Review – The Medici

The Medici: Power, Money and Ambition in the Italian Renaissance

by Paul Strathern, published 2017

The history of the Medici family might best be summarized with the phrase “from dust to dust.” As if to emphasize how they were destined for greatness and nobility, the family started out as a bunch of Tuscan hillbillies who could trace their lineage to a legendary knight of the Holy Roman Empire who settled near Florence in the 8th or 9th Century. From there and then, no one heard much of these people until some of the clan moved into Florence proper in the early 1300s and formed a small money-changing business.

Using conservative business practices and investing in roles of civic responsibility, eventually a Medici was elected to the position of gonfaloniere, the primus inter pares of the Florentine Republic. From this position the dice were carefully loaded in the favor of subsequent Medici generations by artfully forming governing coalitions that cemented their public position while creating leverage across their business and investment portfolio through the tactical use of subsidy, official privilege, insider information and regulatory capture wielded against competitors and opponents.

The story of the “overnight success” of the Medici begins here. The first great head of the Medici family and Medici bank, Giovanni de Medici, had jockeyed for favor with the newly appointed (anti-)Pope John XXIII in order to secure a role as the personal banker to the Papal Curia upon his ascendancy, which was then granted. For much of the 14th Century and Renaissance period in general, the papal revenues and banking needs were equivalent to managing the treasury function for the modern era’s most wealthy and complex multi-national corporations. To gain this trust was not only a measure of unique esteem valuable in and of itself, but a responsibility that carried with it priceless information and irreplaceable business franchises throughout European Christendom and even the Levant.

However, Pope John XXIII soon became embroiled in the Great Schism in which he and 2 other rival popes were called before the Holy Roman Emperor and summarily dismissed, to be replaced with his appointment, Pope Martin V. At his son Cosimo’s urging (whom he had sent to be his representative at the delegation attending the papal conference) the Medici’s continued to support the defrocked pope, even helping to pay his ransom for his release from imprisonment. Rather than being a financial disaster, this loyal support of the former pope led to a new lucrative banking relationship under Martin V, because in return for bartering his release the former Pope John XXIII agreed to support the nomination of Martin V and participate in the reconciliation of the Schism, leading to greater legitimacy for the new pope.

As a major political player on top of his business responsibilities, Giovanni left three apocryphal warnings for his descendants:

  1. focus on business, not politics
  2. do not be ostentatious
  3. don’t oppose popular will, unless it is aimed at disaster

It seems as if it should be unnecessary to say that in time this advice was forgotten and eventually, so, too, were the Medici.

But the dissolution of the Medici was a ways away yet. After Giovanni came Cosimo as head of the family and the Medici bank. He faced a disastrous and unpopular war between Florence and Lucca (backed by Milan) which threatened to ruin the Florentine treasury and which had pitted the various leading families against one another. Subscribing to Rule #3, Cosimo opposed the conduct of the war and worked to hide the bank’s assets outside of Florence to avoid expropriation in the war’s aftermath.

For these maneuvers and others, Cosimo was recalled to Florence and imprisoned in the bell tower of the Palazzo Vecchio by a faction led by the rival Albizzi who had plans to execute him for treachery. However, Cosimo’s far flung banking business and participation in the geopolitics of Western Europe had led him to a series of alliances and power relationships with foreign entities such as the Venetian Republic and the Papal States which he utilized to create a kind of diplomatic protection for himself, pressuring his enemies to choose exile over execution as his fate.

In the meantime, he used bribes and the threat of invasion of the city by his own mercenary forces outside its walls to add to the diplomatic pressure and engineer a favorable outcome for himself, all while behind bars.

Shaken but not stirred, Cosimo came to rule Florence through the intervention of the Pope and Venice, but vowed that “he would rule, but he would not be seen to rule” going forward. He had learned his lesson about bearing personal responsibility when it came to matters of state. Further, he was coming to understand that it was easier to wield power when others weren’t watching.

According to one supporter, “Whenever he wished to achieve something, he saw to it, in order to escape envy as much as possible, that the initiative appeared to come from others and not from him.” One policy he pushed for through his crony network was the use of the “catasto”, which had originally been levied to pay for the war, as a punitive tool to crush his political and business opponents through ruinous taxation. While he was forcing his enemies into exile to avoid financial ruin, purchasing and redistributing their former property to his supporters on a bargain basis, he simultaneously used inflated personal balance sheets to hide his income and appear to be bearing the heaviest personal tax burden on a relative basis.

But Cosimo was far from poor:

Between 1434 and 1471, Cosimo spent 663,755 gold florins supporting public works, by comparison, total assets of the Peruzzi bank at its height were 103,000 florins from Western Europe to Cyprus and Beirut.

If he was able to spend 6X the total assets of a well-known competitor at the height of its powers on public works, his total assets and wealth must have been a multiple of that amount. Normal banking and family secrecy aside, the Medici wealth at this time seems to have been nearly incalculable. It is no wonder, then, that one of Cosimo’s key strategies in building and wielding power was to always return favors with favors.

Following Cosimo, who was once to have said that “Trade brings mankind together, and casts glory on those who venture into it” his son Piero and Piero’s son, Lorenzo began to venture the family increasingly beyond the scope of banking and business and into the realm of politics and social standing via nobility. Depending upon how you interpret the events that followed, Piero and Lorenzo were either some of the most “magnificent” leaders of the Medici banking and political enterprises or they were equivalent to the decadent dissipators of the true talent and generational thrift of their greater ancestors.

Either way, the local power of the Medici in and around Florence was successively traded for inter-regional power and influence within the royal families of Europe. As the Medici gained a queen mothership in France, they lost their rule over the Florentine Republic to foreign invasion and intervention and increasingly squandered the capital of their banking and related enterprises. By the early 18th Century the Medici had failed to produce a male heir and had ceded their Grand Duchy of Florence to the Holy Roman Emperor and ceased to be a meaningful business or political entity forever.

The Open, Free Intellectual Environment Of The American University

A fellow investor friend of mine sent me an e-mail and suggested I read “What’s the point?” by UK fund manager Terry Smith. We were originally talking about Michael Burry’s commencement speech at UCLA [PDF] and the idea that one of the things that was so extraordinary about it is the way he unmasked the villains and the corruption and spoke the truth unapologetically in such a public forum. I had also, in an earlier e-mail, complained about my lack of interest in blogging, feeling frustrated lately at the nearly overwhelming volume of fallacious bullshit floating around the net that seems to deserve a response yet leaves me tired and bored out of my mind every time I attempt another mud wrestling fiasco.

I don’t know if my frustration inspired the link to Terry Smith or if it was simply the next step in the theme of telling it like it is or what, but that blog post got me thinking. I’ve long thought about giving it one last hurrah and then hanging up my hat. Because, seriously, what is the point? You can tell the truth a million times but if your opponent is bent on lies and deceit, nothing can be done. (Of course, Mises adopted the slogan, from Virgil, of “Tu ne cede malis”, but he’s a smarter man than I, with more energy, apparently.)

In light of this, I wanted to share three critical experiences I had in college during my sophomore, junior and senior years, respectively, which have stuck with me to this day and serve, subtlety and fundamentally, to color my view of the intellectual Opposition. I believe my experiences are not unique, although few people besides me may have had the required awareness to realize it, and as such where I went to school back then is not important to the story. This is not about an institution but rather the institution of the American academic system and its culture as it exists today, and likely has existed for awhile before now and probably longer still in the future.

I want to give some insight into why I find it hard not to be dismissive of many people who claim to think differently than me on various philosophical subjects.

I first became suspicious of my academic curriculum when I learned that microeconomics was not a prerequisite for macroeconomics. Rather than being treated as fundamental knowledge built upon and reexamined from a more global standpoint in macroeconomics, microeconomics was treated as a separate discipline entirely, which could be studied before, during, or after macroeconomics or even not at all (at least, if you weren’t concerned about getting an economics degree). Of course, numerous macroeconomic theories contradicted accepted wisdom taught in the microeconomics course, but no explanation was given as to the nature and source of these apparent contradictions, nor where it was in the economic causal chain that things stopped making micro-sense and started making macro-sense. There was simply a dichotomy in place and you were expected to accept it and move on.

