About Bernard Munk

Dr. Bernard E. Munk has had a career spanning academia, public service as well as long involvement as an owner and operator of companies engaged in both trading and production. He has also been a financial advisor to private investors, family offices and hedge funds. Read more on his Economics and Politics blog ? ECOMENTARY.COM

Milton Friedman; Freedom’s Greatest Advocate

(presentation to the Liberta Society; Buenos Aires 7/29/2021)

Image courtesy: clubdelalibertad.com

While Liberalism, in its classic 19th Century sense, is suffering a decline as the State extends its dominion over free markets around the world, the crucial linkage between Freedom and Free Markets for Liberty remains. Its greatest spokesman during the the 20th Century was Professor Milton Friedman. Even in Argentina where Government controls have eroded the potential for economic growth and a rising standard of living, the kernel of Friedman’s ideas remains, hopefully to re-emerge and energize the Argentine economy and the freedom of its people.

In preparing these notes, I have the good fortune to be spending a leisurely vacation in Greece (now in Thessaloniki, but I wrote this in Athens), the home of the first “democratic society” of which we have some considerable records. Ironically, the world is recovering from a hideous, international “plague” (Covid 19) which has limited our freedoms in so many ways, while enabling Governments to intervene in our ability to freely associate, to innovate, to travel, to teach, to express our ideas, to engage in free commerce as well as many other activities, all in the name of “protecting” us! Secondly, we might note that Athens was doubly set back at the beginning of the Peloponnesian war by a “Plague,” (not yet quite clearly identified) which crippled her response to the Spartan attacks and ultimately claimed the life of it most noted political leader, Pericles. I point that out because in my subsequent remarks about Professor Milton Freedom, the question of political leadership is not fully treated as it must be if we are to fully understand the pathways he outlined for us over his long career.

I had the good fortune of being a student at Chicago during Professor Friedman’s prime years in the early 1960’s when many of his ideas were often ridiculed both by other professional economists and by Government officials who had rather Statist views on the role of Government, descending from the then prevalence of Keynesian ideas left over from the last great experiments in Government (The Great Depression and the end of WWII.)

The first edition of Milton Friedman’s luminary work, Capitalism and Freedom, came out in 1962 in the midst of my graduate years at Chicago…and we know that it was not well received at the time. In fact, most of us who were totally overwhelmed by Friedman’s scope of interests in economics and politics, and his well noted analytical capabilities, found much of Capitalism and Freedom as “old news” already featured in some ways by his lectures in Price Theory—which we all took—and his efforts to change the focus of monetary policy. (Via his monumental book with Anna Schwartz, The Monetary History of the United States was published in 1963).

Another irony struck me as I reviewed the Forward (by Binyamin Appelbaum) to Capitalism and Freedom in his statement that capitalism “had fallen into some disfavor,” at the time. (1962). Capitalism and Freedom came out during the great fascination by many students at the time with the alleged success of Soviet Communism (e.g.Sputnik) and some mystic appreciation of what appeared to be the political success in China of the CCPC under Mao Tze tung. The brutalities and exterminations of millions that had occurred during the earlier years of these regimes were not widely documented until Solzhenitsyn’s The Gulag Archipelago appeared in the West in the late 1970’s.

I mention this chronology precisely because we are witnessing a second episode of Capitalism’s “disfavor” in the United States, and also in many other countries. Witness the changes in Latin America in Argentina, Bolivia, Chile, Ecuador, Peru, and Venezuela. And, in the USA, where Capitalism has raised our standard of living to its highest level in history–and reduced poverty by immense amounts wherever it has been given a chance to flourish. If you watch the US Media or read the majority of its newspapers, you wouldn’t know that. It would appear that “Capitalism and Freedom” has failed and failed badly! When we see the epithet of “Racism” cast about so freely by young people, often from middle class backgrounds, you have to wonder just what kind of education has disabled their knowledge of U.S. history; their awareness of brutal coercion in many non-capitalist societies; and, their understanding of the actual data of economic progress over the last 60 years since Milton Friedman published “Capitalism and Freedom.”

Milton Friedman has often been cited as the outstanding economist of the 20th Century. As far as his technical contributions, there is no dispute that his efforts in the 1940s-50s-60s-70s illuminated much of macroeconomics and still continue to bear fruit. His policy analyses of housing, of the virtues of Charter Schools as a market based educational alternative, of the flexibility offered to macro policies through elimination of exchange controls and his long advocacy of abolishing restrictions to international trade are part of the lexicon of freer markets and freer economies.

