The Wealth of a Nation

By Xavier L. Suarez

The Great Depression of 1929 was similar to the Great Recession of 2008, but not identical, either in its cause or its cure. This book explores the reasons why that is and suggests that the US economy has changed radically in the last half-centuryto the point that one must reanalyze the theories of the four great economists, with a view to synthesizing and applying their separate bits of wisdom into a compatible, modern diagnosis of recessions and prescription for curing and avoiding them.

Buttressed on the brilliant reinterpretation of Keynes by Princetons Allan Meltzer, and on the writings of modern commentators and academics, the author weaves together a readable explanation of what nowadays passes for the liberal view and the conservative view. Numerous examples are given of specific industries and enterprises, of joint public-private projects, and of the interdependence between government and the free market.

Vignettes and quotes are also offered of the great deeds, as well as the dismal failures of policies implemented by Teddy and Franklin Roosevelt, Ronald Reagan, Bush father and son, Jimmy Carter, Bill Clinton, and Barack Obama.

In the end, a tantalizing fusion is achieved of the best elements of Keynesianism, monetarism, and free-market economics.

And all the time, the level of discussion is reachable by all and interesting to all who have even a minimal interest in the history and politics of economic theory.

• Language: English
• Publisher: AuthorHouse
• Release date: Sep 13, 2014
• ISBN: 9781496929815

Xavier L. Suarez

Xavier L. Suarez is both an academic and a politician. He was born in Cuba and came to the United States as a refugee from Castro-communism. Here in the states, he obtained scholarships from high school at the famed St. Anselm’s in Washington, D.C. and subsequently at Villanova University, where he was the only summa cum laude graduate in the entire school of engineering. He then obtained joint degrees in law and public policy from Harvard. In 1985, Suarez was elected Mayor of Miami; he was reelected twice. In 2011, Suarez was elected Miami-Dade County Commissioner, where he served for two-plus terms, until termed out in 2020. He has written books on topics ranging from politics to anthropology and economics. He is married to Rita Elena and live, along with my son Francis (currently serving as Mayor of Miami) and daughters Olga, Annie and Carolina, plus 11 grandkids, in the Miami area.

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© 2014 Xavier L. Suarez. All rights reserved.

No part of this book may be reproduced, stored in a retrieval system, or transmitted by any means without the written permission of the author.

Artist name: Danny Battle

Published by AuthorHouse   09/11/2014

ISBN: 978-1-4969-2980-8 (sc)

ISBN: 978-1-4969-2981-5 (e)

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TABLE OF CONTENTS

Acknowledgements

Introduction

Preface: A Tale Of Two Countries

CHAPTER I: The Wealth Of Nations

CHAPTER II: Government Regulation: When Is It Needed, When Not

CHAPTER III: A Brief History Of The American Economy

CHAPTER IV: The Ascent Of Money

CHAPTER V: Money Mischief – Episodes In Monetary History

CHAPTER VI: The Road To Serfdom

CHAPTER VII: Keynesian Economics: Battling The Business Cycle

CHAPTER VIII: The New Deal: Defining Moment For A Nation

CHAPTER IX: Bailout Nation

CHAPTER X: Twilight Of The Elites

CHAPTER XI: The Health Care Leviathan

CHAPTER XII: The Great Degeneration

Epilogue

About The Author

Acknowledgements

I am indebted to so many people who have contributed to my modest effort to explain and harmonize the theories advanced by the four great economists: Adam Smith, John Maynard Keynes, Friedrich Hayek and Milton Friedman. Perhaps there are others who belong in that hall of fame for the science of economics. If so, all I can say is that these are the four that have shaped my thinking the most. Perhaps not coincidentally, I have noticed that they are the four most quoted thinkers in this field.

Books written by three of the four masters are used as chapters for my book. Adam Smith’s The Wealth of Nations was useful both for a chapter and – in slightly modified form – for the title of my own book. From Hayek I borrowed The Road to Serfdom for a chapter; from Friedman, Money Mischief: Episodes in Monetary History.

I also want to thank Princeton’s Allan H. Meltzer and Harvard’s Niall Ferguson. I have quoted both extensively from their works.