In my second year I was excited to take a class with a professor teaching “international trade” (you know, the separate set of economic principles and rules that apply when two people exchange goods across imaginary political boundaries). Everyone I knew who had taken the class spoke highly of this professor as a competent and entertaining lecturer and said the material itself was quite fun. We spent a lot of time in that class studying the roles of quotas, tariffs and other government interference in the economy. It was really about political economy, not economics, because economics doesn’t change when you move stuff over imaginary lines.

But what rubbed me kind of raw in the class was when this beloved professor spoke quite approvingly of the idea, built into his theoretical examples in class, of providing “transfer payments” (read: violent redistributive extortion for special interest groups carried out by the government) to currently privileged groups who would be “hurt” by “free trade”. This professor advocated that paying these highwaymen off and reaping the benefits of freer trade was a good idea in the long run.

“Uh, question, professor– wouldn’t it be best to just have free trade, without a complicated system of quotas, tariffs and transfer payments to interest groups? Isn’t that most economically efficient? Why don’t we learn about that?” This question got a knowing smirk and a request to meet the good professor privately during office hours to discuss, as there simply wasn’t enough time in lecture to discuss such twaddle.

Dutifully, I scheduled some office hours time to meet with the beloved professor and discuss. Again, I posed the question to him, why are we paying these people off? Isn’t it better to let them figure out their own way to survive a competitive market place without getting welfare from everyone else? After all, they have no right to a certain income or position within the market place. Again, a knowing smirk as the professor launched into a short anecdote about how he once was full of piss and vinegar like I about these subjects. But the truth of the matter, he told me, was more complicated.

And then he, in so many words, spilled the beans– if “we” don’t bribe these special interest groups with redistributive social justice, they’ll get their pitchforks and their torches and elect another Hitler. That was it. That was why he doesn’t teach actual free trade economics in his course. That’s why he thinks transfer payments are good. That’s why he was for FDR’s New Deal and the Social Security scam. He saw it as the only thing standing between us, and Hitler.

I tried to make the point that if you fear totalitarianism, transfer payments are actually a step toward totalitarianism, not a step away. He responded by suggesting that granting these dictator-electors-in-the-wings a little welfare would create some kind of social anchor where we’d go no further toward socialism past that point, having bought the evildoers off. Never mind people tried to buy Hitler off and he just asked for more until he went to war. And never mind that the US government has had to move far, far beyond the New Deal since then to keep neo-Hitler at bay, according to his logic.

At this point, having no response to my observation of yet another contradiction, I was informed that office hours had suddenly come to an end (I’d only been there for thirty minutes and had scheduled an hour and I didn’t see anyone waiting in the hall for an audience) and that although he really enjoyed our conversation, he was going to have to ask me to come visit with him during the summer to continue the conversation. Of course he knew I was an out of state student who would be returning home during the summer so he was actually dodging his responsibility to make sense of his intellectual positions.

I left his office reeling in confusion and frustration. Here is a guy that my peers think is one of the best instructors the university has to offer, he is considered to be a thoughtful and intellectual person, etc. Yet, I come to find out he is teaching disingenuously. He is guilty of the “smuggled premise”, that is, his economic values taught in his class have nothing to do with sound economic reasoning but rather a personal, political belief that is never named nor mentioned which is thereby “smuggled” into the lessons. Instead of being honest and telling his students “I am teaching you a bunch of stuff that doesn’t make economic sense, because I think it makes political sense”, he carries out his pedagogical mission in such a way that he exploits his students ignorance and credulity.

Why can’t this professor just tell everyone what he really believes? Are we not old enough for the truth? Did we not pay for the truth? Do we not expect the truth?

To say I was disappointed by this experience would be an understatement. But I tried to put it behind me as I continued my economic studies.

During my third year, I had another run in with an economics professor, this time one teaching a “money and banking” course who had done some consulting for the Fed and who used as a textbook in his class the work of the notorious intellectual bungler, Frederic Mishkin. I raised a lot of challenges to the material which were poorly handled by the professor, but there is one in particular that will always stand out to me because of its zaniness. We were discussing the “money multiplier” of fractional reserve banking and how with a tiny base of reserves banks could pyramid large amounts of credit on top and lever up their balance sheets. I raised my hand and asked, “Doesn’t levering the balance sheet increase the risk of crisis for the bank and for the banking system?”

The professor acknowledged that, well, yes, it does, but it’s all done within the proscription of the FDIC guaranteeing everyone’s deposits and the Fed serving as lender of last resort to prevent a total collapse. Then I asked, “Well isn’t that crisis kind of inevitable when you create duration mismatch between funds that are borrowed short and lent long like this?” And the professor acknowledged, well, yes, it does, but again it’s all done under the keen watch of the overseer regulatory bodies, this time a little bit more apprehensive. And then I went for the F-word. I raised my hand, “But professor, isn’t it fraud to lend out people’s money that they think is being held for safe-keeping at the bank? Why not have the bank separate the two activities, safe-keeping and loan-brokering?”

There was a pause and he looked kind of startled. His skin color rose and his face contorted into a mixture of anger and glee, because now he had “figured me out” and knew my true motive. He exploded: “So I guess if it were up to you the banks wouldn’t make any money, huh?!”

A little shocked at his outburst, I stammered, “Well, no, of course not, I don’t really see what their profitability has to do with my question…” but he cut me off. “Yeah, I see what you’re trying to do. You don’t want the banks to make any money, do ya?! Well, it’s a nice ideal but it doesn’t work in the real world and if banks didn’t make any money, we wouldn’t have any banks and you wouldn’t want to live in a world without banks!” he growled, signaling that question time was over and it was time to get back to his brilliant lecture on fraud-based banking economics.

The episode was so instructive for me. So THAT’S what he’s about– shilling for fraudulent reserve banking, not trying to explore the truth of the matter. He neatly dodged my very simple, very honest inquiry of how we might live in a world without systemic banking risk, a world which would still allow profit opportunities for banking operations. Instead, he constructed a false dichotomy — systemic risk due to fraud, and profit; or no profit and no banks — and then browbeat me and anyone else in the class who was listening to avoid serious discussion of the principle. It suddenly put things into perspective for me. He wasn’t there to impart any real knowledge about the economy to me, he was there to be a hatchet man and paid minion for the banking establishment as it stands today. Wouldn’t want any bright-eyed college kids getting uppity and questioning the scam now, would we?

I really thought that would be the tops. But then I got to my Labor Economics class in my fourth year.

You might be wondering at this point, “Labor economics? Are you mad? Why did you take that course as an elective?” It would be a reasonable question, but the truth is that it was the least horrible option amongst what I had to choose from at the time. To say I went into it with low expectations is an understatement.

Those low expectations were met admirably on two separate occasions, which were not the only examples to choose from but simply the most illustrative.

My professorista had spent her entire life after high school in academia and government bureaucracies like the Bureau of Labor Statistics. I would be surprised if she ever held a part time job as a youngster in the private sector. She demonstrated zero familiarity with the reality of markets. One day she provided the class her argument for government intervention in the economy, which was based on the “paradox of capitalism”, this being that capitalism is SO efficient and SO productive, that it drives things down to the cost of “near 0” (not actually zero, because that’d obviously imply superabundance and the end of scarcity for that good or service) and therefore these things become “uneconomic” to produce and won’t be provided for under the profit system, which means if we want them government must provide them as a public good.

One example she gave of this was childcare services. Now, let’s ignore the “empirical” fact that there are numerous for-profit childcare services out there, right here and now, which would seem to undermine her argument completely. Let’s just think about this logically for a second.

So long as a given good does not have a cost of 0, it is not superabundant and it is an economizable resource. For example, air is not an economic good because it is superabundant. You can breathe as much air as you need and don’t have to think about what you’d give up to ensure your supply of air, it’s just there. It has a cost of 0. But if it has a cost above 0, it must be economized, something must be given up to get it. And if at a particular point in time firms are so numerous and efficient at supplying a good, such as childcare services, that they can’t make a profit, what will happen is that the least efficient firms of the bunch will consume their capital (by earning losses over and over again) and exit the marketplace. And when they do this, the level of profitability for remaining firms will rise because the lowered supply will result in the ability to charge higher prices.

