ourselves facing higher interest rates even today.”

The current position is not sustainable in the longer term. Unless the underlying debt levels and budget deficits are dealt with the ability of the US to finance itself will deteriorate. The US treasury must issue large amounts of debt almost continuously – weekly auctions regularly clock in at $50-70 billion unimaginable a few years ago. America’a ability to finances its need may not continue. As English writer Aldous Huxley observed: “Facts do not cease to exist because they are ignored.”

Debt Calm…

The solution to the US debt problems lies in bringing budget deficits down, through spending cuts, tax increases or a mixture of both.

In 2011, the major categories of government spending were defence (24%), social services (44%), non-defence discretionary (25%) and interest (7%). Interest costs, currently around 7% of total spending, are expected to increase by as much as three times driven mainly by the increase in the level of debt. The major increase in spending will come from social service entitlement programs. If current policies are maintained, pensions and health care for the retired (Social Security and Medicare) and health care for the poor (Medicaid) will increase from 10% of GDP in 2011 to 18% by 2050.

Winding back military overseas commitments and also reduced stimulus spending, assuming the economy and employment improve, will help reduce the deficit. But any significant reduction in government spending requires decreased spending on defence and entitlement programs as well as tax increases. US Federal revenue is around 15% of GDP (down from 18-19%). Comparative levels of government tax revenues are Germany (37%) UK (34%) and Japan (28%).

The task is Herculean. Government revenues would need to be increased 20-30% or spending cut by a similar amount. In a nation where 45% of households do not pay tax (because they don’t earn enough or through credits and deductions) and 3% of taxpayers contribute around 52% of total tax revenues, it is difficult to see the necessary changes being made.

Reducing the budget deficit and reducing debt may also mire the US economy in a prolonged recession. In 2009, students at National Defence University in Washington, DC, “war gamed” possible scenarios for bringing the US debt under control. Using a model of the economy, participants tried to get the federal debt down by increasing taxes and reducing spending. The economy promptly fell into a deep recession, increasing the budget deficit and driving government debt to higher levels. This is precisely the experience of heavily indebted peripheral European nations, such as Greece, Ireland, Portugal, Spain and Italy.

As one participant in the National Defence University economic war game observed about the process of bringing US public finances under control: “You’ll never get re-elected and you may do more harm than good.”

Extortionate Privilege…

Given the magnitude of the US debt problem and the lack of political will, the most likely policy is FMD – “fudging”, “monetisation” and “devaluation”.

There is no shortage of creative ideas of financing government debts. Bankers suggested the US issue perpetual debt, that is, the government would not be obligated to pay back the amount borrowed at all. Peter Orzag, former director of the US Office of Management and Budget under President Obama and now a vice-chairman at Citigroup, suggested another creative way to correct the problem – lotteries. To encourage savings, banks should offer lottery-linked accounts offering a lower rate of interest, but also a one-in-a-million chance of winning $1million for each $100 deposited.

As governments printed money to service their debts, US Post issued 44-cent first class “forever stamps” that had no face value but were guaranteed to cover the cost of mailing a first class letter, regardless of how high that cost might be in the future. Between 2007 and 2010 the public bought 28 billion forever stamps. The scheme summed up government approaches to public finance – US Post was cleverly hiding its financial problems, receiving cash up-front against the uncertain promise to pay back the money somewhere in the never, never future.

Debt monetisation – printing money – is the second option. The US Federal Reserve is already the in-house pawnbroker to the US government, purchasing government bonds in return for supplying reserves to the banking system. Expedient in the short term, its risks debasing the currency and setting off inflation. The absence of demand in the economy, industrial over capacity and the unwillingness of banks to lend have meant that successive rounds of “quantitative easing” – the fashionable moniker for printing money – have not resulted in higher inflation to date. But the longer term risks remain.

Monetisation is inexorably linked to devaluation of the US dollar. The now officially confirmed zero interest rates policy (“ZIRP”) and debt monetisation is designed to weaken the dollar.

