Friday, September 30, 2016
There is growing recognition that the problems with the federal government will never be solved by the politicians in Washington, who created them. They will never vote to reduce their power to spend, regulate the rest of us, and perpetuate themselves in office. The national debt is now $19 trillion—and growing—and 80,000 pages of new federal regulations per year destroy our liberty and make our economy less efficient, rendering us poorer than we otherwise would be. The politicians use public spending for “good” purposes to “buy” voter support that perpetuates themselves in office. As a result, people are showing increasing interest in amending the Constitution through its Article V procedure by the states, which leaves the federal government out of the loop.
A convention of states to consider amendments to the Constitution will be called if two-thirds of the states so request. Any amendments passed by the convention must then be approved by three-fourths of the state legislatures. The most popular subjects for proposed amendments are a balanced budget and term limits for elected officials.
If an amendments convention is called, it is unlikely that amending the electoral college will be proposed, so why am I bringing this up here? Because change will come, one way or other, due to long-standing dissatisfaction with the electoral process. Over the last two centuries there have been over 700 Constitutional amendments proposed for the electoral college, far more than for any other subject. None has met the criteria for adoption, but more will undoubtedly be proposed. So it is likely that sooner or later an amendment on this subject will be passed.
In addition to the possibility of changing the electoral process by constitutional amendment, there is the possibility of simply circumventing it by a compact of the states under the Constitution's Compact Clause. There is a National Popular Vote Interstate Compact movement attempting this. Its scheme is to bypass the electoral college by states agreeing in advance to cast all their electoral votes for the most popular national candidate even if he doesn't win in their state. This agreement would go into effect only after enough states with the electoral votes needed to win an election (270) join the purported compact. Under this arrangement, the presidency could be determined by votes in as few as eleven states. As frightening as that sounds, it is even more frightening that 10 states and the District of Columbia with 165 electoral votes (61% of the necessary 270) have already signed up for this.
There are significant constitutional difficulties for the movement even if it gets to 270 since the Compact Clause states: “No State shall, without the Consent of Congress…enter into any Agreement or Compact with another State.” But exceptions have been made. Moreover, one should not place too much confidence in the Supreme Court's faithful adherence to the Constitution when the Court has decided Obamacare is constitutional and that the law authorizing Obamacare subsidies to “exchanges established by the states” also applies to federal exchanges contrary to the specific language and intent of Congress performing its constitutional role.
So we must be on our guard. Public opinion polls show that 70% of the public believes the electoral college should be eliminated and replaced by a national popular vote. No change should be made without first understanding why the electoral college was created, why the 12th Amendment, which destroyed it, has precipitated 2 centuries of dissatisfaction and 700 efforts to get rid of it, and why replacing it with a national popular vote would be foolish.
Here I must relate a little story. John Hospers was head of the philosophy department at the University of Southern California for twenty years. He was the author of nine books, the statement of principles of the Libertarian Party, and was that party's first nominee for president of the United States. He was the first person ever to teach Ayn Rand's philosophy of Objectivism as part of a university philosophy course. John was a big fan of my book Makers and Takers and even offered an endorsement for the back cover and quotes for advertising that book. After that, we corresponded occasionally for many years until his death. At one point he wrote me that a student in one of his classes had asked, “Why don't we just abolish the electoral college and elect a president by national popular vote?” John told him, “Just you wait. I'm going to bring something tomorrow that will answer your question.”
The next day John brought his copy of my book Makers and Takers and stood up in front of the class and read aloud the entire six-and-a-half pages I had written on the electoral college. He delighted in telling me that the students were awestruck, simply amazed at the subtleties embodied in this exquisitely designed political instrument, some of which I don't think even the Founders were aware of.
Everyone knows that the Founders established three branches of government, the executive, legislative and judicial, and hoped that each would restrain the other two from exceeding their authority. But that is only part of the system of checks and balances they established.