And this dynamic will play out forever over the life of the industry so long as people value childcare services. There will be a constant competitive dynamic tending toward the “right” supply of childcare services because the least efficient providers will exit with losses. And this is “good” from the standpoint of anyone interested in participating in the economy because it means that those extraneous resources will flood into other, underserved industries where profitability is much higher, indicating a relatively more important use for the resources versus childcare. At no point will the market stop providing childcare services entirely, requiring a timely government intervention and provision of this service to correct a “market failure.”

Well, recognizing that as the hogwash it was, I raised my hand and began disputing the logic just as I did above. She was so dumbfounded that I had the temerity to question her transparently flawed reasoning that she began what could best be called “sputtering”, rolling her eyes and trying to form even one word in response as if she were having a seizure. Finally, she gave up and said, “Would anyone like to respond to that and explain why he is wrong?” About ten different hands shot up, eagerly, and she called on a young man who halfway turned around in his chair to straddle his view between me in the back and her approving glances in the front. He began, “Governments can and should correct market failures, which happen frequently. For example, while I was studying abroad in Ghana, the government provided public bus service to the village I was staying at because it wasn’t profitable for private businessmen…”

I stopped him right there and pointed out that the lack of profitability is part of the phenomenon I just described, and it suggests the wastefulness of bus service to a small African village. The class erupted with anger and indignation. This was so not politically correct to suggest some poor villagers in Africa didn’t merit a dedicated bus service just because it wasn’t profitable to provide it! This lecture hall had about one hundred students in it. Suddenly, they were a-chatter, half of them noisily discussing how outrageous my view was amongst themselves, the other half turned and shouting/arguing with me simultaneously while the young man with the bus service anecdote continued droning on. This went on for several minutes before the professorista tried to get control back over the class and insisted we finish up the lesson, but by then it was too late as class was over and everyone made for the exits.

It was at this point that as people filtered out a guy sitting a little in front and to the right of me turned around and said, “For what it’s worth, I agree with you,” and then grabbed his bag and walked out. I guess it was better than thinking the entire class was ready to lynch me, but he certainly didn’t feel the need to come to my rescue in the heat of the argument!

The other memorable moment from that class came right near the end of the semester. The Wall Street investment banks were beginning their meltdown and that particular morning Bear Stearns had failed, which was all over the news and which had greatly agitated the students as several had received offers of employment there at the conclusion of the semester which were now in jeopardy. The professorista sought to calm everyone’s nerves by saying that this was a limited event, contained to a specific firm with poor risk controls and the Fed and the regulatory agencies were all over it.

I raised my hand and pointed out that this was indicative of a systematic impending crisis, that the authorities were NOT in control as evidenced by the fact that it had happened, and that it would get a lot worse before it got any better. I suggested that this was the first of many failures to come.

“Would you like to bet on that?” she said, mischievously, expecting me to back down with the bravado.

“I already have!” I exclaimed, as I had taken a few minor positions in my brokerage account at the time (don’t worry, I didn’t make out like John Paulson).

“Well, we’ll see…” she said, trying to quiet me down.

Yes, we did, didn’t we? I never followed up with her to see what she thought of giving me a hard time about my prediction in class, or whether she was willing to confess she had had it all wrong, but I think it demonstrates again a clear blind spot in the mindset of mainstream academics who are responsible for instructing this country’s (and the world’s) future leaders and productive people about intellectual curiosity, academic honesty and the nature of reality.

How many parents are aware of this when they insist their children must go to college? How many have audited the value of their kid’s higher education and determined that the small fortune it takes to get them through a “better” private institution is worth it in the face of antics like what I’ve described above?

Review – Asian Godfathers

Asian Godfathers: Money and Power in Hong Kong and Southeast Asia

by Joe Studwell, published 2007

Studwell’s “Asian Godfathers” examines the economic development of Hong Kong, Singapore, Malaysia, Thailand, Indonesia and the Phillipines, which are “linked by powerful, unifying themes… similar historical legacies and a very particular relationship between political and economic power.” In so doing, it helps the reader understand curious facts such as how,

a small region that, concurrently, could not boast a single non-state corporation among the global top 500 [but] none the less accounted for a third of the wealthiest two dozen people on the planet.

The narrative of southeast Asia is that it is rapidly privatizing after a narrow-miss with communism and concentrated state-owned enterprise intervention throughout the 1950s, 1960s and 1970s post-war period and this explains some of the fantastic personal fortunes of various “business families” in the area. But if these supposedly privatized economies can’t boast globally competitive businesses, how are these people managing to get so rich?

The three minor inquiries of this major inquiry are (pg. xii):

  1. why have secretive tycoons come to rule the economies of southeast Asia?
  2. what have they contributed to the region’s overall economic development?
  3. why are they still so powerful when the depth and potency of the Asian Financial Crisis — an event to whose origins they were central — appeared, to many observers, to be likely to emasculate them? (It did not.)

In searching for answers, the book explores several key themes (pg. xiii):

  • historical; the southeast Asian economy is the product of a relationship between political and economic power that developed in the colonial era and was sustained, with a different cast of characters, in the post-colonial era
  • mechanical; a political elite grants to members of an economic elite monopoly concessions, normally in domestic service industries, that enable the latter to extract enormous amounts of wealth, without a requirement to generate the technological capabilities, branded corporations and productivity gains that drive sustainable economic development
  • political; it was expedient for new indigenous political leaderships to nurture their own dependent class of, typically, non-indigenous tycoons who could siphon off economic rents, give a share to their political masters and not pose a threat to political power
  • economic; instead, growth came from a combination of small-scale entrepreneurs, many concentrated and around manufacturing, and a policy of renting out the local labor force to efficient multinational exporters
  • crisis; these arrangements seemed to work acceptably well until the July 1997 onset of the financial crisis
  • repetition; most of the institutional failings revealed by the crisis have not been tackled in the decades since the crisis broke and it remains unclear whether they will be [there could be another crash, as a result]

The introduction to “Asian Godfathers” is outstanding. It is one of the best, most coherent summaries of the major arguments of a comprehensive work such as this that I have come across, so it is worth quoting extensively from it before outlining and commenting on the rest of the book.

First, why is the book called “Asian Godfathers” (pg. xiv)?

The use of the term godfather in this book aims to reflect the traditions of paternalism, male power, aloofness and mystique that are absolutely part of the Asian tycoon story… a very romanticized myth…has grown up around southeast Asia’s tycoons [along with] sub-myths about race, culture, genetics, entrepreneurialism… the entire grounding of economic progress in the region since the end of colonialism.

The Asian tycoons are not just characters in the book, they are characters in real life and they have worked hard to consciously develop their public character themselves. And with regards to character, it is interesting to note that,

Most of Asia’s godfathers are ethnic Chinese.

This would seem to fit into the “historical” theme, as during the colonial period many of the ennobled members of the business community were part of the Chinese diaspora throughout southeast Asia and their relationships with indigenous and colonial governments were similar to the roles and functions which exist today between political and economic elites in the region due to the seeming “special” status a racial or ethnic outsider can obtain in such scenarios.

That being said, Studwell objectively rejects the idea that there is a “culture-centered explanation” for the success of (mostly) Chinese tycoons in southeast Asia, founded on three points:

  1. notions of a cultural imperative ignore historical context; arbitrary decisions made by former colonial powers have led to present-day coincidences, such as the high percentage of “subcontinental ancestry” individuals serving as lawyers and judges in Singapore or Malaysia
  2. the Chinese are non-homogeneous and the Chinese in southeast Asia are typical of the Chinese race in general; Chinese emigres were a self-selected group willing to take significant risks for chances at a brighter future, and they emigrated from geographically, culturally and linguistically different regions around China at different periods of time
  3. the Chinese emigration generally can not be conflated with the godfather phenomenon; while overseas Chinese enjoy above-average incomes in some places, there are also large populations of emigre Chinese who live in poverty similar to the indigenous populations

So does this mean culture and race mean nothing in explaining southeast Asian economic outcomes? Not quite. (pg. xix)

This book argues that these individuals are above all the economic products of the political environment in which they operate and that it is this same political environment that is preventing the region from achieving sustained economic progress. In a worst-case scenario, southeast Asia may be headed towards Latin America-style stagnation and inequality.