On 19 October 2010, US Treasury Secretary Timothy Geithner told the Financial Times: “It is very important for people to understand that the United States of America and no country around the world can devalue its way to prosperity and Competitiveness. It is not a viable, feasible strategy and we will not engage in it.” The facts show otherwise.

Despite bouts of dollar buying on its safe haven status, the US dollar has significantly weakened over the last 2 years in a culmination of a long term trend which with minor retracements. In 2007 alone, the US dollar weakened by about 8% improving America’s external position by $450 billion, as US foreign investments gained in value but its debt denominated in dollars were unaffected.

On a trade weighted basis, the US dollar has lost around 18% against major currencies since 2009. The US dollar has lost around 30% against the Swiss Franc, 25% against the Canadian dollar, 37% against the Australian dollar and 16% against the Singapore dollar over the same period.

US dollar devaluation makes it easier for the US to service its debt. In the balance of financial terror, it forces existing investors to keep rolling over debt to avoid realising currency losses on their investments. It also encourages existing investors to increase investment, to “double down” to lower their average cost of US dollars and US government debt. The weaker US dollar also allows the US to enhance its competitive position for exports – in effect, the devaluation is a de facto cut in costs. This is designed to drive economic growth.

Valery Giscard d’Estaing, French Finance Minister under President Charles de Gaulle, famously used the term “exorbitant privilege” to describe the advantages to America of the role of the US dollar as a reserve currency and its central role in global trade. That privilege now is not only “exorbitant” but “extortionate”. How long the rest of world will allow the US to exercise this “extortionate privilege” is uncertain.

No Exit …

The US is in serious, perhaps irretrievable, financial trouble. Peter Schiff president of Euro Pacific Capital, identified the state of the Union with characteristic bluntness: “Our government doesn’t have enough spare cash to bail out a lemonade stand. Our standard of living must decline to reflect years of reckless consumption and the disintegration of our industrial base. Only by swallowing this tough medicine now will our sick economy ever recover.”

There is a lack of political or popular will to take the action necessary to even stabilise the position. The role of US dollars and US government bonds in the financial system mean that the problems are likely to spread rapidly to engulf other nations. As John Connally, US Treasury Secretary under President Nixon, beligerently observed: “Our dollar, but your problem.”

Minor symptoms, often increasing in frequency and severity, can provide warning of a life threatening problem in a key organ, such as the heart. Since 2007, the global financial markets have been providing warnings of an impending serious crisis. Private sector credit problems have spread to sovereign nations. Debt problems of smaller nations have flowed on to larger nations. The problems are gradually working their way to the issue of US debt. Without rapid and decisive action, which seems to be unlikely, a major organ failure within the global economy is now inevitable.