In classical theory there were three types of government: monarchy, oligarchy (or aristocracy), and democracy. These were, respectively, rule by one, rule by a few, and rule by the many. The founders considered which of these types would be best suited to each of the three branches of government. There was, for example, some discussion whether the presidency should be held by a single individual or a committee. In the end the monarchical principle seemed best suited to the executive branch. The Supreme Court and the Senate were oligarchical in principle. Only one-half of one of the three branches of government—the House of Representatives—would be democratic.
That is all the democracy the Founders intended. Supreme Court justices were appointed—for life. The U.S. senators were chosen by the state legislatures. And the president was chosen by the electoral college. Albert Jay Nock once wrote, “One sometimes wonders how our revolutionary forefathers would take it if they could hear some flatulent political thimblerigger [i.e.swindler] charge them with having founded 'the great and glorious democracy of the West.'” What the Founders created was certainly not a democracy—which they detested and feared. When at the Constitutional Convention delegate James Wilson suggested choosing senators by popular vote, not a single delegate supported him.
The Founders created a mixed government drawn on the principles of the three classical types. With the separation and balance of the three branches of government, no one type would predominate. The result is best described not as any one of them but as a limited constitutional republic.
The Founders wanted the people to have a voice in government. The problem was how to give the individual a voice without submitting government to the collective power of raw numbers. It was highly desirable, as Madison expressed it, to structure government so that it would have a tendency to “break and control” the power of factions and guard against the “tyranny of the majority,” which is based upon the rule of numbers, not upon righteousness or excellence.
“A mixed government was desirable,” wrote historian Clarence B. Carson, “because there were differing functions of government which could be best entrusted to one, to a few, or to many. But, if the functions were best performed in this way, the division should not be watered down by having all the branches chosen by the same electorate.” The electorate for the House was the people. For the Senate it was the states. But there was no convenient third electorate for the presidency. One had to be created: the electoral college.
The states' power to chose their U.S. senators was an an important check-and-balance feature of the Constitution. But that was eliminated by the 17th Amendment, which made the Senate democratic by requiring U.S. senators to be chosen by popular election in the states.
The 17th Amendment was a double tragedy for our Constitution. It not only eliminated the only link between the states and the federal government but destroyed the most important structural feature for protecting individual rights. Safeguarding individual rights was not one of the functions best performed by the many, the majority. It was best left to a few. The Senate was the logical few. Madison saw the Senate as a “necessary fence” against a majority “tempted to commit injustice on the minority.” Edmund Randolph, governor of Virginia and one of the more prominent men at the Constitutional convention, said, “The object of this second branch [the Senate] is to control the democratic branch of the National Legislature.” But after the 17th Amendment, the Senate became democratic too, unable to resist democratic pressures within itself, much less restrain those in the House.
Before, when senators were elected by the states rather than the people directly, senators could not be voted out by the majority if they upheld the rights of the individual. Nor could they perpetuate themselves in office by signing away some people's property or other rights in exchange for votes of the majority. Senators could be more concerned with doing what was right rather than what was popular. Political decisions would tend to be made by superior thought rather than superior numbers. “There is no maxim, in my opinion,” wrote Madison, “which is more liable to be misapplied, and which, therefore, more needs elucidation, than the current one, that the interest of the majority is the political standard of right and wrong.” After the 17th amendment, senators--just like members of the House—found it necessary to vote for more benefits to “buy” votes, or the public would vote for others who would. Thus began a spending trend which accelerated over the decades to where we now have a $19 trillion dollar debt
If representation in the legislature were made proportional to population, the large states would obviously be dominant and might pass laws to their advantage at the expense of people in the smaller states. Of course, the larger states objected to equal representation, where all states would have the same number of representatives irrespective of population. The solution was to have two legislative bodies, one of each type, a House and a Senate. Each state would have two senators, but its number of representatives in the House would depend on its population. Any bills had to be passed by both legislative bodies in order to become law. So neither the large nor the small states could enact laws at the others' expense. Laws could be passed only if they were generally considered beneficial to both groups.
Members of the House were to be elected directly by the people. But this democratic feature was immediately balanced by the principle of indirect election in the Senate. Gouverneur Morris said, “The propensity of the first branch of the legislature to legislate too much [and] to run into projects of paper money and similar expedients” needed to be countered by the Senate. The popular was to be balanced by the wise; the voice of the masses was to be balanced by the wisdom of the few who were more knowledgeable than the general public and selected from them by the filtering process of indirect election.