So, again, how do these people get so rich? Essentially, they are “asset traders”, trading assets from one political system (Asia) to another (the Western world/global market economy) and they get paid for arbitraging between the two in the form of rents.

Asian godfathers exploit political inefficiency for gain… their companies’ performance in terms of productivity typically lags behind that of the overall economies in which they operate… it is the smaller scale local businesses and the hard work and thrift of ordinary southeast Asians that have driven development.

Interestingly, this is the same argument that was made about the Chinese communist party in control of coastal trading cities and the inland rural entrepreneurs who were driving economic change in China that was put forth in “[amazon text=Capitalism With Chinese Characteristics&asin=0521898102]”. The state-connected actors get all the credit for “producing” measurable trade activity that their political obstructions necessitate, and the contribution of thrifty commercial operators in the domestic economy which are harder to measure and observe go without note despite being at the root of the phenomenon of “third world development” in these regions.

This is one of the central myths shattered by this book– that the mega-wealthy businessmen of southeast Asia are bootstrapped entrepreneurs operating in competitive markets and that Hong Kong and Singapore have grown because they are liberal, free market economies in a world of state intervention and control. The truth is almost exactly the opposite, with the individuals topping the “rich list” representing a group of crony capitalist concessionaires par excellence, and Hong Kong and Singapore in particular representing what happens when you channel large volumes of cash flow through controlled banking and finance regimes, regardless of wider economic or social principles.

This political economic arrangement is not new, and it is not even just colonial. As Studwell argues, it starts with migration pre-dating European control of the region and it relies upon an ancient

racial division of labor in which locals were the political entrepreneurs– focused on the maintenance of political power against indigenous rivals and, later, in partnership with European and American colonists — and outsiders who became economic, and as a corollary bureaucratic, entrepreneurs.

In a sense, there’s really nothing unique or extraordinary about these arrangements. From the dawn of time some groups in society have sought political control over others, which is to say, they seek to live at the expense of the productive people in society. The ancient trade economy resulted in migrant businessmen who proved to be capable administrators not only of their own affairs but also as hired tax farmers and local bureaucrats for the indigenous rulers. Over time, these two groups came more and more to rely upon one another, the businessmen on the rulers for explicit monopoly concessions in return for loyal service, and the rulers on the businessmen for a class of people who could actually get their hands dirty with revenue generation for the state while serving as convenient scapegoats or distractions for the frustrations of the local populace concerning their rule, when need be.

These political arrangements always result in poverty, suffering and gross economic inefficiency. In the case of countries where the governments overtly monopolize or nationalistically control real enterprises, there is the perennial problem of an artificially low supply resulting in artificially high prices. Combined with foreign trade controls which prevent competitive global exports from arriving in their markets, you have the set up for an extremely lucrative arrangement for these “godfather” types who bridge the gap between the inefficient, politically-controlled domestic markets and the efficient, competitive global market. The success of the “trade nations” of Hong Kong and Singapore, then, can be explained by political interference in the nearby local economies, not the absence of such interference in their own:

What is important about Hong Kong and Singapore is that they are archetypal city states — ‘port city states’ would be more precise. Since colonial inception they have offered tariff-free trade (with few or no questions asked about what is being traded) and have been places to park money (with few or no questions asked about where the money came from)… Hong Kong and Singapore perform a simple economic trick: they arbitrage the relative economic inefficiency of their hinterlands… For as long as surrounding countries have imposed tariffs or quotas on trade in their efforts to fund government, Hong Kong and Singapore have profited from circumventing those restrictions.

In the case of Hong Kong and Singapore, “Hong Kong’s immediate hinterland is Southern China… Singapore’s dominant hinterland… has long been Indonesia.” When was the last time you saw China or Indonesia show up on a list of globally competitive economies?

The reason Hong Kong and Singapore are such large financial centers, in particular, is that

Ethnic outsider tycoons who have profited from business concessions in surrounding countries have always sought to keep the funds offshore, fearing — with good reason — that they may one day be the victims of political change.

Perhaps overlooked by some,

Singapore… increased account secrecy provisions and changed trust laws in a manner designed to attract the kind of money Switzerland had dealt in… foreign private banks almost doubled between 2000 and 2006

And meanwhile, “to sustain its economy, Singapore is building casinos to attract corruption money from China.”

In conclusion, rather than proving the efficacy of free markets (which Hong Kong and Singapore largely do not have in terms of domestic industries), instead the experience of these island countries serves to prove

That a city state with a strategic deep water port in a region that has relatively higher levels of mismanagement, corruption and political uncertainty will prosper with little reference to official economic philosophy.

But what about the “godfathers” themselves? Surely they are talented businessmen in their own right despite the relatively uncompetitive markets in which they thrive?

Whether it is as a sop to the political class to help fool the local populace that it has options and opportunity, or it is a sop to their own egos to glory in a sense of achievement and capability that has not been earned, the godfathers’ public personas are men of meager means who rose through the ranks in short order to become industrial and financial titans in their adopted countries while the reality is that most came from already successful families with existing political connections that they enhanced, or, to the extent they were “penniless” before their rise, they certainly didn’t do it through hard work and sweat equity of their own but happened to be in the right place at the right time and got control of an early government concession which became the rocket engine to the top. Many godfathers of the present generation were war-time smugglers, gambling operators or even cooperators with occupying forces as southeast Asia changed hands back and forth during World War II. As Studwell observes,

whether Hong Kong has been ruled by British colonialism, Japanese imperialism or Chinese communism, it has always been managed through the same group of people.

According to one local observer and member of the monied class, “In one generation it is very difficult [to rise from rags to riches ] because it is not an open society.” And according to a local scholar, “I have yet to find a businessman who started as a coolie.” As such, the godfathers have a notorious reputation when it comes to expensive entertainment vices and

the rumors are legion and suggest a form of gambling that echoes that of Middle Eastern potentates — vast sums of money blown away by people who do not know its real value because they have not really earned it.

Nor are their social habits those of the hard-working middle-class bourgeoisie who cherish being part of their communities and maintaining stable, monogamous relationships with supportive spouses. Says one observer, “None of these people has social friends. They fuck a girl, shake off their horniness and then it’s back to work.” It appears to be the life of an addict and by another’s estimation, “If they don’t have a woman a day they can’t function.” The Asian godfathers are more Bill Clinton than Bill Gates, it seems.

Another important aspect of the godfather character is secrecy. While private businessmen are often protective of their trade secrets, customer relationships, technological know-how and tactical elements of their strategy, this is a different form of caginess. Says Studwell, “Most deals involve some element of government licensing or concession, things that both parties prefer to keep private.” The godfathers get special advantages from the government which, if known, ruin their reputations as self-made men, and the governments themselves want the mystique maintained so as to confuse the masses as to how they are controlled (and how they benefit by their arrangements with these business stars.)

And that secrecy is extremely valuable because

At the heart of the average godfather’s empire is a concession or license that gives rise to a monopoly or oligopoly activity… this non-competitive core cash flow, the river of molten gold that will keep him going through good times and bad

allows the godfathers to build their empires, and survive the inevitable setbacks and speed wobbles as uncompetitive pseudo-entrepreneurs jump head first into a bevy of unfamiliar industries and businesses and try to swim without the floaty wings of government assistance.

