06 Oct 2008

The United Socialist States of America

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Dear readers, I grant you that my title is partly motivated by the urge for ratings (not that I want you to click on the nearby ads–of course not). But I really think that when future Rothbardians are throwing back drinks and speculate as to precisely when the United States crossed the line, and became not a heavily regulated capitalist country, but instead a very liberal socialist country, they will point to October 2008.

First let’s get our working definitions. Murray Rothbard once asked Ludwig von Mises how to draw that line, since after all in the modern world, there is no such thing as a laissez-faire economy, nor is there pure central planning with no money. (To my knowledge, Lenin gave it the best try ever for a few years and then stopped, realizing absolute power was no fun if all you had were corpses to bark orders at.)

To Rothbard’s surprise, Mises had a crisp answer. He said that if a country has a stock market, where private individuals trade ownership claims to the country’s great engines of industry, then it is a capitalist country. On the contrary, if the State owns the large companies, then that is socialism, end of story.

Now, over the last year the government’s control over the financial sector has steadily increased. People think things got serious by this summer, but the big Wall Street firms were already doomed by, say, Christmas of 2007. By that point, they were all addicted to the massive injections of “liquidity” (oh what a harmless sounding word–they might as well call it soma dollars) being constantly pumped in by the Fed. By Christmas, the banks who were on the Fed’s lifeline were completely at the government’s mercy. Even though they were still nominally owned by private individuals, they could be cut off overnight (or in 28 days if you are a purist) if they didn’t do something the government asked of them.

In early September, the government took the gloves off and literally seized control (again, it is the press using the verb “seize,” which terrifies/fascinates me) of Freddie and Fannie. But hey, even this didn’t seem so crazy, because after all they were government-sponsored enterprises.

But then a mere week went by before the government seized AIG. Now we’re cooking! Not only was this a true blue private company, but it wasn’t even a bank. The justification for its seizure was purely pragmatic. Just as the Bush Administration claims it can imprison anyone on the planet with no legal recourse if one man (whose first name rhymes with gorge) declares the person to be an enemy combatant, so too it showed with AIG that it can seize any (American) company if its collapse threatens the financial system.

And now with the recent bailout… Oh my gosh, I am telling you, this thing is truly awful. It is so much worse than it first seems. The negative economic consequences, like moral hazard, are child’s play.

Let’s get something straight: When the government seizes a company, it is truly a hostile takeover. Here’s a great illustration. Australian money manager John Hempton explains how the Washington Mutual takeover wiped out senior debtholders who would probably have gotten something in normal bankruptcy proceedings. OK folks, are you starting to see? When the government comes in and seizes a company, it is stealing property. (Robert Wenzel has a great post explaining how Citigroup and Wells Fargo are battling to see who gets to eat the carcass of Wachovia, after the FDIC slew it.)

Don’t get me wrong, the government has been picking off vulnerable targets. Neither the FDIC nor any other agency could have declared Exxon insolvent and then given its assets to politically connected firms. (Of course, the route the feds are taking there is to impose a windfall profits tax. Not every problem is a nail requiring a hammer. Some companies you kidnap via the FDIC, and some you merely rob via the IRS. Leave it to the professionals, please.)

What is truly sickening with the Paulson bailout is how many “liberal” commentators are gleeful that the forces of truth and justice prevailed, and got some “protections” for the taxpayer by inserting language giving the Treasury Secretary discretionary (!!) power to acquire equity in companies that s/he assists. (In contrast, the original Paulson Plan merely asked for $700 billion with which to buy assets from the financial sector, rather than buying ownership stakes in the participating companies.) I would be hard-pressed to think of a deadlier weapon to place at the disposal of the Treasury, than to give it the ability to grab equity shares in any company it classifies as “troubled.” With our fractional reserve banking system, and all of the complicated interconnectedness of markets in general, any major financial institution can be plausibly labeled in danger.

This is why the wiping out of so many of Goldman Sachs’ competitors is crucial. The fewer firms there are, the easier it is for the government to lean on any one of them. With the $700 billion pot of goodies at its disposal, the government can easily bribe a a few firms to stop dealing with Target Firm X. Then Target Firm X finds itself unable to roll over its short-term debt, and especially with the short-sale ban and all the other nonsense, no outside private group in its right mind will come in to help. So then Target Firm X has no choice but to ask for government help, with all the attendant strings.

To return to the title of this blog post, I admit that strictly speaking, the government has not yet fully nationalized all of the industries. There is still nominal private ownership of the means of production. But because Americans are very proud of their (imagined) liberties, there will probably never be outright, formal socialism. And yet, I suspect that within, say, 20 years, libertarians will have no hesitation in declaring the United States a socialist country.

And when they trace back the gradual evolution, and try to pinpoint the dividing line, the quantum leap in the march towards socialism, I believe they will settle on October 2008 as the obvious moment.

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