The Founders were well aware that not everyone had the same knowledge or ability to make political decisions. If people elected from among themselves those who were ablest, they in turn would be more likely to make a wise elective decision than the populace as a whole. Indirect elections thus tended to upgrade political selection by what Madison referred to as a series of filtrations. “The effect,” he wrote, “is to refine and enlarge the public views by passing them through the medium of a chosen body of citizens, whose wisdom may best discern the true interest of their country.”
The electoral college was one of the most original and ingenious features of our Constitution. Today it is probably the least understood. The electoral college had all the advantages of indirect election just as the Senate did. Indeed, some of these seemed more pronounced by the fact the electors were selected for one task alone. They would have nothing to gain politically because after casting their ballots they would return to their private affairs. They could not vote benefits from the public treasury to ingratiate themselves with the voters and perpetuate themselves in office. It seemed, therefore, that they would be even less susceptible to corruption or political pressure and more likely than ever to exercise the wisdom and independent judgment for which they were selected.
Each state's representation in the electoral college was equal to its representation in Congress, that is, to the total of its House members plus its senators. In this way the exact numerical composition of the legislative branch—which was acceptable to both large and small states—was mirrored in the electoral college. But that numerical composition was acceptable for the legislative branch only because there were two legislative bodies, with power divided and balanced between them. How was such a division and balance of power to be achieved in the single body of the electoral collage? While power in Congress was divided between two houses, in the electoral college it was divided between two votes. The method of voting was the electoral college's most ingenious and least appreciated feature. Each elector was to vote for two men for president. The candidate receiving the most votes would be the president. The runner-up would be vice president.
An obvious advantage of the method was that it provided that the vice president would be the man regarded as the second most qualified to be president, rather than just someone chosen to balance the ticket geographically or for some other political reason. There were, however, subtler but even more important advantages to the system.
The requirement that each elector's votes be split between two candidates tended to “break and control” the power of factions. It cut the democratic power of numbers. It limited the political effects of the larger states numerical strength and prevented them from dominating presidential elections.
While it might be expected that electors would show some partiality to candidates from their own states, this factor would be offset by the requirement that each elector cast at least one vote for someone outside his state. At least half the votes were thus more likely to reflect merit rather than state politics or factions. The voting was deliberately structured to minimize the influence of local political ties or indebtedness and maximize the independent reasoning of the electors. Since electors could be expected to some extent to vote for leading figures from their own states—not only for political reasons but because they might know their qualifications better—such votes would in large measure cancel each other. Important and often decisive, then, would be those votes candidates would receive from outside their states, votes reflecting the impartial judgment of electors who had no political obligations and nothing to gain. The dominant power in electing the president would thus rest not with the states which had most to gain, by electing one of their own men, but with the votes from states which had the least to gain, just as with the electors themselves. (The exact opposite would be true if the president were popularly elected.) Consequently, with the original system there would be little tendency to choose a president on the basis of gaining benefits for some at others' expense.
In the election in 1800 two men had the same number of electoral votes. This happened because the electors did not vote for two men for the presidency. They expected Jefferson would be president and cast their second vote for their choice as vice president. In his book on the electoral college, Roger Lea McBride writes, “It is probable that few people outside his own circle wanted him [Aaron Burr] to be president—and if the electors had voted according to their own convictions, he would never have been a real contender for the job.” The electors didn't want him for president, but he was politically powerful in New York, the nation's largest state, and would balance the ticket by being from the North. (Jefferson was from Virginia.)
With Burr and Jefferson having the same number of electoral votes, the election was thrown into the House of Representatives, where the scoundrel Burr made a bold attempt to gain the presidency. He collaborated with opposition members in the House, persuading them to vote for him for president. After thirty-five ballots, the contest was still deadlocked. Finally Alexander Hamilton prevailed upon several members of his party to cast blank votes allowing Jefferson to be elected. And the 12th amendment to the Constitution, which provided separate ballots for president and vice president, ensued to prevent the situation from occurring again.
