The Commanding Heights

We gather tonight knowing that this generation of heroes has made the United States safer and more respected around the world.  (Applause.)  For the first time in nine years, there are no Americans fighting in Iraq.  (Applause.)  For the first time in two decades, Osama bin Laden is not a threat to this country.  (Applause.)  Most of al Qaeda’s top lieutenants have been defeated.  The Taliban’s momentum has been broken, and some troops in Afghanistan have begun to come home.

These achievements are a testament to the courage, selflessness and teamwork of America’s Armed Forces.  At a time when too many of our institutions have let us down, they exceed all expectations.  They’re not consumed with personal ambition.  They don’t obsess over their differences.  They focus on the mission at hand.  They work together.

Imagine what we could accomplish if we followed their example. Think about the America within our reach:  A country that leads the world in educating its people.  An America that attracts a new generation of high-tech manufacturing and high-paying jobs.  A future where we’re in control of our own energy, and our security and prosperity aren’t so tied to unstable parts of the world.  An economy built to last, where hard work pays off, and responsibility is rewarded.

From President Obama’s 2012 State of the Union speech

I served 8 years in the US Navy, mostly aboard submarines, and I can attest to the value of teamwork. I can also assure you that teamwork in the military is accomplished in ways that, thankfully, are not acceptable in the civilian world. If you don’t do what you’re told in the military, there are options not available to the average corporate manager. The prospect of being forced to accept 99 weeks of unemployment compensation pales in comparison to getting thrown in the brig for disobeying an order. The threat of losing your job is not remotely comparable to the threat of losing your life.

I am happy that we are out of Iraq and I can’t wait until we can say the same about Afghanistan. I am grateful to the many military personnel who made the ultimate sacrifice in the fight against terrorism. Whether our recent military adventures prove worthy of the price we’ve paid – in human life and earthly treasure – is for future historians to decide but the men and women who fought these battles are worthy of our highest praise, admiration and appreciation.

Based on the rest of the speech, President Obama seems to believe that he and the other politicians in Washington can replicate the success of our military in the economic sphere.

We can do this.  I know we can, because we’ve done it before.  At the end of World War II, when another generation of heroes returned home from combat, they built the strongest economy and middle class the world has ever known.

The post WWII period was certainly a golden age for the US economy but it is not a model for our current situation. The US was able to dominate the global economy then because we had just spent 4 years destroying the productive capacity of our economic competitors. The success of the US economy after WWII was nothing more than the broken windows fallacy writ large. Yes, economic activity can be created in one economic sector (or country) by destroying property but it can only come at the expense of another sector (or country). The economic comfort of the US after WWII was built at least partially on the misery suffered in post war Europe and Japan.

This nostalgia for the post war period is misplaced for another reason. Much of what the President – and other Americans as well – pines for is a myth. The top down, command economy of the 50s was made possible only by years of world war and the conformism of a population accustomed to taking orders. It was a world of big business, big government, big media, big unions and the organization man. It wasn’t a time for taking risks or bucking the status quo. It was a world where order was prized over all else. It was a world where the commanding heights were a comfortable perch for those in charge. And the result, at least economically, was the 1970s, embodied almost perfectly by an insulated automobile industry that produced such memorable products as the Chevy Chevette, the AMC Gremlin and the Corinthian leather clad Chrysler Cordoba.

The economy cannot be managed in the same manner as the military and considering that it took nearly 10 years for our superbly trained military to claim victory in Iraq, it is doubtful we should try. Admittedly, it must be tempting for a President to believe something as important to his job prospects can be controlled but economic growth is not territory to be gained from other countries. The plans laid out by the President attempt to control the economy through a sticks and carrots approach that rewards companies who operate according to his blueprint and punishes those who don’t. His vision extends internationally to punish countries that “don’t play by the rules”. The President never acknowledges the potential damage to the economy of wielding too big a stick or offering carrots to the wrong horse.

That isn’t to say that other countries aren’t cheating in some respects, at least as the President defines it. China does manipulate its currency in an attempt to maintain a trade advantage and it does subsidize some of its industries. Unfortunately, punishing China for these acts while the Federal Reserve devalues the dollar and the President calls for more clean energy subsidies is like the pot calling the kettle black. The President is on somewhat stronger turf when talking about software piracy but even there the damage to our economy is likely negligible. What the President doesn’t seem to understand is that China’s policies have consequences of their own regardless of what the US does. The result of their currency policy is a large stack of US Treasuries and an inflation problem that makes our housing bubble look quaint by comparison. There is no such thing as a free lunch in economics and bad policies produce bad results no matter what country uses them.