Normally, a man who covered such a range of social policy should be satisfied with such a menu of accomplishment, but I think the Milton Friedman that we knew in the 1990’s and 2000’s was not completely finished with both his analysis of current conditions nor his vivid assertions that free markets were essential to political freedom. Let me amplify those thoughts a bit.

When we look around the world—particularly at the nominally “democratic states,”— that is those states that are not governed by some form of totalitarian regime, we do observe a growing division between people who believe they are “free” and those who believe they are “controlled” by some amorphous and ill-defined cabal of special interests. We see this in the “Black Lives Matter” movement; in the looting and burning of certain sections of American Cities often by protestors willing to turn their demonstrations into violence. We see it from supporters of our previous President who attacked the Congress in a physically violent protest in which several died. We see it in protests in Europe and Eastern Europe on both the so-called “left” and on the “right.” It almost appears as if we are watching history repeat itself.

Marx claimed that history repeats, the first time as tragedy, the second time as farce. Should we think of what is going on today in nominally democratic states a farce? Perhaps, the second time is a tragedy as well? Or, is there some inherent connection between the seeming success of capitalism in the nominally democratic states and the discontent of our younger generation who frequently storm against “Capitalism,” the very system that has given them such enlarged economic opportunities and that has stood at the base of their political freedom.

In my view, there is a common theme that resonates in our current age of discontent. It is what I would call the “Doctrine of Fairness.” Apparently, the fact that free markets generate immense outpourings of innovation and that markets reward such innovations so well in an age of globalization, are principle ingredients to the Discontent of many. Invidious comparisons are drawn by many individuals between their own personal economic status and the highly publicized outcomes of the very wealthy. The latter, for a multitude of reasons, have gone far beyond the rewards of simple labor income. Indeed, much of their wealth and the income from that wealth is financial, stemming from their ownership of intellectual and physical capital. The wealthy cannot spend but a fraction of what their human and physical capital produces and their lifestyles are far different from the “average” family. Of course, as we know, in economies whose markets are much less than free, the “rich” do proportionately even better than do the “rich” in much less restricted markets, but that fact is scarcely addressed in public media. One has only to look at the kleptocracies around the world for a demonstration of that kind of inequality.

Furthermore, it appears to the Media and to the “common man” that the political clout by the wealthy with bureaucrats and senior politicians is far greater than those whose income derives solely from Labor. The implication of that observation, whether it is true or not, we can put on the back burner for now, is that “special interests” get served far faster and more thoroughly than the “mass” of the people. That observation takes me back to Ancient Greece, and the troubled history of the first great democracy, Athens.

Any fair reading of Athenian politics in the 5th Century BC shows that while it is true that there were always “leading” families and individuals who had closer access to important political and governing figures, Athenian politics was in fact heavily influenced, even dominated by the mass of Athenians who had significant political rights rather than significant property. One can even argue that it was the “Mass” that forced the bad choices of Leaders and Strategies (Sicily for example) that led to the ultimate defeat of Athens. Athens never recovered from its failed campaign in Sicily against Syracuse.

Applebaum in his notes brings out the fact that in his later years the intimate connection that Friedman had initially drawn between the necessity for Free Markets to undergird Freedom itself became perhaps less clear to him. Yet, the clear distinction between a totalitarian state and the freedom of those who are so ruled by such a state and a freely elected democratic state remains. But within democratic states, there are infinite variations in content and in style over property rights and free markets. Some democratic states are freer than others. Fairness of outcomes differs between countries. In some states, overwhelmed by the numbers who are clearly POOR, restricting the freedom of others and changing the distribution of output in a significant way becomes a more appealing choice than allowing extremely capable and industrious people to rise into the class of great wealth. The political outcome is to restrict by taxation or by Government spending programs the growth of the economy as a whole. Furthermore, and this is an area that Milton Friedman did not much opine about publicly, the outcome in different states is heavily influenced by the quality and the understanding of the leaders chosen by the voters.

Inevitably, the poorest voters—who by numbers are the largest class of voters—are persuaded they can have “Guns and Butter,” to use the old antonyms. As a result, politicians compete to spend Other People’s Money in order to gain or retain political office. They change tax laws and conditions of competition attempting to legislate “Fairness of Outcome.” Many of these measures limit the growth in output and often do not even readjust the outcomes to be more “FAIR.” However, appearances count more than substance. Voters are influenced by Presentation, not by actual data.