Hamilton's solution was a quick fix for the immediate problem of electing a president then, but the change required by the 12th Amendment has been so unsatisfactory that more than 700 amendments have been proposed for altering it.
The original electoral system of voting for two candidates had fascinating implications. It might well be that the elector would feel obligated to vote for the most popular candidate among the people he represented. He might even be pledged to do so. But he would have a second vote to cast. Having cast one vote for the popular choice, he might be more inclined to exercise his own judgment on the second. Both would count the same. In this event the electoral college would represent a balance between the numerical power of the people and the independent judgment of the electors, and the choice of the president would reflect some combination of the two.
No less intriguing would be the consequences if the elector reflected popular sentiment in his second vote as well. Suppose instead of exercising independent judgment he cast the second vote for the second most popular candidate in his state. Both votes would be equal. The majority would have no advantage—with obvious implications for minority rights. There would be little political incentive for making lavish campaign promises to gain votes of the majority at the expense of the minority if the minority were equally important politically.
With such a system it would be possible for a man to be elected president who did not carry a single state in popular vote. He could accumulate a winning total of electoral votes by finishing second in a great many states if several different candidates won in those states, each winning only a few. In this situation the man with all the second places finishes would indeed have the broadest political support across the country. Under today's system he wouldn't get a single electoral vote.
If a candidate could receive electoral votes for finishing second, the whole power structure of the two-party system wouldn't have developed in the way that it has. Where the winner takes all the votes under the present system, there can be only two significant parties, both contesting for the majority position. Only the majority on a state-wide basis has any representation in the electoral college. One party is the majority; the other hopes to become the majority and has the best chance of doing so. All its hopes and its influence rest on becoming the majority, because it has no representation as a minority. If, however, each elector cast two votes for the presidency, one representing whoever came in second, both the majority and the principal minority would be represented. There would be political value to being that minority, not just to being the majority. Second place would be worth fighting for, whereas only first place is today. As a result, third parties could effectively contest the second position for the same reason that only two can do so for the top spot in the present winner-take-all system.
Under the present two-party system the greater the dominance of one party in a state, the less important the other becomes, because the more remote is its chance of becoming the majority, which is the only way of winning electoral votes. Under a two-vote electoral system, where the runner-up would receive the second vote, the greater dominance of one party would make it more attractive for third parities to compete. In a state where, let's say, eighty percent of the people vote for one party, a third party would need to gain only little more than half of the remaining twenty percent to obtain electoral representation.
Under the present two-party system, the greater the dominance of one party, the less sensitive it is to the rights of individuals in the minority, because it becomes more difficult for the minority to protect themselves. Under a two-vote electoral system, with the second vote representing the runner-up, the minority represented by that vote would have the electoral power to balance the majority regardless of the size of the majority. For example, if the runner-up had only twenty percent of the popular vote in a state or district, compared to 80 percent for the majority candidate, the former would have the same power to balance the latter as if the vote totals were 49 to 51 percent or even 50-50. Thus the two-vote electoral system was another clever way of protecting the rights of individuals in the minority from the power and desires of the majority.
We shall never know whether or how the electoral college would have utilized these possibilities had the two-vote system been retained, but the potential was there. It was intrinsic to the mechanism.
The 12th Amendment altered the electoral college to provide for separate ballots for the president and vice president, with each elector casting one vote for each. Gone were all the advantages of the two-vote system. Overnight the large states doubled their power to advance their own candidates and amplified the power of the majority. Minorities which might have been represented by the second vote under the original system, no longer had any representation.
Without the requirement of splitting votes between two presidential candidates, block voting for a single candidate became the practice. By casting its votes as a block, a state could increase its electoral power relative to those states that still divided their votes among two or more candidates. To maintain its share of influence, every state soon found it necessary to cast all its votes as a block. The system which originally mitigated the power of superior numbers was turned into one which exemplified them.
While the new system limited electors to a single choice on their ballots, the block-voting practice dictated that it would be the popular choice. Although the electors might have voted individually on the basis of their own minds, there was no way they could do so collectively. Voting collectively, as a block, inevitably meant voting on a physical rather than an intellectual basis, voting on the basis of herd power rather than reasoning. The electoral system, which was originally designed to reflect superior judgment, became a mechanical system where that judgment could not be exercised.
