Rajaji writes about Sri Sri Prakasa and Nehru's policies :
December 18, 1965 Swarajya
Source : Satayam Eva Jeyate Vol : III page : 170
Libertarianism is a political philosophy that upholds individual liberty, especially freedom of expression and action. Libertarianism includes diverse beliefs and organizations, all advocating minimization of the state and sharing the goal of maximizing individual liberty and freedom.
Rajaji writes about Sri Sri Prakasa and Nehru's policies :
December 18, 1965 Swarajya
Source : Satayam Eva Jeyate Vol : III page : 170
Dated: August 05, 2009
Just five months ago, when stock and commodity markets hit rock bottom, capitalism was viewed as seriously if not terminally sick. The Financial Times ran a series of articles labeled "The Future of Capitalism." Economists, politicians, and philosophers saw the Great Recession of 2007-09 as a historic watershed, and produced new visions of a changed capitalism.
Today, that looks like much ado about nothing. Stock markets are booming, commodity prices are rising, and shipping rates have tripled. Pessimists warn of rising defaults in credit cards, commercial realty and corporate debt, so we could have a double-dip recession. But markets believe the worst is over. Despite political and public outrage over "casino capitalism" the financial reforms being contemplated across the world are not fundamental.
Four months ago, pundits waxed eloquent about learning lessons for reform from the financial crisis. Today the greatest lesson of all seems to be that capitalism, with all its flaws, can cope with Great Recessions. We have always had financial crises and always will: that's the nature of capitalism. The system will always need reforms to keep pace with changing technologies and innovations. Yet it has proved its resilience. Mark Twain once said that rumours of his death were greatly exaggerated. The same can be said of capitalism.
In years ahead, financial regulation will definitely increase. But this will change capitalism's profile only slightly, since the financial sector was the most regulated one even before the crisis. Hedge funds, the least regulated financial entities of all, survived the crisis without bailouts, even as banks, the most regulated entities, suffered badly. Regulation does not prevent all crises: Japan had the most regulated financial sector among developed countries but suffered a lost decade in the 1990s. Lesson: while the future will see more regulation, financial crises will still happen.
Stiffer capital adequacy norms look certain, to check the excessive leverage of the last decade. Yet history suggests that financial innovation will ultimately find ways round regulations. Bank regulation was ultimately circumvented by a shadow banking system, and off-balance sheet vehicles. Expect ultimate circumvention of the new regulations. This will not be entirely a tragedy. The gains of financial innovation may initially be eclipsed by losses, but the losses are typically checked after a fiasco whereas the gains become permanent.
In future, most derivatives will have to be traded through a clearing house, ending the counterparty risk that sank the asset-backed securities market. Despite criticism, securitization will continue with modifications. Banks will be able to securitise mortgages subject to retaining a certain proportion of mortgages they originate, a safeguard against excessive risk-taking in mortgage origination.
Some flaws will not be reformed at all. A special US problem is that its mortgages are non-recourse loans: the lender can get back the house after a default, but cannot go after the other assets of the borrower. This encourages massive willful default. Mortgage lenders in India, Europe and most countries, can go after other assets. But US politicians portray the entire housing bust as an evil perpetrated by lenders on innocent home buyers, and this political theatre avoids making borrowers accountable too. This carries the seeds of a future bust.
Politicians rail against excessive executive pay, and pay curbs have been instituted in companies being bailed out. Yet there is no move to fundamentally change payment structures in solvent companies. Some reformers want bonuses to be clawed back after a fall, but in many cases the employees may have left, and it is difficult to pinpoint accountability for innovations several years after they arise.
There is vague talk of reducing the global imbalances that exacerbated the crisis, but no sign of a credible remedy. Neither the IMF nor Financial Stability Forum have the requisite powers to check future imbalances. Asian countries still want to build high reserves as insurance, perpetuating global imbalances. This too has the seeds of a future bust.
Politicians want to check future bubbles, but are unclear how to do so. There will always be differing opinions on when exactly a boom becomes a bubble. Besides, bursting an asset bubble without damaging the overall economy is problematic. High interest rates will check a housing bubble, but will also hit corporates and consumers, and may cause a recession. Imposing stiff margin requirements to check a stock market bubble might drive money into other assets and cause bubbles there.
