Friday, April 15, 2011

Would You Settle Your Claims on Social Security for 83 Cents on the Dollar? (I Would)

Here’s a win-win proposition for all involved.

If a debt cannot be paid, it will not be paid—at least not paid in full. In dealing with such debts, the fundamental logic is to settle unpayable debts at a discount, at less than 100 cents on the dollar. This can happen by voluntary agreement when a mortgage loan is settled for less than the amount of the loan through a “short sale,” for example (an increasingly familiar transaction in the wake of the burst housing bubble). It can happen when a troubled company buys back its own bonds from the market at a discount. Of course, it can also happen in a reorganization under the bankruptcy code. In all cases, the point is for the parties to put past mistakes behind them and for life to go on.

Let us consider the Social Security program. The interaction of its design by politicians with the demographic and economic facts has the unavoidable and well-known result that its debt (its “promises,” if you prefer) cannot be paid in full.

Could Social Security’s debt be settled at a discount by voluntary transactions with its creditors, namely American citizens? I propose that it could. Every time this happened, it would reduce Social Security’s net deficit, because its debt would go down by more than its assets, just as with any individual or company in a similar situation. This is basic balance sheet arithmetic: if your debt goes down more than your assets do, your net position improves.

Could Social Security’s debt be settled at a discount by voluntary transactions with its creditors, namely American citizens? I propose that it could.

Would at least some Americans be interested in such a transaction? Large numbers of people, especially young people, do not believe that they will ever fully collect on Social Security’s promises, that is, its debt at par—and they are right. So I believe significant numbers of people would be interested. These might well include the 68 percent of respondents aged 19 to 29 who were “not confident at all” (48 percent), or “not so confident” (20 percent), that they would get their full benefits, according to a 2009 poll.1 In a 2011 poll, the grand total of those aged 25-34 who were “very confident” that they would get Social Security benefits at least equal to today’s value was 2 percent!2

What might be a fair price to settle Social Security’s debt?

To answer this question, we need to focus on that part of Social Security dealing with pensions. This part, called “OASI”—“Old Age and Survivors Insurance” —represents about 85 percent of Social Security and is in large measure designed as a forced savings program. (The other 15 percent or “DI”—“Disability Insurance”—is a program for forced insurance, not savings, and is a different discussion.)

The present value of all future income of the OASI program is $34.5 trillion, according to the Social Security Trustees 2010 Report.3 This is using the Intermediate Assumptions as the best guess estimate. It values all the future cash payments to the government from OASI—these are the real total assets.4

Against the $34.5 trillion in OASI assets, there are liabilities of $41.4 trillion. This is the present value of all the future cash outflows promised by Social Security. The liabilities are obviously $6.9 trillion greater than the assets. If your liabilities exceed your assets, you are by definition insolvent—and your creditors have reason to think about how they might wish to deal with that.

For those who choose to stay fully in the Social Security program, the Social Security net worth deficit becomes smaller every time someone else settles for 83 cents on the dollar.

Putting these numbers together, the $34.5 trillion in assets of Social Security available to pay promised pensions are only about 83 percent of the promises of $41.4 trillion. Since the assets are equal to about 83 percent of the liabilities, this gives us a reasonable estimate of the fair way to settle the debt of Social Security to its creditors (namely, us): 83 cents on the dollar.

The Social Security Trustees also express the finances of Social Security in terms of future cash receipts and future cash outflows as percentages of the total projected taxable payrolls. In the intermediate estimate, OASI cash receipts will be 11.3 percent of future payrolls, and the cash cost will be 13.6 percent,5 so receipts will be 83 percent of costs: another way to say 83 cents on the dollar.

So would you rather have 83 cents of your own, which you could invest to earn interest you would own, or would you prefer 100 cents of future claims on an admittedly insolvent government pension program? Personally, I’d take the 83 cents in a heartbeat, and so would most other people to whom I’ve put the question. But I think the matter should be entirely voluntary.

For those who choose to stay fully in the Social Security program, the Social Security net worth deficit becomes smaller every time someone else settles for 83 cents on the dollar.

So I propose that Americans be given a choice (imagine that). You could stay in Social Security as it is. Or you could elect to settle for 83 cents, paid in U.S. Treasury inflation-indexed bonds, which you would own outright. These bonds, with all future interest payments on them, would constitute true retirement savings, protected from inflation.6 In exchange, you would forego formula benefits equal to the value of the bonds you received divided by 0.83. You would have made up your own mind about the chances of such promised Social Security benefits actually being paid.

This is clear enough in principle, but how might it work mechanically? Perhaps like this: If you as a creditor of Social Security elect the proposed settlement, each quarter thereafter you would receive a rebate of all the Social Security tax you paid—6.2 percent of your wages is subject to the tax.7 You would receive this in the form of inflation-indexed Treasury bonds deposited in your own tax-deferred retirement savings account. You now have real assets and savings to replace some of the unenforceable, complicated, politicized promises of an insolvent program, and are happy with your choice. Moreover, it is now easy to understand exactly what you have.

You now have real assets and savings to replace some of the unenforceable, complicated, politicized promises of an insolvent program, and are happy with your choice.

As Professor Laurence Kotlikoff rightly said in the Social Security debates of three decades ago, “The perception of Social Security as a savings account has been fostered by every major piece of Social Security legislation since the program’s inception in 1935. Perhaps it is time to make de jure what has long been a de facto relationship.”8 My proposal would achieve just that.

Your rebate would effectively reduce the Social Security portion of your payroll tax to zero. Not bad.

Of course, your employer pays another 6.2 percent Social Security tax, so ordinarily the total tax is 12.4 percent of your wages. The employer’s contribution, like all your past Social Security taxes paid, would continue to be paid and to generate benefits for you. From the government’s point of view, its Social Security income from your wages going forward would have dropped by 50 percent.

But the government would be happy about this. The entire transaction means that its total government liabilities have gone down and its Social Security deficit has been reduced. This is because for every 83 cents in bonds the government issued as rebates, it reduced its Social Security liability by one dollar. In other words, the government bought a dollar for 83 cents and is definitely ahead.

The mechanics of Social Security benefit calculations for those participating in such a Social Security debt settlement, might work like this. The government would calculate your Social Security benefits by the normal formulas, in the normal, convoluted, opaque way. These benefit payments over time would then be reduced by the actuarial equivalent of all the Treasury bonds you received divided by 0.83.

This proposal is a win-win proposition, which improves the financial position of all four parties involved: those who choose to settle the debt of an insolvent debtor at a discount; those who choose to hold the existing Social Security promises; the Social Security program; and the government as a whole.

Atlas Shrugs Off an Opportunity

Atlas Shrugs Off an Opportunity, Alienates Viewers

Most Americans will find Ayn Rand’s worldview distasteful, immoral, and absurd.

Few mainstream movies celebrate business owners and entrepreneurs. Indeed, as Jay Richards has written on these pages, “Survey novels, plays, and movies with business people as characters. Ordinarily, those characters are the villains, not the heroes.” Though he and Michael Auslin later followed up with scattered suggestions, the trend holds strong.

Contra this Hollywood tendency, Ayn Rand’s Atlas Shrugged: Part 1 will pierce theaters on April 15, 2011, in a strong adaptation of her popular novel glorifying the innovative, productive individual. Part 2 is slated for 2012, and Part 3 for 2013.

“Creative people, the ones [studios] empower to make movies, are the ones for the most part not familiar with the book or who despise its philosophy,” producer Harmon Kaslow said in an interview.

The Audience for Objectivism

Atlas Shrugged has several cultural tradewinds blowing in its favor. For one, despite Hollywood’s lack of fare to serve this interest, Americans like entrepreneurs. Polls confirm that Americans hold hugely positive views of small business, entrepreneurs, and capitalism: 95, 84, and 61 percent, respectively, view these positively in Gallup’s latest poll, for example. So pro-entrepreneur plots have a large potential audience.

The vision undergirding Atlas Shrugged ultimately alienates viewers from the consumer-oriented, selfishness-curbing benefits at the very heart of American free enterprise.

Rand’s novel has captured this audience for decades. Back in 1991, a joint survey by the Library of Congress and Book of the Month Club dubbed Atlas Shrugged the “second most influential book for Americans today,” after the Bible. Since the financial crisis hit in 2008, Atlas Shrugged sales have surged. In 2009, the book sold half a million copies, and more than 7 million copies have sold since it published in 1957. The book is No. 2 on Amazon’s bestseller list for political fiction and No. 2 for classic fiction.