The magnitude of the problem and its effects are so large, market participants would do well to heed Douglas Adams famous advice in The Hitchhikers Guide to the Galaxy. Find dark glasses that go black in the case of a crisis and a towel to suck on.

~~~

Real Change and some Hope

Super Awesome New Ron Paul Ad

The essential feature of government is the enforcement of its decrees by beating, killing, and imprisoning.

Is There Room for Compromise with Socialism?

by Ludwig von Mises

Private ownership of the means of production (market economy or capitalism) and public ownership of the means of production (socialism or communism or "planning") can be neatly distinguished. Each of these two systems of society's economic organization is open to a precise and unambiguous description and definition. They can never be confounded with one another; they cannot be mixed or combined; no gradual transition leads from one of them to the other; their obversion is contradictory. With regard to the same factors of production, there can only exist private control or public control.

If in the frame of a system of social cooperation only some means of production are subject to public ownership while the rest are controlled by private individuals, this does not make for a mixed system combining socialism and private ownership. The system remains a market society, provided the socialized sector does not become entirely separated from the nonsocialized sector and lead a strictly autarkic existence. (In this latter case there are two systems independently coexisting side by side — a capitalist and a socialist.)

Publicly owned enterprises, operating within a system in which there are privately owned enterprises and a market, and socialized countries, exchanging goods and services with nonsocialist countries, are integrated into a system of market economy. They are subject to the law of the market and have the opportunity of resorting to economic calculation.

If one considers the idea of placing by the side of these two systems or between them a third system of human cooperation under the division of labor, one can always start only from the notion of the market economy, never from that of socialism. The notion of socialism with its rigid monism and centralism that vests the power to choose and to act in one will exclusively does not allow of any compromise or concession; this construction is not amenable to any adjustment or alteration.

But it is different with the scheme of the market economy. Here the dualism of the market and the government's power of coercion and compulsion suggests various ideas. Is it really peremptory or expedient, people ask, that the government keep itself out of the market? Should it not be a task of government to interfere and to correct the operation of the market? Is it necessary to put up with the alternative of capitalism or socialism? Are there not perhaps still other realizable systems of social organization which are neither communism nor pure and unhampered market economy?

Thus people have contrived a variety of third solutions, of systems which, it is claimed, are as far from socialism as they are from capitalism. Their authors allege that these systems are nonsocialist because they aim to preserve private ownership of the means of production and that they are not capitalistic because they eliminate the "deficiencies" of the market economy.

For a scientific treatment of the problems involved, which by necessity is neutral with regard to all value judgments and therefore does not condemn any features of capitalism as faulty, detrimental, or unjust, this emotional recommendation of interventionism is of no avail. The task of economics is to analyze and to search for truth. It is not called upon to praise or to disapprove from any standard of preconceived postulates and prejudices. With regard to interventionism it has only one question to ask and to answer: How does it work?

The Intervention

There are two patterns for the realization of socialism.

The first pattern (we may call it the Lenin or the Russian pattern) is purely bureaucratic. All plants, shops, and farms are formally nationalized (verstaatlicht); they are departments of the government operated by civil servants. Every unit of the apparatus of production stands in the same relation to the superior central organization as does a post office to the office of the postmaster general.

The second pattern (we may call it the Hindenburg or German pattern) nominally and seemingly preserves private ownership of the means of production and keeps the appearance of ordinary markets, prices, wages, and interest rates. There are, however, no longer entrepreneurs, but only shop managers (Betriebsführer in the terminology of the Nazi legislation).

These shop managers are seemingly instrumental in the conduct of the enterprises entrusted to them; they buy and sell, hire and discharge workers and remunerate their services, contract debts and pay interest and amortization. But in all their activities they are bound to obey unconditionally the orders issued by the government's supreme office of production management.

