Come November

What is the 2010 mid-term election about? However you answer that question determines the way you will vote next Tuesday.

Here’s what this election means to me.

James Madison, while introducing a bill to the first Congress in 1792, referred to the General Welfare clause of the Constitution, saying:

“If Congress can employ money indefinitely to the general welfare, and are the sole and supreme judges of the general welfare, they may take the care of religion into their own hands; they may appoint teachers in every State, county and parish and pay them out of their public treasury; they may take into their own hands the education of children, establishing in like manner schools throughout the Union; they may assume the provision of the poor; they may undertake the regulation of all roads other than post-roads; in short, everything, from the highest object of state legislation down to the most minute object of police, would be thrown under the power of Congress…. Were the power of Congress to be established in the latitude contended for, it would subvert the very foundations, and transmute the very nature of the limited Government established by the people of America.”

Madison was prescient about the corruptibility of Congress, although in those early days of the Republic he could not have envisioned how power would gradually shift from Congress to the Executive. But recently both branches of government have hijacked the liberty of the American people as Madison feared and even more so. Government has purloined the responsibility for education from the states, kicked religion out of the schools and off the town square, limited what local and state police may do to combat crime and illegal immigrants, converted our private health system into a soviet-styled health politburo over the protests of its citizens, launched unsustainable welfare programs, and gone on a reckless spending spree allegedly to stimulate the economy and save privately-owned businesses that in the government’s opinion were “too big to fail.”

The federal government is now intruding on personal matters such as the weight of our kids, imposing taxes on drinks that Big Brother thinks contain “too much” sugar, demanding that restaurants list the fat content in meals, and even sticking its nose into baseball dugouts to limit the use of smokeless tobacco. With ObamaCare the federal government has gone so far as to mandate that everyone buy health insurance – arguably unconstitutionally – and legislated an onerous law compelling businesses to file 1099s on all purchases exceeding $600 per year. Representative Chaka Fattah (D-PA) has floated a bill for a 1% transaction tax on every bank transaction and credit card purchase Americans make, and Representative Peter Fazio (D-OR) floated a similar scheme, imposing a ¼% security transaction tax on every security and commodity transaction. Our noble citizenry has been reduced to political serfs – ordered about and taxed as our political lords and regulatory masters decide.

If we want to board an airline flight we are subject to degrading screening procedures that invade our privacy but uphold political correctness concerning much more suspicious travelers. Airline travelers may be screened in a manner that leaves no doubt of the person’s sex, and in one recent outrage, a 12-year old girl was separated from her parents and subjected to the equivalent of an electronic strip search.

An alarming expropriation of citizen rights and liberties has occurred in the last two years under the most autocratic left-leaning government in the history of the Republic. This same government now tells us that it plans a robust lame duck session of Congress during which it will attempt to pass legislation that would have been political suicide in regular session. In other words, legislators who are voted out of office next Tuesday and can’t be further punished will work with their Democrat colleagues to pass their favored bills notwithstanding the will of the people they supposedly represented. So much for representative government.

The “Hope and Change” election of 2008 was supposed to usher in a new post-partisan Congress and administration. Those who were elected were expected to govern, not rule. But rule they did, and with total disregard, if not distain, for the lack of support from the people who elected them. From the days of John Locke, the social contract that gives the few the right to govern the many has been the consent of the governed. Therefore, the American revolutionaries who sought to justify their secession from the British Empire, declared, among other things: “Governments are instituted among Men, deriving their just Powers from the Consent of the Governed.” I wonder if the political frauds in Washington have a clue what that means, or if they do, have the slightest regard of it.

A recent Rasmussen poll revealed that 61% of Americans believe that the federal government has too much power, and a poll released Thursday showed 65% favored “throwing out the entire Congress and starting again.” Only 21% of adult Americans believe that the federal government enjoys the consent of the governed. Two-thirds – 66% – believe that Americans are overtaxed, and 70% believe the government does not spend their tax money wisely or fairly. This is a damning indictment of a constitutionally-elected government.

In a delightful new book, Ratification: The People Debate the Constitution, author Pauline Meir describes the national wrangling that went on in the late 1780s, both in the public square and in the Federalist Papers, trying to decide whether to accept the plan of union proposed in the US Constitution. We know from the Federalist Papers that there were people who wanted to set themselves up as rulers rather than as representatives of the people. These people wanted a federal government to be the rationale for their rule and thus wanted more power for the government than the Constitution granted to it.

Jefferson, Madison, and others feared that there would be ongoing tension between a free society and the federal government of the new Republic – a struggle between a central authority that controls virtually every aspect of our lives versus individual liberty protected as the Founders envisioned. Madison in particular understood how government corrupts its office holders. Writing in Federalist Paper 45, he said:

"The powers delegated by the proposed Constitution to the federal government are few and defined. Those which are to remain in the State governments are numerous and indefinite. The former will be exercised principally on external objects, as war, peace, negotiation, and foreign commerce. ... The powers reserved to the several States will extend to all the objects which in the ordinary course of affairs, concern the lives and liberties, and properties of the people, and the internal order, improvement and prosperity of the State."

My how we’ve changed. In the last two years, the federal government has been a totally-owned subsidiary of the 111th Congress – controlled by the Democrat Party and the Obama White House. Collectively they have conspired to make government the final arbiter in most if not all aspects of our lives. They want education, healthcare, energy usage, wages, prices and even private property rights to be distributed as government deems to be fair.

Words bespeak attitudes; therefore, listen to those of the political class:

Speaking at a Boston fundraiser two weeks ago, Obama said, “Part of the reason that our politics seems so tough right now and facts and science and argument do not seem to be winning the day all the time, is because we’re hardwired not to always think clearly when we’re scared. And the country’s scared.”

Hmm. Let me see if I’ve got this right. This country, which had no problem thinking clearly when it fought a two-front war 75 years ago – I’m talking a multi-million man war, not Iraq and Afghan scale wars – managed to survive the incompetence of the New Deal schemes that prolonged the Great Depression by at least seven years, lived on the bull’s eye during the Cuban Missile Crisis, and broke the back of the Soviet Evil Empire, this same country suddenly can’t think clearly during a protracted recession made worse by a meddling federal government? It sorta’ sounds like the Maximum Leader is saying the average schmuck in this country hasn’t the cognitive apparatus that he possesses to comprehend the current economic challenges – a quagmire made worse by his team of bush leaguers, most of whom have never held a job in the private sector. Obama’s condescending attitude should be an insult to every thoughtful American.