In sum, no major overhaul of capitalism seems on the cards. The rapid transition from despair in March to the stock market boom today suggests that the markets don't really see the need for great change. The existing system has survived the Great Recession, and that is seen as Great News.
Is this because humans are utterly myopic? No, moaning and groaning about the failings of capitalism are really part of political theatre in a recession. In my youth, the Communist Party would meet delightedly during every recession and proclaim that capitalism was now in its final death throes. Even after the collapse of communism, dirges are still sung by other parties. The singing ends abruptly as economies pick up again, and turns out to be more a recession ritual than an anthem for reform.
Recessions are viewed by the public as outcomes of policy blunders, as tragedies that cost jobs and production. That's certainly true. But recessions are also essential correctives to the excesses inbuilt in a capitalism system driven by animal spirits, innovation, the search for higher returns, and euphoria. The system works through creative destruction. This entails boom and bust, greed and failure, euphoria and panic, fast growth and recession. Recessions and financial crises may look like blemishes of capitalism, but are actually integral to its process of creative destruction.
So, even after reforms, expect more financial crises and recessions in the future. We would be wise to institute reforms that reduce the risks, but even wiser to understand that the risks cannot be ended without ending enterprise and innovation too.
The Smoot-Hawley Tariff Act was passed by the House in May 1929, before the stock market collapse in October, and was enacted in June 1930 despite the opposition of many economists and several leading businessmen. Tariffs were increased 60 percent on 3,200 imported products, although most imports remained duty free. Moreover, most of the tariffs were in dollars per unit, so the real cost of the tariffs increased with the subsequent deflation. This act provoked 60 other governments to enact retaliatory tariffs. The higher tariffs and the general recession reduced total world trade by about two-thirds by 1933, and the U.S. unemployment rate increased from 7.8 percent when the Smoot-Hawley Act was enacted to 25.1 percent in 1933.
Senator Obama had been a cosponsor of the Fair Currency Act of 2007, which would have authorized a countervailing duty on imported products from a nonmarket economy with an undervalued exchange rate. Although directed primarily against China, it was also broadened to include Canada and Mexico. Approval of this act would surely provoke some form of retaliation; the United States is especially vulnerable to retaliation by China, because we are dependent on China to finance our current account deficit. A statement by Treasury secretary-designate Timothy Geithner during his confirmation hearing increases the prospect that the Obama administration will rule that China has manipulated its currency. During his campaign for the presidency, Obama also proposed opening up NAFTA to renegotiate the labor and environmental standards, and he opposed the several outstanding bilateral trade agreements that had been negotiated but not yet approved. During the congressional deliberations on the 2009 fiscal stimulus bill, however, President Obama expressed caution about any Buy America provision that might provoke trade retaliation.
The Davis-Bacon Act of 1931 required that labor employed on a federally financed construction project be paid no less than the local rates on a similar project. The Norris- LaGuardia Act of 1932 made "yellow dog" contracts, which made an agreement not to join a union a condition for employment, unenforceable in federal courts, and it banned any federal injunctions in nonviolent labor disputes. This was followed by the 1935 Wagner Act—which guaranteed workers' rights to organize unions, collective bargaining, and strikes—and the 1938 Fair Labor Standards Act, which established a federal minimum wage and banned child labor. These acts increased the real price of labor services, especially in the industrial sector, and were an important contributor to the substantial increase in the unemployment rate during the Great Depression.
Senator Obama had been an original cosponsor of the Employee Free Choice Act of 2007, the primary effect of which would be to outlaw secret ballots on the decision to certify a union. Another provision of this proposed law would authorize the government to write the labor contract in newly unionized firms if management and the union have not agreed to an initial labor contract within a specified time. Obama has also been a consistent supporter of higher minimum wages, which increases the unemployment rate of young unskilled workers.