Though there are many such arrangements detailed in the book, the explanation of Hong Kong land development patterns on page 68 is worth quoting at length as a kind of summary of how these special arrangements serve to entrench a group of large scale crony capitalists:

The British administration set the scene for real estate oligopoly because it chose to depend heavily on land sales — all land was deemed “Crown land” until sold — to fund its budget. As Hong Kong grew in the post-Second Word War era, the government auctioned off development land in ever more expensive chunks: US$1 billion a pop for large plots by the mid 1990s. Anyone who acquired land in the secondary market that was not designated for building — agricultural acreage in the New Territories was targeted by the tycoon families behind Sun Hung Kai and Henderson in the 1970s and 1980s — had to pay a hefty upfront conversion premium before construction could begin. The effect was to rule out small players and persons without good connections to the large British banks. A government-commissioned 1996 report by Hong Kong’s Consumer Council found that three-quarters of new private residential housing was supplied by only ten developers between 1991 and 1994, and 55 per cent came from the four biggest developers. A separate look at profitability considered thirteen large residential developments. Margins were extraordinary, especially where conversion fees had been set by private tender on large lots of agricultural land. In such cases, the lowest return the Consumer Council found — as a percentage of total estimated development costs, including land — was 77 per cent. The highest was 364 per cent.

For everyone else in Hong Kong, the outsize cost of housing relative to all other living expenses is a constant complaint.

Middle class Hong Kongers, meanwhile, paid low nominal taxes but some of the world’s highest rents, or mortgage repayments, and apartment management fees equivalent to 13-15 per cent of rents.

Interestingly, Hong Kong locals see this as inevitable, not as a necessary outcome of a crony land development and ownership system, but as the necessary outcome of living on a small island! The argument is that there is only so much land, and they aren’t making more (nevermind landfill projects like the airport, ports, etc.)– somehow competition serves to lower prices in every other area of business but in Hong Kong real estate, no matter how tall you build the buildings, supply never improves and prices keep going up. They’re totally bought in on the godfather propaganda.

The whole system seems outrageous to an outsider, as Studwell describes

a graft-seeking culture among indigenous politicians. “They’re broke every week… feed your mouth, feed your prick. That is how they think.”

Yet,

while the south-east Asian system is corrupt, it is more efficient than ones that pertain in socitieies where the holders of power also seek to be exploiters of business rents.

Here he is referring to places like Africa and parts of the Middle East, but the metaphor could also be apt in looking historically at feudal Europe versus bourgeoisie Europe, where one of the primary political trends was the reduction of large landed estates into ever smaller, privately owned parcels controlled by individual land owners or small businessmen.

So, if the godfathers are not business geniuses, what are they and how do they manage to get anything done across their humongous and complicated business holdings? According to Studwell,

their activities are more like those of supercharged chairmen: setting strategy, deal making, hobnobbing, but ultimately leaving others to execute the substance as well as the detail of what they put in train

and it is their gweilo, or running dogs, who are the real business men in their organizations. Yet, even then these individuals are not as much businessmen as they are “enforcers”, with the top enforcer being more akin to “‘the chief slave’. This is the first person called when the godfather wants something done.” And these gweilo, like the godfathers themselves, are rarely members of the local populace but are instead drawn from “a globally traded management cadre” who graduate from top universities and can be found running large enterprises around the world.

The final piece of the puzzle is the godfathers’ relationship with capital markets. The first thing to note is that every godfather has his own affiliated bank, for example, “By the mid 1990s every major business [in Indonesia], and many lesser ones, had a captive bank.” Interestingly, even “different factions of the military had banks”! With control of a bank, godfathers can tap into cheap capital pools and then hand off social problems to the government in the event of a crisis such as the Asian Financial Crisis of 1997.

And while massive, cheap leverage is the favored form of financial fuel, the godfathers have also found unique ways to employ their legerdemain in the equity markets via that ever-so-wonderful technique of arbitrage. In fact, this explains the puzzling question of “why, despite heady economic growth, have long-term stock market returns in south-east Asia been so poor?” For example, Studwell notes that “Between the beginning of 1993 and the end of 2006, dollar returns in Thailand and the Philippines were actually negative; their stock markets destroyed capital.”

The answer is simple: “buying equities in south-east Asia is fundamentally about buying into the godfather business model”. And the godfather model contains the implicit query

why work hard to increase a company’s stock price and pay dividends when all the capital you need is available at a real interest rate close to zero per cent from a bank whose board you control?

From this standpoint, then, it should come as no surprise that

the eight largest conglomerates in the region exercise effective control over a quarter of all listed companies, while the top twenty-two conglomerates control one-third of listed vehicles.

What is, perhaps, surprising is how the godfathers have managed to profit even from running their listed companies into the ground. This was one of the most fascinating reveals in the book:

The game here was for tycoons to sell low-grade property assets into new corporate entities, back-load the debt repayments of the purchaser and list them with the story that dividends in year one would be a guide to future earnings.

The money used to finance this arrangement is often provided by their bank. And when the publicly-listed corporate structures verge on insolvency, the godfather’s private companies offer to repurchase the assets at pennies on the dollar. It is an outstanding bait-and-switch which allows them to swipe millions (billions?) along the way formerly belonging to “dumb money” mutual funds. In many instances of these IPO-to-privatize shenanigans “the boss himself would own only about 10 per cent of what he was selling, a powerful signal that the asset was overpriced.”

The 1990s leading up to the Asian Financial Crisis represented a kind of Golden Era of banking charlatanry for the godfathers where “Hong Kong, for instance, had negative real interest rates from the end of 1990 to the start of 1995”, which allowed for such inanities that “K. S. Lo, the real estate tycoon and elder brother of Vincent Lo, [telling a CSLA analyst] he would buy any property in Hong Kong sight unseen.” If that kind of anecdote isn’t revealing of the reality of the free market, competitive real estate economy in Hong Kong, nothing is.

Studwell has produced an outstanding and deeply-researched resource in “Asian Godfathers.” While my review focused on Hong Kong and Singapore, which are of particular interest to me personally, there is just as much detail here about Malaysia, Indonesia, Thailand and the Phillipines, as well as a variety of throwaway lines that come out of the mouths of the main characters and those forced to bask in their wake alike that are just too funny not to chuckle about. The great detail with which Studwell describes the machinations of the godfathers and the mass of damning evidence he provides that they not only do not operate in free economies but only exist because of the nature of southeast Asian government manipulation of regional economies is deeply satisfying to this reader and I am sure it will be refreshing to other curious minds as well.

This book is not a classic that can be read again and again with new insights about the human condition to appreciate every time, but it is an outstanding treatment in its specific area that I would strongly recommend to anybody curious to know more about southeast Asian political economy in general, and how crony capitalism works specifically, not just in these economies but around the globe because the formula is similar, if not identical. There are only so many ways to rip people off and it turns out it doesn’t require too much creativity. I plan to purchase and read a copy of Studwell’s How Asia Works in the future.

Review – The Panic Of 1819

The Panic of 1819: Reactions and Policies

by Murray Rothbard, published 1962, 2007

Please note, this book is also available as a free PDF on the Mises.org website, which is how I read it [PDF]

Introduction

Rothbard’s “The Panic of 1819” is a lot of things, but the thing it is most is yet another reminder of the old dictum “Plus ca change, plus c’est la meme chose”. Contained in this approximately 250-page reporting of the causes, consequences and social responses to the Panic of 1819 are the same behaviors and political programs that could be found in today’s headlines about corrupt Chinese banking practices, Chicago-school monetarism and Keynesian pump priming, including early recognition that attempts to kickstart “idle resources” logically implies a totalitarian command economy where the government manages all resources (and all people) at all times.

It’s all here, and more. There is nothing new under the sun.

How the business cycle gets started

Early on page 16 the reader is entreated to an excerpt from private correspondence between Pennsylvania politician Condy Raguet and European economist Richard Cantillon in which Raguet tries to clear Cantillon’s confusion as to how fractional reserve banking manages to operate to the point of a catastrophic bubble instead of wobbling and crashing under its own confusing weight:

You state in your letter that you find it difficult to comprehend, why person who had a right to demand coin from the Banks in payment of their notes, so long forebore to exercise it. This no doubt appears paradoxical to one who resides in a country where an act of parliament was necessary to protect a bank, but the difficulty is easily solved. The whole of our population are either stockholders of banks or in debt to them. It is not the interest of the first to press the banks and the rest are afraid. This is the whole secret. An independent man, who was neither a stockholder or debtor, who would have ventured to compel the banks to do justice, would have been persecuted as an enemy of society.