The President and many other politicians ignore the 400 pound gorilla in the US economic living room – the Federal Reserve. In the same week the President laid out his vision for controlling the US economy, Ben Bernanke laid out a vision of his own. Mr. Bernanke believes every bit as much as President Obama that he can control the US economy. Many of the problems the President is trying to solve – and I think he is well meaning if misguided – are a result of the policies formulated by the Federal Reserve. Four decades of discretionary monetary policy have produced an economy dominated by a financial industry that benefits from Fed policies at the expense of other sectors. Too big to fail and all that implies is a direct consequence of Fed policies pursued since the end of Bretton Woods. It has also produced or at least exacerbated the inequality the President so rightly abhors.

The FOMC last week announced that they expect interest rates to stay at current levels until at least 2014. I know of no other government policy that is so specifically designed to benefit the rich at the expense of the poor and middle class. The policy is supposedly intended to spur lending to help heal the housing industry but it hasn’t worked yet and it isn’t likely to. Banks are happy to borrow from savers at miserly rates and buy financial assets with higher yields. Bernanke, when asked about the damage done to savers, said:

In the case of the savers, you know, we think about all these issues and we certainly recognize that the low interest rates that we’re using to try to stimulate investment and expansion of the economy, also impose a cost on savers who have a lower return. And we do hear about that obviously. And we do think about that. I guess the response I would make is that the savers in our economy are dependent on a healthy economy in order to get adequate returns. In particular, people own stocks and corporate bonds and other securities as well as say, Treasury securities. And if our economy is in really bad shape, then they are not going to get good returns on those investments. So I think what we need to do as, is often is the case, when the economy goes into a very weak situation, then low interest rates are needed to help restore the economy to something closer to full employment and to increase growth and that in turn will lead ultimately to higher return across all assets for savers and investors.

What about the retiree who can’t afford to take the risks associated with corporate bonds, stocks and other investments? What about the young person trying to accumulate a financial cushion? What about the former investors who have given up on the stock market after the debacle of 2008? More importantly, what about the poor person who has to pay higher gas and food prices because of the Fed’s inflationary policies? The true beneficiaries of this policy are financial speculators (banks and brokers primarily) and the wealthy who have the means, the ability and the knowledge to invest in the increasingly volatile capital markets. Interest income is down roughly $400 billion annually since before the crisis. That is real money taken from real people and it has consequences for them and the economy.

The commanding heights was a phrase used by Lenin and while I don’t think the President or Ben Bernanke are communists, they both seem to believe they can control the economy just as Lenin did. We do need to reform our corporate tax code but in a way that treats all companies the same, not by favoring one industry over another. We do need to produce more tradeable goods in the US but by making it attractive to do business here not by devaluing the dollar. We do need to hold down inflation in medical care and higher education but we won’t accomplish that by continuing to subsidize those industries while brow beating doctors, insurance companies and college presidents. We do need to improve our education system but we can’t do that by dictating local policy from Washington, D.C. The US economy – the global economy – is too complex and the future too uncertain – as it always is – to believe that it can be forced to conform to the dictates of a few politicians and central bankers.

Economies evolve in ways that cannot be anticipated. Growth comes from entrepreneurs taking risks with their own and others’ accumulated capital on projects that are expected to produce a profit by filling a need. The market is the only true judge of what products and services should be produced. Government can help that process mostly by enacting simple rules that are applied equally to all. The Federal Reserve can help that process mostly by limiting the fluctuations of the US Dollar and thereby making it easier for economic actors to plan for the future free of monetary distortions. The President can help that process mostly by being humble and accepting that neither he nor any future President has the knowledge to competently direct the resources of a $15 trillion economy. The title of Commander in Chief does not apply to the economy.

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@alhambrapartners.com

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3 Responses to The Commanding Heights
  1. Joe, excellent article. You make the very valid point, among many others, that “Growth comes from entrepreneurs taking risks with their own and others’ accumulated capital on projects that are expected to produce a profit by filling a need”; and clearly “devaluing the dollar” is not an economic policy that helps. But you do not mention Wall Street. How do you view Wall Street trading in the so-called “bundling”? Is this an example of entrepreneurs taking risk to produce a profit by filling a need?

    Reply
    • Joseph Y. Calhoun
      January 30, 2012 at 10:53 pm

      Jose,

      Wall Street would not be the behemoth it is without the Fed’s constant meddling. In part, they are filling a need by providing companies the ability to hedge the risks introduced by the Fed. That falls on the Fed since it is dollar volatility that creates interest rate, exchange rate and commodity volatility. The banks and brokers also speculate in these markets but if they weren’t as volatile, they wouldn’t speculate as much. Speculators trade things with volatility. Take away the volatility and you take away the appeal of speculating. Of course, I don’t think we should be allowing banks to speculate with deposits guaranteed by the government either and Dodd Frank is severely limiting that but it will just shift to other entities such as hedge funds. If the volatility continues so will the speculating. The only real answer is to reduce the volatility of the dollar.

  2. Joe,

    You make a number of excellent, common-sense, points. But common sense, as we have come to learn, is much less common than many of us thought.

    Reply

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