Another tradewind: Americans doubt that activist government measures such as the stimulus have done much to ameliorate the recent recession, and are increasingly wary of government regulation.

Atlas Shrugged: The Movie

Into this climate steps the steely Rand via her heroine, Dagny Taggart. Taggart runs Taggart Transcontinental, a train line central to American transportation because oil shocks and world disasters have destroyed road and air shipping. When a train running through Colorado derails, Taggart must navigate crippling federal regulations while attempting to rebuild the track. She puts her trust and money in a new metal invented by Hank Rearden, and the two battle inside and out against legislators, business partners, and family members sponging off Taggart and Rearden’s hard work and ingenuity. Rearden and Taggart also attempt to track the inventor of a new type of super-efficient engine.

Despite Hollywood’s lack of fare to serve this interest, Americans like entrepreneurs.

At the same time, the world’s brilliant businessmen and inventors keep disappearing after whispering the repeated phrase, “Who is John Galt?” The film (part one of a trilogy) ends in a fiery climax as one of Taggart’s new business partners abruptly vanishes amid explosions lighting his Colorado oil wells.

The movie version of Atlas Shrugged has been held up for years due to concerns from her estate and those who bought the movie rights about keeping the screenplay on message. Indeed, Rand was writing her own adaptation of Atlas Shrugged at her death in 1982 because the film of another of her books, The Fountainhead, did not ultimately fit her vision and frustrated her. And concerns about ideological purity have also precluded Angelina Jolie and other A-listers from taking the lead role, as such top-tier actresses demand and get influence over the script, casting, and other creative aspects of movies.

“What guided me was having the words and the meaning be philosophically pure. 100 percent. No compromise to the greatest of my ability. Have the approved script, have the words philosophically make sense according to Ayn Rand,” said the movie’s producer and financial backer John Aglialoro.

Ayn Rand appeals to the natural and highly American intolerance of abused authority; but she locates a replacement authority inside the individual himself, stripping away any mediating institutions, deity, or natural law.

Refusing a philosophical compromise on the book’s message makes the script and its performance, in some scenes, as unconvincing as the book. For example, [spoiler alert!] as Taggart and Rearden successfully drive their first train on the rebuilt Colorado line, the music builds as they forge westward, Taggart tears up slightly, and the two are overjoyed when they finally arrive in the western United States with no trouble from Rearden’s “untested” metal tracks. Many movies pivot on scenes of emotional triumph, but most moviegoers will find it difficult to find great sympathy at an impersonal scene of mechanical victory. Though the movie has decent technical quality and the acting and settings are generally vivid and believable, sticking rigidly to Rand’s message has, more than anything, underlaid the movie with cold, inhuman steel—as if Rearden’s metal, and not blood, runs through Atlas Shrugged’s veins.

Ayn Rand: The Philosopher

Rand’s fiction illustrated and glorified her philosophy, a set of ideas she named Objectivism. The basic tenets, as she described them in 1962: a metaphysics of objective reality, an epistemology of reason, an ethics of self-interest, and a politics of capitalism.

Ayn Rand preaches innovation, creativity of thought and expression, self-direction, and the overruling demands of Nietzschean super-geniuses. But she never allowed deviation from her rules and preferences among her followers.

Rand attacks both liberals and conservatives (take, for example, her speech, “Conservatism: An Obituary”); but it’s her attack on conservatism that’s worth visiting here, since it’s so out of touch with the American character. She appeals to the natural and highly American intolerance of abused authority; but she locates a replacement authority inside the individual himself, stripping away any mediating institutions, deity, or natural law. Man becomes his own measure; yet somehow never disintegrates in her fiction the way he does so often when adopting this mentality in real life.

This Rand hallmark makes her extremely attractive to young people and those whom government has abused or burdened. Rand is an intellectual Siren; she attracts travelers with the sweet songs of freedom, individual responsibility, and creativity; yet her narrow worldview in the end also hacks these ideals to bits.

The case against Rand was perhaps most forcefully made by Whittaker Chambers in National Review in 1957. Benjamin Wiker makes a more recent, and more biographical, case against her in chapter 15 of his recent 10 Books Every Conservative Must Read. And AEI’s own Charles Murray discussed her relative merits and demerits in the context of two excellent new Rand biographies in the Claremont Review of Books.

Rand’s philosophy is solipsist: since, for consistency if nothing else, man must have guiding principles, institutions, or ideas, she removes all others and places herself in their stead. Rand preaches innovation, creativity of thought and expression, self-direction, and the overruling demands of Nietzschean super-geniuses. But she never allowed deviation from her rules and preferences among her followers, even to the most minuscule instances. She liked Chopin and disliked Bach; therefore for anyone else to enjoy Bach indicated mental weakness. She wanted to have an affair with Nathaniel Branden, a married man; therefore, it was rational for her to do so and destroy his marriage and wife.

Concerns about ideological purity have precluded Angelina Jolie and other A-listers from taking the lead role in Atlas Shrugged.

This mode of living she celebrated as exemplifying the “virtue” of selfishness. As she said, “My personal life is a postscript to my novels; it consists of the sentence: And I mean it.” If anything, her life and novels as illustrations of and promotions for her philosophy illustrate exactly the dangers and shortcomings of Objectivism, not just personally, but morally, and for society. Perhaps Rand didn’t care for society, except of her own making—that’s probably why her geniuses in Atlas Shrugged withdraw to a secluded mountain to let the rest of humanity crumble under its own weight. But most Americans, as human beings and citizens with a national heritage of voluntary community resourcefulness and charity, would find this not only distasteful, but immoral and absurd.

Back to the Big Screen

At times Atlas Shrugged: Part 1 strikes sound and timely notes. When Taggart meets a union representative, he tells her his members will not run trains without raises, want better working conditions, and don’t want to use Rearden’s metal. At this point, the company is straining for money and needs the metal to survive. She snaps back: "You want me to provide the jobs and you want to make it impossible for me to have any jobs to provide?"

Excited by this, Tea Party-influenced and other grassroots conservative groups have expanded the number of theaters and markets where Atlas Shrugged will open on April 15 (yes, Tax Day, and deliberately) from 11 cities to more than 100 and counting. They believe a movie with anti-government, pro-enterprise themes will appeal to a broader audience than Hollywood.

So the unfortunate part of this tale is that finally a pro-enterprise, pro-individual movie based on a bestselling book comes to market using serious actors and production; yet the vision undergirding it ultimately alienates viewers from the consumer-oriented, selfishness-curbing benefits at the very heart of American free enterprise.

The masses blow a raspberry

Peru's presidential election

The masses blow a raspberry

Voters engineer an unappealing choice between two contrasting populists, Ollanta Humala (below left) and Keiko Fujimori (right)

IT IS hard to think of two politicians less attractive or qualified to run a country of 29m. But the outcome of a presidential election on April 10th means that Peruvians will have to choose in a run-off on June 5th between Ollanta Humala, a former army officer with no government experience backed by the far left, and Keiko Fujimori, whose father is a conservative ex-president serving a 25-year sentence for human-rights abuses and corruption.

Both Mr Humala, who won 32% of the vote, and Ms Fujimori (23.5%) embody a vein of populist authoritarianism running through Peru’s history. They harvested a protest vote against the moderate democratic politicians who have governed the fastest-growing of Latin America’s larger economies over the past decade, but who have failed to curb corruption and crime or do enough to improve social conditions.

The democratic centre-right vote added up to 44%, but was fatally split between a trio of candidates. Alejandro Toledo, the president in 2001-06, led the polls with 28% six weeks ago, but took just over half as much in the election. Pedro Pablo Kuczynski, who served as finance minister under Mr Toledo, stressed reform within the existing free-market economic regime and managed 18.5%, with his support concentrated among wealthier voters in and around Lima (see map). That was not bad for a former investment banker and IMF official, but not enough. Luis Castañeda, a former mayor of Lima, took 10%.

In the 2006 election Mr Humala won 31% of the vote in the first round, only to be narrowly beaten by Alan García, who has governed as a conservative. Then Mr Humala was close to Venezuela’s Hugo Chávez. He looks better placed this time: Ms Fujimori is a less skilful rival than Mr García, and Mr Humala has moved towards the centre. His inspiration now is Brazil’s former president, Luiz Inácio Lula da Silva, whose Workers’ Party has offered him advisers. As Lula did before him, he has swapped his red T-shirt for business suits.