Then there is Representative Phil Hare (D-Ill) who in responding to a question about the constitutionality of ObamaCare during a town hall meeting, said he was "not worried about the Constitution." He then proceeded to turn his foot into a shoe sandwich by saying that the Constitution guaranteed each of us "life, liberty and the pursuit of happiness." Of course, the Constitution says no such thing. The expression "life, liberty and the pursuit of happiness" is found in the Declaration of Independence ratified a dozen years earlier than the Constitution.

Representative Jim McGovern (D-MA), who has no training in law and has never held a job other than as an aide to various congressmen, opined in a debate with his Republican opponent that "the Constitution is wrong" regarding campaign financing. His comments came in his assessment of the Supreme Court's ruling in Citizens United v. Federal Election Commission, which ruled that parts of McCain-Feingold abridged free speech:

“We have a lousy Supreme Court decision that has opened the floodgates, and so we have to deal within the realm of constitutionality. And a lot of the campaign finance bills that we have passed have been declared unconstitutional by the Supreme Court. I think the Constitution is wrong.”

That wilderness of words has to be parsed carefully if its logic is to be understood, but McGovern seems to be saying if the laws of Congress can’t pass constitutional muster then the Constitution must be wrong – not the laws!

Not to be outdone in the category of outrageous statements by elected officials, Representative Pete Stark (D-CA) responded to a constituent's question about ObamaCare by saying, "There are very few constitutional limits that would prevent the federal government from (making) rules that can affect your private life." Adding, "Yes, the federal government can do most anything in this country." The questioner responded, "People like you, sir, are destroying this nation." Her comment won shouts of approval from the audience.

Last year, a reporter asked Nancy Pelosi, "Madam Speaker, where specifically does the Constitution grant Congress the authority to enact an individual health insurance mandate?" Pelosi responded: "Are you serious? Are you serious?" Pelosi agrees with fellow Californian Stark that Washington can do most anything it wants.

Congressional ignorance and contempt for our Constitution doesn’t reside only on the Democrat side of the aisle. During a town hall meeting, a constituent asked Representative Frank LoBiondo (R-NJ) if he knew what Article I, Section I of the Constitution mandated. He replied that, "Article I, Section I is the right to free speech." In fact, Article I, Section I says, “All legislative Powers herein granted shall be vested in a Congress of the United States, which shall consist of a Senate and House of Representatives.” It is the First Amendment that says, “Congress shall make no law … abridging the freedom of speech or of the press …”

Now we learn in Friday’s Wall Street Journal that Lawrence Tribe, one of the country's most influential liberal law professors, who taught constitutional law to students including Obama, Chief Justice John Roberts and Justice Elena Kagan, confidentially recommended that Obama not appoint Sonia Sotomayor to the Supreme Court last year. Criticizing her intellect and warning that her style could "simply add to the firepower" of the court's conservative wing, Tribe said Sotomayor was "not nearly as smart as she seems to think she is, and her reputation for being something of a bully could well make her liberal impulses backfire." Obama ignored the advice and nominated Sotomayor anyway – apparently for her radical politics.

We should be outraged that we are held in such contempt and the Constitution is held in such ignorance by people elected to govern – not rule – us. The people of the United States have become an abstraction that politicians must tolerate every two years in order to be reelected – not the true body politic that legislators are sent to Washington to represent. And Obama, whoever this guy is in his heart of hearts, has made no bones about his chilling intention to transform America into his radical vision – not the vision held in the minds of the Founders and paid for by the blood of soldiers in the first revolution.

Come November 2nd, then, we must keep Madison’s words in our minds and our desire for individual liberty in our hearts. We must vote out those who seek to consolidate more power to the government and elect those who will restore more liberty to the people. We must reject the siren’s call of government entitlements that lead to dependency and pursue instead the more difficult path of self-reliance and individual liberty. How else will our children live free in a society where they are higher than the government and exist without the shackles of an arbitrary authority?

At the beginning of this blog I asked what the election next Tuesday was about. In my opinion this election, perhaps like none other in history, is about an overreaching imperious government that needs a spanking from its parent – the citizens of the United States. This election must send an unmistakable message via the ballot box that the style of governing during the last two years is totally repugnant to free people and will not be tolerated – not now, not ever! The American people must cut off the allowances of this Congress of juvenile delinquents and the White House with their profligate spending. Voters must repudiate micromanagement of their lives. They must grab their Senators and Representatives by the ear and scream loudly enough into it to get past their political tone-deafness: “You are not elite! You are a paid volunteer! If you don’t like that arrangement, I’ll replace you!”

Perhaps they will get the message. If not, in 2012 a two-by-four with a rusty nail will drive the point home.

No pun intended.

Trading Places

“Demagoguery beats data in making public policy,” former economics professor and later the Republican House Majority Leader, Dick Armey, once observed. He was no doubt proud, then, that the Senate’s recent attempt to bring the Creating American Jobs and Ending Offshoring Act (S. 3816) to the floor for an up or down vote showed how keen his powers of observation were.

S. 3816 attempted to mandate three things: (i) exempt the employer portion of payroll tax on wages paid to new employees working in the US, (ii) prohibit a firm from deducting the expense of discontinued operations for business units transferred out of the US, and (iii) repeal the current tax deferral on unrepatriated income from offshore operations when those operations sell into US markets. All three provisions intentionally erect barriers to free trade to protect domestic jobs without regard to the competitiveness of those jobs in a global economy.

This kind of legislative silliness is based on the old bromide that international free trade causes the loss of US jobs. Where do politicians and protectionists think “lost jobs” go? To the land of lost socks? Jobs aren’t “lost.” The fact that they are done by a different person or done in a different way doesn’t mean they are lost, unless they were unnecessary in the first place. Inefficient jobs misallocate domestic resources. They go to the country that can do them acceptably but at less expense – those evil “low wage” countries. Since it takes two to tango in this transaction, it ought to prove that since there is trade – you give me this and I’ll give you that – both countries win: the country that gets the job done cheaper by exporting it and the country that gets to do the job by importing it.