Abraham Lincoln said, “You can’t fool all of the people all of the time,” but a closely competitive political society doesn’t need the vote of all of the people. It just has to move the margin a bit. Binary voting outcomes are unlike market outcomes. Markets move output by the amount of dollars spent on the output—proportional representation so to speak. Voting outcomes are binary. One votes for A or B but political trades among the political winners can create a working majority of interest. What may count more in a binary choice system is moving the percentages slightly because then the “winner” can restructure the game. The Winner can become a virtual totalitarian. The bottom line of this kind of analysis is the old wisdom contained in the writers of the The Federalist Papers concerning the danger of a Tyranny of the Majority. It always exists in a democracy. Once a majority controls the Government, it can change the rules for political competition.

In my judgment Milton Friedman was the greatest spokesman for Freedom in my lifetime. He lived a very long and extremely productive intellectual life that had many spinoffs. He never gave up his defense of Freedom and the importance of Free Markets in enhancing and protecting that Freedom. However, the implementation of Freedom also requires good leadership ===leadership that is willing to see through the mist of “Fairness”. Politicians and bureaucrats focus on Now; good leadership looks for good outcomes in the Future. We have a deep need for another Milton Friedman to show us how that linkage can be achieved and how to choose leaders that will stay on the right path to that future.

Let me conclude with a few takeaways. In short, Liberals have a big load to lift!

Capitalism and Freedom is an elegant and persuasive argument for Freedom as opposed to growing Government Control… but if we look around the world, LIBERALISM IS NOW LOSING

Whether we look at nominally democratic governments or those governments that are explicitly totalitarian, THE STATE IS WINNING

As empirical economists trained by Milton Friedman, we should be asking why are we losing?

My own conclusion, not necessarily documented by clever and much needed research, is that people seem to accept several major premises:

  1. The functions of Government have grown exponentially over time: Explicit control over individual behavior is vastly preferred to the imperceptible functioning of markets.
  2. Human behavior seems to be heavily influenced by Risk Aversion. People are more prone to the allure that Government can fix the lottery characteristics of human outcomes —in spite of the vast empirical evidence of Government failure to contrive Equality of outcome! Governments can help Equality of Opportunity — they may not be able to create Equality of Outcome.
  3. A survey of Friedman’s critiques of Government intervention leads to some severe disappointments: public housing, social security, professional licensure, minimum wages, the end of the corporate income tax and assignment of undistributed earnings to shareholders as taxable income, the end of the inheritance tax and establishment of a flat income tax, ending tariffs and quotas, farm subsidies, and clearly, monetary authority rules vs bureaucratic authority.
  4. LIBERALISM’s VICTORIES ARE FEW

a. volunteer army— not mentioned in CAPITALISM AND FREEDOM
b. some progress on Charter Schools with small progress on use of public resources for charter schools
c. the negative income tax

WE HAVE OUR WORK CUT OUT FOR US – LET’S GO TO WORK! WE NEED TO START WINNING AGAIN

Friedman, Milton. Capitalism and Freedom (p. ix). University of Chicago Press. Kindle Edition.

Link: http://clubdelalibertad.com/cycle-of-tributes-tribute-to-milton-friedman/

DISORGANIZED CRIMES goes international…

Accounting fraud at WIRECARD.

Every so often a seemingly deliberate accounting fraud deceives investors and accountants and winds up stimulating regulatory zeal.   The financials debacles of 2001-2 and 2008-9 led to Sarbanes-Oxley and Gramm-Dodd. We should expect that if the Corona-virus causes immense financial dislocations, we will see financial fraud and regulatory actions grow apace. Before the curtain on new episodes of Congressional Propriety goes up, we should begin to ask whether regulators have succeeded in the past and what costs are imposed? The recent disclosure of a large financial fraud in a large German public company (Wirecard) is a signal for the fraud parade is beginning. We don’t really have the essential facts to analyze this case but the similarity to our previous work elicits a few comments

1) Most accounting frauds of major public companies are detected by some market participants long before regulators are ever alerted.   Regulators don’t like short sellers so they are often late to the crime and by then the major damage to the “longs” has been done.  Next come the lawyers, but that is a story about insurance law and rewards to successful class action litigators.  There are several lessons here worth remembering. One might be if E&Y, Wirecard’s auditor noticed anything from Wirecard’s price volatility much earlier? If so, why didn’t they act much earlier. The usual answer is that they don’t wish to lose a client. More on this below

  1. such frauds usually begin with companies already on a losing path.  The resulting frauds are designed to conceal true operating losses.  Enron and WorldCom are class one exhibits