This office (the Reichswirtschaftsministerium in Nazi Germany) tells the shop managers what and how to produce, at what prices and from whom to buy, at what prices and to whom to sell. It assigns every worker to his job and fixes his wages. It decrees to whom and on what terms the capitalists must entrust their funds. Market exchange is merely a sham. All the wages, prices, and interest rates are fixed by the government; they are wages, prices, and interest rates in appearance only; in fact they are merely quantitative terms in the government's orders determining each citizen's job, income, consumption, and standard of living.

The government directs all production activities. The shop managers are subject to the government, not to the consumers' demand and the market's price structure. This is socialism under the outward guise of the terminology of capitalism. Some labels of the capitalistic market economy are retained, but they signify something entirely different from what they mean in the market economy.

It is necessary to point out this fact in order to prevent a confusion of socialism and interventionism. The system of interventionism or of the hampered market economy differs from the German pattern of socialism by the very fact that it is still a market economy. The authority interferes with the operation of the market economy, but does not want to eliminate the market altogether. It wants production and consumption to develop along lines different from those prescribed by an unhampered market, and it wants to achieve its aim by injecting into the working of the market orders, commands, and prohibitions for whose enforcement the police power and its apparatus of violent compulsion and coercion stand ready.

But these are isolated acts of intervention. It is not the aim of the government to combine them into an integrated system which determines all prices, wages, and interest rates and thus places full control of production and consumption into the hands of the authorities.

The system of the hampered market economy or interventionism aims at preserving the dualism of the distinct spheres of government activities on the one hand and economic freedom under the market system on the other hand. What characterizes it as such is the fact that the government does not limit its activities to the preservation of private ownership of the means of production and its protection against violent encroachments. The government interferes with the operation of business by means of orders and prohibitions.

The intervention is a decree issued, directly or indirectly, by the authority in charge of the administrative apparatus of coercion and compulsion which forces the entrepreneurs and capitalists to employ some of the factors of production in a way different from what they would have resorted to if they were only obeying the dictates of the market. Such a decree can be either an order to do something or an order not to do something.

It is not required that the decree be issued directly by the established and generally recognized authority itself. It may happen that some other agencies arrogate to themselves the power to issue such orders or prohibitions and to enforce them by an apparatus of violent coercion and oppression of their own. If the recognized government tolerates such procedures or even supports them by the employment of its governmental police apparatus, matters stand as if the government itself had acted. If the government is opposed to other agencies' violent action, but does not succeed in suppressing it by means of its own armed forces, although it would like to suppress it, anarchy results.

It is important to remember that government interference always means either violent action or the threat of such action. Government is in the last resort the employment of armed men, of policemen, gendarmes, soldiers, prison guards, and hangmen. The essential feature of government is the enforcement of its decrees by beating, killing, and imprisoning. Those who are asking for more government interference are asking ultimately for more compulsion and less freedom.

This article is excerpted from Human Action (1949). An MP3 audio file of this article, narrated by Jeff Riggenbach, is available for download.

No further comment necessary

A Dire Warning

This environment is rife with moral hazard.

The Financially Driven Erosion of Scientific Integrity

By Bill Frezza

All else being equal, if you pay for something bad, you will get more of it. If you punish something good, you will get less of it. These basic rules of economics apply as much to junk science and scientific integrity as they do to junk food and political candor.

Science and the scientific method are the jewels in the crown of Western civilization. The ascertainment of facts, construction of reproducible experiments, development of falsifiable theories, impartial training and meritocratic advancement of practitioners, and - most importantly - integrity of the publication process by which a well established body of truth can be confidently assembled all underpin the respect accorded to science by the citizenry. In modern times, this respect translates into tax dollars.

Unfortunately, today those tax dollars are corrupting the process. Unprecedented billions are doled out by unaccountable federal and state bureaucracies run by and for the benefit of a closed guild of practitioners. This has created a moral hazard to scientific integrity no less threatening than the moral hazard to financial integrity that recently destroyed our banking system.

