Friday, March 4, 2011

The Figure No One Wants You to See

The Real National Security Budget


What if you went to a restaurant and found it rather pricey? Still, you ordered your meal and, when done, picked up the check only to discover that it was almost twice the menu price.

Welcome to the world of the real U.S. national security budget. Normally, in media accounts, you hear about the Pentagon budget and the war-fighting supplementary funds passed by Congress for our conflicts in Iraq and Afghanistan. That already gets you into a startling price range -- close to $700 billion for 2012 -- but that's barely more than half of it. If Americans were ever presented with the real bill for the total U.S. national security budget, it would actually add up to more than $1.2 trillion a year.

Take that in for a moment. It's true; you won't find that figure in your daily newspaper or on your nightly newscast, but it's no misprint. It may even be an underestimate. In any case, it's the real thing when it comes to your tax dollars. The simplest way to grasp just how Americans could pay such a staggering amount annually for "security" is to go through what we know about the U.S. national security budget, step by step, and add it all up.

So, here we go. Buckle your seat belt: it's going to be a bumpy ride.

Fortunately for us, on February 14th the Obama administration officially released its Fiscal Year (FY) 2012 budget request. Of course, it hasn't been passed by Congress -- even the 2011 budget hasn't made it through that august body yet -- but at least we have the most recent figures available for our calculations.

For 2012, the White House has requested $558 billion for the Pentagon's annual "base" budget, plus an additional $118 billion to fund military operations in Iraq and Afghanistan. At $676 billion, that's already nothing to sneeze at, but it's just the barest of beginnings when it comes to what American taxpayers will actually spend on national security. Think of it as the gigantic tip of a humongous iceberg.

To get closer to a real figure, it's necessary to start peeking at other parts of the federal budget where so many other pots of security spending are squirreled away.

Missing from the Pentagon's budget request, for example, is an additional $19.3 billion for nuclear-weapons-related activities like making sure our current stockpile of warheads will work as expected and cleaning up the waste created by seven decades of developing and producing them. That money, however, officially falls in the province of the Department of Energy. And then, don't forget an additional $7.8 billion that the Pentagon lumps into a "miscellaneous" category -- a kind of department of chump change -- that is included in neither its base budget nor those war-fighting funds.

So, even though we're barely started, we've already hit a total official FY 2012 Pentagon budget request of:

$703.1 billion dollars.

Not usually included in national security spending are hundreds of billions of dollars that American taxpayers are asked to spend to pay for past wars, and to support our current and future national security strategy.

For starters, that $117.8 billion war-funding request for the Department of Defense doesn't include certain actual "war-related fighting" costs. Take, for instance, the counterterrorism activities of the State Department and the U.S. Agency for International Development. For the first time, just as with the Pentagon budget, the FY 2012 request divides what's called "International Affairs" in two: that is, into an annual "base" budget as well as funding for "Overseas Contingency Operations" related to Iraq and Afghanistan. (In the Bush years, these used to be called the Global War on Terror.) The State Department's contribution? $8.7 billion. That brings the grand but very partial total so far to:

$711.8 billion.

The White House has also requested $71.6 billion for a post-2001 category called "homeland security" -- of which $18.1 billion is funded through the Department of Defense. The remaining $53.5 billion goes through various other federal accounts, including the Department of Homeland Security ($37 billion), the Department of Health and Human Services ($4.6 billion), and the Department of Justice ($4.6 billion). All of it is, however, national security funding which brings our total to:

$765.3 billion.

The U.S. intelligence budget was technically classified prior to 2007, although at roughly $40 billion annually, it was considered one of the worst-kept secrets in Washington. Since then, as a result of recommendations by the 9/11 Commission, Congress has required that the government reveal the total amount spent on intelligence work related to the National Intelligence Program (NIP).

This work done by federal agencies like the CIA and the National Security Agency consists of keeping an eye on and trying to understand what other nations are doing and thinking, as well as a broad range of "covert operations" such as those being conducted in Pakistan. In this area, we won't have figures until FY 2012 ends. The latest NIP funding figure we do have is $53.1 billion for FY 2010. There's little question that the FY 2012 figure will be higher, but let's be safe and stick with what we know. (Keep in mind that the government spends plenty more on "intelligence." Additional funds for the Military Intelligence Program (MIP), however, are already included in the Pentagon's 2012 base budget and war-fighting supplemental, though we don't know what they are. The FY 2010 funding for MIP, again the latest figure available, was $27 billion.) In any case, add that $53.1 billion and we're at:

$818.4 billion.

Veterans programs are an important part of the national security budget with the projected funding figure for 2012 being $129.3 billion. Of this, $59 billion is for veterans' hospital and medical care, $70.3 billion for disability pensions and education programs. This category of national security funding has been growing rapidly in recent years because of the soaring medical-care needs of veterans of the Iraq and Afghan wars. According to an analysis by the Congressional Budget Office, by 2020 total funding for health-care services for veterans will have risen another 45%-75%. In the meantime, for 2012 we've reached:

$947.7 billion.

If you include the part of the foreign affairs budget not directly related to U.S. military operations in Iraq and Afghanistan, as well as other counterterrorism operations, you have an additional $18 billion in direct security spending. Of this, $6.6 billion is for military aid to foreign countries, while almost $2 billion goes for "international peacekeeping" operations. A further $709 million has been designated for countering the proliferation of weapons of mass destruction, combating terrorism, and clearing landmines planted in regional conflicts around the globe. This leaves us at:

$965.7 billion.

As with all federal retirees, U.S. military retirees and former civilian Department of Defense employees receive pension benefits from the government. The 2012 figure is $48.5 billion for military personnel, $20 billion for those civilian employees, which means we've now hit:

$1,034.2 billion. (Yes, that's $1.03 trillion!)

When the federal government lacks sufficient funds to pay all of its obligations, it borrows. Each year, it must pay the interest on this debt which, for FY 2012, is projected at $474.1 billion. The National Priorities Project calculates that 39% of that, or $185 billion, comes from borrowing related to past Pentagon spending.

Add it all together and the grand total for the known national security budget of the United States is:

$1,219.2 billion. (That's more than $1.2 trillion.)

A country with a gross domestic product of $1.2 trillion would have the 15th largest economy in the world, ranking between Canada and Indonesia, and ahead of Australia, Taiwan, the Netherlands, and Saudi Arabia. Still, don't for a second think that $1.2 trillion is the actual grand total for what the U.S. government spends on national security. Former Secretary of Defense Donald Rumsfeld once famously spoke of the world's "known unknowns." Explaining the phrase this way: "That is to say there are things that we now know we don't know." It's a concept that couldn't apply better to the budget he once oversaw. When it comes to U.S. national security spending, there are some relevant numbers we know are out there, even if we simply can't calculate them.

To take one example, how much of NASA's proposed $18.7 billion budget falls under national security spending? We know that the agency works closely with the Pentagon. NASA satellite launches often occur from the Air Force's facilities at Vandenberg Air Force Base in California and Cape Canaveral Air Force Station in Florida. The Air Force has its own satellite launch capability, but how much of that comes as a result of NASA technology and support? In dollars terms, we just don't know.

Other "known unknowns" would include portions of the State Department budget. One assumes that at least some of its diplomatic initiatives promote our security interests. Similarly, we have no figure for the pensions of non-Pentagon federal retirees who worked on security issues for the Department of Homeland Security, the State Department, or the Departments of Justice and Treasury. Nor do we have figures for the interest on moneys borrowed to fund veterans' benefits, among other national security-related matters. The bill for such known unknowns could easily run into the tens of billions of dollars annually, putting the full national security budget over the $1.3 trillion mark or even higher.

There's a simple principle here. American taxpayers should know just what they are paying for. In a restaurant, a customer would be outraged to receive a check almost twice as high as the menu promised. We have no idea whether the same would be true in the world of national security spending, because Americans are never told what national security actually means at the cash register.

Christopher Hellman is communications liaison at the National Priorities Project in Northampton, Massachusetts. He was previously a military policy analyst for the Center for Arms Control and Non-Proliferation, a Senior Research Analyst at the Center for Defense Information, and spent 10 years on Capitol Hill as a congressional staffer working on national security and foreign policy issues

Inflation and the Value of Gold

Inflation and the Value of Gold Explained


As the story goes, someone asked an economist how his wife was doing, and the economist answered "compared to what?"

Joking aside, this is one of the most important questions one can ask when dealing with many economic problems.

In recent times, with gold reaching all-time highs, we have seen people question the valuation of assets in dollars. Basically, the yardstick used to measure your assets — your house, car, or stock portfolio — is a steadily shrinking one. This makes you wonder whether your savings are really growing in value. In other words, if the value of your savings has doubled, but the price of milk and everything else has roughly doubled, you are not getting ahead. If anything, you will likely have to pay taxes on your supposed "gain," which is no gain at all.