Today’s full reserve Austrian economists, caught between clueless and complacent bank executives, a massively indebted “ownership society” public, Keynesian and monetarist adherents and “free banking” friends who are anything but, simply has no place to turn for safety. He defaults to “enemy of society” status in the ensuing confusion though he seeks only to point out the folly of these fractional reserve systems which inevitably injure all in tying their fates by one string.

The Panic of 1819 followed the War of 1812. During the war, imports and exports came to a halt due to the sea being a battleground and many products which would’ve been imported were kept in their home (overseas) markets to furnish the war effort. As a result, the young States United of America saw the development and growth of domestic manufactures and exportable industries. However, when the war ended and international trade resumed, many domestic manufacturers found they weren’t actually competitive facing world markets (this makes sense because if they had been they probably would’ve developed before the war, not during it in a period of “isolationism”). This created a nascent strain of “protectionist” thinking and monied interests who saw a benefit to adding tariffs on imported products.

The end of the war and the resumption of trade saw a banking boom (fractional reserve) which finally ended in 1819 with the panic. From about 1819-1823 the country was in and out of what could be termed depressed economic conditions. In many ways the early country’s experience mirrored the present day experience from 2008-2009 onward, especially the contentious economic and political debates about how to respond.

Something I found fascinating was what happened to various “macro” economic metrics during the Panic (what we’d call a crash):

The credit contraction also caused public land sales to drop sharply, falling from $13.6 million in 1818 to $1.7 million in 1820, and to $1.3 million in 1821. Added to a quickened general desire for a cash position, it also led to high interest rates and common complaint about the scarcity of loanable funds.

That last bit is especially fascinating to me. I don’t know what the state of federal funded debt was in this time period as Rothbard doesn’t really go into the concept or existence of a “risk free rate” but it is interesting to see “deflation” leading to HIGHER rather than LOWER interest rates. In today’s topsy turvy world, low rates are supposed to be the result of the flight to safety during a depression while high rates are supposed to herald an economic recovery. However, it seems it was just the opposite in 1819.

I found myself charmed by the ability of so many in 1819 to see what was the cause of the bubble and the collapse, even politicians. For example, in an address supporting a “relief bill”, Illinois Senator Ninian Edwards observed:

The debtors, like the rest of the country, had been infatuated by the short-lived, “artificial and fictitious prosperity.” They thought that the prosperity would be permanent. Lured by the cheap money of the banks, people were tempted to engage in a “multitude of the wildest projects and most visionary speculations,” as in the case of the Mississippi and South Sea bubbles of previous centuries.

I enjoyed learning that even medical analogies to describe the cause and effect of monetary expansion and collapse were popular in 1819. One government committee, the Hopkinson Committee, arguing against “debt relief” legislation, noted:

palliatives which may suspend the pain for a season, but do not remove the disease, are not restoratives of health; it is worse than useless to lessen the present pressure by means which will finally plunge us deeper into distress.

I thought that pain pill and hangover analogies were something recent and peculiar to adherents of the Austrian school but critics knew of these rhetorical flourishes even two hundred years ago, at least!

On the topic of “flight to safety”, I did make note of one paragraph which seemed to suggest that while interest rates on bank debt and other commercial lending may have risen, interest rates fell dramatically on tax-backed (ie, “guaranteed”) government issues, for example:

“A Pennsylvanian” pointed to United States and City of Philadelphia 6 percent bonds being currently at 3 percent about par– indicating a great deal of idle capital waiting for return of public confidence before being applied to the relief of commerce and manufacturing. Thus, in the process of criticizing debtors’ relief legislation, the “Pennsylvanian” was led beyond a general reference to the importance “confidence” to an unusually extensive analysis of the problems of investment, idle capital, and the rate of interest.

This theme of “idle capital” was remarked on more than once in the text and by various parties with differing viewpoints. This is a particular fetish of Keynesians and monetarists who cite the existence of “idle capital” as an excuse for government to raise public spending to “put it to work.” It is fascinating to see these early Americans predicted Keynesianism by almost 150 years!

Another thing I found remarkable was the prevalence of either state-owned banks (federal, with the Bank of the United States, or individual states) or strong political pushes to establish these banks in response to the ensuing depression and the stress this created on the banking system. In other words, nationalization of the banking industry as a political prop to collapsing FRB institutions is nothing new:

The Alabama experience highlights the two basic measures for monetary expansion advocated or effected in the states: (1) measures to bolster the acceptance of private bank notes, where the banks had suspended specie payment and where the notes were tending to depreciate; and (2) creation of state-owned banks to issue inconvertible paper notes on a large scale. Of course, the very fact of permitting non-specie paying banks to continue in operation, was a tremendous aid to the banks.

People refer to the United States economy and monetary system at various points in time being “free market”, and while it’s true that tax rates and business regulations were generally less cumbersome near the nation’s founding than today, it is also true that there has been a virulent strain(s) of interventionist thinking and policy-making from very early on. It wasn’t until 1971 with Richard Nixon’s closing of the gold window that the US currency finally went fully inconvertible, and yet already in 1820 (if not earlier), people were calling for inconvertible paper currencies issued by state-owned banks. Some free market!

The whole episode seems to beg a question that, sadly, Rothbard did not explicitly address or explore, namely, Why did banks need to be chartered by the government in the first place? Although there were calls during the response to the economic crisis for various forms of occupational licensing and business regulation (aimed at stemming the flood of superior imports damaging local industries), the reality is that any other business but banking, such as butchering, baking, sawmilling, leather tanning, import/export, etc., did not require special permission granted by a session of the local legislature, state or federal. Why was banking different, requiring an act of congress to get the enterprise going?

Besides the fact that many such banks seemed to be public-private partnerships which included state “capital” injected into them, the only answer I have managed to come up with so far that makes any sense is that the banks were all set up on a fractional reserve basis, and a blessing by the government served to either 1.) grant legitimacy to an illegitimate institution or 2.) create the pretense and wishful thinking of providing some kind of “legal oversight” to what everyone at the outset understood to be an essentially criminal organization operating with a special legal privilege or 3.) both.

Because every bank had to be chartered, when the FRB system inevitably hit a bump in the road as it did in 1819 and many banks wished to suspend redeemability of their bank notes to stem outflows of specie, their status as creatures of the public legal mechanism meant they could run to the legislature for permission to violate their own contracts– and they almost always got the permission granted. Now, for example, if angry pitchfork-wielding townsfolk show up to break into the vault, take their gold and lynch the bankers, the Sheriff might step in with his posse to make sure everyone remembered their role.

Keynesians and monetarists and Chinese bankers

Continuing the theme of “everything new is old”, I was struck by commentary from a Pennsylvanian congressman named Henry Jarrett suggesting that government relief money might serve to prime the pump of the economy:

An inconsiderable sum of money, for which the most ample security could be given, being loaned to a single individual in a neighborhood, by passing in quick succession, would pay perhaps a hundred debts.

Kind of sounds like George W. Bush urging Americans to go shopping after 9/11, in order to get confidence in the economy back. It’s a crass Keynesian tactic inspired by a confused understanding of the relationship between production, consumption and the role of money in the economy.

It was also interesting to see how many people back then could sense there was a problem with the way the banking system operated, but were confused into thinking banking in and of itself was illegitimate, rather than simply the practice of issuing a greater supply of banknotes than the amount of specie held in reserve. Consider a campaign circular for a candidate for Congress from mid-Tennessee, who said:

banking in all its forms, in every disguise is a rank fraud upon the laboring and industrious part of society; it is in truth a scheme, whereby in a silent and secret manner, to make idleness productive and filch from industry, the hard produce of its earnings

If you substitute “banking in all its forms” with “fractional reserve banking”, you’ve got a pretty accurate description of the nature of the problem.

