The Lessons of Czar Nicholas II

Critics of the "Occupy Wall Street" (OWS) protests and similar actions around the country and around the world use the term "class warfare" to describe the objectives of the protesters. These critics use terms such as "socialist", "communist", and "anarchist" to dismiss the protesters and their concerns. Supporters of OWS spend too much time is spent arguing against these irrelevant points—it just doesn't matter whether their characterizations are true or false.

Let's then grant the following premise (which aren't actually true): OWS is nothing more than a bunch of communists intent on class warfare against the established power structures of the West. Does this premise mean their concerns should be readily dismissed?

Whether or not you want to grant those assumptions, communism is bad for many reasons not worth discussing in this blog. Any idea that you will address society's current ills by implementing Communism is, at best, misguided and, at worst, a recipe for the Soviet States of America. So, if we grant the absurd premise that the OWS protesters all are trying to overthrow American capitalism for Soviet communism, we're also granting that the protesters' solutions to our ills might be as bad or worse than the disease.

The Russian Revolution (the short version)

Nearly 100 years ago, Russia faced a real class war between real communists and a real ruling elite in the form of the feudalist Russian monarchy led by Czar Nicholas II. The world of early 20th century Russia was a political system based on a largely absolute monarchy with a feudalist economic system. Under feudalism, the "means of production" are controlled by land owners who make up a hereditary aristocracy. If you did not own land, you were at the mercy of your landlord for your economic well being. You essentially worked his land in exchange for protection, housing, and basic sustenance.

It's worth noting that Marx really didn't see communism as a replacement for feudalism. He believed societies needed to go through a progression from feudalism to capitalism to socialism and finally to communism. He also believed that these changes did not occur naturally—they required revolutions.

In other words, the status quo in Russia was a really bad thing with horrible injustices in place. Furthermore, that society did not provide any means for the disadvantaged to alter those injustices. A number of groups nevertheless attempted to make things better, including the Bolsheviks* (aka the Communists). The Bolsheviks were governed by an ideology based on the writings of Karl Marx—Communism. Communism sounds like a great idea in theory. It is an economic system that distributes goods and services based on need. Who wouldn't want a utopia in which everyone gets what they need?

Well, I don't. But that's beside the point and an argument for another time. The point is that Marx painted a very compelling picture to a people abused by a corrupt and unfair economic and political reality. Regardless of how silly or dangerous that picture was, it didn't change the reality that the people of Russia were being harmed daily by an unjust system.

Would anyone today seriously defend feudalism because some of the people protesting it were misguided in the solace they sought from communism?

Even if you would, there's no denying they were seriously pissed off and the result was the Soviet Union.

Having the Wrong Solution Doesn't Mean There's No Problem

We can learn two lessons from Czar Nicholas II and the Russian Revolution:

1. Because the people who see a problem have the wrong answer to a problem doesn't imply that there's no problem.
2. If the people capable of providing a just answer don't provide one, then the people with the wrong answers will ultimately force those wrong answers on everyone else.

The second lesson is much more dire than the first. Russia suffered through 70 years of authoritarian communist rule because the people who solved the problems of czarist feudalism were the Bolsheviks.

The voices of OWS are growing louder because there is a real problem. We've created false democracy in which political speech is equated with wealth and corporations are treated as persons. The result of this situation is the appearance of democracy when in reality only corporations and the people who govern them have any voice in how we are governed. The way Wall Street has behaved since the de-regulation of the late 90's has helped it do serious damage to the world economy and the companies that make up Wall Street have been immunized from those with political power from the capitalist forces that have traditionally make the US economy such a significant success.

The United States is no longer a capitalist democracy. It's a corporatist oligarchy with shades of democracy.

Some of the loudest people among the "Occupy Wall Street" crowd have the wrong solutions to this unsustainable situation. Some of them, however, might have the right answers. Ignoring all of them and pretending they are all Bolsheviks only increases the chances of real class conflict and, perhaps, real class warfare.

