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The Economics of the Free Ride

Gary North
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There is no such thing as a free lunch or a free ride. Somebody must pay. The supreme goal of politics is to manage the flow of information so that those who pay do not complain. Successful politics is like a mosquito's bite: the victim itches only after his blood is gone, along with the mosquito.

In George Orwell's novel, 1984, Winston Smith worked in the Records Department of the Ministry of Truth. His job was to drop printed records of politically incorrect facts down the memory hole. The memory hole destroyed public traces of the now- inconvenient record of the past, thereby rectifying the past. His life's work was based on this principle: "Who controls the past controls the future. Who controls the present controls the past." Orwell (aka Eric Blair) did not foresee the World Wide Web, but he clearly understood the pre-Web media.

The mainstream media can no longer easily deep-six the records of the past. The Web is too decentralized for that. Digital transmission is too inexpensive and too rapid. The mainstream media are losing market share.

The media do retain half of their older function: to ignore most of the present. The media decide what to report and, far more important, what to highlight. What they do not highlight can be concealed more effectively later on than concealing what did get widely reported.

The masters of the mainstream media understand that people have limited time. Time is not a free resource. It is the only irreplaceable resource. Control over how one's time is spent is the essence of responsible living. The mainstream media have long been skilled masters of capturing people's attention. Only in recent years have they lost this ability, due to new pricing conditions: the Web. The media cannot effectively compete with nearly free transmission of digits.


The media whooped it up for the war in Afghanistan in 2001. They whooped it up for the war in Iraq in 2003, even though this war was obviously going to drain funds and troops from Afghanistan. Then the media decided not to cover the war in Afghanistan, because bin Laden had escaped. The Taliban went underground. There were few skirmishes. The media's #1 rule came into play: "If it doesn't bleed, it doesn't lead." The public forgot about the war in Afghanistan, as did the media.

As the public steadily turned against the war in Iraq, because of its high cost and low payoff -- a simple cost-benefit analysis -- the media, except for Fox News, followed suit. They issued an occasional mea culpa for their refusal to present both sides of the story in 2003 on the wisdom of going to war in Iraq. But they remained silent about the war in Afghanistan. They still do.

Newspaper readers and network news viewers -- two endangered species -- seem unwilling to spend time thinking about more than one foreign crisis. The media understand this. So, they focus on only one foreign crisis at a time. Everything else is relegated to the back pages of the newspapers and to MSNBC.

If you were to take seriously the headlines -- and why should you? -- you would imagine that Somali pirates are the major threat to America and Western civilization generally. There is little prime-time, front-page news coming out of Afghanistan.

The war in Afghanistan is being fought in the memory hole. So is the war in Iraq. (Remember the war in Iraq?)


These two wars are costing . . . what? Lives. Deaths are no longer reported. Money. There are few reports on this. There never were. Given the gargantuan size of the Federal budget -- $3.6 trillion in 2010 -- the financial cost of war is not much of an issue. If the entire Defense Department budget were eliminated, the United States government would still run a deficit of well over a trillion dollars in fiscal 2009. Defense absorbs about half a trillion dollars a year, not counting pensions.

Because the media do not feature the costs of war in their reports, the public has only human interest stories as the grounds of assessment. These stories are no longer forthcoming. This is ideal for the military. This guarantees an unchallenged supply of funding. Red ink is irrelevant today. Red blood is not being featured.

President Obama promised in March 2008 that he would end the war in Iraq.

So when I am Commander-in-Chief, I will set a new goal on Day One: I will end this war. Not because politics compels it. Not because our troops cannot bear the burden -- as heavy as it is. But because it is the right thing to do for our national security, and it will ultimately make us safer.

In order to end this war responsibly, I will immediately begin to remove our troops from Iraq. We can responsibly remove 1 to 2 combat brigades each month. If we start with the number of brigades we have in Iraq today, we can remove all of them 16 months. After this redeployment, we will leave enough troops in Iraq to guard our embassy and diplomats, and a counter- terrorism force to strike al Qaeda if it forms a base that the Iraqis cannot destroy. What I propose is not -- and never has been -- a precipitous drawdown. It is instead a detailed and prudent plan that will end a war nearly seven years after it started.