  2. frauds of this kind usually involve auditors who have long standing ties to the fraud company. (ah, yes… should we be asking for term limits for auditors once again?). We can count on the advocacy of those most affected (accounting firms) and political friends to be assured that meaningful term limits are not likely

  3. another question to ask is “Where were the Directors?” But even without the facts in this case, we know that Directors are more often there to bless and shield their managements. They are not likely to probe too deeply in searching potential corporate financial behavior for mismanagement or fraud cases. Company managements get very uncomfortable with a overly-zealous Director

2) Is regulation imperfect as an answer to deter financial fraud?  Again, case details are important, but generic punishments without individual liabilities for Directors, Auditors and Corporate General Counsels make ongoing investigation difficult and unrewarding to outside agencies tasked to protect investors.  Conclusion:  the corporate establishment that includes auditors, directors, general counsels, credit raters, underwriters, and even some bankers is all to willing to sacrifice by investing in more errors and omissions insurance and reliance on the long lag between crime and punishment in exchange for avoiding personal liability. (“You can’t blame me for dishonest clients!”)

It is another example of the famous line in the movie A Few Good Men, when Defense Counsel (Cruise) demands the truth, Colonel Jessup (Nicholson) answers, “YOU CAN’T HANDLE THE TRUTH.” We call this Jessup’s Law. It needs to be a part of every class in Corporate Governance!

In short, Frauds like Crime are inevitable because for some individuals, the probable rewards of fraud exceed the expected value of their personal losses.

Of course, we could do better, but the costs of fraud protection via regulations rise as well.   We could do better, perhaps, but we infer that Society believes the optimal quantity of financial fraud is not zero. The costs of prevention are not zero, while the praise for corporate honesty from Philosophers, Pastors and Op-ed Writers is insufficient to enforce a more rigorous anti-fraud environment.

Bloomberg’s report on Wirecard can be found at https://www.bloomberg.com/news/articles/2020-06-26/wirecard-auditors-say-elaborate-fraud-led-to-missing-billions

The Evil of Two Lessers

Many Americans today are doubly distressed. First, the obvious setback to a “normal” life in a free country are the Government lockdowns to defeat COVID-19. Second, the impending November election in a very badly divided country forcing a choice between the extremist views of the two leading candidates. Both candidates exhibit seemingly less in leadership qualities than what is truly needed.

We need not dwell extensively on the rank statements of the current President and his frequent feuds with the media nor on the rather strange remarks of the likely Democratic nominee. We merely observe that either candidate is likely to heighten the distress of Americans who believe in limited but cooperative government that is nonpartisan in the best sense of the term. It goes without saying that the politics of surviving the onset of COVID-19 in a meaningful way has been hardly nonpartisan. The “helicopter money” approach so far provided is an effort largely devoted to political optics not economics. To state the obvious in a country that needs to go back to work: does it make sense to pay an unemployed worker more to stay unemployed than to have that worker gainfully and permanently employed even at a lower wage? That is what both parties agreed to under the duress of the Virus War. It is not a tribute to rational government policy. It is a device used by both parties to appear to get something done when they fail to agree on an overriding strategy.

On the other side of the coin are the efforts of the Federal Reserve to operate a monetary regime that is as much fiscal as it is monetary policy. The Fed is “applauded” by both parties but the larger term components of massive Fed intervention in the debt markets are left relatively unexplored. The most recent is the Fed’s deployment of buying privately issued loans to unrated public and private companies.1 It is at best an experiment, but it takes our central bank far beyond anything ever contemplated or truly understood as central banking policy measures.

“Do Something Now” is the ruling guidelines of American politicians of all stripes. This is an optics game not a well-engineered policy strategy with appropriate cost-benefit qualifications. It also runs the risk of saddling the country with a monumental debt overhang without necessarily providing the economics of sustainable growth to liquidate that debt. World War II aviators often spoke of flying back from their missions holding their damaged planes together with “chewing gum and baling wire.” That was a necessity.

Flailing government policy to fight the Virus War is surely not optimal policy, but when the politicians have dramatically different purposes for Government, that is what you get. One can only hope that the State does not run out of gum!

“A republic if you can keep it,” as Benjamin Franklin once said, but can we keep it in a war where the politicians do not agree what kind of government we should have?2 One side clearly believes in throwing massive amounts of money out from a vast armada of currency-laden helicopters is a solution while the other side fears that the present economy cannot recover under the set of disincentives now or likely to be established.