The way the dollar yardstick is being shrunk is by increasing the stock of money, which means that there are more dollars in circulation. Governments do this.

Why would governments want to decrease the value of our money? Well, there are many reasons why this is very advantageous to our masters.

First, creating more dollars is an easy way to pay for government expenditures. If the government wants to pay for wars, bailouts, or their own cushy salaries and perks, they can print the money instead of taking it away from us by force through taxation.

Second, we all know that scarce, desirable goods are more expensive than abundant ones. On the other hand, some goods are so abundant that they are free in spite of their desirability, such as the air we breathe. So by increasing the number of dollars — by inflating the stock of money — the state reduces its exchange value. This is very bad if you are saving money, but it's great for governments because they are usually big debtors.

Unfortunately for us, this process of devaluation can be done until money is completely worthless. It happens easier than you might think, and not only to banana republics but also to mighty countries.

Usually, cheap goods are a good thing. If you increase the amount of wheat available, we will have cheaper bread. The progress of humanity is based on making economic goods more abundant and affordable. The difference with money is that you cannot consume it in the same way you eat bread. Money is there for the sole purpose of exchange, especially when talking about our modern paper currencies. Given this fact, the cheapening of money does not bring about any well-being.

But wouldn't more money make us richer? Not really.

You see, if you were thrown in the middle of the desert, a pile of money wouldn't do you any good. Money only facilitates the exchange of goods and services, but underneath it all, it is the goods and services themselves that are being exchanged. Think of it as a highly efficient and improved barter. If you are a plumber, you don't really need money to live (you can't eat money); money just makes it possible for you to indirectly exchange your plumbing services for groceries. If money weren't there, each time you needed food you would have to find a grocer that was in need of plumbing services so that you could barter your services for food.

So if the amount of money does not determine how rich a society is — if that's determined instead by the actual goods it produces and possesses — why should we object to the government's creation of money? What does it matter to me if milk is $1 per gallon and I make $10 per hour, or if milk is $10 and I make $100 per hour?

The answer to that question is that the creation of money does not affect all prices and wages simultaneously. Analogies are never perfect, but imagine that you have a pool of water (representing the money already in circulation), and that you add additional water to it (representing new money), but to keep track of the new money you add red dye to it. Obviously the red dye will not affect the pool all at once. At first you will have a very visible spot of concentrated red color in the area where the water was added, and it will take awhile for the entire pool to have a uniform color. If the amount of red dye is not huge and the pool is big enough, the final color of the water may not even be very red.

This is basically how new money makes its way into the economy. The initial recipients of the new money — the government and its friends — get to spend it first with the old, more concentrated purchasing power, and as the money makes its way into the economy it gradually dilutes the purchasing power of the entire pool of money. So, in effect, because of this uneven readjustment of prices, in some segments of the population the price of goods will go up before wages do, making these people much poorer.

This creates a shift of capital from some segments of the population to others, while not increasing the total amount of capital.

But, don't we need to make our exports cheaper? No, we don't.

By making exports cheaper through a weakened currency we subsidize our exports. The buyer of our goods in the importing country gets a good deal, the producer of exports sells more products, but this is all paid for by the population at large. Once again, the policy itself produces no increase in capital but only a transfer of it.

But if it creates export-based jobs, it must be good, right?

The problem is that you are subsidizing those jobs, not creating real productive jobs. To pay for those jobs you had to take resources from someone else. That other person was going to consume, save, or invest that money anyway. Shifting resources does not lead to increased capital, which is what ultimately leads to higher real wages.

Until the population realizes what is really taking place, politicians and the mainstream media will get away with rejoicing every time real-estate prices rise, or when the Dow Jones Industrial Average reaches a new milestone. Now, this graph shows the Dow priced in US dollars, our shrinking yardstick. It sure looks good.

Figure 1
Click to expand image.

How about changing the yardstick for a more stable one? You could use milk, paper clips, or anything you like. Let's use ounces of gold.

Figure 2

The picture is very different indeed. For one thing it shows that the rise in stock prices or any other good denominated in paper currency may not say much about the real value of your investments. You may have invested your money — in any venture — and be thinking that you are making a nice profit when in fact you might be suffering huge losses. This is one of the dangerous consequences of inflation: by distorting prices it increases the amount of entrepreneurial mistakes. Inflation can mask huge losses.

The other important thing that can be learned from this graph is that gold itself varied in its purchasing power. These variations are greatly amplified by the government-created boom-and-bust cycle.

Let's look at gold priced in ounces of silver; this is a historical chart. Look at how erratic the price of gold becomes in the 20th century with the appearance of central banking.

Figure 3

It is commonly said that gold is a stable yardstick, that its purchasing power has not changed since Roman times. It is said that back then an ounce of gold bought you a full outfit with sandals, and that today an ounce of gold will buy you a full suit, shirt, and shoes. It is claimed by many that gold's purchasing power does not change at all, that paper currencies depreciate against it.

While I agree that gold is much more stable than any modern paper currency, I cannot agree that it has stable exchange value. It is true that paper currencies depreciate against gold, but so does any other good whose supply increases.

At times in history, gold itself has seen its supply increase dramatically, as during the Spanish conquest of the Americas. And silver has at times been more valuable than gold, as in ancient Egypt.

The other claim regarding the value of gold is that it has what is called "intrinsic value," which basically means that the essence of gold itself, its nature, gives it value. It is also claimed that because it is hard and costly to mine, this makes it expensive and gives it a "price floor."

Nothing could be further from the truth. All prices are a product of subjective valuations. If nobody wants it, regardless of how much work it takes to produce, or how amazing its properties are, the good will have no value. It is actually the other way around. Because people are willing to pay a high price for gold, it is economically viable to embark in costly mining and production schemes.

The opposite is also true: regardless of how useless a good is, if people want it, its price will be high. Take jewelry-grade diamonds as an example.

The point that is being missed is that gold is a commodity as well as a monetary metal. There is a market for gold outside the monetary realm, and this is an additional component to its value that modern paper currencies do not have. In that sense one could say that gold's value as a commodity gives it that "price floor," or downside protection.

But above all, gold has value because people want it and because it is scarce. It is that simple.

Capitalism and Socialism

Capitalism and Socialism


Uncle Karl

How many times have you heard "capitalist" used as an epithet or a put-down? How many people do you know who use variations on "capitalism" to describe pretty much anything they don't like? It's a vice that cuts several ways. As the tea-party movement has risen to prominence, how often have you heard people denounce President Obama as a socialist?

Far too often, people use terms like "capitalism" and "socialism" sloppily, either because they don't understand them or because the words make for cheap but effective (albeit inaccurate) political rhetoric. The Great Conversation suffers because of it.

If we're going to have a meaningful conversation about political, cultural, and social institutions, we have to first know what we're talking about. That's the point of my participation in the Mises Academy. From March 31 through May 11, I will teach a Mises Academy course called Capitalism and Socialism.

"You keep using that word. I do not think it means what you think it means."

Debates about capitalism, socialism, and interventionism often proceed as if we are trying to choose between equally feasible sets of institutions, with the social choice being determined by our willingness to trade off efficiency to get equity, the degree to which we care about the poor and downtrodden, the degree to which we believe that God helps those who help themselves, or what have you.

The case for capitalism and the case against socialism are more complex than that. In response to the critics of capitalism who had emerged in the 19th century and who grew progressively louder in the early 20th century, Ludwig von Mises asked a critical question about a critical socialist assumption: was economic calculation even possible under the socialist system, which was allegedly going to produce material superabundance? In short, Mises pointed out that before we have discussions about whether socialism is desirable (or inevitable, as it was in the view of Marx and his followers), we have to ask whether it is even possible. Mises's answer was a straightforward "no."

Why this class? My first motivation is instrumental. Attempts to implement socialism in the 20th century nearly drowned civilization in blood. For the sake of our children, socialism is a mistake we cannot afford to make again.

My second motivation is intellectual. Socialism and interventionism are based on complex knots of errors. If truth is important, then this is a discussion that we need to have.

Enthusiasm for socialism and its variants persists within the academy and elsewhere; indeed, 2009 saw the publication of G.A. Cohen's short tract Why Not Socialism? which I review here, David Gordon reviews here, and James Otteson reviews here. In Gordon's words, Cohen's apology for socialism was "purely ethical: we should institute socialism because this is a morally better system than capitalism."

Last year, I explained "Why Economics is Crucial for Ethics." Throughout this year's course, we will undertake a critical evaluation of capitalism and socialism to see who has the moral high ground. Here is Ludwig von Mises, from page 346 of Theory and History:

It must be reiterated that no reasoning founded on the principles of philosophical ethics or of the Christian creed can reject as fundamentally unjust an economic system that succeeds in improving the material conditions of all people, and assign the epithet "just" to a system that tends to spread poverty and starvation. The evaluation of any economic system must be made by careful analysis of its effects upon the welfare of people, not by an appeal to an arbitrary concept of justice which neglects to take these effects into full account.

