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When the grim reaper’s hand is staid by the twin forces of mass delusion and public policy, the game of capitalism mutates. It can become rational to bet on the irrational if you believe your timing is good enough to leave the greater fool holding the bag. Crazy ideas that have a chance of working get lost in a flood of crazier ideas chasing rewards whether the ideas work or not.

Quick buck artists crowd out fundamentals players as slick positioning trumps due diligence. Early stage investors who cash out not by resolving risk, but by hiring fat-fee investment bankers to package and sell off their risk attract ever more capital when they trumpet their “returns.” Political entrepreneurs outnumber market entrepreneurs as landing government subsidies proves more lucrative than landing customers. With the exception of loathed shorts that are punished mercilessly if their timing is bad, and investigated by authorities if their timing is good, everyone is motivated to keep the delusion alive.

Sooner or later reality rears its ugly head and the grim reaper breaks loose. Except now he doesn’t come for just the foolish and imprudent. With pent up fury he spreads devastation far and wide, breathing down the necks of even the cautious crowd as they flee for safety. Thanks to the unlimited powers of a democracy stripped of constitutional limits run by populist princes on the payroll of this perverted version of capitalism, the hapless taxpayer is usually called on to clean up the mess.

Under normal circumstances, giving a $700,000 no-money down mortgage to a $14,000 a year strawberry picker is crazy enough to attract the grim reaper in a matter of months. It takes congressionally backed Government Sponsored Entities (GSEs) pursuing “enlightened” public policies, aided and abetted by Wall Street sharpies and their short-term bonused minions, to scale such an absurdity into a global colossus of crazy.

Run and hide, the grim reaper is among us and we don’t know who’s next!

As our elected officials reach into our pockets to bail out those favored few grown too big to fail, cultural and political forces are lining up to sew the seeds of our next bubble. The tales they are spinning may sound sensible today, just as “increasing homeownership” had few detractors yesterday. But next time we are forced to run and hide we will surely be asking, “What were we thinking?”

You can color the next bubble green

A Nobel Prize winning PowerPoint presenter wants to end our reliance on fossil fuels in ten years. More power to him if he chooses to bet his own money to make it happen – may he become the wealthiest man on earth if his crazy ideas prove right. But are we really going to gamble 20% of the GDP of the entire human race?

Great banks came tumbling down because they believed computer models could predict housing prices five years out. Are we really going to bet our collective industrial infrastructure on computer models that predict the weather fifty years from now?

A car company that has proven it can only make a profit selling pickup trucks to Joe Six-pack is going to get a public rescue. Do we really think they can be made successful by forcing them to switch over to making compact cars for a handful of affluent environmental zealots with short commutes?

Oil is good if it comes out of the ground over here but is wicked if it comes out of the ground over there. Yet we have to refine it over there because we can’t build new refineries over here. Is it really worth impoverishing ourselves in search of “Energy Independence”?

Windmills may be the wave of the future. So how come we’re not allowed to build them when those waves lap the shoreline of a powerful Senator who supports environmentalism only if it’s in someone else’s back yard? Why does deciding whether generating energy from a particular biomass is good or bad depend on whether that mass votes in a quadrennial political media event in some flyover state?

We didn’t have enough fun constructing a pyramid scheme of complex derivatives based on making houses. Now we are going to spin up an even bigger shell game based on credits earned for not making an invisible gas?

Experienced real estate appraisers proved incapable of honestly assessing the value of a house. But an army of green jobs is going to be created for freshly minted specialists to estimate carbon footprints?

Trillions are going to be spent on bridges and highways by the same people who are browbeating us to drive less?

The world’s most powerful energy source generates no greenhouse gasses. Yet it can’t get a foot in the door because it’s held shut by gale force winds emanating from an army of bloviating lawyers?

As a bipartisan consensus emerges to promulgate a centralized Industrial and Economic Policy on a scale this country has never seen, be afraid as realty takes a holiday and we throw in with hope and change. When today’s grim reaper finishes his grisly task cleaning up the real estate market, he will unceremoniously be stuffed back into the cellar and the door will be weighted shut with a mountain of fiat currency whose ink has yet to dry. We can then celebrate a return to normalcy as Keynesian pundits claim, "see it worked!"

But the grim reaper will bide his time. After all the freshly printed money has been frittered away on well-intentioned clean energy projects that happen to have negative financial returns, the reaper will be back with a vengeance, just about the time we baby boomers are ready to crack open the empty Social Security lock box. In comparison, the popping of this real estate bubble will feel like a gentle breeze.

"The Bush administration backed off proposed crackdowns on no-money-down, interest-only mortgages years before the economy collapsed, buckling to pressure from some of the same banks that have now failed," the report asserts.

The report goes on to catalog what it says are Bush's crimes. Namely, that his administration bowed to "aggressive lobbying" by banks and delayed doing anything for a year. This, says the AP, is "emblematic of a philosophy that trusted market forces and discounted the need for government intervention in the economy."

All utterly wrong.

