Ben Strong had noticed that Pierpont had locked the enormous bronze doors and pocketed the key. He was up to his old tricks—confinement of adversaries, a deadline, the abrupt appearance of the menacing host after long hours of bargaining. At a quarter to five in the morning, Pierpont pushed a gold pen into the hands of Edward King, leader of the trust presidents. “Here’s the place, King. And here’s the pen.” Beaten down by all-night bargaining, King and the other trust company presidents agreed to contribute to the $25-million pool.
On Sunday night, Henry Clay Frick and Judge Elbert Gary of U.S. Steel sped down to Washington on a midnight train. They traveled in a single Pullman car specially hitched up to a locomotive. They had to secure Roosevelt’s approval for U.S. Steel’s takeover of Tennessee Coal and Iron before the stock market opened on Monday morning. They ended up interrupting Roosevelt in the middle of his breakfast; mindful of the panic, TR said it was “no public duty of his to interpose any objections.” In other words, the Sherman Antitrust Act wouldn’t be used against U.S. Steel. Five minutes before the stock market opened at 10:00 A.M., Gary called 23 Wall Street from the White House and told George Perkins that the president had agreed to the plan. The stock market rallied on the news.
…U.S. financial panics recurred with worrisome regularity, every ten years. The 1907 panic exposed many systemic defects. As people hoarded money and banks called in loans, there was no central bank to instill confidence or offset the sudden credit contraction. Sharp drops in the money supply then led to severe recessions. The country needed an elastic currency and a permanent lender of last resort.
From the ashes of 1907 arose the Federal Reserve System: everybody saw that thrilling rescues by corpulent old tycoons were a tenuous prop for the banking system. Senator Nelson W. Aldrich declared, “Something has got to be done. We may not always have Pierpont Morgan with us to meet a banking crisis.”
I thought it helpful to spend so much time on the Panic of 1907 to paint the picture of the financial state of the country prior to the creation of the Federal Reserve or central U.S. bank in 1913. Many sources are easily available to go into great depth about all the ins and outs of this system, thus needing no more detail by me. Suffice it to say, it is the lender of last resort to the banking system, plus having many more functions. From time to time, people have argued for dismantling the “Fed.” I am agnostic on this subject. At one time, I mistakenly thought one of its mandates from Congress was its job to protect the value of the dollar, but during its one-hundred plus years’ existence, has seen the value of our currency drop 99%. I repeat, mistakenly by me having attributed the loss of the dollar’s value to the Fed, for as illuminated in my chapter on the gold standard, the two presidents, FDR and Nixon, and their Secretaries of the Treasury were responsible for setting off the drop in the dollar’s value by altering or removing the gold standard, and in both cases against the advice of or the pleadings of the heads of the Federal Reserve.
What I do like about our system is it is made up of 12 regional banks, each with boards partly staffed by regional boards operating locally with business and deep economic thinkers pouring over research studies carried out in their regions. What I don’t like is that the head in Washington is appointed by the President, who, more times than naught, had unwise economic ideas. I would prefer that the head of the Federal Reserve rather be elected by the directors of the system’s regional banks rather than by the President.
Whether we have a Federal Reserve System in the future is soon to become a moot point. That is because while in the past, banks loaned, for all practical purposes, all the money in the country that was loaned out. That situation is vastly different today where only about 15% of lending in the country is done by banks. The other 85% is done by money market funds, insurance companies and large pension funds, companies such as the autos lending money so customers can more easily buy their cars, government through programs like the Federal Student Loans, which is now carrying up to 2.5 trillion debt, and Fannie Mae and Freddy Mac’s house mortgages.
Further adding to the list of reasons against maintaining the central bank, the Federal Reserve’s record of predicting the economy’s future direction is almost always wrong. The following chart is from The Wall Street Journal, 12-15-16. Take a moment to peruse this chart. I am not overstating my case.
But I believe the main reason that the Federal Reserve is becoming obsolete is that it is getting more and more irrelevant. While the Head of the Fed has heightened self-importance of his/her position and the press hangs on his or her every word, in the real world the market sets the interest rate. I give you two examples from John Tamny’s book, Who Needs the Fed?When the prospective movie producer goes to the financial people to finance his latest idea, the prospective lender knows that the odds of any movie breaking even is poor and the occasional blockbuster is extremely rare; thus, the lender doesn’t look up what interest rate to demand, the lender instead makes very strict terms at a high-interest rate. Ontheotherhand, the entrepreneur with a brilliant new idea or invention goes to the venture capitalists and asks for financing. If these lenders see golden opportunities, they will easily make loans, and on easy terms with the knowledge that if this “thing” turns out as great as they think it will, the future profit may well be in the multiples of million dollars.
Finally, if you are an investor, I would suggest that you take whatever the future economic prediction by the Fed is, and invest in the opposite direction. This, with the caveat that when the interest rate is at rock bottom, it can only move in one direction (which is up), and this kills the value of interest bearing bonds. Conversely, when interest rates are at record highs, as they were in 1980, there the odds of a future drop in rate foretells a rising stock market.