By the time we are finished, we will have established which system "succeeds in improving the material condition of all people" and which system "tends to spread poverty and starvation."

We will meet once a week for five weeks. In our first meeting, we will define the terms "capitalism" and "socialism," unpack exactly what they mean, and discuss the combination of capitalist and socialist institutions that constitute modern mixed economies. The second lecture will consider the socialist-calculation debate and explain at a theoretical level why pure socialism is impossible. In short, we will consider the debate over whether socialism can deliver material abundance and economic stability. In our third lecture, we will explore the shifting critique of capitalism, which holds that it delivers material abundance but at the expense of other values. The fourth lecture will explore the practical consequences of capitalism, socialism, and interventionism and the unflagging popularity of socialism and interventionism among intellectuals and other commentators. In our final discussion, we will draw out implications of what we have read and discussed for how we understand interventionism and attempts to develop a "third way" between pure capitalism and pure socialism.

Mises Academy: Art Carden teaches Capitalism and Socialism

Each week, I will lecture for about an hour and then take about 30 minutes for questions and answers. For each session, I will suggest things to read, watch, or listen to: these will include introductory materials, readings on which I will base my lectures, and suggestions for advanced study for the students who want to go deeper. It's a class that will involve as little (or as much) work as you want to do.

The errors and horrors of socialism are fading from our memory. Indeed, within the next couple of years there will be no one of college age who was alive while the Berlin Wall stood. Henry Hazlitt has said that good ideas have to be relearned every generation. My Capitalism and Socialism course will be an effort toward that end. I hope you will join us.

Taxpayers in Revolt

Taxpayers in Revolt


[Speech delivered at the Naples Mises Circle, February 26, 2011]

Jimmy John Liautaud
Sandwich magnate Jimmy John Liautaud will leave higher-tax Illinois for lower-tax Florida.
Does his move presage a movement?

Jimmy John Liautaud, founder of the Jimmy John's sub chain, just applied to move his residence from Illinois to Florida — and his company's headquarters could soon follow. "All they do is stick it to us," he says of the state legislature's move to jack up the personal income tax from 3 percent to 5 percent — and the corporate income tax from 7.3 percent to 9.5 percent.

"I could absorb this and adapt," Liautaud tells his hometown paper, the Champaign-Urbana News-Gazette, "but it doesn't feel good in my soul to make it happen," he says.

Where the sub business ultimately moves is up in the air — but Jimmy John's kids have already started school in Florida. "My family and I are out of here."

While Mr. Liautaud seeks friendlier tax climates, talk about municipal and state government defaults are all the rage after Meredith Whitney told 60 Minutes there would be 50–100 municipal-bond defaults this year. Ms. Whitney said it will be as big a meltdown as the real-estate crash.

Its hard to know what kind of financial shape many muni-debt issuers are in, because they are not quick to update their financial statements: doing so would allow bond holders to gauge the value of their investments. Plenty of concerned sons probably forwarded to their muni-bond-holding mothers the Wall Street Journal article that mentioned Helen Kirkpatrick, a retired journalist, who was stunned when a broker mailed her an offer for her Maryland Health and Higher Education bonds at 50 cents on the dollar.

Kirkpatrick constantly sought information about the bonds she bought a decade ago but could find nothing amiss.

These bond issuers don't disclose financial information. DPC DATA Inc., a specialist in municipal disclosure, did an extensive analysis of disclosure and found the problem growing since a 2008 study. Of 17,000 bond issues it studied, more than 56 percent filed no financial statements in any given year between 2005 and 2009. More than one-third of borrowers entirely skipped three or more years, and the number grew to 40 percent in 2009, as credit woes mounted. Another 30 percent filed extraordinarily late in 2009.

"This works out to insufficient ongoing disclosure information for more than $2 trillion of the $3 trillion in outstanding bonds," says Peter Schmitt, chief executive of DPC of Fort Lee, New Jersey.

However, California's state treasurer, Bill Lockyer, says the idea of states going bankrupt is ludicrous.

"It's a cynical proposal, intended to incite a panic in response to a phony crisis," Mr. Lockyer said on a conference call with journalists. "Killer bees, space aliens, and now it's the invasion of the bankrupt states."

I'm a little surprised Lockyer is so cocky. After all, California was forced to issue IOUs in lieu of cash to pay taxpayers, vendors, and local governments back in 2009.

Mr. Lockyer's big plan is for his state to refrain from issuing any general-obligation bonds until the second half of the year, cutting down borrowing costs. That doesn't sound like any great trick, except California hasn't done that since 1988. If that doesn't work, well, "Then, the next option, if you run out of deferrals, is to issue IOUs," Mr. Lockyer said. "It's a possibility. It's not one that anyone wants to do. It's at the bottom of the list of choices. But it is on the list."

Nicole Gelinas of the Manhattan Institute also thinks the idea of states going bankrupt is nonsense. Because states pile up debt indirectly, issuing bonds through tens of thousands of separate legal entities. She writes that New York "state" doesn't owe all of that $78.4 billion in debt; it owes only $3.5 billion in "general-obligation" debt, so relax.

"Who owes the rest?" she writes,

The MTA, the Dormitory Authority, the Triborough Bridge & Tunnel Authority and so on. Legally, each is not a government but a "public-benefit corporation." Each has its own board, its own rules, and its own contractual agreements with creditors, from bondholders to unions. Each of those agreements offers creditors different protections.

So New Yorkers, in this case, are supposed to sleep better at night secure in the knowledge that dozens of government entities owe this debt instead of just one? Meanwhile any one of these public-benefit corporations could default out of the blue, because more than likely nobody will get a heads-up if the Dormitory Authority runs out of dough to pay bond holders.

But the main argument is that these states are sovereign entities that can raise taxes whenever needed and cut spending anytime to make everything all better.

Some governors are trying to balance budgets, which means cutting state worker pay and renegotiating union contracts. There's been a bit of a dust-up in Wisconsin with Governor Scott Walker wanting state workers to contribute some of their own money toward their retirements and untie state workers' collective-bargaining agreements.

Badger State teachers will have none of this. They abandoned their classrooms and descended upon the capital, blocking a door to the Senate chambers. They sat down, body against body, filling a corridor. They chanted "Freedom, democracy, unions!" in the stately gallery as the senators convened.

In Nevada, the University of Nevada at Las Vegas may have to declare financial exigency, the equivalent of bankruptcy.

"Our state is nearing a state of fiscal collapse," university president Neal Smatresk told his faculty.

The president's message moved many of the faculty members to tears.

Education-leadership professor Cecilia Maldonado read a list of grievances at a faculty-senate meeting when the bad budget news was delivered, each beginning with "I'm sick."

"I'm sick we are destroying much of what we've built," Maldonado said.

She said she is sick of politicians describing professors as enjoying "fat salaries and easy living," sick that the public doesn't seem to understand the importance of higher education.

This past week, public employees protested at Ohio's statehouse in Columbus and Nevada's statehouse in Carson City to show solidarity with their union brothers and sisters in Wisconsin.

State legislators will have a hard time cutting budgets. You might say government workers feel entitled.

When it comes to raising taxes, as in the case of Jimmy John Liautaud, when the government pushes you down on the sidewalk — seeking to lighten your wallet and claiming someone else is more worthy of your money than you — you push back.

If you have the resources and options like Jimmy John, maybe you just move. But if you're an average working stiff, underwater on your house, with your job prospects local and family tying you down, when the taxman comes wanting more, a fight breaks out.

So what's the cause of state and local government fiscal woes? Is it the recession? The WSJ's David Wessel points out,

At the worst point, in early 2009, state and local tax revenue combined were down 11 percent from year-earlier levels. Local governments took a hit from the housing bust. State governments got hammered when the income, spending and capital gains they tax declined. Despite an improving U.S. economy, tax receipts at the state level remain 12 percent below pre-recession peaks.

But, almost in Austrian fashion, Wessel recognizes that the problem was the boom:

In the good times, governments enjoyed and spent a tax windfall; state and local tax revenue rose 36 percent in the five years before the bust. In the mid-2000s, overall receipts — taxes and federal grants — rose rapidly. In the ensuing years, spending rose rapidly too. Flush with money, government did more, often encouraged by voters who wanted more spending on education, for instance.

Everyone wants to point the finger at how stupid Wall Street was, or the banks, for loading on real estate during the boom, but what about city hall? They hired plan checkers, inspectors, and city planners and built fancy new digs to house them all, strapping themselves to the same real-estate rocket. And ever-increasing tax levies from real-estate appreciation and fees ladled on new real-estate development would fund everything from education to child care to help for the homeless.

Same way at state houses around the country: who cares what kind of onerous union contracts you sign when the money's flooding in? It's like that old Merle Haggard song: "We'll all be drinking that free Bubble-Up / And eating that rainbow stew."