Here at IBD, we've done more than a dozen pieces — most recently, in yesterday's paper — detailing how rewrites of the Community Reinvestment Act in 1995 under President Clinton, along with major regulatory changes pushed by the White House in the late 1990s, created the boom in subprime lending, the surge in exotic and highly risky mortgage-backed securities, and the housing boom whose government-fed excesses led to inevitable collapse.

Despite this clear record, we're now besieged by enterprising journalists blaming Republican "deregulation" or the president's failure to recognize the seriousness of the problem or act. But these claims fall apart, as a partial history of the last decade shows.

Bush's first budget, written in 2001 — seven years ago — called runaway subprime lending by the government-sponsored enterprises Fannie Mae and Freddie Mac "a potential problem" and warned of "strong repercussions in financial markets."

In 2003, Bush's Treasury secretary, John Snow, proposed what the New York Times called "the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago." Did Democrats in Congress welcome it? Hardly.

"I do not think we are facing any kind of a crisis," declared Rep. Barney Frank, D-Mass., in a response typical of those who viewed Fannie and Freddie as a party patronage machine that the GOP was trying to dismantle. "If it ain't broke, don't fix it," added Sen. Thomas Carper, D-Del.

Unfortunately, it was broke.

In November 2003, just two months after Frank's remarks, Bush's top economist, Gregory Mankiw, warned: "The enormous size of the mortgage-backed securities market means that any problems at the GSEs matter for the financial system as a whole." He too proposed reforms, and they too went nowhere.

In the next two years, a parade of White House officials traipsed to Capitol Hill, calling repeatedly for GSE reform. They were ignored. Even after several multibillion-dollar accounting errors by Fannie and Freddie, Congress put off reforms.

In 2005, Fed chief Alan Greenspan sounded the most serious warning of all: "We are placing the total financial system of the future at a substantial risk" by doing nothing, he said. When a bill later that year emerged from the Senate Banking Committee, it looked like something might finally be done.

Unfortunately, as economist Kevin Hassett of the American Enterprise Institute has noted, "the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter."

Had they done so, it's likely the mortgage meltdown wouldn't have occurred, or would have been of far less intensity. President Bush and the Republican Congress might be blamed for many things, but this isn't one of them. It was a Democratic debacle, from start to finish.

The notion that consumption is the economy’s driver is not new. We’re regularly told that consumption constitutes 70% of our economy; a notion that couldn’t be more mistaken. Indeed, how is that people consume without producing first? Don’t the two balance? By definition they have to.

Despite this basic truth, conventional wisdom suggests that we must spend in order to stimulate. Back in 2001, in the aftermath of 9/11, New York City Mayor Rudy Giuliani exhorted New Yorkers to get into shops and restaurants, open wallets in hand.

It would be hard to contemplate more impoverishing thinking than the above, and it speaks to the problem of macroeconomics. With the latter only concerned with broad numbers covering aggregate activity within country borders, consumption is falsely seen as a necessary input to our economic health.

At first glance this thinking makes sense; that is, until we take a micro view. Looked at from the perspective of an individual, we see that excess consumption can only impoverish. Indeed, imagine the health of the United States’ economy if every individual spent every dollar made?

So assuming Americans are prudent, and choose to not to consume, does the economy suffer? Hardly. This is true because a failure to consume in no way detracts from demand.

All we have to do in order to understand this is to once again consider economics from an individual’s perspective. If said individual has $1,000 to spend but chooses to put that money in the bank, the economy doesn’t suffer. It doesn’t because rather than sit on deposited money, banks lend it out.

Often times banks lend the money to individuals with immediate consumption needs. If so, consumption is merely shifted, while the initial depositor can claim a bank balance $1,000 greater than before.

Even better, banks often make loans to businesses. Sometimes they have immediate consumption needs for office space and the like, or sometimes they use the extra capital to hire workers with consumptive needs.

More positively, some businesses buy equipment or make investments that increase their productivity. This of course speaks to the wonders of saving in that if capital enables businesses to act more productively, they’ll likely be the recipients of even more capital; the latter enabling even more job-creating expansion.

Existing businesses could of course stimulate consumption through excess profit-sharing with employees, but this too would lead to a dead economic end. If Google, GE and Microsoft were all to pass profits onto acquisitive employees, they would then lack the money necessary to invest in future growth.

That’s why savers, be they companies or individuals, are society’s ultimate benefactors. If all we did was consume, there would be little capital to fund growth and new ideas.

Beyond consumption, we have to ask what individuals can do to help the economy the most. Excessive spending is clearly not the answer, particularly if today’s spenders are tomorrow’s applicants for unemployment benefits and other forms of aid due to a flagging economy.

The better answer is for individuals to act in their economic self-interest. In saving for a rainy day or even for a distant retirement, savers can help themselves all the while knowing that their savings will either support the consumption of others, or in many instances serve as seed capital for tomorrow’s entrepreneurial ventures.

After saving, and with an uncertain job market in mind, individuals can do best for the broader economy simply by working harder. Economies grow when individuals are productively working, and one positive of economic uncertainty is that it drives us to work more in order to produce more. This is true economic stimulation.

Looking ahead, with the economy somewhat weak, readers can count on all sorts of commentary lamenting the death of the consumer, and with the latter, the death of the economy. Nothing could be further from the truth. If we’re productive as workers, consumption will take care of itself.