Mr Humala once talked of expropriating foreign mining and gas companies and creating new state enterprises. By the end of the campaign he sounded almost like Mr Kuczynski. He talked of legalising Peru’s vast informal economy, negotiating higher taxes on mining and improving schools. But if Mr Humala is to allay suspicion about his plans among two-thirds of the electorate, he must repudiate his far-left written manifesto, drop talk of changing the constitution—the formula used by Mr Chávez to cling to power—and promise to appoint competent technocrats.

If Mr Humala arouses fears for the future, Ms Fujimori awakens fears of the past. Her father, Alberto Fujimori, defeated the Maoist terrorists of the Shining Path and implemented free-market reforms that laid the foundations of Peru’s boom. But he used tanks to shut down Congress, rode roughshod over the constitution and presided over systematic corruption. His daughter has played down an earlier pledge to seek an amnesty for him. She promises continuity in economic policy mixed with social giveaways and illiberal talk of using the death penalty and anti-terrorist laws against crime. She may win the backing of many better-off Peruvians.

If Mr Humala eventually wins, in what remains a tight campaign, it will hardly amount to a triumphant leftist wave of the sort that propelled Bolivia’s Evo Morales to power in 2006. His party will have only 46 seats in the 130-strong Congress. The constitution gives the Central Bank independence. Free-trade agreements with the United States, the European Union and China place limits on economic change. And, as Mr Humala’s Brazilian advisers may point out, one secret of Lula’s success was his decision to respect existing contracts and not reverse his predecessor’s privatisations.

But the single-minded pursuit of foreign investment and economic growth that marked Mr García’s presidency now seems to be drawing to an end. Many Peruvian democrats will have nightmares in the coming weeks. A generation ago Peru’s social fabric was rent apart by economic collapse and political violence. Around two-thirds of Peruvians still work in the informal economy. Although life has improved in the past decade, many are still susceptible to the appeals of would-be saviours—and there is more money to be grabbed to finance a bid for elected autocracy. The democrats will have to work hard to ensure that whoever wins on June 5th leaves promptly five years later.

The rise of the anti-Keynesians

Republican economics

The rise of the anti-Keynesians

Paul Ryan’s intellectual hinterland

WHEN Republicans proposed slashing billions of dollars from federal spending this year, Democrats circulated predictions by economists that jobs and growth would be hit. John Boehner, the Republican speaker in the House of Representatives, countered with an economic expert of his own: John Taylor of Stanford University. “Nothing could be more contrary to basic economics, experience and facts,” Mr Taylor asserted on his blog, which Mr Boehner cited. By cutting government spending, he said, the Republicans would “crowd in” private investment and create jobs.

Mr Taylor, a prominent monetary academic, served under both George Bush senior and junior and advised John McCain during his presidential campaign. In the past few years he has become a strident and prolific critic of the monetary and fiscal stimuli deployed by the Federal Reserve and the Obama administration respectively, views that have received a warm welcome from House Republicans. For if there is one ideology that unites today’s Republicans, it is Keynesianism, whose nefarious influence they are determined to stamp out. “Young Guns”, the book-sized manifesto of Eric Cantor, Kevin McCarthy and Paul Ryan, leading Republican House members, devotes several pages to the evils of Keynesian activism and its exponents in the administration.

The budget Mr Ryan proposed on April 5th seemed to herald the return of supply-side economics, the notion that cutting taxes can generate so much more work and investment that tax revenues rise. In the 1990s Mr Ryan was a speechwriter for Jack Kemp, the effervescent congressman who, in the late 1970s and early 1980s, made supply-side economics a centrepiece of Republican electoral ambitions.

Perhaps that is why Mr Ryan turned to the Heritage Foundation, a conservative think-tank, to produce a wildly optimistic analysis of his budget’s economic impact. It did not say Mr Ryan’s cuts to personal and corporate tax rates pay for themselves; though it reckons they recoup a still hefty 50% of their costs. But it projected an investment boom that would lift output and drive unemployment down to 2.8%, a rate not seen for 57 years. Few economists dispute that lower tax rates boost labour supply and investment. But Menzie Chinn, an economist at the University of Wisconsin at Madison, reckons the Heritage Foundation assumes a boost five to eight times more powerful than conventional models.

Supply-side economics, though, is only one piece of Mr Ryan’s intellectual furniture. He has also paid homage to Ayn Rand, Milton Friedman, Friedrich Hayek and Robert Mundell, a Nobel laureate who champions the monetary straitjacket of fixed exchange rates. His budget cites approvingly the work of Carmen Reinhart and Kenneth Rogoff on how debt cripples growth and Niall Ferguson, a historian, on how it brings down empires. For on-tap advice Republicans regularly turn to Douglas Holtz-Eakin, a former McCain adviser who now runs the American Action Forum, a think-tank, and Mr Taylor, who keeps a flat in Washington, DC.

Republicans may have found intellectual satisfaction in their opposition to fiscal and monetary stimulus. Whether voters will thank them is another matter. The danger is that, when interest rates are stuck near zero, austerity is more likely to hurt growth than help.

The tormented isthmus

Central America

The tormented isthmus

Big-time drug trafficking has arrived in Central America. Its poor, politically polarised countries must now try to cope

WHEN Eduardo’s father came back to Guatemala after a spell in the United States, the tattoos up his arms gave away his roots in the mara (gang). Before long a rival gang had planted a knife in his back; when that failed to kill him they returned to finish him off in the street near his home. Eduardo (not his real name) was only eight at the time. But to avenge his father he joined his gang as a sicario (hitman), and killed his father’s murderer. Eduardo is now trying to find out whether life can offer any of the happiness he says he has never known. Since January he has been studying computing with La Ceiba, an NGO. As for that murder: “I enjoyed it,” he says blankly.

The bullet scar on Eduardo’s chest and the beaten right arm hanging limply by his side are signs of the violence that has come to engulf Guatemala and much of the Central American isthmus. No region on earth is more routinely murderous. Guatemala’s rate of 46 murders per 100,000 people is more than twice as high as Mexico’s, and nearly ten times greater than that of the United States. Honduras and El Salvador—the other two countries that make up Central America’s “northern triangle”, as it is called—are more violent still (see chart in map). Nicaragua, Costa Rica and Panama, the quietest members of the group, have also seen violence increase in recent years, as has Belize.

These man-made tragedies are matched by natural disasters. Four of the seven Central American countries are among the 20 reckoned to be the most vulnerable in the world to destructive weather. Hurricanes, floods, landslides, earthquakes and volcanic eruptions are frequent and deadly events. They add to the steady grind of poverty and malnutrition.

Costa Rica and Panama are much better off and better governed than their neighbours. Costa Rica is one of the world’s oldest democracies; life expectancy there is on a par with the United States. The others have suffered torpid economic growth in the past decade. Nicaragua is the poorest country in mainland Latin America. Almost half of Guatemala’s children are chronically malnourished—a rate worse than Ethiopia’s, and said by the World Bank to be the third-worst in the world. The damage is visible. Eduardo the ex-sicario looks much younger than his 18 years; as he recounts his murderous apprenticeship, he shuffles child-sized shoes.

Political conflict compounds these problems. The civil wars that ravaged Central America in the 1970s and 1980s between dictators backed by the United States and guerrillas backed by the Soviet Union and Cuba are over, but a crippling polarisation of right and left remains. In 2009 the president of Honduras fell victim to a coup prompted by fears—or paranoia—about his ties to Venezuela’s Hugo Chávez. This year will see a bitter election in Guatemala and a dubious one in Nicaragua, where Daniel Ortega will seek a third presidential term in violation of the constitution.

As if being battered by nature, bad government and youth gangs were not enough, Central America now finds itself thrust into the front line of the drugs trade and prey to big-time organised crime. Nearly all the world’s cocaine is produced in Colombia, Peru and Bolivia. The biggest consumer is the United States, where the wholesale price of a kilo of the stuff, even full of impurities, starts at $12,500. The route to market used to run from Colombia to the tip of Florida, across the Caribbean. But the United States Coast Guard shut down that corridor by the early 1990s, and shipments switched to the Pacific coast of Mexico. Now Mexico, too, has increased the pressure on the traffickers, just as Colombia has done in the south.

Ever supple, the drugs business has sought new premises. Somewhere between 250 and 350 tonnes of cocaine—or almost the whole amount heading for the United States—now pass through Guatemala each year, according to American officials. Whereas a decade ago Central America seized less cocaine than either Mexico or the Caribbean, in 2008 it intercepted three times more than the other two combined. Mexico’s Sinaloa, Gulf and Zetas mobs are now active through much of the isthmus, often with local allies. Unlike the Colombians, they pay their local help in drugs, not cash.