A Proposed Solution

I have a simple proposal for a solution that should address the valid objectives of the various OWS interests in the United States while not damage the fundamental values of our capitalist democracy. It's a Constitutional amendment that restructures the way campaigns are financed in the USA.

When you listen to the different voices of OWS, one theme emerges: People are tired of a nation in which wealth determines political voice. When spending money is considered free speech, those with more money will always have more speech. When corporations are considered persons, the considerations of large businesses will always outweigh the concerns of the small business or the individual. Let's end the idea of money as speech and corporate personhood through a Constitutional amendment that restructures the financing of political campaigns.

That means the public financing of all campaigns and elections. All candidates of significance should have equal amounts to spend on elections for public office. All entities with licenses to broadcast over public airwaves (radio, television) must be required to grant candidates equal time to make their case for election. Congress could be allowed to define what "candidates of significance" means, but it should be sufficiently lower to allow for multi-party elections.

Perhaps something like (I am not a lawyer, so this is obviously not bullet-proof legal wording):

The Campaign Finance Reform Amendment

1. Public funding. Elections for public office shall be funded entirely through public funds with the level of such funding determined from time-to-time by actions of Congress for federal elections and the States for state and local elections. All candidates of significance for public office shall have access to equal funds where "candidates of significance" may be determined by acts of Congress and the States. Definitions of "candidates of significance" must include at least three candidates for any office unless there are fewer than three candidates running for the office in question.

2. Independent groups. Congress may establish laws allowing for private citizens to form political groups that may act independent of candidates, but funding for those political groups must come from individuals and not many other kind of entity. Any monies in excess of $100 to a political group must be made public.

3. Use of public airwaves. All entities granted specific licenses over public airwaves must provide access to at least 5% of their total airtime to candidates free of cost in a manner equal in quality and quantity.

* Fun fact: The term Bolshevik comes from the Russian word for majority (the 99%?).

 

Economics, Not Ideology

The battle cry of the Tea Party and so-called "fiscal conservatives" is "Households balance their budgets, why can't the federal government?" It's a nice slogan designed to support a strong anti-government ideology, but it has no basis in economics.

Let's do a simple thought experiment.

Imagine a government with a $100B/year revenues from various taxes and spending appropriations of $100B/year to match. This is a government with a balanced budget. The spending equals the revenues and no debt is created. In addition, no free cash is created.

The problem with this scenario is the nature of the revenues. The revenues are directly dependent on the overall health of the macro economy. If the economy grows, revenues grow and we get excess cash (surplus). If the economy shrinks, revenues drop and we either a) fail to pay the bills for our appropriations or b) borrow money to cover the shortfall (deficit).

Obviously, with a growing economy, this isn't so bad. We have a surplus and don't have all of these discussions about deficits and bond ratings. With a legislated balanced budget, we either give that money back to the tax payers or increase spending (or, possibly, simply make an appropriations for a "rain day" fund).

The problem is the shrinking economy. In a shrinking economy, you have a private sector that is pulling back from investing in growth to a more defensive strategy oriented around cutting costs and gaining efficiencies. Companies stop cutting costs when the economy hits rock-bottom and they are operating at maximum efficiency. They begin hiring again when they see predictability in the economy and feel they safely can begin investing in growth.

When the government cuts spending to match lost tax revenues, it does two things:

1. It creates greater recessionary pressure on the economy because government spending is part of the economy. When you remove that spending, you by definition shrink the economy.
2. It adds to economic uncertainty. Under this scenario, forcing a balance budget means that government spending is no longer a fixed, predictable part of the economy. It instead becomes another downward trending point of uncertainty.

When government cuts spending (or raises taxes) during a weak economy, it takes money out of the economy and creates economic uncertainty. It makes the problem worse.

To be fair, running a deficit doesn't come without cost. Every dollar the government borrows today is a potential tax increase tomorrow of $1 plus interest. Let's continue the thought experiment.

Our $100B tax base drops to $75B in the recession. It lasts one year, and then we recover to normal levels. Our spending is now $100B plus debt service on the $25B from the recession. We have to raise taxes at this point to get the money for debt service or hope the economy grows to match.