It’s also worth quoting at length the argument of “An Anti-Bullionist”, who thought that the economic crisis of 1819 was caused by specie money specifically, rather than abuse of specie money via fractional reserves. In its place he sought to create a fully inconvertible paper currency issued by the government which would of course be “well regulated” and serve to protect the economy from the inevitable deflationary death spiral of the specie system he believed he was witnessing. Shades of later monetarist thinking abound:

His goal was stability in the value of money; he pointed out that specie currency was subject to fluctuation, just as was paper. Moreover, fluctuations in the value of specie could not be regulated; they were dependent on export, real wages, product of mines, and world demand. An inconvertible paper, however, could be efficiently regulated by the government to maintain its uniformity. “Anti-Bullionist” proceeded to argue that the value of money should be constant and provide a stable standard for contracts. It is questionable, however, how much he wished to avoid excessive issue, since he also specifically called a depreciating currency a stimulus to industry, while identifying an appreciating currency with scarcity of money and stagnation of industry. One of the particularly desired effects of an increased money supply was to lower the rate of interest, estimated by the writer as currently 10 percent. A lowering would greatly increase wealth and prosperity. If his plan were not adopted, the writer could only see a future of ever-greater contractions by the banking system and ever-deeper distress.

Even chartalists will be happy to see that early proponents of the “American System” of nationalist public-private industry were representing their views in the debates of the early 1820s, for example:

Law pointed to the great amount of internal improvements that could be effected with the new money. He decried the slow process of accumulating money for investment out of profits. After all, the benefit was derived simply from the money, so what difference would the origin of the money make? And it would be easy for the government to provide the money, because the government “gives internal exchangeable value to anything it prefers.”

Why even have a private industry? Or money, for that matter?

Luckily, advocates of laissez-faire existed in this time period, too, and they were not silent. Commenting on one proposal to deal with “idle capital” by Matthew Carey, the “Friends of Natural Rights” wrote:

The people of the United States being in a very unenlightened condition, very indolent and much disposed to waste their labor and their capital… the welfare of the community requires that all goods, wares, merchandise and estates… should be granted to the government in fee simple, forever… and should be placed under the management of the Board of Trustees, to be styled the Patrons of Industry. The said Board should thereupon guarantee to the people of the United States that thenceforth neither the capital nor labor of this nation should remain for a moment idle.

[…]

It is a vulgar notion that the property which a citizen possesses, actually belongs to him; for he is a mere tenant, laborer or agent of the government, to whom all the property in the nation legitimately belongs. The government may therefore manage this property according to its own fancy, and shift capitalists and laborers from one employment to another.

Finally, I don’t seem to have made a good note of the specific passage that caught my attention in this regard but I chuckled when reading the description of the operations of the average bank before collapse. These bankers would set up a new bank and pay only a fraction of capital with specie, the rest would be constituted by additional promissory notes from other banking institutions (which were themselves fractional). The bankers would pay themselves dividends, in specie, while the bank operated, and issue themselves and their friends enormous loans with which they’d purchase real goods and services, all while the real specie capital of their bank depleted. When crisis hit and they could not redeem their depositors’ money, they’d get legal permission to suspend redemption, ask for infusions of new capital from state authorities and/or set up a brand new bank whose purpose was to steady the previous institution. Ultimately, the bank would collapse and this too would work in their interest because they’d already hauled off the specie via dividends to themselves, and many of them were debtors of the bank who now had loans due in a worthless currency that was easy to obtain.

It reminded me a lot of the present Chinese state capitalist model.

Conclusion

“The Panic of 1819” is not light reading and for some readers it may not even be interesting reading. It depends a lot on how fascinating you find in depth examinations of “minor” historical economic events.

But that doesn’t mean it isn’t surprising, well-written (for all the facts and data, Rothbard still manages to weave together a narrative that helps the reader appreciate the nuances of the various factions and viewpoints of the time) and at times, depressingly relevant. People who care about economic and financial history and unique, formative episodes in the early history of this country, will find a lot of insights and curiosities in this work. I strongly recommend it.

Notes – The Great Deformation, Part III, “New Deal Legends”

The Great Deformation: The Corruption of Capitalism in America

by David A. Stockman, published 2013

Chapter 8
Stockman doesn’t go into much detail on where the boom ending in 1929 came from, but he does provide an interpretation of why the bust lasted so long and went so deep– the forcible closing off of international trade via protectionist policies and the undermining of the global gold-backed monetary regime by American and European governments alike.

In Stockman’s telling, American president Herbert Hoover was a mostly free enterprise and sound money kind of guy who wanted to avoid inflationist solutions to the economic slump. By 1932 the economy had liquidated the bulk of the malinvestments in excess inventories and capital assets and was ready to turn toward genuine recovery. This process only took as long as it did because ill-reasoned policies like the Smoot-Hawley Act in the United States and similar nationalistic policies in European states along with uncertainty about the British plans to keep the gold-backed pound sterling in place hampered international trade flows. According to Stockman, the United States between 1914 and 1929 had become, much like China circa 1994-2012, a major exporter of capital and consumer goods to the rest of the world particularly in response to trade and economic disruptions of industry and agriculture in European economies during the First World War. The US economy was geared up to provide steel, cotton, cereal grains and other commodities to the rest of the world and had a hard time adjusting output to meet domestic demand when the collapse came in 1929.

Then came FDR and his unique brand of economically inane autarkic nationalist policy. Stockman faults FDR for prolonging, nay, creating, the actual Depression singlehandedly. First, FDR began his presidency by fomenting a banking crisis and declaring a major bank holiday which Stockman saw as unnecessary. As Stockman tells it, the 12,000 some bank failures in the United States during this period mostly occurred in over leveraged regional/rural banks centered around the agricultural and export-oriented areas of the economy representing at most 3% of banking system deposits. Major money center banks in financial centers such as New York never faced a solvency crisis, making FDRs response a solution to a nonexistent problem and therefore a serious problem-creating blunder itself.

Second, FDR torpedoed the London Conference on international monetary mechanisms, throwing the whole system into chaos and instigating another round of protectionist measures at home and abroad. Third, he arbitrarily decided to undermine the US’s own commitment to a constant redeemability ratio for the dollar, creating further fear and uncertainty in the economy. And finally, he created a cartel system (National Recovery Administration) which served to freeze prices, arbitrarily shift capital around the economy and buy votes as necessary but did nothing to create the kind of stable conditions preferred by business people and entrepreneurs attempting to make capital investments to serve anticipated consumer demand.

The Depression was a recession that was working itself out despite the protectionist political measures put in place which made adjusting the structure of production to domestic rather than foreign needs, but then FDR came along and made the economy his plaything as he tinkered according to his whims and played power broker on the side. That’s what turned the recession into a true Depression.

Chapter 9
Fannie Mae, which was envisioned as a way to revitalize a moribund middle class housing market during the Great Depression by creating a “secondary market” for uneconomic 30 year mortgages at subsidized interest rates, has in the 75 years since its founding led to the total corruption and now nationalization of the home loan market. The creation of the secondary market divorced mortgage underwriting from mortgage servicing as it allowed for mortgages to be easily issued, packaged up and sold to investors as government-backstopped financial products. Further, it resulted in local savings funding local housing investments being transformed into a national and now international market, with the final result being that “Red China” bankrolls $1T+ of the federal home loan market due to balance of payment issues tied to competitive currency issuance.

Social Security, rather than being the crowning social achievement of the New Deal, was its greatest fiscal folly and has created an embarrassing Ponzi legacy that is with us even today. The systems actuarial projections were based on an impossible 5% continual GDP growth rate. The payroll tax used to fund it has proved “regressive” and continues to grow over time, with a current 6.5% of GDP consumed by the tax. The $3T of “trust fund reserves” have been lent out and spent by other parts of the government and represent nothing more than future taxes due.

In so many words, the innovation of deposit insurance combined with the Glass-Steagall act, a bout of inflationary monetary policy which destroyed the profitability of traditional deposit lending under Glass-Steagall and then a round of “deregulations” designed to create new areas of profitability for banks at the expense of growing moral hazard resulted in the utter corruption of the system and the inevitability of a major financial meltdown as witnessed in 2008.