This all came apart when the financial markets melted down going on three years ago now.

It turns out America has done this before. Three years after the 1929 crash, Herbert Hoover urged Congress to pass the Revenue Act of 1932.

"Politicians only understand the language of bombs and bullets."
Farmer J.M. Setten, in a January 10, 1933, letter to Illinois Governor Henry Horner

Murray Rothbard wrote that "the range of tax increases was enormous." A number of wartime excise taxes were reinstated, and sales taxes were imposed on a number of everyday goods — necessities and luxuries alike. Income taxes were raised dramatically. Of course, these numbers will seem quaint, but the nominal rate was raised from a range of 1.5–5 percent to 4–8 percent. Personal exemptions were reduced, the earned-income credit eliminated, and surtaxes really jacked up from 25 percent to 63 percent on the highest incomes.

Corporate income taxes were raised. The gift tax was restored.

All these tax increases came on the heels of huge increases in state and local taxes during the 1920s. In 1920, state taxes were .83 percent of national income, David Beito writes in his book Taxpayers in Revolt: Tax Resistance during the Great Depression. And by 1929 state taxes had more than doubled to 1.9 percent of national income.

By the end of the roaring '20s, property taxes accounted for more than 90 percent of taxes levied in cities with a population greater than 30,000.

Real-estate owners were filling state-government coffers all over the country.

"The real estate tax seemed almost designed to incite rebellion," Bieto writes. "Only vaguely did it meet the definition of a tax based on ability to pay."

In the 1920s, as is the case now in the early 21st century, real-estate ownership was a poor barometer to measure the wealth of individuals. Just because Fed policies and cheap money go flooding into house prices and driving up values doesn't mean the owners can afford the tax bill that city hall can't wait to assess them. After all, these aren't rental properties, where the tax burden can be shifted.

Local and state governments love property taxes. The administrative costs are tiny. It's hard to hide a house, so no detective work is required for collections. And what happens if you don't pay your real-estate taxes? Well, you get your name in the local paper. All your friends and neighbors can see you haven't RSVP'd the taxman's invitation to pony up.

So what if you don't pay? The local authorities just slap liens on your property and wait. That property ain't going anywhere. And tax liens are superior to your mortgage loan and anything else.

That's the way private property works in the good old US of A.

Property taxes actually predated the American Revolution, thus, as Bieto explains, "possessing the cardinal administrative virtue: 'The old tax is the good tax.'"

During the 1920s land wasn't the only property taxed; personal property was as well, and the assessment of value and the tax burden were arbitrary and ripe with corruption.

Even with the prosperity of the 1920s, taxpayers buckled under the pressure of increased tax burdens. Detroit's rate of property-tax delinquency increased from 4.5 percent in 1921 to 12 percent in 1929.

And this was a trend that was happening nationwide. According to the report of the President's Conference on Home Building in 1932, "The growth of delinquency is apparently not due to the present business depression but has been going on since 1920 at the latest." The report concluded that people weren't paying their property taxes "apparently due to the increase of the property tax more than any other one cause."

Farmers were hit hard by these taxes. While the price of their goods plummeted, the taxes increased, leading the Department of Agriculture to conclude in 1932 that the "real weight [of the farmer's tax burden] has been doubled by falling prices since 1929," and it "takes more than four times as many units of farm produce to pay the farm tax bill now as it took in 1914."

Farmers didn't take this lying down. In January of 1933, farmers in Doylestown, PA, overran a tax sale, purchased the farm's title for $1.18 and then returned it to the owner. Farmers across the country started employing the "dollar sale" strategy. In some cases farmers just quit paying and the local authorities decided to leave them alone.

Tax protesters in Freeborn County, Minnesota, demanded the abolition of the county agent, county nurse, weed inspector, and home-demonstration agents, along with a 20 percent cut in government employees. In a neighboring county, 2,000 protestors turned out to make similar demands.

"The rural tax protest had a distinctly spontaneous air," Beito writes. "Taxpayers' organizations would appear, disappear, reappear, and then disappear again at dizzying rates." Organizing farmers for the long-term was like herding cats.

But nonetheless these protests were effective. Farmer J.M. Setten issued a warning to Governor Henry Horner: "In some states at tax sales the people bought their property for 50 cents with shot guns. Politicians only understand the language of bombs and bullets."

James Babcock wrote in 1934 that farmers are complaining that "Schools cost too much. Teachers are paid too much money. We are going broke supporting our schools. I say abolish the county agent. He was wished upon us by the state college."

Urban protesters did better at coalescing than their rural brethren in most cases. Individual taxpayer leagues sprung to life on a city or county basis. Edward Barrows, who wrote extensively about these protests, believed there to be "not less than three thousand and probably not more than four thousand [taxpayer organizations] now in action, and that their number is rapidly increasing." Seven hundred were formed just in the spring of 1933 alone, according to the Committee on County government of the National Municipal League.

This was a far cry from 1927, when only 43 such organizations existed.

The Socialist mayor of Milwaukee, Daniel Horn, hated the tax-protesting groups, claiming they were "doing more to undermine faith in government than all the communists in the world," and that they were mere fronts for greedy capitalists and real-estate swindlers.

In Atlanta, a brand new taxpayer league attracted 1,000 members in the first week and quickly rose to 5,000. Despite the protests, Atlanta politicians raised tax rates, and were shocked when counseled that the tax increase would cause a rebellion, finding it difficult to imagine "our staunch leading citizens, taking part in any sort of [tax] strike. Why the thing was simply not done!"

Tax protesters wondered why the cost of government hadn't gone down as the economy had. William Munro, who wrote often about local governments at the time, put it this way: "'I buy less food, less tobacco, less recreation,' says the man who holds his job, 'and I would like to buy less government.'"

But Chicago was the flashpoint for tax protests. Corruption was pervasive in Cook County, with its assessment system an embarrassing mark of local distinction. Tax fixing in the Windy City involved juggling assessments, rewarding those who cooperated with the local political machine, and punishing those who didn't.

There were reform reassessments and a two-year tax holiday from 1928 to 1930 but under the Silas Strawn Plan assessed taxes would jump nearly 24 percent from 1928 to 1930. At the same time, real-estate values plunged between 1927 and 1931 with the value of new construction falling 86 percent and existing real estate dropping 38 percent in value.

On November 29, 1930, 4,000 Chicago taxpayers jammed the Board of Reviews' offices to file protests. When the Board ignored the protests, litigation and nonpayment ensued.

The Association of Real Estate Taxpayers (ARET) formed 161 branch offices in the city by August 1931 where taxpayers could join and sign up for the tax strike.

It was common knowledge that city government was helpless. A municipal-court judge complained that his neighbors and friends made fun of him for paying his property taxes.

City hall tried to shame people into paying their taxes. While the ARET couldn't buy advertising in local papers, these same papers donated full-page "Pay-Your-Taxes" ads. Posters were printed up with "Take Your Trade Where the Taxes Are Paid." Taxpaying property owners were given "This Property Is Now Paying Taxes" posters to display.

Despite being called anarchists and worse, ARET membership reached 30,000 people, and in 1931–32, over 53 percent of Chicago property taxes were delinquent. And it wasn't rich fat cats stiffing the tax man. Beito's research reveals that skilled blue-collar workers made up the single biggest group within ARET, and 26 percent of members were women.

Beito writes that the strike's demise came from division in its ranks. So were the tax strikes successful? Beito says yes, but only with qualifications.

Of course all these protests around the country flew in the face of municipal reformers who had spent a generation professionalizing government in an attempt to improve the image of government employees. It was predicted that if these tax protestors persisted "the reform edifice that they had constructed would be irreparably damaged," writes Beito. Prominent political scientist Charles Merriam "warned that these recurrent criticisms of government employees threatened to poison permanently 'the springs of government interest, enthusiasm and service.'"

Glenn Frank worried that the spreading antigovernment ideology would "divert men of capacity and self-respect from the public service for a generation." I guess it probably has. As H.L. Mencken explained, "the average American legislator is not only an ass but also an oblique, sinister, depraved and knavish fellow."

The last time a US state defaulted on it debt was in 1933, when Arkansas stiffed $146 million worth of bondholders. That time has come again, because taxpayers will either flee — as Jimmy John has — or stay, fight, and strike.

As farmer Setten said, "Politicians only understand the language of bombs and bullets."


The Republicans in search of a nominee


Bring forth a pragmatic Republican: he (or she) might win

CAN Barack Obama be beaten in next year’s presidential election? That is the question that a squadron of nervous Republicans are asking themselves as they weigh up whether or not to jump into the fray, an undertaking that will cost them hundreds of millions of dollars and prove intrusive, exhausting and quite possibly humiliating. So far only two obscurities have declared themselves, a pizza mogul and a gay-rights activist. But the field is about to start filling out (see article).