Forty Republican and four Democrat Senators voted against cloture – essentially extending a filibuster and preventing S. 3816 from moving to the floor for a simple majority up or down vote.

Politics aside, what economic justification is there in paying someone $20/hour to do a job that someone else is willing to do for $2/hour unless the former is ten times more productive than the latter? The fallacy in arguing that jobs are “lost” in international trade assumes that trade is a zero sum contest – if someone wins then someone else must lose. Jobs, however, are traded like products – both domestically and internationally. Unless trade is a win/win for both parties, there will be no trade.

For example, most of us have other people launder and dry clean our clothes, mow our lawns, and paint our houses. If someone were to suggest that we should protect ourselves from “losing” these jobs to lower-paid providers by doing our own laundry and dry cleaning, mowing our own lawns, and painting our own houses, we’d think that person daft.

What if Congress had been able to legislate that there would be no more losses of US farm jobs to the US manufacturing sector in the late 19th century. Would our economy be better off today? If laws had frozen the number of manufacturing jobs in the mid 20th century at 25% of the workforce, would we have the standard of living we have today when only 5% of the workforce is in manufacturing? Have any of us been deprived because we didn’t learn to use a rivet hammer or work in a grimy rolling mill?

Somehow we’ve managed to feed ourselves and a good chunk of the world even though we “lost” almost all farm jobs to other occupations – down from half of the workforce in 1900 to 2% in 2000 and almost two-thirds of the remaining farm jobs are part-time. We don’t have nearly 50% unemployment because those who once farmed are unemployed. They and their descendents found work doing other jobs of greater economic value. And notwithstanding the “loss” of manufacturing jobs to automation and to foreign workers, we’ve been able to keep the workforce once employed in those jobs busy doing higher value jobs today. When productivity increases faster than demand, as it did in farming and manufacturing, employment declines and the workforce shifts to other fields.

To which fields will the workforce shift? To the fields in which the US possesses a relative advantage over other countries. The reason I don’t clean my clothes, mow my lawn, or paint my house is that my time is better spent in activities that pay more than the money I save in cleaning, mowing, and painting – i.e. activities in which I have a relative advantage over the people who clean, mow, and paint. Stated differently, it costs me more to do those jobs in addition to my regular job than to pay someone else to do them. I’m more productive doing what I’m most qualified to do and buying the rest. The cleaners, mowers, and painters are more productive doing what they’re most qualified to do. That is the basis for domestic and international trade.

Absent a productivity differential there is no basis for trade. That’s the reason why, for example, US software programming flows to Indian programmers. It isn’t because Indian programmers are “willing” to work for less. Indian and US software programmers are paid exactly the same amount per unit of output – but not per hour. The former is the product labor cost resulting from productivity and the latter a wage rate.

The notion that US goods can’t compete with goods produced in low-wage countries, therefore, is an economic fallacy that isn’t substantiated by logic or experience. If Indian programmers are one-fourth as productive as American programmers (because of tools, processes, management, for example) then the equilibrium wage for Indian programmers will be one-fourth that of Americans. It has nothing to do with the “willingness” of Indian programmers to work for less. Low wages are the consequence of low productivity because low productivity produces lower economic value than high productivity.

Here’s how. Worker A produces one unit per hour. Worker B produces two units per hour. Units have the same value regardless of who produces them or where they are produced. Worker B is paid twice the hourly rate that A is paid, although both are paid the same per unit of output. Productivity and wages always reside at or move toward this equilibrium. Equilibrium can exist with low wages and low productivity or high wages and high productivity, but never low wages and high productivity.

If wages and productivity are misaligned, an arbitrage will occur. Wages that exceed their productivity equilibrium, which commonly occurs in labor union agreements, will cause jobs to export to low wage markets. Wages that fall below their productivity equilibrium will import jobs from higher wage markets, even with a loss of productivity – i.e. even if the market “losing” jobs is in wage-productivity equilibrium. Therefore, if the US is three times more productive in software programming but has twice the wage rate of India, jobs will stay here. In contrast, if India has a third of the productivity and one-fourth the wage rate of American programmers, jobs will move to India.

Do you think anyone in the Congress or White House gets this?

These same principles play out in the US domestic economy. As farming became more productive in the 20th century, the farmers who were less productive earned lower wages for their labor than farmers who were more productive. The least productive farmers were ultimately displaced because they couldn’t live on their wages. Over time only the most productive 2% survived, because they were so productive that only 2% were needed to do the work that 50% once did – i.e. feed the nation and part of the world.

Those farmers who were displaced moved to cities and found jobs in manufacturing and other sectors of the economy. Most became more productive because their jobs were leveraged by technology and automation and/or they produced higher value goods, allowing them to be paid higher wages because of their increased productivity. Wages that became misaligned with productivity because of, for example, collective bargaining resulted in further displacement. If those jobs weren’t exported, they were displaced by a robot or other automated “worker.” They weren’t “lost” simply because a human no longer performs the job.

Even though in the long term Americans enjoy rising incomes and a higher standard of living, the short term can bring difficult times as displacements are going on. Who can dispute that small communities benefit when big box stores like Wal-Mart bring low prices and large selections – unless it’s the “mom and pop” retailers who lose livelihoods because their productivity can’t stand up to that of Wal-Mart? In the short term mortgages, car payments, and tuition must be paid, even though in the long term households enjoy multiple inexpensive, flat screen, high definition TVs with hundreds of channel selections scattered about their houses – unlike the one expensive black and white monster with five channels that occupied the living room in our parent’s house.

Because long term gains produce short term pains, politics lives in the short term. Political silliness like the Creating American Jobs and Ending Offshoring Act can’t prevent a free market economy from destroying old inefficient jobs and replacing them with more efficient jobs. Do we really want laws that protect a farm economy which ties up half of the workforce when it’s been proven that more crops can be produced by a small fraction of the workforce? Do we really want to pay several hundred dollars for shoes made in the US that Nike can make in Vietnam and retail here for $30? (Keep in mind that lower prices have the same effect as higher incomes, which becomes a higher standard of living.) When resources are misallocated, society has to pay for it – it has to give up something. Do we want to give up those hi-def TVs? Cell phones? Second cars? Better public health? There is no free lunch. All of these advances in economic and social well-being came from resources previously tied up doing something that we figured out how to do better with less.