Meltzer’s treatise on Keynes (Keynes’s Monetary Theory: A Different Interpretation) was pivotal for two reasons. One is that he made it possible, by his clear dissection and plain prose, to understand many of Keynes’s theories, which were otherwise beyond my grasp.

The other reason Meltzer is important to this work is evident from the book title quoted above – i.e. that he has a different (and I would venture to say, more accurate) interpretation of Keynes’s theories. Scholars can argue whether his different interpretation is more or less true to Keynes than the conventional wisdom. I am not competent to argue the point. I simply adopt Meltzer’s view of the matter, and rest my narrative on it, providing the reader an abundance of quotes directly from Keynes. Taken together, they might or might not settle the argument; but as I read them, they seem to support Meltzer’s interpretation.

Special thanks also are due to Niall Ferguson. I used two titles of his books (The Ascent of Money and The Great Degeneration) for chapters of my book. Others whose book titles I have borrowed for headings are Jonathan Alter (The New Deal, Defining Moment for a Nation), Barry Ritholtz (Bailout Nation), and Chris Hayes (Twilight of the Elites).

Closer to home, I thank collaborators that include Oscar Echevarria Salvat, Anthony Villamil and Jose Azel. The first two are professional economists; the third is Professor of Sociology at the University of Miami. I also thank Fr. Roberto Manuel Cid, who is by training an economist and by vocation a priest here in the parish where I spent many hours crafting my magnum opus.

Very special thanks to Danny Battle, who is my graphics illustrator and designer of the book cover.

I also want to express loving gratitude to my wife, Rita, and all my readers, including my many brothers and sisters who patiently read and offered suggestions on the text. Last but not least, special thanks to my four children (Francis, Olga, Anna and Carolina) and their respective spouses for giving me feedback and support during the many, tedious hours of editing and proof-reading.

Introduction

The Lights Go Out on the Dismal Science – Robert Samuelson

As I was putting the finishing touches on this book, I read an article by respected economist Robert Samuelson that combined the two most disturbing statistics emanating from the five-year effort at recovery from the Great Recession of 2008.

One statistic, which I will often repeat (and explain) in my manuscript, is the one that quantifies the expansion of the money supply by the Fed. Samuelson observes that since 2008, the Federal Reserve has poured more than $3.2 trillion into the economy to keep interest rates low and accelerate economic growth. The second statistic is equally astounding: the massive deficits accumulated since 2008 constitute $6.2 trillion worth from 2008 to 2013, averaging 6.4 percent of the economy (gross domestic product).

To Samuelson, the massive spending stimulus effort, and the resulting weak recovery of the last five years, places Keynesianism under a cloud. And, he adds: The same fate has befallen monetarism – the doctrine that stable growth in the money supply can promote a more stable economy. Despite a total of almost $10 trillion pumped into the economy artificially by government, the economy has only experienced modest growth; this fact, he says, has created an identity crisis for economists.

Indeed.

What else can you say when those who govern us apply the prescriptions of the two principal, modern schools of economics to double the entire money supply ($10 trillion) with the same amount of fiat money, and the result is continued stagnation?

Samuelson does not put up much of a defense for his scientific cohorts. Instead, he humbly acknowledges that these are hard times for economists; their reputations are tarnished; their favorite doctrines are tarnished. And he continues the barrage of criticism of what he calls the dismal science of economics:

Among the most prominent thinkers, there is no consensus as to how – or whether governments in advanced countries can improve lackluster recoveries. All in all, the situation recalls a cruel joke: How many economists does it take to change a light bulb? None. When the one they used in graduate school goes out, they sit in the dark.

Samuelson ends his essay by the following interesting admission:

The faith in economics was, in many ways, the cause of both the financial crisis and the Great Recession – it made people overconfident and careless during the boom….To regain relevancy, economists are searching for a new light bulb – or better use of the old. Meanwhile, most are still sitting in the dark.

As my analysis will show, Samuelson overstates the problem. Like most economists, he is unwilling to pick out of each school of economics the kernels of truth, with a view to harmonizing and integrating them into an economic theory of everything. Perhaps because he himself has not reinvented the light bulb that went out after his graduate studies, he lacks illumination with which to peer into each major theory and find those nuggets that are consistent with one another, and with the experiences of the last half-century.