In 2007 the race was already in full swing by now. The slow start, many reckon, is attributable to a severe case of cold feet. Incumbent presidents, on the whole, win re-election. The only three to be turfed out since the second world war have been the hapless Jimmy Carter; and Gerald Ford and George Bush senior, who were both running for re-election at the end of, respectively, two and three terms of Republican rule. Mr Obama’s approval ratings, at around 48%, are respectable, and the economy is clearly recovering, though still fitfully (see article). He has a huge war chest and the slickest electoral machine that America has ever seen. He will, certainly, be hard to beat.

But not impossible. Consider that Mr Obama, who ran a pretty good campaign in 2008, beat John McCain, who didn’t, by 192 electoral-college votes, a big number but not a landslide. The challenger needs therefore to switch states “worth” 97 votes to his (or her) column—a total that falls to 91 once you take into account the census which has helped the Republicans. Next, look at the 81 votes in five big swing states which plumped for Mr Obama in 2008: Ohio, Florida, Virginia, Indiana and Wisconsin. In all these places his appeal, especially to white working-class voters, has collapsed as the downturn has worn on and the implications of his expensive health-care bill have sunk in; the Republicans did well in them in the mid-terms. And some other states look promising: North Carolina, Colorado, Nevada and Minnesota. Above all, things can change, especially in a weak economy. The Republican starting position is considerably better than Bill Clinton’s in March 1991 (when the older Bush’s post-Iraq approval rating was 85%).

Let the elephants stampede

But the Republicans still have to find the right candidate. What would he or she look like? The next election could be dominated by some foreign event, but that is hard to plan for, and usually domestic policy is more important. Mr Obama’s weaknesses are his perceived affection for big government, his lack of empathy with wealth-creators, his remoteness from the common man and the sense that he has never been a chief executive: witness the former senator’s willingness to hand over the tough decisions about health care and the deficit to Congress. In 2008 Americans chose a charismatic leftish senator who spellbound them with his rhetoric; in 2012, with reform of their government a priority, they might choose a conservative pragmatist who has met a payroll.

The Republicans’ first problem is Sarah Palin. She has a strong base in the “tea party”, but she terrifies independents. Fortunately, the party is starting to understand this: at a recent conservative conference in Washington, DC, she picked up just 3% in a straw poll. But once you look beyond her, there is a reasonably impressive slate of moderates, headed by a clutch of governors who (unlike Mr Obama) have grappled successfully with budget issues: Mitt Romney, formerly of Massachusetts; Mitch Daniels, of Indiana; Jon Huntsman, formerly of Utah; Hayley Barbour of Mississippi; Tim Pawlenty, formerly of Minnesota; and Chris Christie of New Jersey.

At the moment none of them stands out. Mr Romney is the best-known—though he is hampered by his famously flexible convictions and his Mormonism (see article). Mr Christie, who is turning around a Democratic state by taking on Mr Obama’s friends in the public-sector unions, says he is not running; others, including Mr Daniels, are hesitating. That is sad for their party, and also for America. A pragmatic alternative to Mr Obama would drag the president to the centre. And it would also leave independents who backed Mr Obama last time, like this newspaper, with an interesting choice.



Fighting between forces loyal to Libya’s leader, Muammar Qaddafi, and his opponents in the east grew fiercer. He remains in control of Tripoli, the capital, and is battling to seize back towns under rebel control. Western and Arab leaders discussed whether a no-fly zone should be imposed. See article

The UN said that the humanitarian situation caused by the fighting was dire, with more than 100,000 refugees from Libya in makeshift camps across the borders with Egypt and Tunisia. The UN suspended Libya from the Human Rights Council; the International Criminal Court opened an investigation into possible crimes against humanity committed by Libya’s leaders. See article

The Egyptian prime minister, Ahmed Shafiq, stepped down, as did the Tunisian prime minister, Mohamed Ghannouchi. Protests continued in both countries, with pro-democracy campaigners complaining about the slow pace of reform and the continuing presence of allies of the former regimes. See article

Demonstrations got angrier in Yemen’s capital, Sana’a, and in other towns across the country. At least 27 people are reported to have been killed since the protests began a few weeks ago. President Ali Abdullah Saleh’s offer to form a unity government failed to quell the unrest. See article

At least one person was killed in protests by jobless and ill-paid youths in Sohar, a port city in hitherto peaceful Oman. Days later, however, thousands of Omanis took to the streets in support of Sultan Qaboos, who has promised reform. See article

Mir Hossein Mousavi and Mehdi Karroubi, leaders of the Iranian opposition Green Movement, have been thrown in jail, according to their families. Thousands of protesters took to the streets in response, leading, said the opposition, to 200 arrests.

Six men were killed in an apparent assassination or coup attempt in Congo. Shooting broke out in Kinshasa, the capital, after unidentified men armed with guns, rocket-propelled grenades and machetes attacked the home of Joseph Kabila, the president.

Religious intolerance

Shahbaz Bhatti, Pakistan’s minister for minorities, was gunned down outside his home in Islamabad. Mr Bhatti, a Christian, was a critic of Pakistan’s harsh blasphemy laws, as was Salman Taseer, the governor of Punjab, who was assassinated two months ago. A message left at the scene of Mr Bhatti’s murder promised death to those who offer support to blasphemers. See article

A court in the Indian state of Gujarat found 31 Muslim men guilty for the deaths of 59 Hindu activists who died in a fire at a railway station in 2002. The killings at Godhra ignited rioting in which at least 2,000 people, mostly Muslims, were massacred. Eleven of the defendants were sentenced to death.

India’s Supreme Court ordered the head of the country’s anti-corruption commission to resign, because he faces corruption charges.

Get with the programme

The recently retired head of Bolivia’s drug police was arrested in Panama and sent to the United States to face charges of trafficking cocaine. Three other senior police officers were arrested in Bolivia. In its annual report this week the International Narcotics Control Board, a UN body, complained about the failure of the government of Evo Morales, Bolivia’s president, to curb cocaine production. See article

Brazil’s government said it would scale back planned spending on housing for the poor, postpone the purchase of 36 fighter jets for the air force and freeze the federal government payroll as part of its effort to cool an overheating economy.

The beginning for Enda

Voters in Ireland threw out their Fianna Fail-led government at an election. The new government will be led by Fine Gael’s Enda Kenny, whose party scored its best result ever. Mr Kenny has promised to secure a better deal from the European Union on Ireland’s bail-out. See article

The Dutch government looked set to lose its majority in the upper-house Senate after its coalition partners did badly in regional elections.

France’s president, Nicolas Sarkozy, sacked his controversial foreign minister, Michèle Alliot-Marie, over her apparently close links with the ousted Tunisian regime. Her job went to a former Gaullist prime minister, Alain Juppé. See article

The German defence minister, Karl-Theodor zu Guttenberg, was forced to quit after a long row over plagiarism in his doctoral thesis. Chancellor Angela Merkel, who was reluctant to lose the popular Mr zu Guttenberg, replaced him with a Christian Democrat stalwart, Thomas de Maizière. See article

Two American air force servicemen were shot dead and two were wounded when a gunman opened fire on a military bus at Frankfurt Airport. A suspect, apparently from Kosovo, was arrested.

A Bangladeshi man was found guilty by a court in London of involvement in a plot to blow up airliners. Rajib Karim worked as a software engineer for British Airways, where he contacted Anwar al-Awlaki, an American-born radical cleric based in Yemen.

Round and round again

Democrats and Republicans in Congress passed another interim measure that avoids a shutdown of the federal government and cuts $4 billion in spending. But the bill provided only a two-week extension to funding, and the whole issue will have to be resolved again by March 18th. See article

Barack Obama suggested that he would give states the opportunity to seek waivers from mandates in the new health-insurance law as soon as the legislation comes into effect in 2014. The act that was passed by Congress requires states to wait until 2017 before they can apply for opt-outs.

The Supreme Court ruled that the constitution protected the right of a fundamentalist church from Kansas to picket the funerals of troops killed in the Afghanistan and Iraq wars, overturning the decision of a lower court that had sided with the family of a marine who had served in Iraq. The Westboro church believes the wars are God’s punishment for America’s tolerance of homosexuality. It airs its views near memorial services for the troops, usually under police protection.

Oil and the economy

Oil and the economy

The 2011 oil shock

More of a threat to the world economy than investors seem to think

THE price of oil has had an unnerving ability to blow up the world economy, and the Middle East has often provided the spark. The Arab oil embargo of 1973, the Iranian revolution in 1978-79 and Saddam Hussein’s invasion of Kuwait in 1990 are all painful reminders of how the region’s combustible mix of geopolitics and geology can wreak havoc. With protests cascading across Arabia, is the world in for another oil shock?

