Philadelphia Reflections

The musings of a physician who has served the community for over six decades

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Westphalia: Church Politics Adjusts Boundaries, Then Everything Changes
In 1648, the Treaty of Westphalia created the modern nation-state.

Debt and Corruption: One of Them May Ruin Us, or Save Us

We are going without a metal gold standard, substituting 2% inflation targeting because we don't really know what else to do. And we seem to be getting away with it, although most people don't trust it. And indeed we have the shock of discovering that the Phillips curve (inflation and joblessness balance each other) doesn't work because we just can't get inflation to rise. By the way, this includes Milton Friedman, who blamed it on the Federal Reserve, but that can't be right, either. Don't listen to experts -- no one knows why this is true. I have a solution which hasn't been tried: we could use index funds as a new gold standard. They would be a real currency backing, which would flexibly respond to inflation and deflation. Come back in a century, if you want to find out how that works.

We have too much paper money. That's another way of saying the banks have thirty times as much paper money as they have hard currency (safe) reserves to back it up. We started out with banks making it two to one, two centuries ago, and gradually raised the ratio. No one knows what the right ratio should be, so we push the envelope and watch. One day, it will be too much, but it will then be too late to do anything about it. Thirty to one seems to account for most of our prosperity, but we have several billion of the world's population still living in poverty, but with atom bombs to blackmail the rest of us. So we apparently are going to inflate the bubble until it breaks. Then we will know what the right ratio should have been. Along comes Stephan Moore of the Heritage Foundation, with either the greatest trial balloon in history or else the best idea. Who cares why interest rates are so stubbornly low, just take advantage while that is the case. He suggests we take advantage of stubbornly low rates to have the federal government issue long-term bonds until interest rates rise, possibly paying off our national debts with the profits. And also bankrupting almost everyone whose survival depended on continuing low rates, and will surely oppose the move. At least, the argument may surface the reason the Phillips Curve stopped working.

Along a different line, James Madison was scared to death poor people will outnumber rich people, so in a democracy, poor people will win. They will vote themselves free college, free medical care, free wealth they didn't earn. We will then be tempted to substitute dictators for leaders, sacrificing democracy permanently to have the joys of a dictatorship temporarily. We may try everything else first, but what we need is something which will work, not demagogues, and probably not college professors, either. God help us if we start electing newspaper columnists. Even Ben Franklin learned that much.

Just remember how long we have been tinkering with bankruptcy solutions. Instead of cutting your heart out if you don't repay your creditors, we improved things somewhat by putting defaulted debtors in prison. Morris the billionaire showed George Washington how to strip all personal wealth from the defaulted debtor in exchange for extinguishing their debts; it's called bankruptcy. The banks figure out how many defaults they will have in bulk, and add that charge to the interest rate they legitimately charge substandard risk debtors and illegitimately charge a lesser amount to non-risky debtors. Unfortunately, lots of people have figured out how to cheat on their bookkeeping, and with cell phones, soon tell their friends. Just have the government bail out bad debts, and then tax the rest of the population to pay for it. It's that last step which makes it socialism. In Philadelphia, someone a century ago thought it was a good idea to have a city/county consolidation, with sheriffs sales to pay the bills. Today, hundreds of millions of dollars are skimmed off this arrangement by corrupt politicians, and the current --allegedly non-corrupt-- Mayor is running for re-election on the promise he will absorb this revenue for worthy causes, like education. In most cities in this country, this corruption goes on, because it pays off. We have had this corruption for a century, and keep electing the same people to continue it. Yes, I know we have a drugs problem, but we voted for this scam and the taxicab medallion scam. We need a few more people to get mad, but they soon turn into elected crooks, if the rest of us let experts seem to run things. Our Constitution assumes half of the public are inherently honest and the other half are inherently bad apples, seeing its job is to maintain a balance between the two.

In short, the Supreme Court could easily fix this, by fixing enforcement and penalties. Let's see if they try. Congress could also fix this, but it would be opposed by others in Congress. The overall potential might be to lower consumer and retail interest rates, because bonds average 5% return over the long run, while equities average 10% for the same risk. If stocks and bonds returned an equal amount, as they should, there should be a doubling of effect. Bonds are mostly purchased by insurance companies, forced by state insurance commissioners to limit equity purchases to 10%. Presumably, insurance commissioners are holding down the cost to the state of municipal bonds, so the cost of this subsidy is not visible. But the net effect is to have the municipal taxpayer subsidize the defaulting debtor. The tax exemption of municipal bonds is yet another feature of this subsidy, in this case drawing the federal government into the process.

Simplifying somewhat, raising the permissible insurance commissioner's permissible level of insurance company's purchase rate from 10% to 11% would double the permissible stock purchases by insurance companies. Not enough to pay off the national debt to foreigners, perhaps, but demonstrating the opportunity just waiting for a presidential candidate to exploit in his campaign.

 

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