Recall, Atlas Shrugging from Washington Policy Hounds

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I recently found the following opinion piece that, although written two years ago, presents the case of Washington policy hounds in strikingly luminous and parallel fashion to Rand’s magnum opus.

“For the uninitiated, the moral of the story is simply this: Politicians invariably respond to crises — that in most cases they themselves created — by spawning new government programs, laws and regulations. These, in turn, generate more havoc and poverty, which inspires the politicians to create more programs . . . and the downward spiral repeats itself until the productive sectors of the economy collapse under the collective weight of taxes and other burdens imposed in the name of fairness, equality and do-goodism.”

The relevance of Rand’s masterpiece half a century after its entrance into the public forum is evident in two ways.  First and foremost, we are living its story.  Secondly and subsequently, the controversy over Rand’s ideas has grown to magnificent proportions since 2008.  Whether you are for or against Rand’s philosophy of Objectivism, one thing remains clear.  The more the government meddles, the more the government is called to meddle.  So the question is to examine whether such meddling has been more beneficial or harmful. What has such meddling produced beyond additional calls for government stimulus, bailouts, and tax reform?  Most recently and attributable to the heavy hand of government fiscal policy and the Federal Reserve’s perpetual devaluation of the dollar – the world’s reserve currency – is the S&P downgrade of U.S. credit.  While many mainstream Washington pundits attempt to rationalize S&P’s move, I suspect they do so in modest aspirations to avert potential panic among investors; this of course makes sense.  However, what they overlook is the more fundamental implications of such a downgrade, instead maintaining by a posteriori logic that U.S. credit is still good to foreign investors like China and Japan from the simple fact that they have nowhere else to invest.  But a credit downgrade of this type carries with it much deeper implications that cannot be shucked aside due to the dollar’s preeminent place in the global markets.  Indeed it is for this very reason why investors, foreign and domestic, should be concerned.  The implication is this: when the dollar fails due to government mismanagement, whether from loose fiscal or monetary policy, the entire global financial network, due to the dollar’s preeminent place in it, will surely follow.     There will be no “stimulus-effect,” no bailouts, nor any liquidity because to a large degree, global liquidity is furnished by the dollar.  To deny this, is to assume some other universal currency will provide a safe haven for investors.  Perhaps gold, but such a shift still necessitates the destruction of the dollar, U.S. Treasuries, and much of the wealth of our nation.

It should become quite clear at this stage that government interference in the economy – whether one calls it Keynesian economics, deficit financing, or stimulus spending – encroaches upon and binds up the free-market.  Such programs as the $700 billion Emergency Economic Stabilization Act of 2008 (H.R. 1424), the Auto Industry Financing and Restructuring Act of 2008 (H.R. 7321; note that this bill was never voted on in the Senate, but was passed in the House), the American Recovery and Reinvestment Act of 2009 (H.R. 1), and the most recent Budget Control Act of 2011 (S.365) with its 13-member ‘Super Congress’ have failed to generate adequate job growth.  Instead, the national debt has grown to proportions even Washington is unable to manage.  Much can be gleaned from the general descriptions of these bills.  For example, H.R. 1 is summed up as follows: “Making supplemental appropriations for job preservation and creation, infrastructure investment, energy efficiency and science, assistance to the unemployed, and State and local fiscal stabilization.”  Job creation and investment are primarily functions of the economy, not government, while assistance to the unemployed – when done in perpetuity – only exacerbates natural market fluctuations, which delays natural readjustment by the market.  Moreover, state fiscal stability, so long as it lies at the federal level negates the very core conception of statehood.  If I live in Georgia and decide I do not agree with its policies, I can move to Oregon.  But if both states depend too heavily on federal sustenance, where does one go?  Where has one’s choice gone?  The end result here is statism, whereby the State (i.e. the federal government) controls most aspects of private life.  Economic policy that negates market principles in place of political ideals inevitably fails because this is to replace principles grounded in reality (i.e., the market) with those conjured from the depths of human emotion.  While not the only avenue of statism, this is arguably its most far reaching.