This fact has gone down the media's memory hole.

He did not run on a promise to shift the war to Afghanistan, yet that is what he is doing. The media remain silent. As far as I can determine, Fox News favors war anywhere, any time, so it remains silent. The liberal media favor war whenever it can be fought without a risk of a humiliating loss. But, having backed Obama, these outlets remain silent.


He can focus on the economy, which is what matters most to voters. He can propose new government programs, promise new benefits, and guarantee stiffer regulation in the future, knowing that the media, which are owned and operated mainly by liberal Democrats, will give him a free ride.

Economists are also giving him a free ride. This recession has revealed that the vast majority of economists never did abandon Keynesianism. They believe that government spending is the source of economic recovery. They still believe that government deficits don't matter.

The amazing fact is this: the better Keynesians know it's a religion based on hope and weak evidence. Probably the clearest admission of this came from Benn Steil, the economist who serves as a Senior Fellow and Director of International Economics for the Council on Foreign Relations. He wrote this in London's "Financial Times." It appears on the CFR's site.

And indeed, we as a profession are making our voices heard in a way we never get the chance to do when the credit is flowing, businesses are investing and consumers buying what business wants to sell. Then, we make arguments based on data, otherwise known as "facts", processed through regression analysis and logical rigour, which few humans read. (I know, I am an economics journal editor.) Now, on the other hand, we call for trillion dollar stimulus plans on the basis of little more than citing John Maynard Keynes -- and politicians revere us. Citing Keynes gives us special licence to talk economics without using any. To paraphrase the lawyers' dictum, when the facts are on our side, we pound the facts; when theory is on our side, we pound theory; and when neither the facts nor theory are on our side, we pound Keynes -- and to great effect.

Keynes, not coincidentally, had nothing to say about the proper components of fiscal stimulus. This allows him to be cited with great effect by both paternal progressives (who favour government spending) and caring conservatives (who favour middle-class tax cuts). (

Meanwhile, Chicago School economists have abandoned their public commitment to Milton Friedman's call for a steady 3% to 5% annual increase in the money supply. He believed that the Federal Reserve could not successfully promote long-term economic growth by lowering short-term interest rates by increasing the monetary base. His methodological heirs remain prudently silent in the face of an increase in the FED's adjusted monetary base of over 90%, March 2008 to March 2009.

Only the Austrian School economists write continually about the monumental transformation in the economy that has taken place since last September. The West has moved from the soft-core Keynesianism of the English-language edition of Keynes' "General Theory of Employment, Interest, and Money" (1936) to the hard- core Keynesianism of Keynes' Foreword to the German edition, the economy of "the total state." But there are so few Austrian School economists that people in places of influence agree: Austrians can be safely ignored.

Obama's free ride here is going to continue. The well- organized corporate interests that supply each President with his advisors want the taxpayer-funded subsidies. Goldman Sachs provided Clinton's Secretary of the Treasury (Rubin) and Bush's (Paulson). Kissinger & Associates gave Timothy Geithner his first job. He rose to become the second most powerful official in central banking: president of the Federal Reserve Bank of New York. Nobody notices. Nobody complains. I mean nobody significant.


Politicians fear a taxpayer revolt. Such a revolt is unlikely until investors cease buying Treasury debt. For as long as the government can run deficits at low interest rates, that is how long they will continue.

The last months of Bush's Administration ended any serious claim that Republicans favor a balanced budget. The bailouts were nonpartisan. The voters knew it was a rip-off and complained loudly. This did no good.

The first three months of Obama's Administration have produced deficits on a scale never seen in peacetime American history. The estimated $1.8 trillion deficit for fiscal 2008 will be exceeded if the economy continues to decline, which is virtually certain. Tax revenues will fall as corporate profits fall and payrolls fall.

Meanwhile, in January and February, foreign investors started selling Treasury debt -- almost a quarter of a trillion dollars' worth, net. This Treasury deficit will have to be covered by other buyers. It is likely that foreigners will sell another half a trillion dollars' worth this year, and this could be more.