After the Jefferson-Burr crisis, a change was clearly needed, but that need not have been one that amplified the power of the majority and destroyed the advantages of the original system. All that was necessary was to have separate ballots for president and vice president but to allow each elector two votes for each.
What I have just suggested is what I hope would be the ultimate change in the electoral college. Until then, the present system is not as good but far superior to replacing it with popular election of the president.
The Senate is no longer a bulwark for the protection of individual rights, as the Founders intended. Ideally, we should repeal the 17th Amendment, but there is no chance of that happening. The best we can hope for is to change the 12th Amendment to reflect the Founders' intent to elect a president through the filtering effect of indirect election and incorporating reasoned judgment—not merely numerical superiority—which would help to protect individual rights from the “tyranny of the majority.” Popular election for the presidency would do the opposite. To sum up: we need a Constitutional amendment that gives each elector two ballots for president and two for vice president, with one of each being required to be for someone outside the electors home state.
election of our third president.
the great danger for democracy, according to Tocqueville, is the rise of “democratic despotism,” e great danger for democracy, according to Tocqueville, is the rise of “democratic despotism,” he great danger for democracy, according to Tocqueville, is the rise of “democratic despotism,” There is no maxim, in my opinion, which is more liable to be misapplied, and which, t
ore needs elucidation, than the current one, that the interest of the majority is the political standard of right and wrong.”--James Madison “There is no maxim, in my opinion, which is more liable to be misapplied, and which, therefore, more needs elucidation, than the current one, that the interest of the majority is the political standard of right and wrong.”--James Madison
Wednesday, August 31, 2016
News of the U.K. withdrawal (“Brexit”) from the European Union drove the Dow Industrial Average down 611 points, but that was just the tip of the iceberg. More unsettling news is on the way on economic, political and social fronts. Events will be startling, severe and global.
France's president Hollande is losing support among the public, according to polls. Meanwhile, Marine Le Pen, leader of the opposition National Front political party, is gaining in the polls, which show she would easily get more votes than Hollande if the election were held today. She has stated that if she wins the April election she will immediately call for a referendum on a “Frexit,” that is, whether France should withdraw from the European Union.
In the long period leading up to the vote on the Brexit, the “stay in” voters held a comfortable lead over the “leave” voters until nearly the very end. An important factor—perhaps the decisive one—in the Brexit vote was increased concern the country was losing its “Britishness” because of the influx of Syrian immigrants. The EU policy calls from free movement of people across the borders of the individual countries. No need for passports. France has taken in far more Syrians than the U.K., and Hollande has stated his country will accept 30,000 of them, which is not likely to help him politically. After the terrorist attack in Nice, France, in July that killed 84 people, the polling gap between Le Pen and Hollande widened. Sixty-one percent of the French now have an unfavorable view of the EU.
Brexit has compounded the strains on Europe's banks and Italy's in particular. “Brexit could lead to a full-blown banking crisis in Italy,” says Lorenzo Codogno, former director general of the Italian Treasury. A Frexit would add momentum for an Italian exit from the EU. But even before the Brexit, Europe was facing a looming banking crisis in Italy, which has $400 billion in bad loans, nearly 18% of the nation's loans. That is nearly ten times the level in the U.S., where even in the worst of the 2008-09 crisis, the level was only about 5%. Italian banks have nearly half of all the bad loans in the entire 19-nation euro zone.
In the crisis of 2008, Italian banks were inclined to roll over loans of delinquent borrowers and hope an economic recovery would rescue the borrowers and the banks. It didn't happen. Impaired loans are now quadruple the 2008 level—and still rising. On July 29, 2016, the European Banking Authority disclosed the result of stress tests on 51 euro zone banks. Italy's Banca Monte dei Paschi di Siena—the oldest bank in the world (since 1472) and the nation's third largest—finished dead last. The EBA concluded that bank would be wiped out if the global economy and markets were strained. The EBA test did not factor in negative interest rates or the effect of Brexit. Also, it didn't include any Portuguese or Greek banks and left out some of the smaller unprofitable Italian banks. So the situation is really worse than the stress test showed.