Overwhelmed in Panama

The impact has been lethal. Guatemala’s murder rate has doubled in the past decade. In both Guatemala and El Salvador, the rate of killing is higher now than during their civil wars. Guatemala’s government reckons that about two-fifths of murders are linked to the drugs business. Even Panama, much richer than many Central American countries and a favourite retirement spot for wealthy foreigners, has seen its murder rate almost double in the past three years.

As well as using Central America as a corridor, the traffickers are moving more of their operations there. “We went through a phase in which we made the mistake of seeing ourselves as a supply transit centre, so we just had to interdict. That’s not enough. In Central America drugs are produced, processed and consumed,” says Laura Chinchilla, Costa Rica’s president. In March, to official surprise, what looked like a Mexican cocaine factory was uncovered in Honduras.

As well as taking lives, insecurity carries a heavy economic cost. All in all, dealing with crime and violence costs Central America around 8% of its GDP, according to a report this month by the World Bank. In the most violent countries, cutting the murder rate by 10% could boost income growth per head by up to 1% a year, the bank reckons. Security-related costs are equal to around 4% of private businesses’ sales. Alberto Díaz Lobo of Constructora Eterna, a building firm in Honduras, says his security bill has gone up about 20% in the past five years. Walmart recently moved some of its Central American operations from Guatemala to Costa Rica, partly because of higher insurance premiums caused by insecurity, according to a former manager.

In the northern triangle, weak law enforcement and tracts of wilderness make a perfect environment for organised crime. The Petén, a sprawling, sparsely populated jungle region in northern Guatemala, has become a landing zone for clandestine flights from Colombia and Venezuela. In the Laguna del Tigre national park lies a “cemetery” of more than 30 crashed light aircraft which had been used to ferry cocaine. (The drugs business is so profitable that aircraft are considered disposable.) Locals are paid by narcos to keep the runways open, and sometimes clear more themselves to attract business.

The government does not have the resources to police such an area. Under the peace agreement of 1996 that ended the guerrilla war, the country was supposed to slash the army and expand the police. Only the first happened. The army was cut by two-thirds, but the police force of 25,500 is less than half the size required, says Carlos Menocal, the interior minister. Last year Álvaro Colom, the president, declared a state of emergency in the northern department of Alta Verapaz and sent in the army. He claims that only two drugs flights have landed there since, whereas “before it was like an international airport”. The state of emergency was lifted in February. But Mr Colom concedes that there are still four areas of the country where the drug barons have “temporary control”. To recover them he would need 10,000 more soldiers and 15,000 extra police, he says.

Honduras ordered the army on to the streets of its cities in March; El Salvador did the same last September. Costa Rica abolished its armed forces in 1948. Its 11,000 police are “badly trained, badly armed and equipped and badly housed”, admits José María Tijerino, the interior minister. Plans to recruit an extra 1,000 officers a year for the next four years will still not be enough, he says. The entire force has two two-man helicopters. Its coastguard has a dozen second-world-war-era patrol boats to police two coasts and territorial waters that are 11 times bigger than the country’s land area.

Education and the lack of it

Organised crime feeds on Central America’s other weaknesses. In several of the countries these start with the economy. This has traditionally been based on the export of coffee and other crops. In the 1990s foreign investors set up textile factories to supply the United States market. Nevertheless, income per head in the northern triangle, plus Nicaragua, rose by 1.6% a year between 1995 and 2009, barely above the Latin American average of 1.5%. Central America’s ties to the United States meant that it was badly affected by the recession. It also depends on imported oil and food. As commodity prices rose, poverty increased in the region even before recession struck.

By contrast with its neighbours to the north Costa Rica remains a success story, though not without problems. It is more egalitarian than the others, and since the 19th century has made an effort to educate its people. After opening up its economy in the 1980s, Costa Rica saw foreign direct investment and exports flourish. It is now home to an Intel silicon-chip plant, a cluster of medical-equipment manufacturers and back-office operations of multinationals such as Hewlett-Packard and Procter & Gamble. “This was an educated country that had no economic use for that education,” says Alberto Trejos of INCAE, a business school. “Now foreign investment has turned education into a key comparative advantage.” If Costa Rica faces a shortage of engineers and English-speakers, that is a problem of success. Panama is doing something similar by using its canal to turn itself into a regional business hub.

Contrast that with Guatemala, home to a third of Central America’s 42m people. It has a few institutions that work reasonably well, such as the central bank and the private universities. But it has failed to invest in its people. Recent governments have made some effort. But the average Guatemalan has just 4.1 years of schooling. The shocking prevalence of malnutrition rises to up to 80% of children in some rural villages. The health and schooling of the 45% of the population who speak a Mayan language has been especially neglected. Mr Colom admits to “shame” over that, but few other Guatemalans seem to.

In a vicious circle of opportunity forgone, most Central American countries fail to generate enough jobs for their unschooled people. Only 27% of Central Americans (and just 10% of Nicaraguans) are enrolled in their national social-security systems, according to Miguel Gutiérrez Saxe, a Costa Rican economist who compiles regional data. The rest labour in the informal economy, or are among the 11% of youths who neither study nor work. This idleness feeds the maras: in El Salvador some 800 juveniles languish in jail, more than double the number in 2004. At least 15% of Central Americans (6m of them) have emigrated, most to the United States.

One way of injecting more dynamism into Central America’s economies would be by improving transport links and cutting red tape. Astonishingly, it can be cheaper to ship goods to the United States from China than from Central America, according to a World Bank study. Border hold-ups and bottlenecks through towns mean that it can take up to five days for a truck to travel the 870km (540 miles) from Guatemala City to San José. Some 80% of Costa Rica’s exports and imports, and a chunk of Nicaragua’s, pass along a single-carriageway road and a modest wharf at the run-down Caribbean port of Limón.

But governments are now struggling just to maintain existing infrastructure. Central America has long suffered natural disasters. But these now seem to be more frequent—something its leaders attribute to climate change. After a severe drought in 2009, Guatemala suffered its worst recorded flooding last year; together these caused losses of $1.5 billion, according to Mr Colom. Between 2005 and 2009 natural disasters cost Costa Rica 0.8% of GDP, equivalent to around 18% of public investment.

States without cash

While the demands on governments multiply, their cash does not. Even by Latin American standards, the state in Central America is weak and poor. In Guatemala the tax take is just 10.4% of GDP. To reach Costa Rica’s social indicators of 2010 would need a tax take of 18% for ten years, reckons Edelberto Torres Rivas, a consultant to the UN Development Programme.

But fiscal reform is a hostage to Guatemala’s political deadlock, blocked by the country’s powerful business lobby. Businessmen complain, reasonably enough, of government corruption and say that the civil service needs reform. But their implacable opposition to a modest cash-transfer programme for the poorest, implemented by Mr Colom’s wife, Sandra Torres, betrays a complete lack of social solidarity. The contrast with Colombia is instructive. Álvaro Uribe, Colombia’s stern former president, who made his country safer and also implemented a similar transfer programme, has become the hottest conference speaker in Central America. Businessmen in Guatemala last October loudly applauded his message about security; but when he exhorted them to pay their taxes, he was met with silence. Even in Costa Rica, “Tax evasion is the national sport,” says Ofelia Taitelbaum, the ombudsman.

That is partly because the better-off in Central America make private arrangements not just for health and education but for security. Private security guards are reckoned to outnumber the police and the army by a ratio of about five to one in Guatemala and four to one in Honduras. Everyone pays for protection, “including the poor, who pay for poor security”, according to Pedro Trujillo, a former colonel in the Spanish army turned political scientist at Francisco Marroquín University in Guatemala City. He found that in the 12 years following Guatemala’s peace accords in 1996, 110 private security firms were registered in the country; the previous three decades had seen fewer than 40. In San Pedro Sula, the economic capital of Honduras, the chamber of commerce reports that security is the biggest cost for its members after manpower and electricity.

Explore the drugs paradox north of the region with our interactive map of Mexico's traffic routes, "cartels" and violence

Change can come only through political consensus. But Central America’s political systems are nearly all dysfunctional. Nicaragua’s democracy has been castrated by Mr Ortega, whose party orchestrated widespread fraud in local elections in 2008. In Guatemala, no political party has held office for more than one presidential term since democracy was restored in 1986. By contrast, in El Salvador it was only in 2009 that the opposition managed to end two decades of rule by Arena, a powerful conservative party. The new president, Mauricio Funes, is a moderate left-winger; he must battle against his own party, many of whose leaders are pro-Cuban. Honduras has paid a high price in lost aid money and investment for its political strife.