Faith is declining in the Treasury's ability to repay in dollars of constant purchasing power. This will lead to higher Treasury interest rates unless: (1) the Federal Reserve buys most of this added debt by creating new money, or (2) the economy gets so bad that investors sell shares and corporate bonds and buy Treasurys, or (3) both. Any cogent hope in a balanced Federal budget is gone. Only the terminally naive will believe that either political party will have the will to balance the budget once it is in power. The likelihood of $2 trillion deficits over the next few years is high. Even in an inflation-funded recovery, the deficit will stay above $1 trillion a year.

This will not faze voters until price inflation drives up non-Treasury interest rates. Mortgage rates will rise. That will put downward pressure on real estate, despite price inflation. Fewer buyers will be able to buy homes. If the FED supports the mortgage market by funding Fannie Mae and Freddie Mac bonds, as it is now doing, home prices will rise, but bond rates will rise and therefore bond prices will fall. The present value of all long-term credit will fall, especially annuities, whole life insurance policies, and Social Security payments, whose cost of living increases will lag behind the actual increase in consumer prices.

When it becomes clear to the majority of those voters who actually vote that the deficits will not revert to pre-2009 levels, there will be a rush to get into debt. People will see that the dollar is falling in value. They will not understand that the Federal Reserve's purchase of Treasury debt and toxic financial assets is the cause of the dollar's decline. They will understand only that prices are rising along with debt. They will be lured back into the credit markets. "Buy now and pay off with depreciated money."

Why will anyone lend? Because of rising interest rates. Creditors will hope against hope that the Federal Reserve will come to its senses and stop inflating. Bernanke twice this month has promised that the FED will reverse its present policy of expanding the monetary base (balance sheet). He has said that the FED has ways of doing this when the recovery appears. But he has not said which assets it will sell, or to whom, or on what terms.

We are beyond the point of no return. The markets do not acknowledge this yet because investors care mainly for the short run. They do not count the cost of being a taxpayer and a holder of dollar-denominated wealth. They care about the next quarter. They believe in the greater-fool theory, that there will be someone to buy their assets at higher prices. They used to believe this about real estate. They still believe it about stocks, bonds, and retirement promises.

Most investors are Keynesians, as are most politicians, economists, and historians. They believe that digits are capital, and that the government can redirect digits to multiply capital. Keynes explicitly taught this: the multiplier effect. It was nonsense in 1936, and it is nonsense today. But Keynes was right about one thing in 1936. In the closing pages of "The General Theory," he wrote this.

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.


I can think of no better way to describe investors, economists, voters, and politicians today than to cite Benn Steil once again.

But hope is precisely the platform on which President Barack Obama ran during his campaign. Hope has enabled the president to raise the estimate for the number of jobs his stimulus plan will create from 2.5m to 3m and then to 4m in the space of just a few short speeches. It is the ultimate faith-based initiative. And in the spirit of unity he promised to bring to Washington, his proposal comprised 60 per cent new spending and 40 per cent tax cuts, the same proportion as that of Democrats to Republicans in Congress. Yes, we can!

Economic reality will triumph over hope. The monetary base will triumph over hope in stable prices. Federal deficits will triumph over hope in Social Security and Medicare.

You have put your money where your hope is. If your hope is in salvation by deficits and salvation by the Federal Reserve's balance sheet, then you are a person of enormous hope.

If your faith is in the law of scarcity -- "There ain't no such thing as a free lunch" -- then your hope had better be in the voluntary society, which rewards productivity and service to final buyers: consumers and savers. Given what has happened to voluntarism since last September, that is a long-term hope.

Keynes wrote that in the long run, we are all dead. He missed the point: in the long run, some people will inherit, while others will not. Inheritance is based on degrees of conformity to the truth. Keynes had no biological heirs. His intellectual heirs are now making their last stand. I have said this before. ( I will say it again. I promise.

There are no free rides in this life. The public transportation system economy, which offers free rides, is headed toward a trestle that has collapsed. The engine got halfway across the trestle and disappeared last October: investment banking. The rest of the train is still moving forward at an accelerating rate.

I suggest that you jump.

April 17, 2009

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