Next comes the Presidential and Congressional Elections. What can we expect from such a contest in which each side has assembled a set of Generals to run the war with totally divergent strategies? One is reminded of Lincoln’s three-year struggle with inadequate military leaders until Grant proved willing and able to defeat the Confederacy? Then the country had a national purpose and a leader whose unifying principle was to save the Union. Can we expect the same in November? On the basis of the evidence so far, it seems highly unlikely. Both presumed candidates have waffled on a “needed national purpose.” Both are frightened by health and medical experts whose own models of the pandemic have given and still give conflicting predictions about the course of the Virus War.

Good strategy in war begins with a defined objective and a multiplicity of tactics evaluated with common tools. It is impossible to discern the strategy of each party or its presumed candidate at this point. One observes such a variety of changing tactics that hardly any military historian would infer a high likelihood of success. STUMBLECONOMICS might be a better description of either Party’s strategy?

Like Lincoln, we are still looking for our General.

  1. The Main Street New Loan Facility, authorized under Section 13(3) of the Federal Reserve Act, can purchase loans in a SPV made to all kinds of businesses including corporations, partnerships, LLC’s, trusts, associations, cooperatives, and joint ventures or tribal businesses, where the initial lender is a financial intermediary that will take a minority risk interest in the loan. []
  2. Quoted in Walter Isaacson, Benjamin Franklin: An American Life (New York: Simon & Schuster Paperbacks, 2003), 459. []

Impediments to Rational Policy Choice on Covid-19

Fauci has become an impediment to rational policy choice. He is talking his book and his book was and is wrong.

The data pretty clearly show that for those under 45 (the principal cadre of industrialized country work forces) the true mortality rate is not going up nor is it hugely high.  But expectations of testing and hospitalization have been pushed up way out of line with what the current state of treatment availability and success rates can do.

(I ignore developing countries with high density cities whose public resources are badly limited.  That is an issue more closely aligned with underdevelopment and resource limitations of the state, both financial and physical).

Distancing and working on hotspots are a legitimate strategy which should be promoted along with a careful statement by health care and political leaders that policy has to be one of triage — treating heavily those most likely to recover.  Lockdown is not a strategy that can promote recovery. Lockdown may work to save Grandma, but at whose expense? Re-opening is not heartless.  It is fighting back.  It is doing what we have to do to survive and prosper once again.  There will be casualties, and some will die.  That is what happens in war.

It is “Heartless” but not “Headless”. It is a health truth, but our Politicos lack the courage to tell the public what the current state of medical arts can do. We have a political aversion to truth that is totally bipartisan.   Churchill understood that in 1940 but we have no Churchill to lead the public.

We have dealt with and can deal with the physical capacity issues of medical treatment. NYC proved that.  But we are going to have death loss in the + 45 age group. Not high in % terms but a family that loses a parent or a grandparent will not be easily consoled.

Those are the facts.  Until we have a viable set of treatments (forget about a quick vaccine answer this year), our major focus is recovery for those most likely to recover.  In the meantime, we will have casualties and death loss.  That is what triage means in war and this is a war.

Political lying only encourages bad policy.

Now, the real risk is the economic recovery. And wringing tears from Fauci are an obstacle course. They can only promote bad policy as is evident in Democratic Helicopter Money proposals today.  The talking heads all criticize markets and public firms about being so short run focused on next quarter’s earnings.  From what I read public firms are adapting very quickly and considering how to operate with the virus going forward.

I don’t see that same degree of adaptability and innovation in the public sector — take the Tesla Tantrum as an example or closing the Fall semester at CSU! The right public strategy is to work out a plan that allows some reopening, and not stand on ceremony!  By the way non-elected permanent bureaucrats rule with as much foresight as George III once did!  They are not accountable!

And adaptability and innovation are the critical strategic aptitudes of winners in war and again this is a war!

Unfortunately Trump is not a believable leader so I am at a loss as to  how to get thoughtful strategy into the public arena over the crying towels of the public sobbing heads of the media or non-elected bureaucrats with fixed ideas and agenda.

The Troubling Return to Central Controls

No one ever claimed that the path to freedom was untroubled by rocks in the road, but the corona pandemic has put added potholes and big detours in freedom’s path. We need to be observant of the risks that have now been created by the massive “step-in” of Government. Perhaps, the most amazing aspect has been the willingness of so many Americans to give over their personal responsibilities and ambitions to the cabal of politicians who in recent years they had learned to distrust. This is a bi-partisan, if misguided, delusion–––by the voters. They had previously demonstrated extreme disgust with the antics in Washington (and in many State Capitols in 2016), but the virus has thrown an unexpected curve ball at that stance. Fear of the unknown is a great mobilizer for giving up one’s personal controls over the conditions of life. More problems than additional infections and deaths is the current willingness to surrender control over our lives, and this terror has not been confined to individuals. Many corporate leaders, not seeing an immediate way out of the morass that lockdowns have created, are now on a pleading platform hoping to save what is left of their companies and their own power.

