Peter T Treadway, PhD
Historical Analytics LLC
www.thedismaloptimist.com
pttreadway-at-hotmail.com
305 761 4718
July 14, 2011
THE DISMAL OPTIMIST
THE MARKETS WILL DECIDE – PART II
“The right of suffrage is a fundamental Article in Republican Constitutions. The regulation of it is, at the same time, a task of peculiar delicacy. Allow the right exclusively to property, and the rights of persons may be oppressed… Extend it equally to all, and the rights of property or the claims of justice may be overruled by a majority without property, or interested in measures of injustice…
In a just & a free, Government, therefore, the rights both of property & of persons ought to be effectually guarded. Will the former be so in case of a universal & equal suffrage? Will the latter be so in case of a suffrage confined to the holders of property?”
James Madison, 1787
“In democracies the main alternative to majority rule is not dictatorship, but markets.”
“What happens if fully rational politicians compete for the support of irrational voters—specifically, voters with irrational beliefs about the effects of various policies? It is a recipe for mendacity.”
Both quotes from Bryan Caplan, The Myth of the Rational Voter
Urgent Bulletin – What Are the US Lawmakers Using for Brains?
The Sovereign Debt Crisis has come to Europe. Decades of populism and state intervention are finally catching up with the weaker European economies. The Europeans have a real crisis on their hands.
The US on the other hand with its debt ceiling impasse in Washington has a make-believe crisis. The markets are not demanding – not yet anyway – that the US mend its evil fiscal and monetary ways. Right now, US Treasury bonds – with the ten year yielding under three percent – are a place of refuge.
So why the threat of self-induced default? It’s the wrong way to go about this since the fiscal conservative, tea-party gang doesn’t have the votes to achieve fundamental reform and the public will abandon them at the first sign of any serious government disruption. They will ensure the reelection of their opponents. The world doesn’t need this artificially induced US crisis. Why the rush? Sooner or later the real Sovereign Debt Crisis will come to the US. The Potomac solons will get their chance then. Why should the US shoot itself in the foot now when sooner or later the markets will do it anyway?
Broad Historical Trends Unfold So Slowly – But They Are Unstoppable
Now to the main topic. In my opinion, representative democracies contain within themselves a fundamental populist urge that glacially though inexorably propels these democracies to governmental default. There are two alternative approaches to the economy that democracies face, viz., leave economic decisions to the markets or have them be guided and controlled by the state. Citizens of representative democracies have perceived two options to improve their standard of living: 1) hard work, self-improvement and maybe luck within the market system or 2) voting for representatives that will allocate benefits (entitlements) to them.
Since the end of the nineteenth century the statist, populist urges have become more irresistible. Option 2 and state control, redistribution and socialization of risk, has been the road increasingly taken by Western democracies (including Japan). Economists of the free market bent have repeatedly argued that all citizens in the long run will come out ahead if the market rather than the state solution is followed. But –excepting the Reagan/Thatcher interlude — their voices have been ignored. In the US, even the Republican Party, while it dutifully preaches the virtues of markets, has generally when in power expanded the government, redistribution and socialization of risk. As officials facing reelection, Republicans could not ignore the deep-seated populist urges of their electorates.
Moreover, if authors like Bryan Caplan are to be believed, voters instinctively mistrust markets and are not rational on the subject of economics. Voters, according to Caplan, are xenophobic, unduly pessimistic and distrust foreigners, free trade and globalization—the latter being essential ingredients in an efficient twenty first century market economy.
Take Medicare as an example. In 1966 President Lyndon Johnson launched the program in the United States. How could the voters know then over the next 50-75 years later birth rates were going to plunge and that the recipient/worker ratios were going to become so unfavorable as compared to 1966? How could they know in 1966 that medical progress was going to become such an expensive proposition? How could they (with their anti-market bias) realize in 1966 that Medicare was going to become a grossly inefficient way to deliver health services? Why should they have worried anyway? The government would pay. Riccardian equivalence? The notion that citizens increase their savings to offset government borrowings. Nice theory.
Analysts have been slow to connect the dots on the historical trends. Take declining birth rates. In our agricultural past, children were the social security program. Grown children took care of their parents. Today with the welfare state and overall prosperity, state sponsored social security programs (and private pension plans) have replaced children. Children are seen by their parents as a financial burden, a cost. But society is as dependent on children for old age support it ever was. In the total historical process, the birth rate decline is not something that just independently happened. The birth rate decline is an endogenous not an exogenous variable. It is a product of the welfare state and prosperity.
Universal Suffrage – The Holy Grail, the Villain?