In short, it's just not as simple as "balance the budget". Running a deficit is bad for long-term economic growth. Cutting spending and raising taxes address the deficit, but they are bad for short-term economic growth. Increasing spending and cutting taxes are good for short-term economic growth, but they create a deficit.

The narrow-minded focus on the deficit as the problem facing the US is causing us to ignore the real problem: jobs. The reason this recovery is so weak is because companies just aren't hiring right now. They aren't hiring because there's so much uncertainty from the government right now. And the uncertainty from the government is almost entirely a result of the bickering in Washington right now because no one really knows what way Washington is going to go on August 2 and even beyond.

Policy certainty is what we need from Washington right now, not balanced budgets or spending programs or tax cuts or tax increases or spending cuts.

Let the Big Three Die

All of the consequences of GMs failure that proponents of a bailout use to argue support the bailout idea are true. If GM fails, people are out of jobs, good companies that have done nothing worse than offer services to GM will suddenly be saddled with bad receivables and the prospect of not making payrolls, and the state of Michigan will plummet in despair. 

But those arguments do not justify a bailout. Ford, GM, and Chrysler are poorly run companies with bad products. They have not continued to operate over the last 20 years by innovating and meeting consumer demand; they have remained in business by chaining the state of Michigan to their well-buying and spending money lobbying the US government for regulations that favor the folly of their product offerings.

Few industries have the luxury of seeing a trend coming for 30 years. The auto industry has had that luxury. We have all known that the price of gas would eventually go through the roof (and it will again). Japan, Germany, and the other auto-making countries recognized this and have a number of different products on the road today to match that need.

But not Detroit. 

In the past election, we had a number of silly discussions about "socialism" and "capitalism"—as if a 4% difference in tax rates on the highest 5% of income earners was somehow that dividing line. Bailing out the Big Three, however, is actual socialism. The worst of socialism. It says that employing people is more important than the value they add to our society. It also ignores what we know is a failure of socialism: if you save a job today that should not be saved, you will have to save it again tomorrow, and the next day, and the next day. And they will become less and less worthy of having a job as time goes on.

So, the bailout people have clearly illustrated a short-term impact. It's devastating and real.

Here's the long term outlook:

GM fails and sells off its assets, probably to a foreign car marker or a silicon valley company. Ford fails and sells off its assets. Chrysler sneaks by. Michigan goes into a severe depression and hordes of people leave Michigan for good. The auto-makers no longer control Michigan politicians and, amazingly enough, Michigan finally diversifies its economy. It learns how to survive without the auto-makers and eventually starts to see a prosperity that is actually earned prosperity. Detroit is no longer the cesspool of the nation.

On the other hand, if the Big Three are bailed out, we will save some jobs (there will still be a lot of layoffs), executives will get their golden parachutes, and we will be back in this position again in the future. You know why? Because these are bad companies. They must fail.

And if they truly are too big to fail, they must be broken up.

Analysis of the Economic Crisis

This economic crisis is every bit as serious as its being billed. The bottom line: if nothing gets done about this situation, no one will lend money. Period.

I know there is a minority of anti-fiat money people who think that is a good thing; but the reality is that it is a horrible thing.

You know in the good ole days the ads that said, "Bad credit? NO PROBLEM! You're approved." Today, those will read, "Good credit? DOESN'T MATTER! WE WON'T LOAN YOU A DIME!"

Why?

To put it simply, our lending institutions don't have the capacity to lend any more money. All of these "trash debts" on their balance sheet have diminished their reserves and put them at great risk. They just can't lend any more money unless the following things happen:

1. They increase their cash reserves
2. They decrease their risk profile

So what happens? Perhaps the most critical things are that:

• Big businesses don't have the cash to operate properly
• Small businesses can't get loans to make payroll or expand
• Individuals cannot buy houses or cars

Net result: an economic downward spiral

Individuals stop buying houses because they cannot get loans. Housing values decrease. Loan defaults increase as more and more people are upside down on their mortgages.