Don’t believe me? This chart below shows the Fed’s predicted inflation rate, compared to the actual result. The chart covers the time period of 2012 through 2016 and shows in color the range of Fed inflation forecasts. The horizontal black bar shows the actual result.
Today I do fear return of inflation like we had in the latter ‘70s/earlier ‘80s, and I’m watching the commodities index and the federal funds rate. They became disconnected after Nixon’s withdrawal of the gold standard. In the Reagan years Paul Volker managed our monetary system by following the commodities index, which is a proxy for the gold price.
15 - INFRASTRUCTURE SPENDING
Both presidential candidates in the 2016 cycle made infrastructure spending part of their platform. They were talking in gargantuan terms; hundreds of billions to trillions of dollars, to be spent over many years. It is now a serious issue deserving serious thought, and not loose or aspirational talk going from building new physical structures from highways, bridges, and mass transit to airports and seaports. Some things for Congress to explain to the electorate are, who would be expected to pay the cost—taxpayers or private sources? What are payment mechanisms—user fees or general taxes? What is maintenance and what is entirely new? Finally, is the purpose to stimulate the economy, or to provide something the electorate really needs? At a minimum, let’s put the electric grid and electricity generation into a separate category of energy needs, and probably not an infrastructure dilemma (though the grid is definitely a security issue and a terrorism threat).
Futurologist George Gilder says that is foolhardy to be thinking in terms of what was new technology hundreds of years ago: railroads and windmills. Private entities are quite capable of supplying whatever specific industry needs are. Imagine Google having massive needs for electricity supply and has endeavored to make all their electric needs worldwide met by clean energy starting next year. Google says that its 13 data centers and offices consume 5.7 terawatt-hours of electricity annually, which is about the consumption of the 800,000 plus in San Francisco. This can be achieved by offsetting every megawatt-hour of electricity supplied by a power plant running on fossil fuel with renewable energy purchased through contracts with wind power farms and solar power.
For mass transit, the railroad lines of the past were terribly expensive, required massive amounts of land, and would now interfere with highway crossings of highways established years ago. Legal ownership was clear-cut then when the federal government owned all the land in the Midwest and West, but today’s mix of legal jurisdictions would present nearly impossible negotiations. But the technology has since advanced. One example is the Chinese car and electric battery maker BYD,which recently launched a monorail transport system into operation at its Shenzhen headquarters. Beijing has called for companies to intensify efforts in developing new rail technology. BYD, about 8% owned by Berkshire Hathaway, Inc., said that building a monorail system requires one-fifth of the capital expenditure of a metro line and one-third of the construction time. And being elevated, it could go over present highways and easily cross other roads.
A first step: Before Congress debates infrastructure spending, here is a great idea to get things moving. This from an op-ed penned by Paul Kupiec, a resident scholar at the American Enterprise Institute, titled “How the Feds Can Really Spread the Wealth Around”,The Wall Street Journal, 12-9-16. This could go a long way toward reducing federal spending, decrease congestion in the already heavily congested Washington, D.C. region, and be a boon to economically devastated other U.S. cities.
“Donald Trump pledged to rebuild America’s troubled inner-cities, ‘drain the swamp,’ and restore America’s confidence in their government. The president-elect can deliver on these promises by moving federal government agencies out of the nation’s capital and closer to the citizens they serve in cities like Detroit, Cleveland or Milwaukee. Mr. Trump can begin by relocating two federal agencies that are currently looking for new headquarters in the Washington, D.C., metro area: the Federal Bureau of Investigation and the Labor Department.
The FBI’s Current headquarters, the J. Edgar Hoover Building, was built in 1975. It is now too small to meet the FBI’s needs, and it requires major repairs. The specifications for a new FBI headquarters include 2.1 million square feet of office space with access to adequate transportation. The construction budget alone is about $2.5 billion.
The new location for the FBI headquarters is expected to be announced this month. There are currently three locations under consideration. Two sites, Greenbelt and Landover, are in suburban Maryland. A third possible site, Springfield, is in suburban Virginia.
The labor department is also looking for a new headquarters to replace its 40-year-old building currently located on Constitution Avenue in Washington. The plan is to construct a new building on one of three possible sites within the district. The new building could be as large as 1.4 million square feet and, if costs are similar to those proposed by the FBI, the building budget alone would exceed $1 billion.
To understand the potential impact of moving a federal-agency headquarters out of Washington, consider what relocating the FBI headquarters to Detroit would do. Moving 11,000 FBI employees would hardly make a dent in the D.C. economy. Over 275,000 people—over 14% of the workforce—are federal-government employees, according to the Office of Personnel Management. In contrast, 11,000 well-paid federal government jobs and $2.5 billion in construction spending would provide a significant boost to the Detroit economy, where less than 2% of the workforce are federal employees.
With modern communications technology, there is no reason that the FBI’s new headquarters, or the headquarters of other federal government agencies, must be located in the nation’s capital. The concentration of federal agencies in a single area increases the potential for a breakdown of government services in the event of a terrorist attack, a snowstorm, a hurricane, or even the increasingly frequent service interruptions on the Metro, the Washington area’s troubled subway system.