Germany is the largest economy in the euro zone, followed by France and Italy. United Kingdom, which had been in the number two spot, is already gone. If France and Italy leave, the euro zone will have lost three of its four largest members. That will likely spell the end of the European Union. Dissatisfaction with the EU is already growing in various other member countries. Recent polls in Germany, Spain and the Netherlands show almost 50% of their populations have negative views of the EU. In Austria, polls show anti-EU candidate Norbert Hofer has an edge in October's presidential election. And Greece probably will not be able to remain in the euro zone for long, said Alan Greenspan in a recent CNBC interview—a conclusion that certainly doesn't surprise me or anyone who has read my latest book. Greece now has a debt of 320 billion euros ($362 billion), about 175 percent of gross domestic product, and no one wants to lend that country any more money, having been disappointed by three bailouts already.
While banking problems are most severe in Italy, other banks in Europe and elsewhere too, have their problems largely because of the stupid policy of negative interest rates. Banks are in business to make a profit by making loans at a higher rate than they pay depositors for use of their money. When loans are made cheap by increasing the supply of money (quantitative easing) or negative interest rates, bank profits plummet. In the second quarter 2016, profits at the British bank HSBC, Europe's biggest lender, dropped 45% from a year earlier. At Santander, Spain's largest bank, the drop was 50%. And at Deutschebank, Germany's largest bank, profits plummeted 98%.
Not surprisingly, the decline in banking profits has been reflected in the banks' stock prices. The shares of Italy's largest bank, UniCredit, have lost nearly 70% of their value. Shares of the Royal Bank of Scotland has declined more than 55%, and those of Credit Suisse and Barclays are down by half. Since the start of 2016, twenty of the world's bigger banks have lost about $455 billion, a quarter of their combined market value.
Not surprisingly, the decline in banking profits has been reflected in the banks' stock prices. The shares of Italy's largest bank, UniCredit, have lost nearly 70% of their value. Shares of the Royal Bank of Scotland has declined more than 55%, and those of Credit Suisse and Barclays are down by half. Since the start of 2016, twenty of the world's bigger banks have lost about $455 billion, a quarter of their combined market value.
Bank leverage is the a proportion of a bank's debts to its equity/capital. Deutsche Bank has leverage of 40 times. By comparison, Lehman Bros. had leverage of only 31 times when it imploded in 2008, setting off the global banking crisis.
The European Central Bank has assets of $3.5 trillion on its balance sheet, according to Yardeni Research Inc.'s June 2016 Global Economic Briefing: Central Bank Balance Sheets. In addition, the ECB is committed to purchasing another 80 billion of euro assets every month until March 2017 (which might be extended) in European sovereign bonds and corporate bonds, including junk bonds. However, ECB's capital, which determines its solvency is a mere $12.2 billion. If the ECB were a “real” bank, its leverage would be almost 287.
Deutsche Bank's chief executive John Cryan has warned of the "fatal consequences" of the European Central Bank's negative interest rate policy, which he said punishes savers and is “working against the goals of strengthening the economy and making the European banking system safer.” He said low interest rates have dire implications for savers and pension plans. In fact, according to insurance giant Swiss Re, the U.S. Federal Reserve's low interest rates cost savers $470 billion in forsaken interest income between 2008 and 2013. It calculates that by the end of 2016 savers, retirees and pension funds will be shortchanged $752 billion.
Since the ECB introduced negative interest rates in 2014, the euro has lost 18% of its value. Worldwide there are now $13 trillion of government bonds with negative interest rates. More than 90% of Japanese government bonds have negative yields, as do about 84% of German government bonds.
In a 12-page damning analysis, Deutsche Bank compared the European Central Bank's mistakes to those made by the German Reichsbank and the U.S. Federal Reserve in the 1920s, which eventually helped lead the U.S. into the Great Depression. "That was a hundred years ago,” the report said, “but mistakes keep happening despite all the supposed improvements to central banking, from independence to better data and more sophisticated theoretical and econometric models."