The historical movement to universal suffrage is a major underlying force tilting governments toward intervention and populism. The desirability of universal suffrage is regarded as sacrosanct in modern Western political thinking. Rarely do economists dare to even investigate the effect of the shift to universal suffrage on the economy. One exception is Barry Eichengreen, who in his must-read book Golden Fetters, argued that the granting of universal suffrage by the major nations of the world during WWI (and the rise of unions) undermined the support for the classic gold standard.
After WWI the expanded electorates would not allow their governments to leave monetary and macro policy to the workings of a market directed supranational metal standard, no matter how efficient its operation. And so governments gradually assumed direct responsibility for the workings of the market economy and the business cycle and implicitly socialized risk. The classical gold standard was abandoned and replaced by modern central banking, fiat money and management of macroeconomic policy. 1914 was a major turning point. Later would come deposit insurance, various versions of social security and socialized medicine, Fannie Mae, too big to fail, stimulus programs, QE1, QE2, etc., etc.
James Madison, the principal author of the American constitution, did take on the topic of income redistribution and suffrage. As the above quote suggests, he was uncomfortable with the topic. If only a few could vote liberty was threatened. If everyone could vote, those “without property” would vote to take the property of those who had it. One solution to this was the creation of a popularly elected House of Representatives and a countervailing Senate whose members were elected by state legislatures. This solution would later be discarded by the 17th amendment in 1913. Ironically the beneficiaries of Medicare were going to be baby boomers– a group not poor as a whole, many of them persons of property in Madison’s terms.
The history of the movement to universal suffrage varies by country but the broad outline and result was usually the same, i.e., the franchise was initially restricted to propertied males but it later opened up to all adult and even near-adult citizens. Universal suffrage and the rise of the populist interventionist state go together.
American history follows this broad outline although uniquely it carries a major racial aspect. Non-American readers may be unfamiliar with the American story. I offer a historical timeline below on the American march to universal suffrage. (See http://www.infoplease.com/timelines/voting.html). Note numerous recent court decisions and laws not mentioned in the timeline have continued the trend toward suffrage expansion.
1790 Only white male adult property-owners had right to vote (10-16% of population)
1810 Last religious qualifications removed
1850 Property ownership and tax requirements eliminated. Almost all white males could vote.
1855 Some states enact literacy requirements for voting. Aimed at Irish Catholic immigrants.
1870 15th Amendment to the Constitution passed giving former slaves right to vote and protecting right to vote of all male citizens of any race.
1880 Initiation of poll taxes and literacy tests in Southern states designed to keep African Americans from voting. Ways found to exclude poor whites from these requirements.
1913 17th Amendment to the Constitution passed calling for members of the US Senate to be elected directly by the people instead of state legislatures.
1915 Supreme Court outlaws literacy tests for federal elections
1920 19th Amendment to the Constitution guarantees women’s suffrage
1924 Indian Citizenship Act grants all Native Americans citizenship, including the right to vote
1964 24th Amendment to the Constitution bans poll tax in federal elections
1965 Passage of Voting Rights Act protecting rights of minority voters and eliminating literacy tests
1971 26th Amendment to the Constitution sets minimum voting age of 18.
The Sovereign Debt Crisis
Is it possible that modern democratic societies are driven by populist tendencies that take even hundreds of years to reach an inevitable massive default climax?
Following the path of increased intervention, income distribution and socialization of risk, governments increasingly have taken on obligations and interventions that have been financed by debt and have amassed huge amounts of debt. It is my view that the day is fast approaching when advanced country governments including the United States and Japan will be restricted or outright denied market access for their debt. This will bring a wave of economic defaults and reneging on previous debt and entitlements. Massive wealth transfers are likely as this unfolds. The process is already underway. Greece (and the Eurozone periphery) is the canary in the coal mine.
Governments are going to have to default in an economic if not a legal sense. Desperate measures will be employed. Many options will be considered– money printing, significant inflation, financial repression including punitive measures on alternative currencies such as gold, higher taxes , restrictions on foreign investments, invasion of pension plans, reneging on entitlements, curtailment of essential but non entitlement services. Military expenditures will be vulnerable to major cuts. The list goes on. Desperate governments will do anything. But those who lent to the government and who expected major entitlement benefits will be the losers.
Nobody knows when the US will have its debt market access crisis. Some think it will happen in the next year, some over the next twenty years. The odd thing is that US interest rates could stay negative in real terms until the crisis knocks.
As I have said in previous essays, assuming the hard line fiscal hawks do not sweep the 2012 elections there is a significant chance the US could have its market access crisis right after those elections as the markets realize the US is not going to reform. The optimists – or are they the pessimists—argue that the military and underlying financial strength of the US will allow it to go much longer before the crisis hits. Stay tuned.
Peter T Treadway also serves as Chief Economist, CT RISKS Solutions, Hong Kong
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