We do not share his despair. We are not resigned to the darkness of a condition that results when the theoretical money gurus and the practical money barons join hands to convince us, the people, that we simply don’t know enough theory to guide the economic policies of the country.

We know what worked during the Great Depression, and now we know what didn’t work during the Great Recession. And we are smart enough to know that there were common causes.

The Last One-Hundred Years

Samuelson’s pessimism notwithstanding, there are nuggets in economic theory that have transcendent worth. Classical economic theory is invaluable to explain a free-market economy, such as what the United States had from colonial days until the First World War. Even after that, it has enormous relevance, if properly understood as to the limitations imposed by greater and greater government involvement in the economy.

And there is some consensus that excessive deficit spending by government can stunt the economic growth of a nation. For a while, there was almost unanimity on that, to the point that it seemed that economic science was settled on that issue.

The consensus reached a crescendo in 2010, when Harvard economists Carmen Reinhart and Kenneth Rogoff completed an exhaustive study consisting of 3,700 separate economic observations and concluded that there was almost no relationship between growth and debt. Even more importantly, for countries in which debt exceeded 90 percent of economic output, the median growth rates fell by 1 percent, and average growth fell considerably more.

But then a couple of University of Massachusetts students crunched the raw data relied on by Reinhart/Rogoff and showed that the two eminent Harvard professors had omitted important data that went against their conclusions. In the final analysis, it appeared that the correlation between higher debt and slower than normal growth was almost non-existent.

And so the pendulum of economic science went back to a position of neutrality (or, should we say, uncertainty). Nobody seemed to know whether deficit spending was good, whether government should tinker with the money supply, or, in the final analysis, whether Samuelson was right that the light bulb of economic science had burnt out.

That agnosticism does not play well with me. There are evident economic truths and there are proven fallacies. There are solid economic principles that apply in every case and exceptional situations, in which the collective hysteria of a nation needs to be counteracted by swift government action led (preferably) by the magic of a charismatic leader.

America has seen such leaders; and they have come, interestingly, from both sides of the ideological spectrum. Democrats such as Franklin Roosevelt and Bill Clinton have advanced policies that led to robust growth. Similarly for Republicans like Ronald Reagan.

Others (Carter, Bush the younger and Obama) have not been so successful.

In the chapters that follow, we will look objectively at the economic realities of the last century. We will do our best to weed out the theoretical rants of extreme ideologues and concentrate on the sober, statistically supported assertions of those who back their theories with concrete accomplishments, or conversely, are contradicted by the failures of their proposed policies or the inapplicability of their models.

We will also delve into what is the single biggest defect in the modern, American economy. We will explore what Samuelson meant when he said that the Federal Reserve has poured $3.2 trillion into the economy in the last five years. The reader will see that no one questions the amount, or who the recipients of the bounty have been. The term to remember, in that connection, is the monetary base.

Monetary Base = Game of Monopoly

The monetary base is quite distinguishable from the money supply, though it has many of the same properties. The main difference is that the monetary base is part of a game in which only the big banks are invited to play.

It is very much like the game of Monopoly, in which the lucky players are given a certain amount of fake money and allowed to invest it, exchange it for real estate or commodities or currencies, and basically play with it to see who ends up the richest, when all the properties are bought.

The only difference with the real-life game of Monopoly being played by the banks is that when the game is finished, the money they have made is given to them in real dollars. Yes, you read that right: By the end of the five years since the Great Recession began, the banks that participate in the Federal Reserve System got to keep a total of $3.2 trillion – equivalent to one entire year of the federal budget.

The rationale for this largesse is found in the prevailing, modern economic theory, which is a combination of Keynesianism with monetarism. In simple terms, its core principle is that government must intervene in a stagnant or recessive economy by providing credit to banks at very low rates of interest, so as to increase economic activity at both the production and consumption ends. The consensus among economists is that even after the initial shock has been overcome by government subsidies and bailouts of major industries (including banks), there is continued need to have artificially low rates of interest.

The fancy term used for this kind of prolonged credit manipulation is quantitative easing. The presumed economic model is one that relates lower unemployment to lower interest rates. Here’s how Columbia’s Dean of the Graduate School of Business Administration, Glenn Hubbard, describes the hoped-for relationship:

The Federal Reserve also has used monetary policy, through aggressive quantitative easing, to combat the shock from the financial crisis…If labor-force participation is down because of cyclical factors, keeping interest rates low has been a smart policy, even as unemployment falls—in fact, even if it continues to fall to very low levels to draw nonparticipants back into the labor force.