Panama has built an increasingly solid democracy since American troops overthrew General Manuel Noriega in 1989, but its politics have been marred by corruption and high-handedness. Even Costa Rica faces political problems. A stable two-party system broke down when one of the parties, the Social Christians, imploded after corruption scandals. Lacking a majority in Congress, Ms Chinchilla faces a struggle to win approval for extra taxes to pay for her modest security build-up.

Not everything is gloomy in Central America. The Central American Common Market has survived political conflicts among the neighbours—including an incursion into Costa Rican territory last year by Nicaraguan troops. Most countries are making efforts to respond to the security threat. Honduras last year passed an asset-seizure law, copied from Colombia. In Guatemala, a UN-sponsored anti-impunity commission, known by its Spanish initials as CICIG, has secured such innovations as wiretaps, plea-bargaining and witness protection. But the country still lacks a computerised intelligence platform. The World Bank cites estimates of 2m guns in the country, of which less than 10% are legally registered. And Francisco Dall’Anese, CICIG’s head, has faced a campaign of vilification from businessmen.

Uncle Sam’s role

Not surprisingly, Central America’s leaders think the United States should do more to help tackle the consequences of its own demand for cocaine. Though the region is more violent than both Mexico and Colombia, Central America receives much less American aid. The Central American Regional Security Initiative, the latest aid scheme, offers just $260m over three years to the seven countries. “A drop in a bucket,” says Óscar Álvarez, Honduras’s security minister. “Costa Rica is not a country that goes begging,” says Ms Chinchilla. But she is frustrated that when the Americans come to help, “they always arrive late. When they give significant aid it’s when countries have been invaded by organised crime. They think Nicaragua, Costa Rica and Panama are OK.” Seizures of drugs are neither a good measure nor a good solution to the problem, she says.

The Obama administration has at least shown “an understanding that the problem isn’t just ours,” says Mr Colom. “They are looking for a different plan, because the plan they already have isn’t working,” he believes. Though American officials stress that the strategy will come from Central America and not from Washington, there are some signs of a shift in thinking. William Brownfield, a former ambassador to Colombia who is now the State Department’s top anti-drug man, visited Guatemala, Honduras and El Salvador in February, his first trip in his new job. Mr Obama visited El Salvador in March, when he announced a modest increase in anti-drugs aid to the region, if Congress agrees. There is a feeling that in the isthmus, aid delivers “more bang for your buck” than in Mexico or Colombia, one diplomat suggests. With cash scarce in Washington, aid may be redistributed rather than increased.

Some things are getting better in Central America. But the problem, as an American diplomat in the region says, is that whereas the improvements are linear, the threats are growing exponentially.

China's crackdown

China's repressive new rulers

China's crackdown

The vindictiveness of China’s rulers betrays their nervousness

LIKE so much else under Heaven, repression in China has often seemed to go in cycles. Every now and then it has suited the country’s leaders to relax their steely grip on the country and allow a modicum of political liberty.

Freer criticism in the media has helped give the party a veneer of credibility. Lip-service to the law and due process has won plaudits overseas and boosted the economy at home. So a thaw would set in for a while, a “Beijing spring”. A freeze would always follow. But, until lately, in each new cycle the springs were seeming warmer and the freezes not quite so harsh. When the country was starting to liberalise, Westerners justified doing business with China on just such grounds. More economic openness would surely lead to more openness of other kinds.

The latest freeze casts this widespread hope into doubt, for three reasons. The first is the scale of the crackdown. Ai Weiwei, China’s best-known artist and dissident, who was detained at Beijing airport on April 3rd, is only the most notable figure to be caught by it. Calls on the internet for a “jasmine revolution” have prompted armed police and plain-clothes goons to descend in huge numbers on public places to stop people from “strolling”, as a veiled form of protest.

Baby, it’s cold outside

Dozens have been detained and now face criminal charges in relation to these inchoate calls. Others have faced different kinds of harassment, including beatings and house arrest. But the freeze runs deeper. Since February some of the country’s top defence lawyers have vanished. Activists for villagers’ rights and the environment have faced repression. Bloggers have been rounded up. Members of a big underground (ie, non-state) church in Beijing, stopped from meeting in their usual building, were arrested as they tried to worship outside.

A second reason for doubt is the duration of the crackdown. With hindsight, it began after Tibetan riots in 2008 drew a harsh response. Since then, two events, the Beijing Olympics later that year and the Shanghai World Expo of 2010, might have served as coming-out parties for a rising China. They offered the regime the chance to show the world a more confident face. Yet both were accompanied by harsh treatment of anyone deemed likely to embarrass the government. Tens of thousands of unwashed migrant workers were forced out of Beijing for lowering the tone. Outspoken activists were kept out of sight.

Even natural disasters have triggered repression. Mr Ai’s first serious run-in with the authorities came when he attempted to account for all the schoolchildren killed during the Sichuan earthquake in 2008, many as a result of corrupt building practices. Taking in all its manifestations, which include tightened internet censorship and a stifling of public debate, the latest crackdown on political dissent certainly constitutes the worst since Tiananmen Square in 1989 and its aftermath.

A third reason to doubt the notion of gradual warming lies in the method of repression. Even the post-Tiananmen crackdown had a semblance of due process. Now such pretence is out of the window. People are picked up under arbitrary detention rules and then made to disappear. Mr Ai has not been heard of since being bundled away. Violence is part of the mix. Mr Ai needed brain surgery in 2009 after being beaten up by goons. Foreign journalists are being harassed on a scale unseen since Tiananmen Square. Vaguely defined “state security” is used as a reason to round people up. For perceived “troublemakers” such as Mr Ai, the government says, “no law can protect them.”

Western observers tend to describe the crackdown as a massive overreaction to perceived threats, but it may well be that China’s rulers know better. True, no seething mass stands ready to overthrow the regime. But in a vast country, many aggrieved people, from dispossessed villagers through unemployed graduates to angry bloggers, resent the state. The government is quite capable of handling each of these groups separately. But were those with grievances ever to coalesce, especially if the growth slows—as it will sooner rather than later (see article)—they would represent a potent force.

The view from Beijing, thus, is different to the view from abroad. Whereas the outside world regards China’s rulers as all-powerful, the rulers themselves detect threats at every turn. The roots of this repression lie not in the leaders’ overweening confidence but in their nervousness. Their response to threats is to threaten others.

Imminent political change may also play a part. Next year a crucial party congress will anoint a new generation of leaders, led by Xi Jinping, now the country’s vice-president, to take over the running of the country. Repression is the job of China’s powerful “security state”—the regular and secret police. Sensing rudderlessness at the top, it may be particularly inclined to flex its muscles now.

The fear of hanging separately

Many of China’s new leaders come from the “princeling” class, an aristocracy of families with revolutionary credentials from the days of Mao Zedong (see article). Some have lucrative positions which give them a financial interest in tighter party control over both the economy and society. Others use their ideological pedigrees to advocate a neo-Maoist approach, which includes scant regard for the law. There is plenty of resentment within the system at the growing power of this aristocracy, and repression can be used to defang opposition. A nastier China is the result.

In the short term at least, these troubling developments undermine the comforting idea that economic openness necessarily leads to the political sort. All the more reason, then, for the West to hold China to account. America and the European Union are right strongly to condemn Mr Ai’s detention, though it would have been better had they taken a stand sooner. Speaking out might just help constrain the regime’s behaviour. It will certainly give succour to those in China working bravely to create a better future.

The drug war hits Central America

Central America's woes

The drug war hits Central America

Organised crime is moving south from Mexico into a bunch of small countries far too weak to deal with it

FOR most of the 20th century, the small countries of Central America were a backwater, a tropical playground for dictators and adventurers. In the 1970s and 1980s they turned briefly into a violent cockpit of the cold war as Marxist-inspired guerrillas battled US-backed tyrants. Places like El Salvador and Nicaragua generated daily headlines around the world and bitter partisan battles in Washington. When the cold war ended, peace and democracy prevailed and Central America slipped back into oblivion. But its underlying problems—which include poverty, torpid economies, weak states, youth gangs, corruption and natural disasters—never went away.