Reducing risk is but one benefit. It would also be healthy for the country to more broadly distribute the wealth and power of federal government agencies across the nation.
According to the 2010 U.S. Census, 11 of the 20 richest U.S. counties—including the three richest counties—are in the Washington, D.C., metro area. Incomes near the nation’s capital are bloated not only by generous federal-governmentpayrolls, but also by “Beltway bandit” consultancy firms that provide contract services to federal agencies. It is little wonder that many Americans view the federal government as a money machine for bureaucrats and political insiders.
Unless the president-elect intervenes, this government money-machine will continue to keep federal spending concentrated in and around Washington. For example, to attract the new FBI headquarters to his state, Virginia Gov. Terry McAuliffe has committed to spend $120 million on public-works projects in Springfield. In an effort to bring the FBI to suburban Maryland, Gov. Larry Hogan has pledged $317 million in Maryland taxpayer funds to make infrastructure improvements if the FBI headquarters moves to Greenbelt, and $255 million if it moves to Landover.
Many towns and cities across America would welcome the economic development and stability that accompanies a well-paid federal-agency workforce, like the FBI or the Labor Department. The expense of managing the federal government should be used to spread wealth beyond the nation’s capital and revitalize the economies of America’s ailing cities.
Moving agencies out of Washington will also save millions of dollars because the costs of acquisition, building maintenance and housing for federal employees will shrink outside of the Washington bubble. In 2016 federal employees in the D.C. area receive a 24.78% premium over the base federal pay scale because they work in a high-cost region, according to the Office of Personnel Management.
Many federal agencies will still need to maintain a portion of their offices in the D.C. area to facilitate interaction with cabinet officials. But modern communications make it possible to locate the largest share of any agencies’ operational staff and facilities far outside the region.
Perhaps the biggest benefit of moving federal agencies is an increased perception among voters of equality and fairness. For many years, the D.C. region has prospered from its proximity to the federal government while many parts of the country have suffered. This long-standing imbalance has reinforced some voters’ belief that the system is rigged to benefit insiders. With two agencies looking for new headquarters and a president-elect already working to shake up the Washington status quo, now would be a good time to begin relocating agencies.”
The second step should be for Congress to agree that “a well-designed, rigorously vetted, steadily funded program addressing infrastructure needs of national importance would be better than a hastily written and passed bill, justified on false premises, that is likely to end in disappointment.” The words of Michael J. Boskin when writing “All Aboard the Infrastructure Boondoggle”, 11-1-16, The Wall Street Journal.
“I support the federal government funding all public infrastructure projects that pass rigorous national cost-benefit tests. But here’s the rub. Most federal infrastructure spending is done by sending funds to state and local governments. For highway programs, the ratio is usually 80% federal, 20% state and local. But that means every local district has an incentive to press the federal authorities to fund projects with poor national returns. We all remember Alaska’s infamous ‘bridge to nowhere.’
In other words, if a local government is putting up only 20% of the funds, it needs the benefits to its own citizens to be only 21% of the total national cost. Yet every state and every locality that has potential infrastructure needs that it would like the rest of the country to pay for. That leads to the miscalculation of federal funds and infrastructure projects that benefit the few at the cost of the many.
Politicians have all sorts of ways to hide the true costs of such projects from taxpayers.
First, they know most citizens won’t fully appreciate the future taxes that must be paid to cover interest costs on the added public debt. This allows them to underestimate the full cost of projects, an insight first made by the late Nobel laureate James Buchanan.
Second, t
axpayers generally don’t notice all of the fiscal cross hauling, sending their money to Washington to be sent back in leaky buckets to local jurisdictions. Since we all reside in a state and locality, it’s an inefficient negative sum game with complex cross-subsidies. If these local projects are so good, why aren’t citizens willing to finance projects locally?
Third, politicians sell infrastructure programs by saying they lead to an immediate economic boost. But given the scope and duration of these projects, this is rarely true. After the 2008 sub-prime mortgage meltdown, President Obama signed an $828 billion ‘stimulus’ program. But 7% devoted to infrastructure did not go to the areas of highest unemployment or worst housing bust. Mr. Obama eventually had to joke in June 2013 that ‘shovel-ready was not as, uh, shovel-ready as we expected.’
The late University of Michigan economist and Clinton Federal Reserve Board appointee, Ned Gramlich, the leading expert on the subject, concluded in a 1994 paper for the Journal of Economic Literature that attempting to stimulate the economy through federal matching funds for infrastructure projects gives state and local officials ‘a powerful incentive to wait and see if they can get a federal grant, rather than just going ahead with their own project.’
Japan tried infrastructure-heavy serial fiscal stimuli for decades and is trying again under Prime Minister Shinzo Abe. Yes, Japan now has many new bridges, roads, and paved drainage ditches, but spending has done little to improve Japan’s meager growth rate. What politicians in Japan or the U.S. don’t mention is that government infrastructure projects tend to use massive, modern construction equipment, so they aren’t labor intensive.
Return to Capitalism Page 15