When the US steel industry lost over 200,000 jobs in the 1980s to a more productive Japanese steel industry, the industry howled and politicians obligingly interfered with the free market to limit steel imports. Absent competition, higher steel prices drove up the cost of steel-based products, like cars, putting them at a cost disadvantage with competitors in their US and international markets. In the end, government protectionism gave an estimated $240 million in added profits to the US steel industry and “saved” 5,000 jobs – much to the delight of the steel workers union. But the industries that had to buy more expensive steel, because foreign competitors were shut out of the US market, lost $600 million in profits and 26,000 jobs. Who won?

Demagoguery beats data in formulating public policies. After their jobs losses to the more efficient Japanese steel industry, there remained 160,000 workers in the US steel industry lobbying for tariffs to be imposed for their protection. But it was well known that there were nine million workers in industries using steel. So it can hardly be surprising that these tariffs caused net job losses nationwide. Too often laws are passed for political motivations, restricting international trade for the benefit of a concentrated and vocal constituency, even though these restrictions will likely cause far more losses of jobs nationwide that lack the concentration to be a vocal constituency.

PCs became a mainstream product in the mid-1990s as their performance improved in leaps. Each leap increased the economic value of the PC. But in time, performance overshoot occurred because performance and economic value became disconnected. PC performance became “more than good enough.” At that point, the PC began to be commoditized. Manufacturing shifted to the Far East, primarily Taiwan, which produced PCs on razor thin margins. Economic value shifted from hardware to software. While the US lost many thousands of PC manufacturing jobs, it became the leader in software development, something it couldn’t have accomplished if its computer engineers had remained tied down in the production of machines that could be produced just as economically in other countries. Manufacturing moved where the comparative advantage was higher, Taiwan, causing the US to “lose” jobs where it had no comparative advantage, freeing engineers to focus on software development. Not one single politician “helped” make this dramatic transition. It occurred in only a few years, guided by the invisible hand of self-interest. The media, of course, gushed the manufacturing job lost news, guardians of the status quo wrung their hands, but the sky didn’t fall. We have more people employed in software product development today than we ever had building computers. Who won?

Notwithstanding Ross Perot’s doomsday prediction of a “giant sucking sound” when NAFTA was implemented, one post-NAFTA study showed that 37,000 jobs were lost to Mexico from 1990 to 1997 because of free trade while, during the same period, 200,000 jobs per month were being created in the US. Unemployment in the US fell to record lows. No zero sum here, however. Both Mexico and the US exploited their comparative advantages to gain from international trade. Who won?

Mark Twain said that he was all for progress. It was the change that he didn’t like. Change is painful and disruptive in the short term. Even though it usually benefits everyone in the long term, structural economic change impacts a relative few in the short term. There are no political platitudes, no easy solutions to propose to people whose jobs have traded places with a machine or a person across the globe. Their careers and lives are forever changed and must start anew somewhere else in an economy that treated them roughly. However badly we may feel about this turn of events, preventing it is not the answer if America is to continue to be the largest exporter and the largest economy in the world. Whatever our problems, we have more options for solving them as long as we are the leader of the world economy.

The Ghost of Smoot-Hawley

Reading the headlines of the news this week and last, you’d think the US suddenly found itself in imminent peril of economic collapse because of the bad old Chinese. “Goodbye Free Trade?” a Wall Street Journal editorial asked. “Americans Sour on Trade” another Journal editorial lamented. “Americans Are Turning against Trade” The New Republic chortled.

Huh? The Chinese are in the third decade of currency-driven economic growth. Where have these commentators been?

Apparently they don’t understand that all countries try to exploit their domestic economic system, as well as the international economic system, to their advantage. Doing so has given China exceptional growth as a developing economy – recently passing Japan as the second largest economy in the world. As one of their major trading partners, we might not like their tactics but the impact of those tactics on the American economy, in my opinion, is overblown.

Here’s why.

Since Mao Zedong died 35 years ago, the government of the People’s Republic of China has walked a tightrope to continue the ideological vision of its single-party Communist regime in power while gradually introducing capitalist ideals that are imperative to maintaining social order – i.e. jobs and a more equitable distribution of wealth, even among the poorest villages. So far, Beijing has been able to pull this off even though their rickety state-owned enterprises can’t be absorbed easily into the capitalist system. A high rate of year over year GDP growth is required to produce the capitalist transition.

Since China didn’t have the domestic infrastructure to support a consumer-driven economy like ours, and it didn’t have the money or time to create one, it chose to grow as an exporting nation, requiring that it keep its currency low against foreign currencies. A cheap currency allows China to achieve its domestic goal of alleviating poverty and potential social unrest by moving large numbers of poor people out of the fields and the interior and into the factories for export production that populate the industrial zone along China’s east coast.

Beijing's currency is called renminbi, which translates as “the people’s currency” and it is denominated in yuan – pronounced like saying UN fast in one syllable. There is no American equivalent to the Chinese currency system, but the British currency is called sterling and is denominated in pounds. The Chinese government pegs the yuan to the dollar, and currently it trades in a narrow range around 6.7 yuan per dollar. To keep the yuan from appreciating, the central bank buys dollars brought into China by foreign investors and Chinese exporters. Then the bank issues bonds to scoop up the yuan it has paid for those dollars, thus warding off inflation.

Because the yuan is cheap against the dollar, their products – our imports – are inexpensive and our products – exports – are expensive to the Chinese market. This causes a trade deficit and (allegedly) the loss, if not the export, of jobs.

During difficult economic periods, people look for villains and as of late China has replaced Wall Street as the villain de jour. It’s not surprising, therefore, that the Demagogue in Chief has tried to deflect attention away from his failed stimulus and unemployment numbers by attacking the trade deficit. He recently warned US global companies that they should not expect to be treated the same "if you create a job in Bangalore, than if you create one in Buffalo." Nevertheless, two weeks ago the Senate failed to muster enough votes to begin debate on the laughably named Creating American Jobs and Ending Offshoring Act. Perhaps a few sober minded Senators realized that this sword cuts both ways and our trading partners might retaliate in kind and repatriate all of the jobs they create in the US.