There are good reasons to worry. The Middle East and north Africa produce more than one-third of the world’s oil. Libya’s turmoil shows that a revolution can quickly disrupt oil supply. Even while Muammar Qaddafi hangs on with delusional determination and Western countries debate whether to enforce a no-fly zone (see article), Libya’s oil output has halved, as foreign workers flee and the country fragments. The spread of unrest across the region threatens wider disruption.

The markets’ reaction has been surprisingly modest. The price of Brent crude jumped 15% as Libya’s violence flared up, reaching $120 a barrel on February 24th. But the promise of more production from Saudi Arabia pushed the price down again. It was $116 on March 2nd—20% higher than the beginning of the year, but well below the peaks of 2008. Most economists are sanguine: global growth might slow by a few tenths of a percentage point, they reckon, but not enough to jeopardise the rich world’s recovery.

That glosses over two big risks. First, a serious supply disruption, or even the fear of it, could send the oil price soaring (see article). Second, dearer oil could fuel inflation—and that might prompt a monetary clampdown that throttles the recovery. A lot will depend on the skill of central bankers.

Of stocks, Saudis and stability

So far, the shocks to supply have been tiny. Libya’s turmoil has reduced global oil output by a mere 1%. In 1973 the figure was around 7.5%. Today’s oil market also has plenty of buffers. Governments have stockpiles, which they didn’t in 1973. Commercial oil stocks are more ample than they were when prices peaked in 2008. Saudi Arabia, the central bank of the oil market, technically has enough spare capacity to replace Libya, Algeria and a clutch of other small producers. And the Saudis have made clear that they are willing to pump.

Yet more disruption cannot be ruled out. The oil industry is extremely complex: getting the right sort of oil to the right place at the right time is crucial. And then there is Saudi Arabia itself (see article). The kingdom has many of the characteristics that have fuelled unrest elsewhere, including an army of disillusioned youths. Despite spending $36 billion so far buying off dissent, a repressive regime faces demands for reform. A whiff of instability would spread panic in the oil market.

Even without a disruption to supply, prices are under pressure from a second source: the gradual dwindling of spare capacity. With the world economy growing strongly, oil demand is far outpacing increases in readily available supply. So any jitters from the Middle East will accelerate and exaggerate a price rise that was already on the way.

What effect would that have? It is some comfort that the world economy is less vulnerable to damage from higher oil prices than it was in the 1970s. Global output is less oil-intensive. Inflation is lower and wages are much less likely to follow energy-induced price rises, so central banks need not respond as forcefully. But less vulnerable does not mean immune.

Dearer oil still implies a transfer from oil consumers to oil producers, and since the latter tend to save more it spells a drop in global demand. A rule of thumb is that a 10% increase in the price of oil will cut a quarter of a percentage point off global growth. With the world economy currently growing at 4.5%, that suggests the oil price would need to leap, probably above its 2008 peak of almost $150 a barrel, to fell the recovery. But even a smaller increase would sap growth and raise inflation.

Shocked into action

In the United States the Federal Reserve will face a relatively easy choice. America’s economy is needlessly vulnerable, thanks to its addiction to oil (and light taxation of it). Yet inflation is extremely low and the economy has plenty of slack. This gives its central bank the latitude to ignore a sudden jump in the oil price. In Europe, where fuel is taxed more heavily, the immediate effect of dearer oil is smaller. But Europe’s central bankers are already more worried about rising prices: hence the fear that they could take pre-emptive action too far, and push Europe’s still-fragile economies back into recession.

By contrast, the biggest risk in the emerging world is inaction. Dearer oil will stoke inflation, especially through higher food prices—and food still accounts for a large part of people’s spending in countries like China, Brazil and India. True, central banks have been raising interest rates, but they have tended to be tardy. Monetary conditions are still too loose, and inflation expectations have risen.

Unfortunately, too many governments in emerging markets have tried to quell inflation and reduce popular anger by subsidising the prices of both food and fuel. Not only does this dull consumers’ sensitivity to rising prices, it could be expensive for the governments concerned. It will stretch India’s optimistic new budget (see article). But the biggest danger lies in the Middle East itself, where subsidies of food and fuel are omnipresent and where politicians are increasing them to quell unrest. Fuel importers, such as Egypt, face a vicious, bankrupting, spiral of higher oil prices and ever bigger subsidies. The answer is to ditch such subsidies and aim help at the poorest, but no Arab ruler is likely to propose such reforms right now.

At its worst, the danger is circular, with dearer oil and political uncertainty feeding each other. Even if that is avoided, the short-term prospects for the world economy are shakier than many realise. But there could be a silver lining: the rest of the world could at long last deal with its vulnerability to oil and the Middle East. The to-do list is well-known, from investing in the infrastructure for electric vehicles to pricing carbon. The 1970s oil shocks transformed the world economy. Perhaps a 2011 oil shock will do the same—at less cost.

A civil war beckons


A civil war beckons

As Muammar Qaddafi fights back, fissures in the opposition start to emerge

WHAT began as a more or less peaceful uprising is set to degenerate into a full-scale civil war. After losing a string of cities on all sides of Tripoli, his capital, Colonel Muammar Qaddafi is fighting back. The coastal strip on Libya’s east side remains firmly under control of the rebels, with their headquarters at Benghazi. The rebels beat off the colonel’s forces in their attempt to recapture Brega, an oil town west of Benghazi (see map). But the Libyan leader seems determined to retake some of the towns closer to his capital and has sent his aircraft to bomb targets in a swathe of rebel-held areas.

Meanwhile Western and Arab leaders pondered whether, if the bloodshed worsens, they should enforce a no-fly zone over the country in an effort to isolate and bring down the colonel (see article). The rebels, unsurprisingly, are keen on the idea. For the moment, the Americans sounded wary. The Arab League said it was not against it in principle, provided the Arabs and the African Union gave a green light. Venezuela’s president, Hugo Chávez, a friend of the Libyan leader, aired a peace plan, which few seemed likely to take seriously. As the battle intensified, speculation grew that outsiders might become more involved. American battleships assembled off the coast, while global jihadists eyed their chance to get embroiled.

In any event, the rebels’ heralded push to the west has slowed right down. Impatient rebel sons are begging their fathers to let them march on Tripoli; some 17,000 have signed up as volunteers in Benghazi alone. But it is unclear who is in charge. Civilian leaders, saying they must call the shots, mistrust the rebel soldiers, especially those bearing the rank of colonel, who question the civilians’ capacity to command. Standing on a balcony above the entrance to Benghazi’s court-house, now the rebel headquarters, an elder tells a champing crowd to expect a long struggle.

Moreover, Colonel Qaddafi still commands a band of tribal support, running down through central Libya from Sirte, where his own clan is based on the Mediterranean coast, south through the tribal lands of Oulad Suleiman to Tuareg territory near the border with Chad. “We’re facing a stalemate,” says a banker-turned-opposition leader in Beida, a conservative religious and tribal centre in the Green Mountain, north-east of Benghazi. The rebels’ priority is to fortify and hold on to Ajdabiya, a gateway between east and west.

Libya’s tribes are in a state of flux. Elders from the Zintan tribe, south-west of Tripoli, which has traditionally been allied to Colonel Qaddafi’s, have broadcast a statement on a satellite channel aligning themselves with the rebels. But Libya’s largest tribe, the Warfalla, with nearly 1m members (in a total population of nearly 7m), remains nervously part of a federation loyal to the colonel. Its members still fearfully remember the bloody punishment they got after backing an abortive coup in 1993. “Their elders still refuse to talk to us,” bemoans a rebel leader from Beida.

The civilian opposition may be doing better than the armed one. Since breaking free from the Qaddafi regime in the east, young men with paintbrushes have been whitewashing the police stations they previously torched and urging policemen to return to their posts. Others have repainted shutters on shops, which the colonel’s officials required to be a monochrome green. (“He made us hate green,” says one.) The rebels have started a newspaper, replacing the official Libyan calendar dated from the Prophet Muhammad’s death with the Gregorian one that all Libyans understand. Merchants in Benghazi’s gold market are tentatively opening their shops.

Cyrenaica, Libya’s eastern slice that was once a breadbasket of the ancient world but has since been ruined by the colonel’s eccentric economic theories, is re-establishing its trading links. Benghazi’s ice market is stacked with donated medicine and food from Egypt. Bankers say their vaults have enough cash to last a good month. Oil-refinery managers say they can still meet most of the demand, despite the disruption caused by the fighting.

In areas in rebel hands, a feared descent into chaos has not materialised. Despite a dearth of policemen, crime has not risen. Female students attending celebrations have not reported harassment. For almost two weeks, restaurateurs have been offering free tea and sandwiches. To display their new-found sense of fraternity, businessmen have helped sweep the streets. “We’ve defied Qaddafi’s claim that chaos would ensue,” says Abdel Hafiz Ghoga, an opposition spokesman in Benghazi.