The reader should notice a key assumption in the analysis: that the cycle of recession and unemployment is cyclical. That assumption, as we shall see, underlies the entire edifice of modern economic policy. Well, that is a slight exaggeration, as there are critics, from both the left and the right of the ideological spectrum, that doubt the wisdom of that approach.

We shall analyze those, and try to determine whether there is any logical basis for constantly stimulating a stagnant economy by letting America’s central bank hand over to the financiers the equivalent of one entire year’s federal budget in cash.

This is what has been done in the last five years by the Fed – and with no strings attached. What they did with it is recounted in this book. Suffice it to say that most of it did not go to the middle class, or to needy families. Most of it stayed with the banks themselves, and pumped up their value in Wall Street, as well as their earnings and their wealth.

Did it stimulate the economy as a whole? Did all this wealth, all this off-budget money reduce substantially unemployment or poverty? This book is all about those questions, and we will look for evidence without the impediment of ideological bias. We are not professional economists, but we can look at facts and consider the often contradictory opinions of the experts, with a view to sifting out the truth.

As they say, the proof is in the pudding. And the pudding starts, for our purposes, about one hundred years ago, when the First World War was coming to an end. That moment marked the end of one empire and the beginning of a new one.

Winston Churchill quipped that Britons and Americans were two peoples, separated only by a common language. He was talking about semantics, not economics. But the saying applies to economics. By the end of the First World War, the language of British economics and American economics had totally separated; and the British were stagnant, while America was thriving in every possible way.

It was the beginning of the American century, and it coincided with the end of the British Empire.

Preface

A Tale Of Two Countries

It was the era right after the second Great War, which was now called World War II. England had managed to stem the tide of Nazism (initially almost single-handedly) and was in the process of reconstructing its war-ravaged economy.

On the other side of the Atlantic stood a new global power, a new economic colossus, soon to become the world’s lone superpower. Far from being ravaged by the second world war to take place in a quarter century, America was intact; in contrast to Britain, which had lost 500,000 homes in a country of 45 million – or one for approximately every 20 families in the nation – the United States had not had a single home destroyed, a single factory or shipyard put out of commission, a single church or monument wiped out by bombers or rockets.

All it took for America to begin a wave of prosperity was some re-tooling of tank factories so as to start cranking out cars. And Americans were buying American cars, despite having a much stronger currency than England. Paul Reid (in his collaborative manuscript, written jointly with William Manchester to complete the Churchill trilogy called The Last Lion) described the U.S. recovery thus:

Americans were buying American – GM, Studebaker, Ford, Packard, and Chrysler automobiles and electric clothes dryers, radios and televisions. American children rode bright-red Schwinn bicycles, which – as with all American products – benefited from tariffs slapped on European imports.

The British lacked the physical assets and the capital necessary to benefit from the comparative advantage of having to comply with the famous Bretton Woods agreement, which required all participating countries to float their currency against the U.S. dollar. As a result, the British pound had been devalued by 30 percent, from $4.08 to $2.80. That, combined with generous loans from the United States, amounting to $3.75 billion at a measly 2% interest rate, should have placed England among the world’s great exporters of goods.

Alas, it did not work out that way – among other things, because of trade barriers posed by the United States. Reid explains:

A devalued currency results in a nation’s products becoming cheaper in foreign markets, but Britain had little to export, and very little that Americans wanted….[O]ther than shipping their best scotch whiskey to America, Britons were not exporting much, not producing much, and not buying much….

Currency devaluation should have been accompanied by free trade, yet tariffs remained high after the war. It was not until 1947 that the world’s economies were joined in an orgy of tariff reductions by what came to be called the General Agreement on Tariffs and Trade (GATT). The existing trade barriers did not hurt the United States much, since its enormous population and contiguous land mass, diverse regional weather and free-market tradition and laws enabled it to prosper by producing and consuming internally.

Today we would compare the U.S. economy not to Britain, but to the entire European Union, which has a comparable population, diversity of weather and only slightly more socialized economies, with no trade barriers. It is not a coincidence that the Gross Domestic Product (GDP) for the European Union as a whole is comparable to that of the United States.