Even though the trade deficit with China has been going on for decades, some candidates – mostly Democrats – have tried to make it a political football in the fall elections. In northern Illinois, Democrat US Representative Debbie Halvorson is running ads slamming her opponent, Adam Kinzinger, for backing trade pacts that "ship our jobs overseas." "China is cheating," she said in an interview. "We need to send a message that they need to play by the rules." I wonder if she knows what she is talking about.

Kinzinger countered that 95% of the world’s consumers are outside of the US and therefore Illinois’ top manufacturers "say that in order to be successful and to hire people in Illinois to manufacture and put our stuff together, we've got to have trade." Well, yeah. If you refuse to buy low tech goods from China they have no way to pay for high tech American goods like computers, drugs, software, and airplanes.

Apparently the House of Representatives didn’t get the word. Skipping town like a bunch of juvenile delinquents, they couldn't find the time to pass a budget or keep the Bush tax cuts from expiring. But they did find time to start a senseless trade war with China by passing the Currency Reform for Fair Trade Act, which will do nothing its name implies. It won't make trade any fairer and it won't "reform" China's currency. Passing by a hefty 348-79 margin in the House, including 99 Republican votes, it's unlikely to ever become US law, but if it does, the WTO will declare it illegal.

Even so, it's a dangerous bill, reflecting the ugly mood in Congress more than anything else. The bill is nothing short of a return to protectionism. It amends Smoot-Hawley (yes, that awful law is still on the books) empowering the Commerce Department to slap tariffs on Chinese goods as punishment for keeping its currency artificially low against the dollar. Forcing such a currency realignment on China would be a blunder of historic proportions.

Smoot-Hawley became law in 1930 just as the U.S. economy was slipping into a recession. Some say it caused the Great Depression. It set off a round of retaliatory reactions around the world and shrank the global market for goods and services at the very time nations needed trade to boost their growth. Over three years, U.S. trade with its major trading partners fell 68%. That helped turn what might have been a normal recession into the Great Depression, with a 30% drop in GDP and joblessness of 25%.

Democrats – all but five of whom voted in favor of the currency reform bill last week – would do well to remember that in 1932 their hero, FDR, ran as a free-trader, pledging to lower Smoot-Hawley's tariff walls. The 99 Republicans who voted aye should likewise remember that Herbert Hoover's name lives in infamy for erecting those walls. Wednesday's vote was a bipartisan display of stupidity to build Smoot-Hawley’s tariff walls even higher.

China has already reacted angrily that it is justly torqued by the bill, hinting that it would retaliate. That makes the bill a nuclear threat of mutually assured economic destruction. If it becomes law and, notwithstanding a WTO ruling on its illegality, if it is implemented, the cost basis of Chinese imports could be jacked up as much as 40%, crushing trade between China and the US, which are huge export markets for each other. One of every six human beings on the planet today is Chinese. China is our third largest export market. In short, China is our partner and our rival.

But let’s suppose China blinks and revalues the yuan to avert the impending nuclear threat. Even if doing so creates some American jobs, which is unlikely because of China’s low-end manufacturing economy, it would make Chinese goods more expensive in the US – an immediate inflationary tax on American consumers.

Concurrently, goods priced in dollars would become cheaper for China to import, supposedly boosting US exports. (That assumes there is a Chinese market for the cheaper American goods. Remember that there’s not a large consumer market in China.) A stronger yuan will make China an even more dangerous competitor for oil on the world market because oil is priced in dollars. A stronger yuan-to-dollar makes a barrel of oil cheaper to China. Look at any currency conversion chart and you’ll see that the yuan fell from about 8.2 per dollar to about 6.8 per dollar between 2005 to 2008 as political pressure from the US forced a revaluing of the renminbi. Not surprisingly, oil prices shot up from $60 to $147 per barrel, translating into pump prices of $5 per gallon in some US cities. If this were to happen again, the gas price inflation is a tax on American citizens and businesses.

The large appreciation in the value of the yuan demanded by exporting nations would cause Chinese exports to fall, setting off widespread plant closures and layoffs among marginal producers. Chinese companies would shift low-wage manufacturing to countries like Sri Lanka and Vietnam to regain profitability. The industrial belt along the China’s east coast might be able to absorb some of the layoffs, but the less developed interior of the country would have few options.

On balance, no nation benefits if China’s economy falls on hard times. The revaluation during 2005 to 2008 was accompanied by improvements in productivity that lowered the costs that the more expensive yuan started pushing up. Even in a developing country like China, however, there is a limit to offsetting a stronger currency with efficiency increases.

Rather than demanding that China let the yuan float, which it won’t and shouldn’t do, or revalue the renminbi by some arbitrary amount, Western nations would be better served if China began building a consumer economy, increasing the renminbi as part of its economic rebalancing. It would have to do so over a long period to avoid creating a financial bubble of too much cash chasing too few products and to avoid large scale unemployment as it reduces reliance on exports.

Rebalancing will shift income from producers to households because a more valuable renminbi increases Chinese household income by reducing the cost of imports. It balances this by lowering the profitability of exporters. If done carefully and over a long period, China’s household income share of it GDP would rise as the renminbi is revalued and consumption would rise also. Since China exports what it produces but doesn’t consume, raising the value of the renminbi will reduce China’s trade surplus.

But as noted earlier, an increase in the renminbi too quickly might placate Western politicians but it would cause export profitability to decline so quickly that Chinese exporters would be forced either into bankruptcy or into moving their facilities abroad to lower-wage countries. Layoffs would be inevitable. Unemployment would cause Chinese household income to fall and with it, household consumption. Rebalancing would fail, and Chinese society might destabilize. The US could lose one of it largest trading partners. Americans would lose a supplier of low cost products.