According to a report in Nature Reviews Drug Discovery, nearly two-thirds of the experimental results published in peer-reviewed journals could not be reproduced in Bayer's labs. The latest special issue of Science is devoted to the growing problem of irreproducibility. The Wall Street Journal reports that Amgen, Pfizer, and others have abandoned research programs after spending hundreds of millions pursuing academic research that could never be replicated.

And, of course, there is the heated controversy over claims of impending doom made by climate scientists, each trying to out-sensationalize the other as they bid for taxpayer money to fund their research. Declaring an active area of investigation "settled," demonizing critics, and promoting unfalsifiable theories may qualify as topics of study within political science, but they are alien to the scientific method. This kind of behavior imperils not just the scientific community. When translated into international policy, it imperils the entire global economy.

Exactly what is going on here? To find out, we must analyze the motivations and behaviors that lead scientific investigators first to job security and academic freedom and, sometimes, onward to fame and fortune.

Tenured faculty at our research universities sit at the pinnacle of the scientific community, acting as Principal Investigators (PIs) on government-supported research projects. To become a PI, one must serve an undetermined number of years as an indentured apprentice, first as a graduate student and then as a post-doc. Pleasing one's PI is the key to graduation, publication, and advancement.

The lion's share of actual laboratory work is done by these apprentices. PIs preside over the process. They formulate theories, as they try to become the first to plant a flag in virgin research territory. Well-funded PIs assign apprentices to conduct experiments that will confirm their theories, sometimes assigning multiple teams to work on the same project in parallel. They write grant applications seeking to expand their domain along with the number of apprentices they can support. And they put their names on all the papers that come out of their fiefdoms, acting as gatekeepers in the process.

Fame goes to those that publish first, not necessarily those that do the best, most thorough, or most reproducible science. Grants go to those with the most fame. The work of PIs who publish novel work in prestigious journals may be peer-reviewed, but it is rarely replicated by their fellow PIs.

For some PIs, life gets even better. Thanks to the Bayh-Dole Act of 1980, PIs can patent the results of their work even if it was supported with tax dollars. The benefit to society is that both venture capital and industry investments can be attracted to translate breakthroughs into the market that might otherwise languish in academia if they were unprotectable.

The downside is that some peripatetic PIs make a specialty of dashing about planting broad and vague patent land mines. These PIs may never reduce a single idea to practice, but the mines they plant sit and wait to extract tribute from future entrepreneurs who do. Either way, personal fortunes can be made.

This environment is rife with moral hazard.

While outright data fabrication does occur, it is rare. The bigger threat to scientific integrity is the temptation to cherry pick results as they are produced by a Darwinian horde of apprentices clamoring for admission into the guild. Failed experiments never get reported, the definition of failure sometimes including results that call a PI's pet theories into question. Confirmation bias pervades the process much more so than in industry since the consequences of spending billions drilling a dry hole are severe.

But what are the consequences for publishing a paper with irreproducible results? What becomes of tenured PIs whose junk science leads us down blind alleys, polluting the literature while precipitating hundreds of millions of dollars in someone else's losses?

They write another grant application.

Searching for utopia

Europe's Predicament Is Similar to Ours

By Robert Samuelson

We Americans fool ourselves if we ignore the parallels between Europe's problems and our own. It's reassuring to think them separate, and the fixation on the euro - Europe's common currency - buttresses that mind-set. But Europe's turmoil is more than a currency crisis and was inevitable, in some form, even if the euro had never been created. It's ultimately a crisis of the welfare state, which has grown too large to be easily supported economically. People can't live with it - and can't live without it. The American predicament is little different.

Government expansion was one of the 20th century's great transformations. Wealthy nations adopted programs for education, health care, unemployment insurance, old-age assistance, public housing and income redistribution. "Public spending for these activities had been almost nonexistent at the beginning of the 20th century," writes economist Vito Tanzi in his book "Government versus Markets."

The numbers - to those who don't know them - are astonishing. In 1870, all government spending was 7.3 percent of national income in the United States, 9.4 percent in Britain, 10 percent in Germany and 12.6 percent in France. By 2007, the figures were 36.6 percent for the United States, 44.6 percent for Britain, 43.9 percent for Germany and 52.6 percent for France. Military costs once dominated budgets; now, social spending does.