Coronaviruses–––there have been more than a few–––have crippling effects precisely because developing proper pharmaceutical treatment, let alone efficacious vaccines, has been a monumental task for even the best of the “biopharmas.”1 Believers in the efficacy of Government over Markets can point to the Manhattan Project and the claims that DARPA created the Internet as evidence that a properly marshaled government can perform wonderful magic when pressed into service. But is that a question of organization or an unlimited budget, untroubled by the personal concerns of private business for an adequate return to investment capital? Surely, we should distinguish between a war mentality that pits our survival as a nation as justification for Government takeovers and what we truly face, ugly though it may be, with COVID-19? Our national survival is not at stake.

No one should ignore the deaths that the virus has caused or is likely to cause before this particularly ugly pandemic has receded. As we currently approach some 70,000 deaths in the US caused by COVID-19, we are unpleasantly reminded that an ounce of prevention is better than a pound of cure. That said, adequate preparation for rare events is not particularly a virtue that Government has demonstrated. On the contrary, Government has been caught out more frequently than not when confronted with a rapid change in geopolitics, pandemics, or rapid technological change. That is in the nature of a free state governed by modest checks and balances. There will always be new dangers and questionable responses. Freedom is not a free lunch. We pay for our freedom by allowing multiple sources of information…and the threat that is insidious is to suppress the vast amounts of information that markets provide merely by their operation. Government may be a poor example of a first responder.

There are always post event claims of the “gurudom,” voices unlistened to at an early time, but Government is always and anywhere a late starter and then an information suppressor. Risk management occurs in private business because of the necessity of a budget restraints and the claims of equity and debt holders on current earnings coupled to the limits of corporate saving. That is how it should be. Failure in corporate or personal business is a great, even if unplanned, source of innovation. Yet, innovation is the mechanism that produces a better life for our specie. We learn, often through tragic circumstances, where not to reside, which natural flora and fauna are dangerous to our health, and which devices are likely to help us when we are surrounded by dangers to our survival. We do it piecemeal, and the uphill road to knowledge and control is fraught with many setbacks. However, the human condition is built on learning and progressing diversified by our experience in many different environments. That cumulative learning curve is our human history..

In military affairs, the State is often the driver of technology change, but there too, the State stumbles and often goes down roads to dead ends. In the worst of cases, we see the State collapse when it cannot marshal sufficient technologies or manpower or bureaucratic organization to overcome its adversaries. That is an important historical marker that should caution us to rely solely on the State organization of science, technology, production, and distribution. There is simply no way centralized government planning can duplicate the massive information production and distribution that a myriad of private markets provides nor the ever-present incentives to innovate when sufficient information is available. State planning often relies on very imperfect information and then commits vast quantities of resources chasing down roads to nowhere.

While it is true that there some counterexamples to these State-generated failures, it is more often than that States bury false moves and strategies until the light of historical research finally highlights them…often generations later. Sometimes, we attribute these cover-ups as the result of poor leadership, but that is truly another kind of error. With the power to marshal State resources, most leaders that go down false paths do not willingly provide evidence of their errors and there is no market response that normally would be self-correcting when error produces loss. In the most violent examples, States that find individuals who disagree with policy or judgment calls on the direction of technology or strategy use State violence to suppress alternative interpretations of facts and policies. Stalin murdered Tukhachevsky—his erstwhile former leading general of WWI—-prior to the advent of WWII. While the US doesn’t murder dissident military leaders, it does punish those out of step leaders who want to pursue alternatives not endorsed by the current ruling military clique. Hello Billy Mitchell, and George Patton—-you have great company with Winston Churchill.

That is the nature of Government—-it severely punishes dissenters within. Furthermore, it is hard for Government to finance and nurture alternative paths under the duress of military survival—-precisely what markets do every day. Great discoveries come from mavericks who throw out conventional wisdom because their failures are personal, not societal. Government failure can be societal precisely because once we hand over markets to Government, there are few outside alternatives to the Government ”truth!”