Smoot-Hawley was one of many mistakes committed by Depression-era policy-makers who had never held a real job in the real economy and therefore had little understanding of the law’s likely impact. The Currency Reform for Fair Trade Act has all of the marks of being the ghost of Smoot-Hawley at a time when our economy is weak. If we are to avoid the destructive, beggar-thy-neighbor trade wars that contributed to bringing down the world economy in the 1930s, we had best admit the obvious: no one wins a currency war.

All Rise! God Save the United States and this Honorable Court

This past Monday the 2010-2011 term of the Supreme Court began with the traditional proclamation by the marshal of the Court: "Oyez! Oyez! Oyez! All persons having business before the Honorable, the Supreme Court of the United States, are admonished to draw near and give their attention, for the Court is now sitting. God save the United States and this Honorable Court!" – Oyez meaning “Hear Ye.” Each subsequent session of the term will be heralded in the same way.

Article III of the Constitution establishes a Supreme Court and “such inferior courts as the Congress may from time to time ordain and establish.” The Constitution does not specify the number of justices on the Supreme or any other court.

It would be the Judiciary Act of 1789, establishing the Federal court system, which set the number of Supreme Court justices at one chief and five associates. As the country grew, and along with it more circuit courts and increased case volume, Congress increased the Supreme Court to seven in 1807, and then nine in 1837 then ten in 1863. The Judiciary Act of 1869 put the number of justices at nine where it has remained since.

However, during the first term of Franklin D. Roosevelt, the Supreme Court ruled many of his New Deal programs unconstitutional, infuriating him. His infamous “court packing” scheme attempted to add an additional justice for every justice who reached the age of 70 ½ years, allegedly to ease the workload of the older judges, but in fact to expand the Court to 15 justices, the majority of whom would then be favorable to Roosevelt’s political agenda. The attempt failed miserably. Public opinion and his own party turned against him. But in the end, Roosevelt got a Court to his liking when seven of the nine justices retired or died, allowing him to replace them with people inclined to favor his political agenda.

Knowledge of this tidbit of Court history is relevant because Senator Patrick Leahy (D-VT), Chairman of the Senate Judiciary Committee and founding member of the Dumb Ideas of the Month Club, attempted last week to pull his version of court packing. He introduced a bill to allow a retired Supreme Court justice to fill in when one of the sitting nine recuses himself – or more to the point of Leahy’s concern, herself. Leahy, who openly frets over 4-4 decisions that allow the lower court decision to stand – something that happens rarely, incidentally – is worried about the number of recusals the newest Court justice, Eleana Kagan, has announced – 25 so far out of the 52 cases the Court has accepted – which loses a reliable liberal vote. Her recusals are due to the fact that she was Solicitor General before Obama nominated her to replace John Paul Stevens, another liberal. As the SG, she was essentially the 10th justice. The Court often asks the SG’s opinion on whether a case ought to be reviewed, and much of the Court’s caseload comes from government challenges to laws and policies the SG must defend. The SG and the Court work so closely that it would be unpardonable if Kagan didn’t recuse herself from any case she has touched.

Apparently Leahy tosses and turns each night grieving that the Supreme Court, unlike the courts in 39 states and the District of Columbia, has no authority to replace a recused justice in order to allow an en banc hearing of every case. In fact, federal law specifically forbids it. When a justice is recused, or retires, or dies, but a successor has not yet been confirmed to fill the open seat, the Supreme Court sits as an eight-judge banc – or less if there are multiple recusals or vacancies.

Justices can often dispose of potential conflicts of interest that necessitate recusal. The Court confirmed last week, for example, that Chief Justice John G. Roberts Jr., who has recused himself previously in cases involving Wyeth's parent company, Pfizer, has sold his stock in the company. Two cases involving the pharmaceutical company come before the Court this term. If Roberts had not sold his stock, there would have been only seven justices able to hear the case.

The beginning of this new term brought the usual lamentations on the front pages of major newspapers concerning the partisanship of the present Court. The Los Angeles Times, for example, bemoaned:

“As the Supreme Court begins its new term Monday, its sixth with John G. Roberts Jr. as Chief Justice, the reality is that this is the most conservative court since the mid-1930s. Since Richard Nixon ran for president in 1968, conservatives have sought to change constitutional law, and they have succeeded in virtually every area.”

This kind of journalistic hand-wringing seems more like a thinly veiled attempt to influence the ideological leaning of Justice Anthony Kennedy, the frequent swing vote in a mostly centrist Court, judging from the number of 5-4 decisions. This Court and others that preceded it are no more than a quirk of age, illness, and presidential elections. From 1968 to 2009, there were only two Democrat appointees to the Court, Ginsburg and Breyer, in part because Carter is one of the few presidents who did not get to fill a vacancy. Republicans Nixon, Ford, Reagan and both Bushes filled 12 vacancies and their picks included four constitutional conservatives who are now on the court: Roberts, Scalia, Thomas and Alito.

If the court is split 5 to 4, as is often the case in the most high-profile and important cases, the four constitutional conservatives are usually joined by Kennedy. In the 2009-2010 term, for example, there were 12 cases in which Roberts, Scalia, Thomas and Alito were on one side, with Stevens, Ginsburg, Breyer and Sotomayor on the other. Kennedy sided with the conservatives in nine of these cases and with the liberals in only three. Similarly, the year before, there were 16 decisions that were split 5 to 4 along ideological lines, and Kennedy sided with the conservatives in 11 and with the liberals in five. During the five years of the Roberts court, Kennedy has been with the conservatives more than twice as often as with the liberals in ideologically split 5-4 decisions.

The court's actions this term are more likely to make conservative Court-watchers happy than liberal Court-watchers. Because of Kagan’s recusals, close cases in which Kennedy goes with the Court conservatives will be won 5 to 3. Cases in which he goes with the liberals will fail with 4 to 4 ties because it lets the lower court ruling stand, allowing the conservatives to again win. Kagan's recusals have essentially made the liberal banc a three-member minority for at least 25 cases, and maybe even more since the Court will likely take up to 100 additional cases to fill its calendar.