But let’s get back to the initial theme of this preface, which was to compare the economies of the two great industrial nations of the world, at the beginning of the twentieth century. What is evident from the above is that by the end of the Second World War there was no real comparison. America reigned supreme and England was forever destined to be a secondary economic power.

The British Empire reigned no more.

And yet, the prevailing economic theory of the times belonged to an Englishman. His name was John Maynard Keynes; his theories were bound to set the tone of all economic discourse in the Western world for at least a half century. Therefore, it was no coincidence that he had been sent by the British Prime Minister (Clement Atlee) to negotiate the huge and favorable reconstruction loan mentioned before.

Keynesian economics was a theory based mainly on a serious defect in the British economy between the wars – an endemic high unemployment. After the Second World War, and for a period lasting a little more than half a century, the U.S. economy thrived under essentially free-market conditions, while the British economy lagged, under more socialized conditions. Keynesian prescriptions of high government involvement in capital formation – so useful in an economic crisis – were not particularly helpful to the American economy of the last half of the twentieth century.

But neither were the laissez-faire theories of the Austrian school, as championed by Ludwig Von Mises and Friederich Hayek. By the fourth quarter of the twentieth century, America had converted its economy to a modified, quasi-European mixture of private and collective. The idea that a pure, laissez-faire, totally free-market economy would ever take hold in America was quickly becoming an illusory dream engaged in by a handful of Austrian-school economists.

Hayek v. Keynes was a nice, theoretical juxtaposition of inapplicable extremes – useful for academic and political debate, but not for actual implementation, as we shall see. They are like the left and right wooden edges of a painting, which hold up the canvass but are not the venue for the actual painting. They are the explanatory book-ends, but not the actual text of the book.

They define the fringes of the discussion with eloquence and quantitative models. Their interaction frames the debate.

In the succeeding chapters, we shall explore the two opposing theories and attempt to show that each has useful principles for the kind of hybrid economy that the U.S. has evolved into. A lot of the discussion will involve the role that government has played in determining the amount of money that circulates and fuels investment and supports consumption.

This analysis is partly global due to the globalization of banking. Yet it is focused on the American economy, which has peculiar institutions that are not comparable to those that exist in Japan and Europe, and even less to those that guide China’s economy.

The role of banking in twentieth century economies is paramount. Banking, which has evolved into a system that uses dollars (cumulatively referred to as the money supply) consisting mostly of riches which were never actually produced or earned, is a controlling factor in the U.S. economy. For that reason, we will delve into the inner mechanisms of banking – and not just private banking, but public banking, as carried out by a creature begat in Jekyll Island (off the coast of Georgia) that goes by the name of the Federal Reserve.

It will be in that analysis that we will meet the third of the great economic theories we are trying to understand (the Chicago school), with a view to fusing them and weaving them into a proper, holistic analysis of the contemporary U.S. economy.

But first, we must look at the master economist of all times, the one that gave birth to what we now, euphemistically, call the science of economics.

His name was Adam Smith, and he was the intellectual architect of classical economics – a name that befits the first enunciation of any science.

Chapter I

The Wealth Of Nations

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It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest. Adam Smith

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Adam Smith was to economics as Freud was to psychology and Darwin to evolutionary theory. Like Freud and Darwin, Smith was the pioneer, the seminal theorist, the precursor of everything and everyone that came after him in his field.

But that doesn’t mean that his analytical models were perfect, even for the era when he wrote.

For one thing, Smith’s models assumed a free-market economy, in which government had a very limited role. They assumed that money represented capital accumulated from work performed and thereafter available for either saving or investing in some new production.

Such an economic system, in which government has very limited functions (typically national defense and domestic policing) is often referred to as laissez-faire. At the other extreme from such laissez-faire (or entirely free-market) economies lie the state-controlled economies of hardline, Marxist systems that permit no private enterprise and control all the means of production, as well as the prices and distribution of consumer goods.

Cuba and North Korea are two current examples of that.

In between total state-control and perfect free-market, lie the economies of most of what used to be known as the Western world – notably Western Europe and the Americas. Eastern Europe came into the fold of free-market nations in the last three decades, completing a process of economic Westernization that nowadays also embraces most of Asia and Africa.