Small businesses simply go out of business because they cannot make payroll. New businesses cannot start (as an aside, one of the saving graces of a traditional recession is that people losing jobs start businesses that inject economic growth into the economy; that won't happen here because people losing their jobs won't find capital).

Big businesses that normally can borrow their way through economic downturns suddenly find they have no place to find capital. They cut jobs dramatically or go out of business.

HUGE job losses.

In short, we are honestly talking economic catastrophe. And I don't see where we recover. Eventually, I believe in America and believe we would recover. But this is Depression-style badness.

The Proposed Solution?

Any solution must create a health financial system capable of providing capital for economic growth. In other words, that has to be the end objective to deal with the short-term crisis.

Obviously, a long-term solution needs to include checks against lending the protect against over-exuberant lending to high risk customers as well so we don't end up in the same bucket the next time we have a real-estate bubble.

The proposed solution involves having the government buy off these "trash debts" at a fairly absurd price. For whatever reason, Paulson has proposed buying these things out at above the institution's carrying price (the carrying price is what the bank values the debt at on its balance sheet). The market price is well below that rate. For some reason, Paulson claims the market price undervalues these debts. I think that's bullshit. The market price is the right price.

At any rate, the government buys these debt instruments and then collects the payments. In an ideal world, everyone ends up paying back their loans and the government makes a profit. If the rate of return on the profits exceeds the interest the government is paying to borrow all these money, the US government ends up making a net profit.

In the mean time, the financial institutions are relieved of the burden of these risky debts AND they have money to loan into the economy.

Good news?

Well, three problems:

1. As mentioned above, Paulson is currently seriously overvaluing the debt. As a result, the government will overpay for these bad debts. That means more interest the government is paying on the money it is borrowing, and the harder it will be for the taxpayer not to get saddled with higher taxes to pay off this loss.
2. That's a lot of money being injected into the economy outside normal channels. I honestly fear two things:
   1. Inflation will kick in
   2. The Fed will have to hike interest rates a lot, thus making capital hard to get!
3. The proposal as I understand it now lacks important checks and balances. As a result, there is a lot of opportunity for corruption. If you are a Republican and don't care that Paulson has absolute authority over $700B, keep in mind it could be a Democratic appointee in the near future with that control. Either scenario is untenable. Beyond the risk for corruption is simply the risk of incompetence. Even with the best intentions, $700B in the hands of incompetents without any oversight is a bad thing. And finally, without tying any strings to this buyout, we risk these financial institutions turning around and making the same stupid mistakes.

Who is to blame?

Everyone is to blame. Not simply Republicans and Democrats. Managers and home owners, farmers and financial gurus.

It does start with the relaxation regulations governing financial institutions that began in the 1980s. These regulations were put in place in the 1930s in response to the excesses that caused the Great Depression.

Remember, in the 1920's we had a rapidly expanding economy with little regulatory oversight over financial markets. The result of the two things combined helped cause the Great Depression (among many, many, many other causes).

Fast forward to the 1980's. We relax many of the regulations meant to prevent another Depression. That relaxation continues through the end of the 1990's. In the mean time, we have an amazing period of economic growth.

So, what happens? Lots of capital is sitting in our financial markets as a result of rapid economic growth. Low inflation means that the cost of lending is low. And the lack of oversight combined with phenomenal growth in real-estate values makes financial institutions more and more willing to accept inappropriate loans (the real-estate values are key; they create the illusion that the loans are less risky than they really are).

So, now combine lack of regulatory framework with bad business decisions.

And add to that bad personal finance decisions. People are accepting way too much debt because they believe their home values will double in 5 years or something stupid.

So, we have:

• Lack of regulatory framework
• Rapid economic growth
• Rising real-estate values
• Low inflation
• Bad business decisions by financial institutions
• Bad personal finance decision by individuals

Remove 1 from the mix, and things are likely not so bad. Mix up the cocktail, and BOOM!