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The ideological and practical implications of this are enormous for Republican government.  It is critical to realize that the more a people rely on their government, the less freedom they allow themselves.  I am reminded of Hobbes’ classic political tract written in defense of the monarchy during one of England’s most turbulent times.  I am reminded of this because Leviathan assumed the natural inferiority of the people to their government and the doctrine of the “Divine Right of Kings.”  He argued the necessity of an absolute monarchy, lest we fall back into the “state of nature,” whereby the weak succumb to the brute force of the strong.  I recall the cover of Leviathan (seen left), whereby the body (the people) is incomplete – dysfunctional – without the head (the state).  The political (post-9-11) and cultural (welfare-dependence) ideologies of America today resemble more closely than at many times past the traditional justification of the authoritarian state called from the necessity for stability and safety. This ideology is highly antiquated.  Hobbes published this tract in 1651, yet we still see today the fear-mongering that has become the cornerstone of big government.  The state is quickly becoming the sole arbiter of private disputes, the sole thinker of our generation.  Rand once stated that “A country without intellectuals is like a body without a head” (For the New Intellectual, p. 12).  What she meant was that a generation without those willing to think and judge will sink beneath the weight of government.

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Congress and President Ignore Warning from S&P, Pass Meaningless Debt Package Anyway

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On 14 July, Standard & Poor’s explicitly warned Washington that passage of meaningless legislation would likely result in a sovereign downgrade.

From a creditworthiness perspective, we believe that failure to formulate a fiscal consolidation plan, even if the president and Congress were to agree to raise the debt ceiling in time to avert a potential default, would be materially less optimal than hypothetical scenario 1. Such a partial solution would essentially put before American voters in the 2012 presidential and congressional election the spending vs. revenue debate. Meanwhile, debt would continue to mount and the results of the election might not, in any event, resolve the issue.

Under this scenario, we might lower the U.S. sovereign rating to ‘AA+/A-1+’ with a negative outlook within three months and potentially as soon as early August.

Agreement on raising the debt ceiling without making any tough budget decisions would not be shocking, in our view, given the number of times Congress has done so in the past.

So Washington was warned and Washington ignored said warning.  The budget package failed to cut the minimum $4 trillion S&P felt was needed to begin getting our fiscal house in order.  Essentially, the Budget Control Act is meaningless.  It makes only $917 billion in cuts (but over the next ten years) and leaves an additional $1.5 trillion in cuts to be determined by an ad hoc bipartisan committee with far too much power.

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S&P Downgrades U.S. Credit Rating to AA+ Amidst Shambled Debt Deal

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Today’s market news can be summed up in one announcement.  Standard and Poor’s downgraded the U.S. credit rating.  The U.S. has lost its perfect credit score for the first time in over a century.  In response to the butchered debt deal signed into law on August 2, S&P issued a credit downgrade for the U.S. from AAA to AA+. The following are only key excerpts from the press release, the full text of which can be found here. S&P Downgrade of US Credit Rating (5 Aug.)

My contention is that the S&P downgrade is illustrative of the diminishing stability of the U.S. legislative process.  Consequently,  I have included key excerpts that highlight the degradation of the political establishment and its inability to legislate substantive policy due to an increasing divide between Parties.  While there is much more to discuss in the press release regarding the fiscal issues at hand, I find it critical to highlight the inability of the political establishment to perform its most basic functions.

Overview

We have lowered our long-term sovereign credit rating on the United States of America to ‘AA+’ from ‘AAA’ and affirmed the ‘A-1+’ short-term rating.

The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.

The debt deal, officially known as the Budget Control Act, only cuts $917 billion over the next ten years with cuts yet to be determined of up to $1.5 trillion.  S&P feels that cuts of $4 trillion are needed to start with in order to “stabilize the government’s medium-term debt dynamics”  In other words, the U.S. needs to reduce spending by at least $4 trillion now in order to keep its books from bursting into flames.

More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011. 

Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.