The mistakes keep happening because those theoretical and econometric models are fundamentally wrong. They are based on Keynesian economics—which means they are not economic at all; they are anti-economic. As Professor Robert Barro—who has studied Keynesianism extensively—put it: “The Keynesian model asks one to turn economic common sense on its head in many ways.”
Hunter Lewis, author of the book Where Keynes Went Wrong writes: “Keynes suggested that the government could print new money. That money would flow into the economy in the form of debt, and that would take the place of savings, but there is just no evidence for that at all, there is no logic behind that. In fact, if you want a good economy, what you need is savings, and you need to invest savings in a wise way...Of course, Keynes completely ignores the issue of how you are investing. For him, not only is any investment equivalent to any other investment, but spending is equivalent to investment.” He believed, said Professor Barro, that “more government spending is good even if it goes to wasteful projects.” Of course, it is not promoted as wasteful spending; instead it is called stimulus spending.
Keynes claimed government spending created a multiplier effect as that money was, in turn, spent over and over again throughout the economy. The Obama administration based its massive stimulus spending program on a multiplier of 1.5, meaning that every dollar of government spending would lead to a $1.5 increase in the GDP. But Lewis says, “There is just no evidence” that spending ever cured a recession, and Keynes “wasn't particularly interested in evidence.” Professor Barro says, "What few know is that there is no meaningful theoretical or empirical support for the Keynsian position.” In my book, secondedition, I cite several academic studies proving this point. For example, a study by Barro and Charles Redlick found a multiplier effect of 0.4 to 0.7. A study by economics professor Gerald W. Scully covering sixty years of data found a multiplier of 0.46. When the multiplier is less than 1.0, it shows a negative effect: the benefits are less than their cost. I also include a graph (which I showed as Figure 2 here on this blog in June) showing the Obama stimulus act worsened—rather than reduced—the unemployment rate. The U.S. economy would have done better if the government had done nothing, rather than attempting to stimulate it.
There is extensive evidence that Keynsian policies of Franklin Roosevelt prolonged the Great Depression rather than curing it. And the same faulty doctrine has produced two “lost decades” of economic growth in Japan, which is now well into its third such substandard decade, while fear of a depression is growing. Nevertheless, Obama has been implementing the same failed doctrine throughout his presidency, and it has produced the weakest recovery from any U.S. recession since 1949.
The stock market today is one of the few economic aspects that some view as positive because stock prices have held up, but this requires further inspection. According to Goldman Sachs, buybacks have been the biggest driver of stock prices since the financial crisis. Companies have spent $2.5 trillion on “share buybacks” since then. A buyback is when a company buys back its stock from shareholders. This reduces the number of shares on the market and raises a company's earnings per share, which makes the company look good—it may pay a higher dividend—and may lift its stock price, but it doesn't make a company any more profitable. Low interest rates have allowed companies to borrow cheaply to buy their shares, as opposed to expending capital on business improvements, hiring and growing earnings.
Basically, rising stock prices correlate to higher earnings or the expectation of higher earnings; and if earnings are disappointing, stock prices will adjust accordingly. Here are some facts that indicate the high level of stock prices is out of whack with economic realities—and are due for a sharp downward adjustment:
- The Standard & Poor's 500 index now has a P/E (price/earnings ratio) of 25. Only twice in history has this metric been this high: (1) at the top of the high-tech (“dot.com”) bubble that burst in 2000, and (2) in 2007 at the peak of the stock market before it and the housing/mortgage market collapsed into the Great Recession of 2008-09.
- Earnings have moved in the opposite direction from stock prices. Earnings for the S&P 500 peaked in 2014 at $106 per share. Corporate earning for those same companies have declined for four straight quarters, and the end of the second quarter 2016 stood at $86.67 per share. This despite the fact that the Dow Industrials and the S&P 500 hit all-time highs in August.
- Business investment fell 2.2% last quarter, the third straight quarterly decline in investments in property, plant and equipment, which hasn't happened since 2008-09.
- U.S. companies are borrowing faster than they did during the dot-com bubble or housing boom.