That is where the real danger lies today. Ironically, in spite of manifold distortions of truth and information, even this much criticized Administration has created, albeit by default, some remedy to overall Government takeover. Our Federal system allows, in fact, commands, many sources of alternative information and activity. Those politicians who demand a National Policy for fighting the corona virus miss the virtue of multiple attempts by State and local leaders—-and that provides an unending stream of useful information over what works and what fails. This administration has stumbled into the virtues of multi-pronged efforts by State governments probably because of its own lack of risk management much earlier in the game. Unfortunately, the current wisdom was that Lockdown was the appropriate death-mitigation model. That may turn out to be a half-truth if we find that restarting the American economy becomes a painful experience.

In the long postmortem on failed Viet Nam strategies, many military historians concluded that the massive firepower of the Westmoreland approach was inappropriate and devastatingly counterproductive. Early attempts at small local groups invested in the local communities—-a strategy vigorously asserted by our then chief of the Marine Corp—was squelched by the Johnson administration in favor of massive aerial bombing and huge suppression of the Viet Cong by tanks and napalm.2 Protecting the people from the Viet Cong was abandoned by a fixation on body counts. That massive kill strategy ignored the politics of collateral damage.

The US has finally learned that massive power projections often have countervailing downsides. We now try with small groups of tactically distributed forces in Iraq, Afghanistan and Syria, with much better results and much lower collateral costs. We do learn—-but it is a painful learning experience for both for our military forces and for the residents of countries torn apart by conflict.

Somehow, whether because of crony capitalism or national leadership failure, it seems there are now prospects of utilizing markets to deal with the treatment and vaccine development to fight COVID-19. By default, we are unleashing many non-governmental firms to search out the myriad of possible pharmaceutical answers to this pandemic. It is highly probable that we will learn more quickly with less direct expense than by a massive single effort by our national government agencies. That is what markets are good at. They sort out multiple paths. They follow small bits of information that possibly can be profitable as well as efficacious.

Sadly, some of the current drift toward collectivization is suffused with claims that profits will interfere with efficacy—-nothing is further from the truth than this canard. Bureaucratic collectivization is the long trod path of singular direction. The next battle will be the socially powerful claim to controlling the profits of the pharmaceuticals taking the risks ancillary to developing treatment and vaccines. This is the old story of Government trying to control the distribution of outcomes (income and wealth) through mechanisms with massive dis-incentives. When it comes to profits, politicians invariably forget old lessons. Killing the goose doesn’t produce new eggs. If the Government wishes to subsidize the cost of treatment or vaccine, it must do it in a way that does not punish the creators of these silver bullets. We don’t need to provide more examples of the Bourbons “learning nothing and forgetting nothing.”

Sadly, the talk in Washington has a punitive theme: “don’t let the drug companies profit from our misery.” Will politicians ever learn how disastrous such a policy can be? Subsidies for use of a drug are one thing. Suppression of pharmaceutical pricing is quite another. This is not a panegyric for unlimited monopoly pricing power. We should expect that private pharma will have a number of remedies for treatment. We want many approaches. Hopefully each will be thoughtfully vetted by good statistical practices and early use limited to medical emergencies until suitable validation is obtained. We will make mistakes. Drugs with subtle contraindications will occur and we will never be perfect in eliminating hard to discover side effects. We can take reasonable precautions, but we should not promote the illusion that there are risk-free treatments or perfect vaccines. In medicine, it is also true that perfect is the enemy of good. To offer such false illusions—-even by well-meant Governmental health officials—-is another road to nowhere.

Ultimately, herd immunity must be the outcome or we will have to live with future episodes of corona virus emergence. What we should demand of Government is rapid response to local upsurges and a willingness to allow multiple paths in emergency situations. We will not be perfect. We never are. But we can do much better than we have done, as long as the learning path is not so obstructed by the “good intentions” of politicians who fail to make necessary cost-benefit calculations. Doing better is a worthwhile goal. Doing it perfectly is an errand for fools.

  1. Swine fever, another coronavirus, is decimating pigs around the world. Known since 1907 it still has no known vaccine or for that matter a successful treatment. []
  2. Victor Krulak []

Trump’s China Wrecking Ball Express

The recent arrest in Canada, under a request from the US, of the CFO of Huawei, the leading Chinese telecom equipment manufacturer, doesn’t seem to be an accident. In the context of the growing commercial dispute between China and the US, it will undoubtedly inflame the Chinese. In our view, it is a catastrophic strategic error. Was it merely an agency of the US government acting without Presidential instruction? Was this bad political governance or just an errant bureaucratic mistake? Either way, the consequences seem horrendous. Continue reading