Some migrant workers, without tribes to protect them, have been targeted by rebels. Vietnamese and Filipino nurses have been turfed out of their homes and have fled. But most of the 1.5m foreign workers in Libya from poor countries such as Bangladesh, whose governments were unable to arrange airlifts home, have stayed on. A Scandinavian oil man, who doubles as an honorary consul, has tried to protect dozens of Eritrean labourers cowering in a warehouse for fear they will be mistaken for the colonel’s reviled mercenaries, 60 of whom were said to have been massacred in the Green Mountain town of Shahat, after rebels captured them.

The resentful east

It is easy to see why the people of Benghazi have little love for their long-time leader. He is said to call the town ajouz al-shamta, “the old hag”. Most of its better buildings predate his rule. His plan to demolish the old Ottoman-era markets was stymied by UNESCO, the UN’s cultural arm, just before the bulldozers moved in. As a punishment, the colonel removed the city’s holiest modern shrine, to Omar Mukhtar, Libya’s anti-colonial hero, dumping it 50km (31 miles) to the south. Much of the Ottoman quarter is rutted and swamped in sewage.

But before Libya’s economy can be resuscitated, especially in the neglected east, the rebels must rebuild virtually every civil institution and win back the trust of just about every sector of society, from lawyers and doctors to soldiers and farmers.

The protesters came from all walks of life. But the revolt began when lawyers marched on the court-house to complain about the arrest of colleagues who had represented the families of 1,270 Libyans, most of them Islamists and many from Benghazi, who had been massacred by the colonel’s men in Tripoli’s Abu Salim prison in 1996. But the Islamists and secular liberals, with the shared aim of dishing the dictator, have struck up an alliance.

One early decision of this broad-based rebel movement was to retain the services of the police and to focus their ire on the ruling Qaddafi family. Municipal committees in rebel-held towns were assigned the basic tasks of humdrum administration. At a higher level, an interim “national council” has been formed, with authority over a 13-man military council overseeing the forces that defected from the colonel.

But a coherent government in the liberated zone has yet to emerge. No one is quite sure what laws should prevail. Despite banners calling on Benghazi’s merchants to reopen their shops, many are still shuttered. Children have yet to go back to school, despite a deadline for doing so. Many urban Libyans are too frightened to hang the old flag from King Idris’s time from their windows lest the military tide flows back in Colonel Qaddafi’s favour.

The first big crack in the rebel movement opened when Mustafa Abdel Jalil, who had been the colonel’s justice minister until he joined the rebels, took to the airwaves to declare himself head of a provisional government. His credentials seemed sound. He had the backing of the people of Beida, where earlier revolts had broken out. And he had a record of defying the colonel from within government.

But many of Benghazi’s lawyers, who had orchestrated the first protests, thought he had jumped the gun—and carped at the prospect of ceding a youth revolution that started in the towns of the coast to a 70-year-old tribal elder from the mountains. A day after Mr Abdel Jalil’s proclamation, they nominated an alternative spokesman, another lawyer half his age.

Despite this hiccup, the coalition has survived. Representatives of religious foundations tell journalists they want a mainly secular constitution, not one based on the Koran. A leader of the Libyan Islamic Fighting Group, a global jihadist outfit whose members were let out of prison last year, insist that the organisation, contrary to the colonel’s claim, has no truck with al-Qaeda, nor does it seek an Islamic emirate. Benghazi’s new council includes both Islamists and westernised merchants, and promises elections within six months.

But at prayer times, differences among the celebrants in front of Benghazi’s court-house do emerge. In the front rows a few hundred secular-minded youths cry “Free Libya!” and play Arab pop music over loudspeakers. Behind them, in rows 20 deep, a far bigger crowd chants prayers.

Could a post-Qaddafi Libya reflect a similar division? Based on relationships forged in the notorious Abu Salim prison, a loose Islamist front is emerging. Old-time sheikhs and graduates schooled in Salafi pietism (who seek to emulate the behaviour of the Prophet’s comrades) have teamed up with Muslim Brothers who temper their enthusiasm for sharia law with pragmatism in their dealings with non-Muslim people and governments.

The jihadists take a more rigid line, saying they will tolerate anything—as long as it does not conflict with Islam. Muhammad Busidra, a British-trained doctor freed a year ago after 21 years in Libya’s jails, who calls himself the jihadists’ lawyer, derides the colonel’s claim to be the “liberator of creed and faith” but says his ban on alcohol and cinemas should continue. The Islamists grumbled when an American-trained secular professor was given the education portfolio on the new council. Mr Busidra reassured them that it would please their Western helpers and anyway would not last long.

All in all, the Islamists are gaining ground. Mosques, hitherto closed between prayer times to limit public assembly, are open round the clock. The imams have started to preach politics, offering their pulpits to Islamists tortured by the regime. The clerics have also begun to dispense welfare. Salim Jaber, a prominent Benghazi imam appointed to the new council’s religious committee, hands out food, shifting its distribution from market to mosque. “The sheikhs will decide who deserves food—and who does not,” says an oil engineer helping with the catering.

America has permission to help

So far, both hardline Islamists and secular liberals want the Americans to enforce a no-fly zone over Libya, mainly to prevent Colonel Qaddafi from flying reinforcements of African mercenaries to his base in Tripoli. They also want the West to recognise the national council. And both want a quick end to the colonel’s regime. “If we start a guerrilla war, we’ll get help from foreign jihadists, and Libya will be another Afghanistan,” says Mr Busidra, who wants to keep jihadists out. “International opinion should move.” Lawyers, businessmen, Muslim Brothers and former exiles in the national council all say that no measures should be ruled out; the council specifically called on America to raid Colonel Qaddafi’s base in Tripoli.

Explore our interactive map and guide to the Arab League countries

But others disagree. “We’ll stop fighting the tyrant and shoot the Americans instead,” says a veteran of Libya’s war in Chad, who now mans an old anti-aircraft gun on Benghazi’s corniche. Some Islamist leaders say they may face pressure to fight American troops if they became involved. If the liberals were to endorse Western military ground action, they could soon be pilloried as foreign stooges, thus strengthening the Islamists’ hand.

Libyans have a strong jihadist tradition, going back a century to Omar Mukhtar, who conducted a holy war for two decades against the colonising Italians; he lost but remains a heroic unifying symbol. Religious, tribal and nationalist feeling is still strong. More recently, Libyan jihadists have been prominent in Iraq, where, according to a study by West Point’s Combating Terrorism Center in 2008, Libyans (nearly all from the eastern part of the country) made up a fifth of foreign jihadists, the second-largest group after the Saudis and the highest per person of any country. Sufian bin Qumu, a rebel leader in Darna, north-east of Benghazi, was once Osama bin Laden’s chauffeur.

Yet Libya before Colonel Qaddafi’s coup in 1969 combined respect for Islam with friendship towards the West. King Idris’s legitimacy rested on his leadership of the Sanussi religious order, whose flag the rebels have made their own. He co-operated with Islamists but let the British and Americans have military bases on his soil.

Most of today’s Islamists in Benghazi look to the West for help in rebuilding civil institutions, after decades of military rule. The reopening of the American cultural centre in Benghazi, says Mr Busidra, the jihadists’ lawyer, would be rather nice. But it may not happen for quite a while.

Greenspan Says Government ‘Activism’ Hampering U.S. Recovery

Greenspan Says Government ‘Activism’ Hampering U.S. Recovery

Former Federal Reserve Chairman Alan Greenspan

Alan Greenspan, former chairman of the U.S. Federal Reserve. Photographer: Andrew Harrer/Bloomberg

Former Federal Reserve Chairman Alan Greenspan said a surge in U.S. government “activism,” including fiscal stimulus, housing subsidies and new regulations, is holding back the economic recovery.

Increased bond issuance by the Treasury Department crowds out borrowers with the weakest credit ratings, Greenspan said in an article in International Finance, published on the Web today. At least half of the shortfall in companies’ capital spending “can be explained by the shock of vastly greater government- created uncertainties embedded in the competitive, regulatory and financial environments” since the failure of Lehman Brothers Holdings Inc. (LEHMQ) in 2008, Greenspan said.

Greenspan’s conclusions fit with his long-held free-market ideology and may aid Republican lawmakers who argue that cutting federal spending now will help spur job growth. Critics including members of the Financial Crisis Inquiry Commission have said Greenspan’s failure to regulate the mortgage market last decade helped fuel the housing bubble whose bursting precipitated the financial crisis.

“Much intervention turns out to hobble markets rather than enhancing them,” said Greenspan, 84, who was appointed Fed chairman by Republican President Ronald Reagan in 1987 and served until 2006. “Any withdrawal of action to allow the economy to heal could restore some, or much, of the dynamic of the pre-crisis decade, without its imbalances.”