A year before the bottom of the Great Depression, the Revenue Act of 1932 increased the top marginal federal tax rate on personal income from 25 percent to 63 percent, increased the corporate tax rate from 12 percent to 13.75 percent, and doubled the estate tax rate. The Revenue Act of 1936 further increased the top marginal tax rate on personal income to 79 percent and the rate on undistributed corporate profits to 42 percent. These two revenue acts increased federal tax rates more than in any other peacetime period and extended the length of the Great Depression by substantially weakening the incentive to work, save, invest, and increase productivity.
During his presidential campaign, Senator Obama proposed a combination of tax credits for low- and middle-income households, a substantial increase in marginal tax rates for those with an annual household income over $250,000, and several selective changes in business taxation. The top marginal rate on income would be increased from 35 percent to 39.6 percent, the marginal payroll tax would be increased from 1.45 percent to 5.45 percent (plus an equal increase to the employer), and the rate on capital gains and dividends would be increased from 15 percent to 20 percent. A phase-out of the personal exemption and specific deductions would add about 4.5 percentage points to the marginal tax rate (an estimate by the Tax Foundation).
The total marginal tax rate, thus, would be increased from 36.45 percent to 49.55 percent, reducing the after-tax return to additional earnings by about one-fifth; a lot of small business owners and professional couples would be subject to these higher marginal tax rates. Obama has not proposed a reduction in the corporate tax rate, although this rate is now the second highest among the industrial nations. His proposed changes in business taxation are designed to change the composition of U.S. business activity, increasing taxes on oil and gas companies and on U.S. multinationals that defer repatriation of foreign profits in favor of companies that produce renewable energy and increase domestic employment.
Obama's proposed federal tax rates do not look unusual compared to federal taxes before the Reagan-era rate reductions, but they would be a significant increase relative to recent years at a time when many other governments are reducing their personal and business tax rates.
In retrospect, the origin of the Great Depression seems surprisingly similar to recent conditions— with one huge exception. The Federal Reserve had increased the money supply from 1921 through 1927 by around 60 percent, contributing to the rapid increase in stock prices. In early 1928, however, the Federal Reserve began a policy of monetary restraint that continued through May 1929, increasing the discount rate from 3.5 percent to 5 percent in three stages. This triggered the stock market collapse in October.
The fall in stock prices and the subsequent general deflation led to a large increase in the demand for money. Following the collapse of the Bank of the United States in December 1930, however, the Federal Reserve increased interest rates again in early 1931. From 1929 to 1933, the money supply declined by around one-third, constrained by the rules of the gold standard, although the Federal Reserve Bank of New York had consistently urged a policy of monetary expansion. During this period, the number of U.S. banks also declined by around one-third due to either failure or merger.
This combination of a large increase in the demand for money and a substantial reduction in the supply of money was the primary cause of the first phase of the Great Depression. This period of monetary contraction ended only in 1933 when President Roosevelt raised the price of gold by 75 percent, permitting a renewed expansion of the money supply. In 1936 and 1937, however, the Federal Reserve doubled bank reserve requirements, leading to the short sharp recession of 1937–38 within the longer period of the Great Depression.
The monetary policy that led to the current recession was similar to the policy that led to the first phase of the Great Depression. The Federal Reserve maintained an expansionary monetary policy from 2001 into 2004, with a federal funds rate lower than the general inflation rate, contributing to both the housing boom and the increase in stock prices. Then from mid-2004 through mid-2007, the federal funds rate was increased by 4.25 percentage points, leading to a decline in residential investment beginning in the spring of 2006 and a decline in the stock market and national output beginning in the fall of 2007.
As in the 1930s, the decline in stock prices and the subsequent deflation greatly increased the demand for money and other financial instruments such as Treasury bills. The major difference from the earlier period is that the Federal Reserve has maintained a very aggressive monetary policy since mid-2007, reducing the federal funds rate by 5 percentage points. Moreover, beginning last fall, the Federal Reserve has purchased a wide range of private and public financial instruments, doubling the monetary base since last August. This dramatic change in monetary policy is primarily attributable to the lessons from Fed Chairman Ben Bernanke's studies of the monetary policy mistakes during the 1930s.