The short interpretation is that markets are beginning to feel the heavy hand of a highly dysfunctional U.S. government, prevalent in both its policies and its partisan bickering.  The differences between the Republican and Democratic parties are so great as to cast a shadow over the viability of an economic recovery and the solvency of the U.S. government.

Rationale

We lowered our long-term rating on the U.S. because we believe that the prolonged controversy over raising the statutory debt ceiling and the related fiscal policy debate indicate that further near-term progress containing the 
growth in public spending, especially on entitlements, or on reaching an  agreement on raising revenues is less likely than we previously assumed and will remain a contentious and fitful process.

The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

The fact that our political establishment is becoming increasingly unstable – opposing parties residing at opposite ends of a lengthening political and ideological spectrum – sends signals that any policy reconciliations over government spending and programs such as entitlements (Social Security, Medicare, Medicaid) are not likely.  Moreover, the fact that Party politics resulted in using the threat of a default as a “bargaining chip” attests to the instability and recklessness of the American political establishment. Consequently, the hope of the U.S. government reaching a meaningful and lasting consensus of spending reduction is greatly diminished.

In our view, the difficulty in framing a consensus on fiscal policy weakens the government’s ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth… 

The political grandstanding and chicanery that has come to define Washington politics over recent decades damages confidence within the markets that any mutual agreement on reducing spending will be reached.

The Outlook

We view the act’s [Budget Control Act] measures as a step toward fiscal consolidation. However, this is within the framework of a legislative mechanism that leaves open the details of what is finally agreed to until the end of 2011, and Congress and the Administration could modify any agreement in the future.

The structure of the Budget Control Act renders any solution to government insolvency largely to be determined.  The act does very little.  This reflects the typical legislative process in controversial matters, whereby the government passes legislation that seems to do a lot, just not right now.  The fact that some of the cuts occur over the next ten years, with the remainder yet to be determined suggests that political division has rendered substantive policy implementation untenable.  In short, our government is fragmented and has become legislatively inept, thus incapable of reaching consensus on important policy matters.

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Raising Debt Ceiling Overlooks Costs, Undermines Future

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Chris Mayer of The Daily Reckoning explains why raising the debt ceiling fails to fix the underlying credit problem in Washington.  His key points:

  • The precise reason why raising the debt ceiling (a common practice in Washington) was so controversial is because the only way for the government to pay its obligations (debt) is for it to take on more debt.

“[R]aising the debt ceiling is not a magic cure-all for America’s debt problems. Raising the ceiling just gives the U.S. Treasury permission to borrow more money. It does that by issuing Treasury bonds and notes — in effect, they take out loans, promising to repay the bondholder the principle plus interest.

Here’s the thing, though — right now, the only way the government can repay its existing debt obligations is to take on more debt!…It’s sort of like using credit cards to pay your mortgage.” 

  • In August alone, the government will need to raise over $650 billion to avoid a shutdown – $500 billion to pay bond holders for matured U.S. Treasuries and another $159 billion to cover the expected monthly deficit.
  • Over the next four years, the government will need to pay bond holders over $3 trillion from additional matured securities.
  • The essential worry in Washington was that failing to raise the debt ceiling would impede the government’s ability to continue “rolling over” its debt (taking out debt to pay for debt).  The implication for the debt-ceiling issue is not cutting government spending in the future, but figuring out how to pay for programs already committed to such as entitlements.
  • A default would surely have resulted in a credit downgrade for the U.S., causing interest rates on U.S. Treasuries to increase.  This worry still persists among investors, so even in the absence of a credit downgrade, major holders of U.S. debt such as China and Japan may demand higher yields on their investment, which means higher borrowing costs for the U.S.

“[A]s more investors worry about America’s financial health, they will need more incentive to buy its notes and bonds. Convincing them to take on the risk will require a higher interest rate.”

  • Higher borrowing costs for the U.S. government will ripple out into the economy, making borrowing costs for everyone increase, impeding lending, job creation, and any chance at a recovery.

“Higher Treasury rates will create a ripple effect, forcing other interest rates up, too. Suddenly, the cost of borrowing money goes higher for everyone, which will encourage more saving than spending.”

The full article can be found here.

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