With the outbreak of war in Europe in 1914 and the initiation of a war loan program by the United States government, US farms became the breadbasket of the world. They took on massive debt to expand capital machinery and bring additional acreage into cultivation which resulted in growing farm output prices. When the war ended, the capital investments, including the debt overhang, remained. The financial collapse in the 1930s further exacerbated the situation, leaving farmers as a desperate coalition looking for a political solution to their contractual obligations.

With the nations farmers the hardest hit by the twin spikes of failing cash flow and high debt burdens, they became a powerful voting bloc that got FDR elected which allowed for the cartelization of the farming industry to take place. The thought was that cartelizing the industry and pushing up farm and farm output prices would result in a return to prosperity as rural buyers bought manufactured products from city centers. With their programs in place, the farming lobby was then willing to trade votes for growth and maintenance of these subsidies and controls going forward into the future.

The “Thomas Amendment” created four options for expanding the money supply via currency issuance or gold or silver content debauchery. This inflationary response was seen as the proper antidote to too much debt and too little money and political authorities of the day figured it would give them a free pass to avoid the pains of the bust following the ill-gotten gains of the boom.

FDR channeled the $2.8B windfall from his emergency dollar “revaluation” against gold into his Exchange Stabilization Fund, which the Secretary of the Treasury was then able to disburse at his discretion, turning him into what Stockman calls a “money czar” much like Hank Paulson and Neil Kashkari during TARP.

Chapter 10
In this chapter, Stockman argues that World War II and the Korean War were the last wars to be mostly financed by current taxation in the US. WWII in particular saw a rise in household saving and a decline in household indebtedness that offset the massive rise in public indebtedness. He attributes this in part to the fact that wartime command economy measures dictated that there was little to consume on store shelves, in part to the fact that the government’s propaganda campaigns for war bond drives were a success and in part because the government had adopted an arbitrary bond yield peg that lowered investment returns in competing assets and made government bonds more attractive as a conservative savings vehicle.

Stockman claims that William McChesney Martin, who headed the Fed through the 1950s, was a “tribune of sound money” and saw it as his mission to restrain credit expansion and tame the inflation rate, rather than to stoke it like modern Fed heads. He also claims that the Fed only lent on liquid commercial receivables during this era, compared with the present where the Fed has become a warehouse for illiquid claims on real assets.

Chapter 11
Stockman argues that President Eisenhower was the “last of the fiscal Mohicans” dedicated to trimming federal budgets and making government spending respectful of tax revenue means. At the same time, a growing chorus of voices on the right and the left begin arguing for a “new economics”, Keynesian government planning of the macro economy, to not only fight recessions but “fine tune potential GDP” during recoveries and booms. This theory comes at the expense of sound money and has a pro-inflation bias.

Chapter 12
Following World War I, Great Britain attempted to return to the pre-war parity between the pound Sterling, gold and the US dollar despite a massive inflation during the war years. At the same time, the British government embarked on an expansion of its domestic welfare programs which ultimately broke the back of the pound culminating in the London gold conference in 1931 which proved the futility of maintaining the old exchange ratios in the face of inflationary chaos.

At the end of World War II, the United States attempted to take the lead with a gold-backed dollar as the world’s reserve currency in a new arrangement, the gold exchange standard, engineered at the Bretton Woods conference in 1944. Of course, the architect of this scheme was the exact same architect of the doomed British plan (monetary and social policy), the imperious Lord Keynes. And rather than a true gold standard, what Keynes wrought was a feeble attempt to hide dollar inflation by creating a scheme where foreign exchange was to be exchanged for dollars, not gold, which was ostensibly suppose to allow additional credit and currency to be pyramided atop the same amount of gold reserves at formal exchange rates.

For a time, this precarious system seemed to work, helped along by the US-led international “gold pool” which sought to exchange gold against currency to calm price increases in the private London gold market.

However, the decision to engage in fiscal expansionism in the US via welfare spending increases and costly wars abroad (ie, Vietnam) all financed by deficit spending rather than real tax increases led to an unhinged inflation and a boiling London gold market. The international gold pool was quickly depleted in a series of panics in the late 1960s, eventually culminating in Nixon’s infamous closing of the US gold window.

This “guns and butter” policy, led by the intellectual disciples of Keynes ensconced in major US universities, was the final nail in the coffin of sound money in the US, and perhaps even the world, and ushered in a new era of freely floating currencies, chronic deficits, massive credit expansion and a seemingly never-ending series of financial and economic bubbles that we are all living with the consequences of today– ironically, the media at the time was fooled into believing this “enlightened” policy had permanently tamed the (government-policy induced) business cycle.

Chapter 13
Milton Friedman, hailed as a staunch libertarian and champion of small government politics and free market economics, gave intellectual blessing to the greatest economic bastardization of all time– the transformation of the gold standard US dollar, once and for all, into the “T-bill Standard”.

Friedman’s erroneous analysis of the cause of the Great Depression — a crashing M1 money supply caused by an overly tight Federal Reserve — led him to faith in a new standard for monetary policy, a simple inflation targeting of 3% per annum, with the market smoothing out the rest. Friedman believed that if the Fed could credibly adhere to a uniform rate of inflation over time, the business cycle could be banished and the economy would be free to grow without abatement and without the restrictive context of a gold-backed currency.

This new policy proved its danger almost immediately with the out of control inflation of the 1970s and opened the door for unending deficit finance by the federal government. And while Friedman had hoped for a series of Fed chairmen who would objectively guide the M1 money supply along this path (a strategy destined to failure because it turns out the Fed doesn’t control M1, market demand for loanable funds does) instead the office has been inhabited by activist acolytes since the tight money days of Volcker.

The current global monetary regime of competitive free floating currencies is truly without precedent and much of the modern US’s largesse was financed by willing mercantilist politicians in foreign trading partner nations. It remains to be seen what happens to this system when one or more countries reach the end of their rope, domestically, and are not longer willing to import the United States’ inflation as they export their wealth to foreigners for consumption.

More Banking Confusion: Liquidity Versus Solvency

Here is a choice quote from the recent EconTalk podcast with Anat Admati of Stanford University:

Well, they have fancy ways to talk about banks, and we try to unpack those. They talk about maturity transformation, liquidity transformation. What that means is really that the depositor, the people who lend to the banks, often time want their money quickly, especially demand deposits. But when they invest it, they kind of invest it longer term and in less liquid things. So there is a sort of imbalance between the money that they use to fund and their investment in the sense of the length of time until something has to happen and also the speed with which they have to pay versus get paid. And so that mismatch creates fragility by itself, which also means for example if all of us run to the bank at the same time then the bank may not be able to cover all of that. Even if it technically would be solvent, it has everything, that’s kind of an inefficient run that you could have, in principle. So basically the banks tend to run a little bit more than other people into liquidity problems. You could say that, just, I have the money but I didn’t go to the ATM kind of thing–I can pay you back but we’re going to have to find a liquidity solution, sort of a rolling back my debt. Their funding is kind of fragile almost by definition because of the way it comes and the way people can come back for their money on short notice or any time they want. So that’s part of the funding. And the investments are not as liquid or longer term than that. (emphasis added)

This is an utter confusion. This is not a “liquidity problem”, it’s a solvency problem.

Money-in-an-ATM is not the same economic good as money-in-my-hand. That is, money-five-minutes-from-now is not the same as money-right-now.

They are separate economic goods due to the time value of money. What Admati has done is create an arbitrary distinction between a future money good and a present money good, by projecting her preference/judgment onto an exchange involving two other parties of which she is not one.

If party A demanding “liquidity” from the bank B truly saw no difference between money-right-now and money-a-few-days-from-now, for example, then a bank run would never happen and these items would trade at the same price, which they do not.

This is a fundamental error of economic reasoning. I expect a professor of finance and economics to understand something like this and as a result I find myself disappointed to see that she does not.

Economists and politicians only let banks get away with this. If anyone else were to be so arbitrary and haughty toward contracts they’d be thrown in prison, but for banks insolvency never comes so long as you can contort logic to the point that you convince yourself that all that’s missing is a bit of liquidity.

This is more free lunch thinking.