Did Leahy see this coming? His court packing scheme wouldn’t have anything to do with the fact that there are only three living retired justices – Sandra Day O'Connor, David Souter, and John Paul Stevens – two of whom are card-carrying liberals and the other, O’Connor, was a centrist who turned liberal as she grew older, would it? It wouldn’t have anything to do with the fact that ObamaCare hasn’t yet worked its way up to the high Court and we don’t know if Kagan’s fingerprints are on any of the OBCare lawsuits currently in lower courts, would it? If she was involved in any of these cases, or derivatives of them, she would be off the bench when a liberal vote is most needed. Leahy’s motive is obvious.

Leahy's bill won’t pass constitutional muster, however, because it inserts Congress into filling seats on the Court when that has always been the constitutional prerogative of the executive. It’s true that his bill would allow the justices of the Court to determine which retired ex-Justice was chosen to fill a recusal – something that sounds fair – but it more likely would encourage horse-trading between the liberal and conservative wings of the Court. With a recusal, those wings, which are currently matched at four each, would become uneven. Given the ideology of the three replacement candidates, a liberal recusal would repair the ideological balance, whereas a conservative recusal would shift the Court left. Rather than encouraging recusals, Leahy’s Dumb Idea of the Month would discourage them, even when they were clearly in order. Let’s hope that other Senators see these flaws as well as the constitutional ones and send Leahy’s bill to the round file.

As for the accusation that the Court is conservatively activist, Obama has done more to promote that idea than the media. His preachy talk-down to the justices attending his State of the Union address after their Citizens United ruling was constitutionally reprehensible. In a recent Rolling Stone interview, Obama again whined about Citizens United:

“If we want the kind of country that respects civil rights and civil liberties, we'd better fight in this election. And right now, we are getting outspent eight to one by these 527s that the Roberts court says can spend with impunity without disclosing where their money's coming from.”

Ironically, one of the cases that Kagan had to recuse herself from was a First Amendment free speech case like Citizens United that was heard Wednesday.

Instead of finagling with recusal work-around tricks, the question liberals ought to be asking is why, during Kagan’s confirmation hearings, she so badly underestimated the number of recusals she thought would be necessary. Eleven was her guess at that time and she’s at more than twice that number with probably more to go as the Court’s calendar continues to fill.

Coming from an academic administrative career, Kagan has never practiced law, has never been a judge, and her short stint as SG displayed a less than average performance. However, the SG job caused her to touch a lot of cases now coming to the Court. It’s patently obvious that Obama nominated her for her politics rather than her legal scholarship. But had her recusals been more accurately estimated, liberals might have wanted to rethink their support for her confirmation.

It was expected that Kagan would make little difference on the Court, because she, a liberal, replaced Stevens, a liberal. It turns out, in fact, that her presence on the Court will be more felt by its absence.

Why We Can’t Downsize Government

"The natural progress of things is for liberty to yield and government to gain ground." – Thomas Jefferson to Colonel Edward Carrington, from Paris, May 27, 1788.

The New Deal instituted by President Roosevelt in the 1930s changed the structure and function of government, putting it in opposition to the Founder’s constitutional aim that the pursuit of individual liberty required a limited government. The New Deal struck a Faustian bargain with an America wallowing in a depression that promised prosperity and security under government management in return for less individual liberty and, unknown to the citizens of that time, greater future dependency.

Four decades later, as a stagflated economic malaise settled over the US, those promises weren’t being kept. The 1970s saw the US economy perform worse than it had in the previous decade and worse than other nations, causing people to lose confidence in government and ushering in the reform-minded presidency of Ronald Reagan. In his first inaugural address Reagan addressed the nation’s economic malaise arguing: "In this present crisis, government is not the solution to our problems; government is the problem." His rhetoric and his policies sought a return to limited government. Both spending and taxes were reduced. Measured by the government’s take of the national wealth, Reagan was successful.

Following Reagan’s “third term,” Clinton attempted to undo the Reagan Revolution. Two years into his first term, his big government ideas with increased debt, more taxes on the rich, and an attempted takeover of healthcare caused voters to turn against him and led to an electoral debacle for his party in 1994. Fifty-four seats switched parties and Newt Gingrich became the Speaker of the House. As if he were a newly-elected president, Gingrich claimed a mandate and continued the Reagan Revolution. Clinton was forced to the political center and forced to admit in his 1995 State of the Union speech that “the era of big government is over.”

A budget confrontation between Republicans and Clinton led to a government shutdown and assured Clinton’s reelection in 1996. However, the GOP retained control of Congress, and eventually a budget accord was reached with Clinton that reduced spending and taxes and projected an elimination of the deficit by 2002.

With the election of George W. Bush, the Republican party turned away from Reaganite aims of small government and free markets. In his attempt to remake the Republican party as the party of compassionate conservatism, fiscal restraint was tossed to the wind. Bush centralized federal control over education with No Child Left Behind, introduced an expensive Medicare drug benefit, and ended his second presidential term as the majority owner of AIG and Chrysler and the owner of a large part of GM and Citigroup. His big government conservatism nearly destroyed the GOP and led to its loss of both houses in the disastrous election of 2006. Two years later voters gave the heirs of FDR’s New Deal the White House and an absolute majority in Congress, putting them in total control of government. Lacking the political restraint of an opposing party, they have made the last two years ruinous.

The history of elections is the history of political misreads. Assuming the prime mover of politics is to get elected and stay elected, politicians in both parties need to understand what Americans want from government. Their answer doesn’t seem to be obvious.

Government provides benefits to society that must be paid for by society. If the benefits and costs were felt concurrently, governance would be self-correcting. When society got more benefits than it was willing to pay for, or if it was willing to pay more to get more, the variance would be communicated to politicians either directly or through the ballot box.

But that isn’t the way government works. Benefits are given to the many that are paid for by the few, or benefits are given to the few that are paid for by the many – as in the case of special interests groups. The elderly, for example, are a special interest group – well organized, very vocal, and politically active. The minority who pay for benefits enjoyed by the majority are not organized and, by virtue of their minority, are incapable of changing their fate through political action.

Reagan tried to curb government spending by cutting taxes. Deprived of tax revenues, he reasoned, future politicians would have to decide between reducing spending or incurring deficits. They would choose the former because of the political risks of the latter, or so he thought. However, as Clinton and the Democrat Congress showed in 1993, one way around Reagan’s blockade was to raise taxes on the rich to avoid deficits. As it turned out, taxes on the rich didn’t provide enough revenue and deficits occurred. The other way around Reagan’s blockade was to leave taxes alone and borrow the money to pay for spending, which given the global credit markets, was raised to an art form under the Obama administration. Thus, Reagan’s attempt to reduce the size of government failed because spending has not been brought into line with the taxes people are willing to pay.