Now violence is escalating once more in Central America, for a new reason. Two decades ago the United States Coast Guard shut down the Caribbean cocaine route, so the trade shifted to Mexico. Mexico has started to fight back; and its continuing offensive against the drugs mafias has pushed them down into Central America.

Whatever the weaknesses of the Mexican state, it is a Leviathan compared with the likes of Guatemala or Honduras. Large areas of Guatemala—including some of its prisons—are out of the government’s control; and, despite the efforts of its president, the government is infiltrated by the mafia. The countries of Central America’s northern triangle (Guatemala, Honduras and El Salvador) are now among the most violent places on earth, deadlier even than most conventional war zones (see article). So weak are their judicial systems that in Guatemala, for example, only one murder in 20 is punished.

A collapse in social order, however bloody, is normally an internal matter. Yet it would be wrong to leave Central America to its own unhappy devices. Although the new violence thrives on the weakness of the state in those countries, its origins lie elsewhere. Demand for cocaine in the United States (which, unlike that in Europe, is fed through Central America), combined with the ultimately futile war on drugs, has led to the upsurge in violence. It is American consumers who are financing the drug gangs and, to a large extent, American gun merchants who are arming them. So failing American policies help beget failed states in the neighbourhood.

Reason to worry

The United States is involved in Central America’s troubles not just because it helped cause them, but also because it will feel their consequences. By air, Central America is less than three hours from Miami. It is the gringo “near abroad”, a destination for elderly Americans looking for a warm place to retire, though violence will stem the flow. Already the lethal combination of conflict and lack of opportunity is driving thousands of Central Americans to brave the threat of kidnap and extortion to migrate to the United States. More will follow if conditions worsen.

A generation ago, the United States rightly concluded that it had much to gain if the Americas became a community of prospering democracies. Yet it is in Central America that democracy is under greatest threat. The isthmus seethes with ideological polarisation and political mistrust. China is active there. Venezuela’s Hugo Chávez is stirring things up. In Nicaragua Daniel Ortega is set to win an illegal third term in an election this year, in part thanks to Mr Chávez’s largesse. Honduras saw a coup that ousted an elected, albeit irresponsible, president in 2009. Some Central American countries are doing better: Costa Rica is still one of the safest places in the Americas, for example. But its economic success is based on attracting foreigners as tourists, investors or retired residents. A deteriorating security situation will jeopardise its prosperity—and undermine democracy throughout the region.

Escaping the Hobbesian trap

Central American governments have begun to recognise the scale of the battle they face. But stopping their slide into violent chaos requires many things: reform of the police, prisons and courts; better intelligence and information-sharing; a huge effort to provide more legal opportunities for young men, not least by educating them properly; and more hardware, such as helicopters and patrol boats.

Explore the drugs paradox north of the region with our interactive map of Mexico's traffic routes, "cartels" and violence

All this, of course, will have to be paid for. Central American governments do not collect enough tax revenue to provide the rudiments of a modern state: security, education and health for their people, and transport infrastructure to allow their economies to reap the full benefit of their privileged position close to the United States. Central America has fallen into a Hobbesian trap: the better-off make private arrangements—there are five times as many private security guards as policemen or soldiers in Guatemala, and four times as many in Honduras—and therefore block efforts to levy the tax revenues necessary to strengthen the state. There is a lesson for Central America’s governments in Colombia: the tide turned against los violentos only when Álvaro Uribe introduced a wealth tax to pay for a security build-up.

But the Central American governments are not solely responsible for the countries’ problems. The drugs policies of the United States are also to blame. And, to cap it all, climate change—to which the unfortunate Central Americans have contributed virtually nothing—seems to be increasing the ferocity of nature in the isthmus. Catastrophic flooding is killing people with increasing frequency, and raising the cost of maintaining infrastructure.

When the guerrilla wars of the 1970s and 1980s ended, Americans forgot about Central America. It is time they remembered it again, and offered some help. They could, for example, lead an aid programme that would tie money for roads, ports and security hardware to increases in the tax take to pay for better security and social conditions.

Such schemes will not, however, solve the fundamental problem: that as long as drugs that people want to consume are prohibited, and therefore provided by criminals, driving the trade out of one bloodstained area will only push it into some other godforsaken place. But unless and until drugs are legalised, that is the best Central America can hope to do.

Roots of Crisis Buried Deep After Inquiry

Roots of Crisis Buried Deep After Inquiry: Peter J. Wallison

No one wants to excuse the managers and regulators of financial companies from responsibility for the financial crisis. But it is too easy to assign blame and walk away, without doing the serious work of finding out what really happened.

This observation was triggered by news last week that the U.S. Securities and Exchange Commission is considering an enforcement action against Daniel Mudd and Richard Syron, the chief executives of Fannie Mae and Freddie Mac, respectively, before the two government-sponsored enterprises collapsed.

If, as news reports suggest, Fannie and Freddie failed to fully disclose the potential subprime mortgage losses, the implications would extend beyond a violation of securities laws. It would also have important implications for the causes of the financial crisis and the thoroughness of the work of the Financial Crisis Inquiry Commission.

The commission’s majority report blamed the crisis on financial executives who failed to understand or didn’t care about the risks they were taking. Regulators didn’t do their jobs either, according to the commission.

The conclusion to draw from this is that the crisis was caused by private greed and the indolence or lack of authority of regulators. The remedy implied by this narrative was tighter regulation, and the now-notorious Dodd-Frank Act was the result.

Nearing Truth

Yet the commission, headed by Phil Angelides, a former Democratic candidate for governor of California, and Bill Thomas, a former Republican congressman from that state, never investigated what information about Fannie and Freddie’s loans was available at the time, or why investors and regulators continued to believe that mortgage-backed securities were safe.

With the SEC’s impending enforcement action, we are getting close to the truth.

Under legislation adopted in 1992, Fannie and Freddie were required to meet affordable housing goals when they bought loans from mortgage originators. Initially, the goals required that 30 percent of all mortgage acquisitions had to be classified as affordable -- that is, made to borrowers who were at or below median income in the areas where they lived.

Over succeeding years the goals were increased so that, by 2007, 55 percent of all mortgages the two companies acquired had to be made to borrowers at or below median income.

Competing for Loans

It’s possible to find prime borrowers at this income level. But not when more than half of all loans had to meet this test, and especially when the companies were competing for the same loans with the Federal Housing Administration, and insured banks, and savings and loan associations with similar requirements under the Community Reinvestment Act.

By 2008, Fannie and Freddie held or had guaranteed 12 million loans that were made to borrowers with FICO credit scores below 660 -- a common definition of a subprime loan -- or were otherwise risky because they had no or very low down payments and other deficiencies. By then, 27 million loans, or half of all U.S. mortgages, were subprime or otherwise risky.

When the housing bubble began to deflate, these loans started defaulting at unprecedented rates, dragging down housing prices and the financial companies holding securities backed by these mortgages.

Subprime Exposure

For many years, Fannie Mae defined subprime mortgages as loans that it bought from subprime lenders, not by credit score. This had the effect of making its investment holdings seem less risky. In its 2007 10-K annual report, for example, the company estimated its subprime exposure at about 0.3 percent of its single-family mortgages. Tables deeper inside the report showed loans with FICO credit scores of less than 660 were 18 percent of the company’s single-family holdings.

The significance of this for the financial crisis is that Fannie and Freddie’s reports might have lulled analysts and risk managers into believing that if the housing bubble collapsed, the damage would be limited because the number of risky loans was small.

We now know the damage was severe. Had those 12 million Fannie Mae and Freddie Mac loans been prime instead of subprime, delinquencies and defaults probably would have been around 2 percent, not almost nine times higher.

No Inquiry

In writing my dissent from the commission’s majority report, I searched widely for examples of anyone -- academic researcher, credit rating analyst or housing market expert -- who knew before 2008 that half of all mortgages in the financial system were subprime or otherwise risky, or that Fannie and Freddie had contributed almost half of that total.

The commission had a chance to investigate the risks that Fannie and Freddie were taking and why the information available in the market was so deficient. But this would have required the commission to examine the losses caused by government housing policy. Angelides refused to do so. Instead, Fannie and Freddie’s contribution to the housing crisis was called “marginal” in the commission’s report.

As a result, the American people and Congress received a distorted picture of the causes of the financial crisis, not the thorough investigation they deserved.

Paul Ryan Plan or Higher Taxes, Take Your Pick

Paul Ryan Plan or Higher Taxes, Take Your Pick: Amity Shlaes


Amity Shlaes

This week President Barack Obama is offering his plan to solve America’s debt problem. The president’s approach will include tax increases.