So, with few exceptions, it can be said that the great majority of societies are at least partially free-market based, varying in state control (by regulation or taxation) of their economic output from about 50% in Europe to about 40% in the United States. The rest of the world’s large economies are now also within that range, with the exception of China, which controls banking, natural resources, investment and currency, but allows limited private ownership of retail, distribution and production of goods and services in less important industries.

The objective of this book is to study the United States economy. As such, there is not much that needs to be said about small, state-run economies like Cuba’s and North Korea’s. China’s economy comes into play only because it has an enormous amount of trade with the United States and an almost equally enormous positive trade balance, which is never adjusted by the market mechanism of currency fluctuations, as needed to reach a balance of trade.

We will get to that later. For the moment, what is important to understand is that the theoretical notion of a totally free-market economy does not exist anywhere on the face of the earth. And yet the principles and equations of that model do have current applicability.

As I said, the study of economics was not much of a science before Adam Smith. He is truly the father of economics.

But he is even more than that. Adam Smith remains synonymous with classical economics. He is the guru, the precursor, the founder, the one theorist who proposed an entire system of analysis in what is perhaps the most complex of the social sciences. Unlike other sciences, where consensus follows not only the initial theorist but the modifications and amplifications, in economics there remains a tension between the initial theory and the subsequent efforts to adjust and modify it.

Smith’s theories have not been modified in the same way that Newton’s laws of physics were modified by Einstein’s equations of relativity and that Einstein’s equations have been modified by quantum physics. If we think of physics as a building whose foundations were laid by Newton and whose upper floors were superimposed by Einstein and modern particle physicists, economic is more like a two-story building whose first floor was laid by Adam Smith and whose second floor is a sort of bazaar, where competing storefront merchants like Keynes, Hayek, Von Mises, Arthur Laffer, and Milton Friedman sell their wares in a competitive market of ideas, from which commentators and policy analysts choose from a menu of viable theories.

In modern economics there is no consensus. There is a piecrust of solid, free-market principles and a smorgasbord of toppings from which to choose, depending on one’s ideology. I suppose a good comparison can be made to political philosophy, where there is agreement on some very basic core principles and then a large variety of competing ideologies, each with a prescription as to how best to promote those principles.

Economics, in short, is a somewhat scientific, somewhat political jungle, where only the most powerful voices survive. And those voices necessarily echo the prevailing political rulers, who in turn echo the prevailing popular view of how the American economy should work.

Under Democrats, John Maynard Keynes is the guru; under Republicans, Arthur Laffer or Milton Friedman reign supreme. And if Libertarians ever ruled, they would invoke Von Mises/Hayek and the Austrian school.

And that state of affairs, that anarchy, begs the question that we now need to ask.

Is Economics Really a Science?

In reality, economics is part science and part predictive art. In another sense, it is history – or, more precisely – that subset of history that seeks to recount in some coherent fashion the events that happened in the sector of society that deals with production and consumption of goods.

It is akin to political science, in the sense that it seeks to understand the ideal rules for economic exchange in a society of many, many people, not all of whom have the same preferences, values or priorities. Ideally, the rules by which they play the game of economics must be universal, in the same sense that the rules by which a people play the game of politics must be universal. But in economics, the rules are not constant; they change with the political seasons.

There is no charter or constitution to guide the economic debate.

The changing nature of political economics makes it that much harder to find a cause-and-effect for each major event in the economy of nations. Economists do their best to use the methodology of the hard (empirical) sciences, i.e., equations and quantitative models, which assume fixed rules of nature. But the sheer complexity of economic variables, compounded by the human factor, requires the methodology of the soft (social) sciences, particularly statistics.

Even combining methodologies is not enough to define the science of economics. The sheer complexity of the economic models makes economics a lot like meteorology – which is a fancy name for predicting the weather. As in economics, there is much in weather forecasting that relies on the analysis of causes and effects. But when you try to predict the precise path of a hurricane, the hard analysis gives way to statistics. The best models for predicting hurricane activity are those that give us that familiar cone of probability that we see on our television sets and computers when tracking a hurricane.

Being inside the cone means a high degree of probability that some stormy weather is in our future; being outside the cone means we can relax. But the cone is not fixed; it changes with time. It is subject to the same kind of statistical margin of