Another reason why reducing government is difficult is that future generations are taxed to pay for today’s deficit spending. In other words, current deficit spending costs current society nothing. It will be paid for by a future society that will pay higher taxes than justified by its spending while current society enjoys lower taxes than its spending should require. Over a long period, taxing and spending have to balance but politicians have figured out how to shift taxes to voters they don’t represent. Of course, future society and politicians can pull the same trick until the national debt becomes unsustainable. We are on that course now.

Reagan’s strategy, therefore, was flawed in this respect: lower taxes, like lower prices, increases demand for government and therefore increases its spending. And in fact empirical research by the Brookings Institute has shown that reduced taxes do not reduce spending. This suggests that increased taxes would reduce spending because the demand for government would fall, reducing its cost. This seems to have happened when rising taxes through the 1970s brought Reagan and his smaller government reforms to the White House in the 1980s. If high current taxes create resistance to high current spending, then in the long run both the cost of government and taxes would fall. This would cause taxpayers to pay for their own spending because they would stop shifting it to future taxpayers in the form of deficits.

The theory that higher taxes will lower spending, however, holds true only if society is taxed equally, or at least equitably. That isn’t the case. Half of society pays essentially no federal taxes, and the half that does pay taxes does so inequitably. The extreme progressivity of the tax system makes the top 10% of household earnings pay 70% of the tax revenues and the top 1% to pay 40% of the tax revenues. Yet the votes of the both halves of the household income spectrum count equally in determining how government will tax and spend. Since the suppliers of tax revenue and the consumers of government benefits aren’t the same people, and since the suppliers of most of the tax revenue have very little political voice, high taxes don’t bring down spending.

This logically leads to the conclusion that a flat tax on consumption – a tax on what people spend rather than what they earn – would share the tax pain more equitably, although not equally if some spending is exempted from taxes, such as food and healthcare. Shared tax pain would share consciousness of government spending, which should be the aim of a democratic society. A consumption tax would put tax policy beyond the manipulation of politicians who can currently use preferences to influence votes. Special interest spending would fall equitably on all taxpayers and possibly provoke a backlash if taxpayers deemed the spending unfair.

Of course the replacement of our current “income” tax with a “consumption” tax would have to be enacted by the very people who benefit most from the manipulability of the current tax system – politicians, thus assuring that it will likely never happen. We are trapped, therefore, in a device of our own making: a tax system in which politicians aren’t accountable to those who pay most of the taxes and a spending system that shifts repayment of deficits to future generations who don’t elect current politicians. This is why it is difficult, if not impossible, to limit government.

While George Bush was no piker when it came to spending, the 10-year deficit when he left the White House was projected by the CBO to be $4.1 trillion. Now, after only 20 months of Obama’s presidency, the expected deficit has almost doubled, to $7.7 trillion. And, the latest forecast from the White House budget office shows the government is borrowing 41 cents of every dollar it spends – essentially taxing future generations heavily. Since WW II the average level of government spending as a percent of GDP has been 19.6%. It exploded to 24.7% in the first year of the Obama administration, and is estimated to increase further to 25.4% in 2010. Unless we change our expectations of the role of government, we are headed toward national bankruptcy.

Twice in recent decades, Americans seem to have revolted against the incompetence of their government – in 1980 and 1994.

In 1980, Ronald Reagan won the presidency on a promise to check – and reverse – the growth of government. Reagan carried 44 states, winning 489 of the 538 electoral votes and 60% of the popular vote. It was the worst defeat for an incumbent President since Herbert Hoover lost to Franklin D. Roosevelt in 1932 by a margin of 18%. In the Senate, Republicans held every incumbent seat and won 12 more seats to gain control for the first time in 28 years. Democrats lost 35 House seats but managed to retain control.

In 1994, in the middle of Clinton’s first term, the GOP continued the Reagan Revolution by presenting six weeks before the election ideas from Reagan’s 1985 State of the Union speech in a “Contract with America.” It was the first time since 1918 that a mid-term election was nationalized. Democrats lost 54 House seats, giving Republicans control for the first time in 40 years. Even the Democrat Speaker of the House, Tom Foley, lost his reelection bid – an historic event that hadn’t happened since the Civil War. Democrats also lost the Senate, which they had held since 1986. The day after the election, Clinton tried to explain the Republican landslide by saying, the American people “want a smaller government that gives them better value for their dollar … [one] that is not a burden to them, but empowers them.”

Yet after his 2008 election, Barack Obama declared the Reagan Revolution was over – promising not only to restore big government, but to make it bigger and more intrusive than ever. In his inaugural speech, he employed his omnipresent rhetorical straw man, whom he called cynics, and declared, “What the cynics fail to understand is that the ground has shifted beneath them – that the stale political arguments that have consumed us for so long no longer apply. The question we ask today is not whether our government is too big or too small, but whether it works.” His stimulus spending and a $3.6 trillion budget to fund expansion of government showed how committed he was to ending the Reagan Revolution and restoring government to a central role in the economy. In so doing, Obama and Congress completely misread the message of their election – to roll back the excesses of the Bush administration, not to add to them.

It now appears that voters are poised to revolt against governmental incompetence yet a third time in as many decades in this fall’s elections because polling shows a seismic shift will occur in both houses of Congress. House Republicans, confident that voters will give them control, hopefully have grasped their mandate this time. Reminiscent of 1994, last week they unveiled their "Pledge to America" which promised to "launch a sustained effort to stem the relentless growth in government that has occurred over the past decade."

Will Obama move to the center as Clinton did after the 1994 Democrat debacle? The smart money says no. As Eric Cantor observed in a WSJ editorial this week, the White House will not let go of its leftist ideology and work with a Republican Congress in solving the nation’s problems. “The question is whether the survival instinct overtakes their ideology,” Cantor said. “I don't see that happening."

The next two years should be interesting.