Republicans will huff that the Grand Old Party will never raise taxes. They will tell the president that they want to be like Ronald Reagan or Calvin Coolidge or Andrew Mellon, the Treasury secretary from 1921 to 1932. Mellon, who cut income tax rates to 25 percent from 73 percent in the 1920s, is the tax- cutters’ deity. His anti-tax manifesto, “Taxation: The People’s Business,” is so hot that a first edition sells for $1,250.

What Mellon’s admirers overlook is that that those cuts made up only part of his program. Mellon also cut the budget. Several years into the Great Depression experts concerned with widening deficits went to the Treasury Department, demanding tax-rate increases, levies on autos and radios and even a creepy tax on checks.

Did the legendary Treasury secretary tell those wonks to take a hike? He did not. Mellon duly trashed his own legacy and pushed the top tax rate right back up, to 63 percent.

What caused Mellon’s humiliating surrender? Timing. By December 1931, it was too late for him to do anything else but raise taxes.

Mellon was trapped by errors made in preceding years, at home and abroad. His own Republican Party had pushed through a nasty tariff, Smoot-Hawley. Investors had pushed stock prices too high. The U.S. was on the gold standard, and people feared that gold and dollars would flow overseas if the U.S. deficit deepened too much.

Dwindling Options

The French were hogging gold at the time. Less gold in the U.S. meant less currency in circulation, and the Great Depression got even worse. Mellon had also tried raising money by selling government bonds, but he believed the bond tool was exhausted. In 1931 Mellon feared the U.S. would lose its status on the world stage if the country couldn’t prove it was solvent. That winter’s tax increase was his, and the nation’s, last worst resort.

Here’s what the Mellon story tells us: there comes a point when even the most devoted tax cutter will raise taxes. The trick for the country is to avoid getting to that point. In our own cycle, that point of needing a dramatic tax increase is just years, possibly even months, away.

Time Running Out

There was an era when U.S. politicians had the luxury of ample time, and their motto could be “tax cuts first, deficits second.” Another maxim was also popular: “deficits don’t matter because we outgrow them.” In many instances from the 1960s to the 1990s, tax cuts did indeed promote growth and prevent deficits.

The argument that tax cuts were the one answer for growth was plausible because the U.S. lacked competition. Europe was still divided by multiple currencies. China wasn’t yet on the scene. Republicans could tell themselves that even ridiculous tax code changes such as child credits helped the economy. The U.S. economy was doing so well that a Republican who grumbled about the debt looked like an irrelevant Scrooge.

Some Republicans still think this way. Indeed, Republican denial about the damage of deficits neatly parallels Democratic denial about the damage of high wages. Republicans pretend they are living in the 1980s. Democrats pretend they are living in the 1950s. Both parties ignore the fact that international competition has now changed our situation.

Inhibiting Growth

What about today? We all are starving for growth. This week I’ll be in Dallas at a conference on economic growth hosted by the new George W. Bush Institute. It’s part of the group’s ambitious 4% Project, which seeks ways to achieve long-term economic growth of 4 percent.

This time yearly growth in the U.S. can’t reach 4 percent, or even 3 percent by tax changes alone. Cuts in debt and entitlement reform are also necessary. The federal debt is too big to outgrow, especially with interest rates heading up. The very structure of our entitlement programs guarantees that greater economic growth will yield larger budgetary shortfalls. The formula for Social Security is pegged to the average real wage. When the economy grows, that wage increases, driving up the government’s pension obligations commensurately.

And this time, the competition from China and Europe, in terms of their economies and currencies, will not go away. America’s next big financial crisis will be a money crisis. To survive, the dollar will have to demonstrate that it’s not based upon ever-widening debt and is worthy of investment by foreigners.

Best Strategy

The best move for anyone of either party who wants even a shot at blocking tax increases before it’s too late ought to line up behind House Budget Committee Chairman Paul Ryan like a recruit at basic training.

Ryan’s proposal is imperfect, but the plan is at least ready. Critics unhappy with elements of it can add their own changes to the next budget, once unity creates momentum. In short, the U.S. has to show it realizes it is confronting an existential threat. Monetary policy must also change. Arbitrary moves like the Federal Reserve’s second round of quantitative easing make the U.S. look unreliable to investors with other options.

This past weekend Ryan said, “we need a clean break” with old history. True enough. But those who can’t remember Mellon’s past are condemned to repeat it.

Venezuela Raises Some Food Costs 48%

Venezuela Raises Some Food Costs 48% Amid Inflation Surge

Hugo Chavez

Hugo Chavez, Venezuela's president, speaks at a meeting during the COP15 United Nations Climate Change Conference at the Bella Centre in Copenhagen. Photographer: Chris Ratcliffe/Bloomberg

Venezuela raised government-set price caps on some food products by as much as 48 percent even as President Hugo Chavez’s government struggles to contain one of the highest inflation rates in the world.

The government raised the price on cans of powdered milk 48 percent to 23.7 bolivars ($5.50) and on corn oil by 36 percent, according to a resolution published today in the Official Gazette. The costs of sunflower oil and mixed vegetable oil were also raised.

Venezuela, a net importer of food, avoided raising prices caps following a devaluation of the bolivar earlier in the year in a bid to stave off an inflationary spike. Food is the principal driver of inflation in Venezuela, according to the central bank, and consumer prices may climb more than 4 percent in April with today’s decision, said Boris Segura, a Latin America economist at Nomura Securities International.

“That’s the problem with price controls - they are unsustainable,” Segura said in a phone interview from New York. “The trigger is a devaluation but the reality is that Venezuela has severe inflationary inertia.”

Consumer prices in Venezuela rose 27.4 percent in March from a year earlier, the most among 78 economies tracked by Bloomberg. Prices rose by 5.2 percent, the most in seven years, in April 2010 from a month earlier after the government raised price caps on dairy products and cheese.

IMF Forecast

The International Monetary Fund forecast inflation in Venezuela will accelerate 29.8 percent to 31.3 percent in 2011, according to its World Economic Outlook report released this month.

Chavez devalued the bolivar for the second time in less than a year in January by weakening the exchange rate on so- called essential goods such as food and medicine by 40 percent to 4.3 bolivars per dollar and unifying the two fixed foreign- exchange rates.

The government, which controls the price of more than 100 basic food goods, raised price caps on bread and pasta last month by as much as 33 percent.

House Passes Ryan Plan

House Passes Ryan Plan That Will Help Guide U.S. Budget Debate

Representative Paul Ryan, a Republican from Wisconsin

The Republican-controlled House will set the stage for an even bigger fight with its expected passage of Representative Paul Ryan’s bid to slash spending by more than $6 trillion over the next 10 years. Photographer: Brendan Hoffman/Bloomberg

April 15 (Bloomberg) -- Michael Tanner, a senior fellow at the Cato Institute in Washington, talks about federal deficit-reduction plans by President Barack Obama and House Budget Committee Chairman Paul Ryan. He speaks with Bloomberg's Melissa Long on Bloomberg Television's "Fast Forward." (Source: Bloomberg)

April 15 (Bloomberg) -- Marc Morial, president and chief executive officer of the National Urban League, talks about House Budget Committee Chairman Paul Ryan's budget proposal. The House today passed the measure that would cut U.S. spending by more than $6 trillion over a decade and privatize Medicare. Morial speaks with Mark Crumpton on Bloomberg Television's "Bottom Line." (Source: Bloomberg)

April 15 (Bloomberg) -- Donald Marron, director of the Urban-Brookings Tax Policy Center, talks about the U.S. deficit and its implications for economic growth. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday." (Source: Bloomberg)

April 13 (Bloomberg) -- U.S. President Barack Obama speaks about his proposal to cut $4 trillion in cumulative deficits within 12 years. In presenting his long-term plan for closing the budget shortfall, Obama set a target of reducing the annual U.S. deficit to 2.5 percent of gross domestic product by 2015, compared with 10.9 percent of GDP projected for this year. (Excerpts. Source: Bloomberg)

The U.S. House passed a Republican budget that would cut spending by more than $6 trillion over a decade and privatize Medicare in a party-line vote that will help define the fight over the deficit into next year’s elections.

Lawmakers approved House Budget Committee Chairman Paul Ryan’s proposal today on a 235-193 vote, one day after wrapping up their first budget battle of the year with passage of a $38.5 billion spending cut for 2011.