The very rapid increase in the monetary base since last August was, I believe, the correct response to the huge increase in the demand for money and is likely to be much more effective than any fiscal stimulus plan. But it presents a potentially large future danger. At such time as there is a revival of some general inflation and increased confidence in the security of nonmonetary assets, the demand for money will decline to a more normal level relative to total money income.
At that time, the Federal Reserve and the Obama administration will be faced with a very difficult choice—allow a high rate of inflation or raise interest rates fast enough to avoid that outcome. The first option would be the policy of inaction; the second option would require selling most of the financial assets that the Federal Reserve has accumulated in the past few months. My guess is that the time for this difficult choice is not too far off, probably in the next year or two, a guess based on observing that there has already been some increase in stock prices and commodity prices since November. And that will be a difficult time to make this difficult choice. Bernanke's term as Fed Chairman expires in January 2010 and, of course, there will also be a congressional election that fall, reducing the incentives and support for a rapid increase in interest rates. The second option would also present the potential for a W-shaped recession and recovery, extending the period of weak economic growth to avoid a high rate of inflation. In either case, the only way to avoid being faced with such a difficult choice in the more distant future is to correct the conditions that led this recession to be a financial crisis. This would require restructuring the mortgage market such that mortgages and mortgagebacked securities are more liquid and their risks are more transparent.
Other Related Policies
The trade and labor policies of the 1930s were designed to maintain the prices of products and labor services, usually at the expense of the amounts supplied. Other policies had the same objectives and effects. The 1933 National Industrial Recovery Act authorized cartels to maintain prices; until this act was declared unconstitutional in 1935, for example, members of these cartels were subject to fines for discounting. The most egregious of such policies was the Agricultural Adjustment Act of 1933; until this act was declared unconstitutional in 1936, this act authorized payments to farmers to reduce their acreage under cultivation. In effect, these policies established a floor under prices that prevented many product and labor markets from clearing, given the decline in nominal demand. These policies were an important reason why total output did not recover to the 1929 level until 1939, and the unemployment rate at the end of this decade was 17.2 percent.
Several current agricultural programs also have much the same objective and effects. The price of milk is maintained by a government- authorized cartel, the price of sugar by a quota on imports, and the price of corn has been increased by a regulation that requires a substantial production of corn-based ethanol as a motor fuel. I do not know Obama's position on the dairy cartel. During his campaign for the presidency, however, Senator Obama was a strong supporter of both the sugar quota and the ethanol program.
One other policy of both the Hoover and Roosevelt administrations was a substantial increase in federal expenditures for public infrastructure, especially hydroelectric facilities. These programs did not reduce total output but they were clearly not effective, given the combination of other policies, in reducing the depth or duration of the Great Depression. The government of Japan enacted a substantially larger public infrastructure program in the 1990s, also with no effect on ending what turned out to be a decade of very low economic growth. A major provision of President Obama's fiscal stimulus proposal, of course, is a substantial increase in federal expenditures for public infrastructure. Fed Chairman Bernanke was correct to observe recently that "Fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system."
The most important lesson of this paper is to avoid repeating the policies that increased the depth and duration of the Great Depression, particularly in combination. Unfortunately, some of these policies still have broad political appeal—limiting international trade, strengthening unions, other measures to support the prices of some products and labor services, and higher taxes on the wealthy and the income from capital. One important lesson that we seem to have learned from the 1930s is to avoid reducing the supply of money in response to an increased demand for money. Another important lesson that we have not yet learned is that some government spending for infrastructure may be both popular and valuable but is not very effective in countering a recession.
We have yet to learn the lessons about what caused the current recession and the general financial crisis. The United States had experienced 11 prior recessions since World War II without a general financial crisis, so something new must have happened that caused the current financial crisis. My judgment is that the government policies and private practices that changed the way mortgages are financed are that dangerous new development, but that is a story for another occasion. In this respect, I agree with Chairman Bernanke's recent conclusion that "we should revisit capital regulations, accounting rules, and other aspects of the regulatory regime to ensure that they do not induce excessive procyclicality in the financial system and the economy."
This article originally appeared in the March/April 2009 edition of Cato Policy Report.