"Survival of the fittest" no longer sufficed. Europeans have never liked markets as much as Americans do. In the 1880s, German Chancellor Bismarck created health, old-age and accident insurance - landmarks regarded as originating the welfare state. The Great Depression discredited capitalism, and after World War II, communists and socialists enjoyed strong support in part because they "had formed the backbone of wartime resistance movements," writes Barry Eichengreen in "The European Economy Since 1945."

To flourish, the welfare state requires favorable economics and demographics: rapid economic growth to pay for social benefits and young populations to support the old. Both economics and demographics have moved adversely.

The great expansion of Europe's welfare states started in the 1950s and 1960s, when annual economic growth for its rich nations averaged 4.5 percent compared with a historical rate since 1820 of 2.1 percent, notes Eichengreen. This sort of growth, it was assumed, would continue indefinitely. Not so. From 1973 to 2000, growth settled back to 2.1 percent. More recently, it's been lower.

Demographics shifted, too. In 2000, Italy's 65-and-over population was already 18 percent of the total; in 2010, it was 21 percent, and the projection for 2050 is 34 percent. Figures for the European Union's 27 countries are 16 percent, 18 percent and 29 percent.

Until the financial crisis, the welfare state existed in a shaky equilibrium with sluggish economic growth. The crisis destroyed that equilibrium. Economic growth slowed. Debt - already high - rose. Government bonds once considered ultra-safe became risky.

Switch to the United States. Broadly speaking, the story is similar. The great expansion of America's welfare state (though we avoid that term) occurred in the 1960s and 1970s with the creation of Medicare, Medicaid and food stamps. In 1960, 26 percent of federal spending represented payments for individuals; in 2010, the figure was 66 percent. Economic growth in the 1950s and 1960s averaged about 4 percent; from 2000 to 2007, the average was 2.4 percent. Our elderly population was 13 percent in 2010; the 2050 estimate is 20 percent.

What separates the United States and Europe is that (so far) we haven't suffered a backlash from bond markets. Despite high and rising U.S. government debt, Treasury securities still fetch low interest rates, about 2 percent on 10-year bonds. Will that last? It's true that cutting spending too quickly might threaten a fragile economic recovery. But President Obama and Congress can't be accused of making this mistake. They do little and excel at blaming each other.

The modern welfare state has reached a historic reckoning. As a political institution, it hasn't adapted to change. Politics and economics are at loggerheads. Vast populations in Europe and America expect promised benefits and, understandably, resent any hint that they will be cut. Elected politicians respond accordingly. But the resulting inertia poses an economic threat, one already realized in Europe. As deficits or taxes rise, the risk is that economic instability will increase, growth will decline, or both. Paying promised benefits becomes harder. Or austerity becomes unavoidable.

The paradox is that the welfare state, designed to improve security and dampen social conflict, now looms as an engine for insecurity, conflict and disappointment. Facing the hard questions of finding a sustainable balance between individual protections and better economic growth, the Europeans have spent years dawdling. The parallel with our situation is all too obvious.

Who’s more deluded

Britain vs Iran: the politics of nostalgia

Iranian students who think Britain’s still an imperial threat, or British ministers who fantasise that Iran is EVIL?

by Tim Black

Yes, a US spy-drone really was shot down over the weekend, to the barely disguised glee of the Iranian authorities on the one hand, and the ‘we wondered where it had got to’ embarrassment of the US on the other. And yes, a student stage-army really did break into the British Embassy in Tehran last week and smash a portrait of the British head of state, Elizabeth II, much to the manufactured glee of a few hundred Iranian protesters and manufactured outrage of the British foreign secretary, William Hague.

Yet despite the contemporary reality of the stand-off, it appears a little too rich in political nostalgia. It’s as if both sides are desperate to fight old battles, desperate to reinvent older certainties in the midst of so much contemporary uncertainty.

So, the ransacking of the British Embassy has been eagerly compared by some commentators to the 1979 storming of the US Embassy in Tehran, when supporters of Ayatollah Khomeini held US staff in captivity for 444 days. Likewise, Britain’s response to the embassy attack, with Hague puffing his tiny chest out and ‘expelling’ Iranian diplomats from London, seemed like an excited attempt to pose once again as an important player on the world stage.

On the part of the Iranian state, the whiff of wilful historical re-enactment is also difficult to dispel. ‘Death to Britain’ was reportedly one of the chants in the Iranian parliament last week, following the announcement of further Western sanctions against Iran. As the BBC’s John Simpson reports: ‘The speaker of the Iranian parliament, Ali Ardashir Larijani, said the attack on the embassy was Britain’s fault for interfering in Iran’s affairs and trying to dominate it over the decades.’