- Corporate leverage, which measures net debt against earnings, is twice as high as it was in 2007.
- The real GDP growth rate for the year ending in June was a mere 1.2%—the weakest four-quarter rate since the Great Recession.
The stock market is thus very vulnerable in its own economic terms, but a major collapse here could also be triggered by an outside event such as a Frexit. Remember the 611 point drop in the Dow Industrials after the Brexist. After a Frexit, there won't be an immediate rebound as happened then, because there will still be the specter of an Italian banking crisis and the likelihood of Italy also exiting the EU.
It is also possible that Italy will take the lead in exiting the euro zone rather than France, not just because of its banking problems but because of a referendum in October or November. The current prime minister Matteo Renzi, who has pursued reforms, is risking his future on a referendum over badly-needed constitutional changes. He says he will resign if the referendum fails. A “no”vote will not only bring about the downfall of his government but throw Italy's membership in the eurozone in doubt. If Renzi is gone, it is quite likely other parties will call for a vote on whether Italy should stay in the EU.
Another possible trigger for a stock market collapse and the fall of other economic dominoes could be the Fed instituting negative interest rates to try to “stimulate” (ha!) economic growth after a series of increasingly negative economic reports. That would be the final nail in the coffin of economic growth. It would reduce the available money supply in the banking system because people will simply withdraw money from their accounts and hide it under a mattress or equivalents. Even Commerzbank, the second largest bank in Germany, says it is considering storing cash in its own vaults to avoid paying the negative interest storage costs at the European Central Bank.
The aim of negative interest rates was to induce people to spend more and save less, on the faulty assumption this would improve the economy. It has produced the opposite effect. Central banks in Japan, Denmark, Sweden and Switzerland have adopted negative interest rates; but consumers in all those countries are saving more. They are looking out for their own future and want to replace lost interest income from savings and retirement accounts, not spend more. And banks in some countries, such as Switzerland, have responded to negative rates by making mortgage borrowing more expensive, not less as had been hoped.
Since the formation of the EU in the 1990s, there has been a concerted political effort to phase out gold in the international monetary system and replace it with a fiat currency, the euro. The euro experience has shown that an unlimited ability to print money with no backing cannot replace the effectiveness of a tangible monetary asset, gold. It may be useful, therefore, to look at the history of the EU's agreements on gold.
The first Central Bank Gold Agreement took place in 1999. At that time, central banks held nearly a quarter of all gold held above ground, about 33,000 tonnes. The second gold agreement (GBA2) took place in 2004. CBA3 and CBA4 followed in 2009 and 2014. The first clause in each of these four agreements began: “Gold will remain an important element of global monetary reserves.” In one of its first pronouncements, the ECB governing council decided the capital subscriptions of eurozone members would be paid 15% in gold and 85% in dollars or Japanese yen. (The capital subscriptions were based on population and GDP of the members.)
In a speech at Harvard's Kennedy School of Government in October 2013, Mario Draghi, head of the ECB and responsible for printing huge quantities of fiat euro, said, there are “several reasons” to own gold, among them “as a reserve of safety.” At the close of 2015, the world's centrals bank held about 31,400 tonnes of gold. The ECB held 503.2 tonnes, while national central banks held the rest. In 2014 the central banks bought 477 tonnes, the second highest amount in 50 years. In 2015 they bought 588 tonnes.
In the many centuries since the Chinese invented paper, there have been some 3,400 fiat paper currencies. All of them became worthless. There are no exceptions. The record is perfect failure: 100 per cent. The dollar will eventually become totally worthless, too. It may be a tossup whether the euro will get there first.
The rising gold price—and the fact that the central banks not only have thousands of tons of gold but are increasingly adding to it—shows a concern for safety and stability of money as a store of value. People throughout the world have the same concern and been increasing their buying of gold. Gold has answered the need for a store of value for 5,000 years. Quantitative easing and negative interest rates have never done so. Indeed, negative interest rates are unknown in 5,000 years of history.
However this issue plays out, gold will win in the end—because it best exemplifies the realities of the natural requirements of money—and its price will be much higher than it is today.