Beware of Market Gurus Pushing New Strategies

Beware of Market Gurus Pushing New Strategies: Roger Lowenstein


Roger Lowenstein

One cheer for James K. Glassman, the investment writer and co-author, in 1999, of “Dow 36,000.” That book, published when the stock market was near a dot-com- charged speculative peak, urged investors to load up on shares. The Dow, the authors prophesied, would reach the gaudy figure in their title most likely in “three to five years.”

The market crashed soon after. The Dow didn’t get close to 36,000, and the book became a symbol of New Economy hysteria. (Glassman’s co-author was economist Kevin Hassett, a Bloomberg News columnist and, to me, a frequently helpful source.)

Now, Glassman, the lead author, has published an apologia.

“I was wrong,” he wrote in a Wall Street Journal op-ed promoting his latest book, “Safety Net.” In the spirit of curiosity, Glassman asks “What happened” and sallies forth with this: “The world changed. While history is usually the best guide to the future, it is far from perfect.”

Give Glassman credit for fessing up. But still, his explanation is troubling. History is always capable of doing something new. So when we pick an investment guru, we want to make sure the advice will endure for longer than the latest headlines.

According to Glassman, two bombshells upended his forecast. One is that U.S. economic growth slowed relative to those of emerging countries. For Glassman to call this a “change” is like an insurance underwriter blaming stormy weather. Throughout history, growth rates have been subject to change. No prudent analyst would overlook such a possibility.

Dependable Odds

As for Glassman’s second “change,” back in the days when he was writing “36,000,” he considered “only one kind of risk” -- price volatility. Volatility is what you can learn from a price chart. If markets were dice, charts would be sufficient. Roll enough dice and you will discover that snake eyes occur once in every 36 rolls. And those would be dependable odds in the future.

But markets, Glassman learned, are also subject to “a second kind of risk” -- better known as uncertainty. This refers to risks that can’t be captured in price data, such as the chance of a terrorist incident or a depression. You can’t quantify the odds of a depression simply by knowing that we had one in the 1930s and haven’t had one since.

This revelation isn’t a “change” either. Economists such as Frank Knight and John Maynard Keynes wrote about uncertainty early in the 20th century. Modern investors have oft learned (to their chagrin) that models based on volatility don’t capture all relevant risks. This isn’t new. It is only new to Glassman.

I think he has papered over the real story of why “36,000” was so off base. It wasn’t that history changed -- it was the authors’ expectation that the market environment was likely to persist.

Cisco, Lucent

“Some say the stock market is the most powerful and efficient computing device in the world,” they wrote. And: “Today’s price reflects all known information.” And again, “We see the market as efficient.” In other words, markets are computers. They don’t get thrown off by exuberance or self- delusion; they simply reflect “known information.”

While urging caution on the Internet in general, they touted then-tech favorites like Cisco and Lucent. The authors succumbed to the prevailing hothouse fever, urging readers to “seize the opportunity now to profit from the rise to 36,000.”

Glassman’s faith in markets explains why he has consistently been scornful of government regulation. (Why regulate markets if they are basically perfect?)

Apparently, he has turned a new leaf. Glassman now writes of Keynsian uncertainty and concedes that the market is not so efficient -- i.e., that some investors can beat it. And where once he was ebullient, now he is chastened. “Safety Net” promotes a strategy that “fits the reality and danger of our times.”

Value Conversion

Glassman argues for reducing exposure to U.S. stocks, investing in “bear funds,” and hedging through put options. He is full of praise for “value” stocks -- by which he means, stocks that trade at low multiples of assets or earnings.

It may be that Glassman has metamorphosed into a value investor like his seeming hero, Warren Buffett. (I’m a shareholder in Berkshire Hathaway, which Buffett controls.) But books like his make me nervous. Glassman seems to like value stocks because they have performed in the past. You could have said that about Lucent in 1999.

What is missing is a deep exploration of why value stocks do better. One looks for a patient analyst scouring the market for bargains; what one finds is a promoter spewing statistics on asset allocations.

Back to 1999

Glassman says value stocks benefit from “investor psychology.” He says they offer more reward with lower risk. But he still defines “risk” in terms of volatility. And he doesn’t seem to have learned that psychology can change. His new book, he says, “fits the psychology of investors” -- as if that condition were immutable.

Glassman is gaga on China because, over the past decade, it has grown much faster than the U.S. He thinks this is “a harbinger of even greater disparities to come.”

It sounds to me that Glassman is doing exactly what he did in 1999. He is proposing a strategy that is guaranteed to work as long as the future mirrors the recent past. In 1999, he counseled exuberance. Today he urges de-risking. Then he shunned bonds; now he can’t get enough of them.

A real safety net isn’t to be found in a preference for any class of assets over another but, rather, in the discipline of bottom-up security analysis -- a timeless rather than a trendy approach that urges looking for underpriced securities wherever they reside. It requires real labor, of the sort that cannot be reduced to boldface headings.

Glassman likens his experience and in some ways his approach to that of Buffett, but don’t be fooled. Buffett does not rewrite his investment philosophy with every passing decade.

Obama, Calderon Tensions Ease

Obama, Calderon Tensions Ease After U.S. Pledges to Help Fight on Drugs

Mexican President Felipe Calderon praised U.S. President Barack Obama yesterday after he pledged more help in the fight against drug traffickers, signaling an easing of tensions between the two countries.

Obama is offering “renewed cooperation” and doing more than any previous U.S. president to help Mexico, Calderon said at an event in Washington. The comments followed Obama’s commitment at a joint press conference to do more to prosecute gun-runners bringing weapons into Mexico.

Yesterday’s bilateral White House meeting may help reduce friction that was building between the two governments, said Andrew Selee, director of the Mexico Institute at the Woodrow Wilson Center in Washington. Mexico has complained that the U.S. has been doing too little to slow the demand for illegal drugs or stop arms trafficking as drug-related violence and killings soared in Mexico, he said.

“Calderon’s tone has been one of frustration for the past few weeks,” Selee said in a telephone interview. “The meeting helped the leaders to reconnect on a common strategy.”

The two leaders said they agreed on a plan to resolve a longstanding dispute over allowing Mexican trucks in the U.S., and Obama promised that the U.S. will be a “full partner” with Mexico in the battle against drug cartels. He also pledged that deliveries of equipment to help Mexico combat the drug trade will be accelerated.

Obama said the U.S. “accepts our share of responsibility” for the violence between drug gangs that claimed the lives of 15,000 Mexicans last year.

“We’ve stepped up enforcement,” Obama said. “We’re putting more and more resources into this.”

‘More Must Be Done’

Calderon still urged more action by the U.S. on weapons and drug use.

“We have found renewed cooperation to face this problem in the Obama administration,” he said at a separate event after his meeting with Obama. “But more must be done.”

As an example, he said, he wants to find ways of “sealing ports of entry” to secure the borders.

In a Feb. 23 interview with the newspaper El Universal, Calderon called U.S. cooperation “notoriously insufficient.” He also said that the U.S. ambassador to Mexico, Carlos Pascual, had hurt bilateral relations through his criticism, revealed in cables published by WikiLeaks, that various Mexican government security entities suffered from a lack of coordination.

“Their ignorance distorts what is going on in Mexico,” Calderon said in the interview, referring to U.S. officials. “It affects and irritates our officials.”

Agent Killed

Mexico’s violence claimed the life of a U.S. customs agent and resulted in injury to another on Feb. 15 when the two were attacked by gunmen linked to organized crime.

Calderon said the agent’s alleged killer has been detained, and Obama said the U.S. intends to seek extradition of the suspect to face trial in the U.S.

“We expect the full weight of the law to be brought against this perpetrator,” Obama said.

To spur economic growth, both leaders said yesterday that they will work to lower trade barriers to increase the cross- border flow of goods. They also announced an agreement to allow Mexican trucks broader access to the U.S. in return for a reduction of tariffs on U.S. goods.

“We finally have found a clear path to resolve the dispute over trucking between our two countries,” Obama said. “We’re working to expand the trade that creates jobs for our peoples.”

Part of Nafta

The trucking agreement, which needs congressional approval, would end a dispute over the passage of Mexican trucks from factories south of the border to destination points in the U.S. that dates to the North American Free Trade Agreement in 1995. While the U.S. is bound by the North American Free Trade Agreement to allow Mexican trucks through, opponents in Congress have blocked compliance, citing safety concerns.

The agreement would lead to Mexico dropping tariffs on $2.4 billion worth of U.S. pork, cheese, corn and fruits, the White House said in a statement. Half the tariffs will be lifted as soon as the deal is signed, and the remainder once the first Mexican truck is allowed to enter the U.S.

In 2007, the U.S. initiated a pilot program that let as many as 100 Mexican trucking companies haul cargo into the U.S. It was canceled in 2009 under a provision in spending legislation passed by Congress and signed into law. Mexico responded by placing retaliatory tariffs on U.S. imports.

Along with the trucking agreement, U.S. congressional approval would be required for increasing aid to Mexico or restricting the cross-border weapons trade.

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