The Credit Raters Oligopoly

Sometimes, the obvious solution to Agency Problems turns out to be impossible. Disorganized Crimes discussed to an obvious agency issue in the meltdown of the 2007-8 Credit Crisis. Who paid for credit ratings seemed to be an obvious conflict of interest problem for issuers of complex mortgage securities. Credit rating agencies competed for business of credit issuers, and the rating issuers didn’t want to lose issuer business by looking more deeply into the real credit quality of complex mortgage structures, and, more particularly, what could happen if the housing market went into sharp decline. Institutional buyers of mortgage securities needed particular ratings of these structured issues that would qualify them as consistent to their respective investment mandates. They were label and yield driven.
Everything was fine…until the wheels came off the mortgage bus!

Obviously, conflicts of interest made quality credit reporting highly suspect, deeply troubled by agency considerations. Solution: Have buyers pay for ratings!

Maybe? Maybe Not!

Along comes a new credit ratings agency with that kind of business model. The new Credit Rating agency business model seemed to be an obvious way to break up the credit ratings oligopoly? That’s what Jules Kroll thought, and his successful prior career in providing security to large firms seemed to make him a highly qualified entrant to the Credit Rating market.

Guess what? Credit portfolio managers like free lunches. Pay for ratings that known credit raters provide freely to the credit issuers? Didn’t happen! Kroll found it difficult to attract customers.

After struggling for a few years, poor market responses convinced him that to get customers he had to play on the traditional rating agency ball field. Let the issuers pay. Back to square one.
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What’s the real lesson from this market test? Markets don’t price extreme events very well! Credit crises don’t happen frequently and 2007-8 had some singular peculiarities. They are not an everyday event ,and in addition, there was a new regulatory regime in place after Dodd-Frank and the Fed got involved with financial intermediary balance sheets. Users of credit ratings didn’t place a high enough value on receiving credit ratings likely to be less influenced by the obvious Agency issue of having the issuer pay the Rater for its services. The obvious conflict of interest got very little attention, and few customers of credit ratings were willing to pay for them. Mr. Market spoke loudly!

A similar situation might be the relative lack of shareholder interest in comparative compensation data that Public Firms must now release when Executive Compensation plans are being established. That raises interesting issues on assessing the costs and benefits of regulations designed by regulators with the “public interest” in mind.
At the end of the day, the failure of a buyer-paid credit rating agency tells about how markets tend to diminish “highly less probable events.”

Sometimes the “obvious” isn’t really so obvious!

Why is Distrust of Politicians So High?

The Founders argued over successive terms for Congress and the Presidency but allowed life terms for Judges (subject to “good behavior”). Was this an accident or did they have a different notion of fidelity when it came to Judges as opposed to Legislators and Executives?



Was Montesquieu correct in asserting that Direct Democracy fell because of factions–majoritarian politics— and were the Federalists specious in their argument that the faction would have to win in each Sovereign State so that the argument made in Federalist 10 really does not hold up when one considers “vote trading” by representatives?



Cronyism is the market’s response to more rules and more distance from rule making

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The American and French Revolutions contained two embryonic themes brought down throughout history: overthrowing the power of absolute monarchy and to one degree or another, empowering the people’s representatives with the power to govern. A generic feature of the American Revolution and its enduing Constitutionalism was its evident fear of an unshackled executive authority as well as the fear that populism would lead to legislative majoritarianism. There was a corresponding faith that Liberty would create a multitude of economic opportunities that should remain largely unshackled. The dividing line within the Constitutional Convention was the need for a strong central government to defend the new Republic from external and internal enemies and the fear that too strong a central authority would usurp the power of the thirteen separate sovereignties that were giving up some of their authority to create centralized authority for the purposes of safety from abroad and domestic harmony within. The latter concern was often conjoined with a preference for transparency and a faith that local control — seen and disciplined by local voters — would limit the feared excesses of a State over its own inhabitants.

The rather sophisticated structure of “checks and balances” designed into the Constitution was always a compromised outcome that reflected the need to create Federal authority while preventing such authority from becoming a new absolute “monarch” all on its own.



The same thematic division still runs thru American politics: between political leaders who “know what is best for the people” (and who also dislike “market generated outcomes);” and politicians and political theorists who believe that creating opportunity is sufficient while favoring minimal interference with market determined outcomes.



At a philosophical level, “market types” believe political rights begin with paying strong attention to property rights and “control types,” who believe that the “people” have both a right and a duty to push outcomes in an egalitarian direction, because equal opportunity is not sufficient for justice.