If Hague and Co would like to imagine Britain as an important world power, it seems their Iranian counterparts are only too happy to help out. The attack on the British Embassy, allegedly encouraged by parts of the Iranian regime, can be seen then as an attempt to reinvent Britain as the imperial enemy of yore. This is not 2011 anymore, when Britain’s impotence in the Middle East has been apparent throughout the tumult in Egypt, Syria and elsewhere. It is 1913, when Britain really was confident enough a power to draw up a contract which made Iran’s oil fields British property. Or perhaps it’s 1919, when still-imperial Britain annexed the Iranian treasury and army. Or even the 1950s, when the decision of Iran’s democratically elected leader Mohammed Mossadegh to nationalise the oil industry and rid Iran of Anglo influence prompted Britain and the US effectively to engineer Mossadegh’s downfall.

So although Britain has not been an imperial power proper for at least 50 years, parts of the Iranian state, beset by considerable internal problems both economic and political, are only too keen to portray it as such. On both sides of this stand-off, then, there is mutual gain. The West, with Britain to the fore, can act tough and moral towards that one-time pivot in then-President George W Bush’s ‘axis of evil’; and conservative elements in Iran, striving to hang on to and justify their power, can act tough and moral towards various sizes of Satan.

Of course, this current, barely diplomatic dispute has occurred within the broader narrative of the West’s recently revamped crusade to rid the world of nuclear weapons. And, like the current stand-off, this broader narrative has provided Western leaders with the chance to pose as forces for good, as leaders with moral purpose. Indeed, in April 2009, US president Barack Obama announced to the world that it was his ‘agenda to seek the goal of a world without nuclear weapons’. This, he said, was a ‘moral responsibility’.

The current Western antagonism towards Iran stems from the attempt to exercise this ‘moral responsibility’. Not that Iran actually has a nuclear weapon. The problem, it seems, is that the Iranian government might be trying to manufacture one. As Patrick Hayes reported on spiked recently, this was the dubious finding of the West’s weapons inspectorate last month. The International Atomic Energy Agency (IAEA) reported that Iran had supposedly carried out tests ‘relevant to the development of a nuclear device’. That the IAEA did so on the basis of intelligence which ends in 2003, that it relied on documents that the Israelis conveniently found on a laptop, and that the claim itself that the explosion chamber supposedly used for nuclear testing was disputed by a former IAEA chief inspector… all this was disregarded by the US, Britain and Europe in their rush to fight the good fight against the mad, bad and dangerous of Iran.

So, on 17 November, the UN issued a resolution urging Iran to ‘comply with all of its obligations under international law’ and to ‘cooperate with states seeking to bring to justice all those who participated in the planning, sponsoring, organisation and attempted execution of the plot’. That wasn’t enough for the US, Canada and UK which, a week later, announced a new raft of economic sanctions against Iran, effectively freezing Iranian assets abroad and refusing to do business with Iranian banks. And then last week, the EU, with the UK and France leading the charge of the morally light brigade, declared further measures to deal with the none-too-obvious threat of Iran, namely freezing assets of Iranian companies and individuals, and implementing travel bans.

While some commentators appear to be keen to re-enact a bit of history of their own, viewing the current round of moral posturing and rusty sabre rattling as a replay of the run-up to the Iraq War, this use of nuclear-weapon ownership to demarcate morally responsible nations from the morally irresponsible and immature hordes actually has its own distinct post-colonial function. It allows, under the conditions of the 1968 Nuclear Non-Proliferation Treaty, the West, or at least the permanent members of the UN Security Council (America, Russia, China, France and Britain), to continue to divide the world up between the civilised and uncivilised. It’s just that the mode in which this divide is expressed is no longer racial, but moral: there are some nations mature and responsible enough to possess nuclear weapons, and some, such as Iran, which are not.

This is no doubt why of the 22,000 nuclear warheads estimated to be knocking around the world, Russia has 12,000, the US 9,400, France 300, China 240 and Britain 185, with Israel, Pakistan and India sharing somewhere in the region of 250. Iran, the dread enemy of the month, the current threat to world peace, has precisely… none. And the only country actually to have used a nuclear weapon against people? That remains the ‘moral responsibility’ of the US when it bombed Hiroshima and Nagasaki in 1945.

The phoney battle with Iran does have a contemporary reality, then. But it is not the one of current historical fantasy; it is the reality of the West’s purpose-seeking leaders. Befuddled before the economic crises gripping the developed world, the chance to pose, on the basis of nuclear-weapon ownership, as the righteous guardians of world peace has proven too alluring. Iran is not the Iran of 1979 in this historic re-enactment. It is merely the token opponent in Western leaders’ desperate struggle for moral authority.