“Yesterday we cut billions, today we cut trillions,” said Representative Kevin McCarthy of California, the House’s third- ranking Republican.

The measure is certain to die in the Senate where Democratic leaders have endorsed President Barack Obama’s competing call to reduce the deficit through a combination of tax increases and spending cuts.

“The House Republicans have let Tea Party zeal get the better of them, and this vote will reverberate for a long time,” said Senator Charles Schumer, his chamber’s third- ranking Democrat. “In the months to come, we will not miss a single opportunity to remind the public that Republicans voted to end Medicare in order to give extra tax breaks for millionaires.”

Vote Breakdown

No Democrats voted today for Ryan’s plan while four Republicans opposed it: Representatives Denny Rehberg of Montana, David McKinley of West Virginia, Walter Jones of North Carolina and Ron Paul of Texas.

Rehberg, who is running next year for the Senate, said in a statement: “There are still too many unanswered questions with regard to Medicare reform, and I simply won’t support any plan until I know for a fact that Montana’s seniors will be protected.”

White House spokesman Jay Carney said “the president agrees with House Republicans that we must reduce our deficit and put our country on a fiscally sound path, but we disagree with their approach.”

Carney also said “any solution will require Republicans and Democrats working together, and we are committed to that process.”

Spending Cuts

Ryan’s proposal relies exclusively on spending cuts to reduce the government’s deficit, slicing $6.2 trillion over 10 years from Medicare and scores of other programs including Medicaid, food stamps, farm subsidies and Pell college tuition grants.

It calls for replacing the traditional Medicare health-care system for the elderly with subsidies to buy private insurance starting with people who turn 65 in 2022. It would also cut the top corporate and individual tax rates from 35 percent to 25 percent. The plan wouldn’t balance the government’s books until 2040.

Most Americans would pay more for their health care under the plan, according to the Congressional Budget Office, while states may have to cut participants in Medicaid, the federal- state health-care program that serves the poor.

Representative Allen West, a freshman Republican from Florida, said he is ready to take the plan to his constituents.

“I’m not up here to worry about being re-elected,” West said. “There is a dire situation” and “we have to explain it to the people, not stand up and demagogue it and just try to scare people.”

‘Defining Moment’

Representative Lou Barletta, a Pennsylvania Republican, called the vote a “defining moment,” saying “we’re doing it even at risk of our own political future -- but we’re doing it for the next generation and that’s what I came here to do.”

After today’s vote, the chamber will need to produce additional legislation to make specific changes to tax and spending policies. That process could produce bills deviating from Ryan’s plan, and some Republicans said it allows them to back his budget even if they don’t support his policy prescriptions.

“I don’t necessarily think that just by voting for the budget, you’re signing on” to his proposals, said Missouri Representative Jo Ann Emerson, co-chairwoman of a group of Republican moderates known as the Tuesday Group.

“He doesn’t have control over what the committees do,” she said. “You know what happens once the committee process starts. It turns out to be a lot different.”

Framing Debate

Each side is seeking to frame the debate over Ryan’s budget around large themes.

“It’s important to define ourselves with our actions and show the country that we’re serious about getting this debt under control,” Ryan said in an interview. “To sit back and not do anything about it because of politics would be a huge moral failing.”

Representative Rosa DeLauro, a Connecticut Democrat, said the Republicans’ budget “throws seniors to the wolves.”

Today’s vote opens another round of fighting over the so- called discretionary part of the budget -- the areas lawmakers control through annual appropriations bills. Ryan’s plan calls for $31 billion in 2012 cuts, on top of the $38.5 billion in savings approved yesterday after negotiations that almost led to a government shutdown.

“We’ll be going through this same battle all over again,” said Representative Scott Garrett, a New Jersey Republican on the Budget Committee.

Ryan said the fact that his plan is coming to a vote shows how “times have changed.” A similar budget plan by Ryan attracted just 14 co-sponsors last year when Democrats controlled the House. Ryan credited his party’s 87-member House Republican freshman class, many elected with the help of Tea Party activists, for the change.

“They brought a whole new perspective. They brought a lot of energy, a lot of gumption, a lot of backbone to Congress,” Ryan said.

Republican Horror Movie

Republican Horror Movie Sequel Hits Theaters: Jonathan Alter


Jonathan Alter

Republicans jumped all over President Barack Obama’s budget speech at George Washington University as political, and they are absolutely right.

It was the old Obama, the one who changed history in 2008, and he is back on his game, both thematically and tactically. The domestic debate now is much clearer and the takeaway for Republicans is out of a horror movie: Be afraid. Be very afraid.

Obama was elected as a story-teller. Beginning with his famous speech to the Democratic National Convention in 2004, he weaved a personal narrative about Africa, Hawaii and community organizing in Chicago into a compelling message of “Change we can believe in.”

His first two years as president brought plenty of change. He responded to the worst economic conditions since the Great Depression with the most legislation since the Great Society. Yet somewhere along the line Obama lost the thread of his narrative. He was no longer telling a story about America, where it had been and where it is going.

The George Washington speech signaled the return of an overarching idea. Obama said that while we’re a nation of “rugged individualists,” this country has always understood that public investments in education, research and infrastructure -- what Republicans call “wasteful spending” -- helped make us great.

National Amnesia

He told a story that national amnesia has somehow erased: that through the combined efforts of the first President Bush and President Clinton, we balanced the budget in the 1990s. It was only in the last decade when Republicans put two wars, a prescription-drug benefit and massive tax cuts on the credit card that we got the trillion-dollar deficits that confronted him when he took office. Most important, the president stressed the fundamental American values of fairness and compassion.

The plan offered by Republican House Budget Committee Chairman Paul Ryan that will likely pass the House by the end of the month would lower the top marginal tax rate to 25 percent, another trillion-dollar windfall for the wealthy. And it would, as the president said, “end Medicare as we know it” by turning that hallowed program into a voucher system that has already proven to be a failure when tried in a few states.

The Ryan proposal would also effectively gut Medicaid, under which the elderly poor get to live in nursing homes instead of in their children’s homes.

Popular Programs

While everyone agrees that Medicare and Medicaid must be reformed, the basic programs remain wildly popular. The GOP understood this as recently as last fall, when it took control of the House with the help of scare ads across the country saying “Obamacare will slash $500 billion from Medicare.” Now the same freshmen elected on that message will vote to end Medicare -- and in many cases end their political careers.

Older, independent voters that Republicans won in 2010 will despise the Ryan plan once it filters down to them. A Democratic war cry of “They’re killing Medicare!” isn’t demagoguery this time. It’s true.

The president offered few specifics about how to save $4 trillion over 12 years beyond letting the tax cuts for wealthy expire in late 2012. That won’t be enough. But teeing up tax cuts for the rich as a campaign issue will clearly help the Democrats, as it did in 2008.

The president sounded concerned about the deficit but understated the threat. As David Stockman, who served as Ronald Reagan’s budget director, told me last week, the $4 trillion in savings now embraced by both parties is woefully inadequate to the scope of the challenge. He was particularly withering in his critique of what he called the “religious obsession” within the GOP to keep cutting taxes amid terrifying deficits.

Known Folly

Even Republican Senator Tom Coburn, a conservative member of the Bowles-Simpson deficit commission, knows that this part of the Ryan plan is folly.

At George Washington, Obama announced that Vice President Joe Biden would head the effort to negotiate with Congress. Emotions are running too high for any agreement this summer on where to find huge savings. The president made it clear he would veto any bill resembling the House plan.

With the Senate still controlled by Democrats, it’s unlikely anything significant will reach his desk any time soon. The important part of his proposal was a “fail-safe” provision to compel huge savings if Congress can’t reach agreement by a certain date. The idea of adding teeth to budget cutting worked in the 1990s and can work again.

Default Crisis

After a lot of posturing and finger-pointing, this might be just enough to get Washington through the treacherous waters of raising the debt ceiling and avoiding a default crisis. The specifics on where to cut will await the results of the 2012 presidential election, which is now teed up by Obama as a referendum on competing visions of what we owe each other as a people.

“One vision has been championed by Republicans in the House of Representatives and embraced by several of their party’s presidential candidates,” the president said, a clear sign that he intends to wrap the Ryan plan around the neck of the eventual Republican nominee.

Ever since he agreed to extend the Bush tax cuts in a deal last winter, some progressives have doubted whether Barack Obama had the intestinal fortitude to stand up for the great social contract of the 20th century -- the one most Americans still support. Now we know.

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