So with Christmas and the economy in mind, individuals should do that which enhances their own economic outlook the most. If that means lots of work and lots of saving, those who do both should go forth with certain knowledge that they’re bringing the economy the greatest stimulus of all.

The goal of Bretton Woods II should have been to repeat the result achieved during the 1944 confab, which was to link the value of the U.S. dollar to gold. If this should somehow happen going forward, the dollar would take on magnetic qualities for its ability to attract capital from around the world. Of perhaps greater importance, in one year’s time most of the world’s currencies would be linked to the U.S dollar at different ratios. As a result, currencies the world over would have a stable gold definition.

But didn’t the first Bretton Woods fail? And if we re-linked the dollar to gold, wouldn’t we be setting ourselves up for failure again? The great thing about history is that it can be studied to understand why we achieved a result that we did not expect. It has been known for quite some time why the original Bretton Woods system failed; therefore, we can create a new system that fixes those flaws.

The first mistake made under the old system had to do with the U.S. government being given full power to maintain the dollar link at 1/35th of an ounce of gold. This was not considered a flaw in 1944 because at the time, it was seemingly inconceivable that the U.S would decide to break the gold link by inflating in the way it did.

Nevertheless, this is exactly what happened in the mid to late 1960’s. At the core of the original 1944 world dollar standard was a convertibility feature that allowed foreign banks to exchange dollars for physical gold if the U.S started to inflate.

This basic form of convertibility served as an essential signal for U.S. monetary authorities when it came to knowing whether too many or too few dollars were being created. The system worked well for three decades due to the fact that the U.S kept its promise when it came to maintaining the integrity of the dollar-gold link.

With the dollar defined in terms of an historically stable commodity, the United States economy and economies around the world prospered tremendously in the 1950s and ‘60s. However, by the mid ‘60s, monetary authorities stateside began to break their promises with regard to the dollar, which set off a chain reaction throughout the dollar-linked world.

Simply put, the U.S turned on the dollar printing presses and refused to turn them off. And with the world awash in greenbacks, the aforementioned convertibility feature served its market purpose in revealing U.S. monetary error.

In short, by the late ‘60s and early ‘70s there was a marked increase when it came to foreign central bank redemptions of cash for physical gold. The signal to President Richard Nixon’s monetary authorities was that they had over-issued the dollar.

But rather than reduce dollar liquidity, or, restate the U.S.’s commitment to the gold/dollar standard, Nixon advised Fed Chairman Arthur Burns to continue printing money owing to the mistaken belief that money creation itself fostered economic growth. With an election looming, Nixon chose to sever the dollar’s link to gold on August 15, 1971. Nixon’s action devalued the U.S dollar and the inflation of the 1970’s began.

Fast forward to today, two issues need to be dealt with if the U.S wants to return to a commodity standard whereby the dollar is linked to gold. The first has to do with what is the appropriate gold-price target. Given the certain deflation that would result from a $35 gold fix, returning to the exact Bretton Woods standard would be highly inappropriate.

The second issue concerns how a new Bretton Woods-style monetary fix could avoid the mistakes of the late ‘60s and ‘70s where the lead country (the U.S.) over-issues the standard currency. Absent a credible commitment to maintaining a sound currency, any new system would quickly come undone.

What is the appropriate gold target price?

Long-term gold-price averages were calculated over different lengths of time below. The averages are the monthly mean price of gold using the London PM fix. The idea here is to let this market data tell us what the optimal gold price should be.

The first thing that becomes apparent when looking at these long-term averages is that the recent average prices are very high compared to the longer-dated ones. The second notable feature is the cluster of longer-term averages that includes the 15-year through 30-year averages, which all are in the $400/oz range. The third aspect is that the further we go out in time, the lower the mean price of gold.

Due to the volatility of floating exchange rates, returning to a specific optimum gold target will need to be a process, as opposed to the Treasury or Fed simply picking a gold price. The process will involve the utilization of longer-term averages to set up various stabilization zones. The zones will allow the price of gold to drift down and therefore allow the value of the dollar to increase. You can create a downward staircase approach in setting up the stabilization zones because of the sequential drop in the mean prices of gold.

As the above chart shows, each zone consists of the long-term averages. The high price for each zone is the shortest average in terms of time. The low price of each zone is a longer-term average, and therefore lower in price. To create symmetry a middle-price target is created. When two averages are very similar (8-year and 9-year) the longer dated average is used.

The Fed would target the middle price of each zone via open market operations. The price would float between the high and low end of each zone. If the gold price hits the high or low end of the band, then the Fed would act by driving the price back to the middle target price. Each stabilization zone would last one month.

To start this process, the Fed would state its intention of driving the gold price down to $635. This is exactly where the price will open because no one would be stupid enough to fight the Fed.

The process of setting the first trade as the middle price of each zone and letting the price float after will continue until the fifth zone is reached. If you start with the first trade in December, by April of 2009 the U.S would have optimum monetary policy for the first time in 37 years.

The great thing about the long-term mean prices is that they point us in the direction of picking the correct optimum target price. By setting the low end of the fifth zone as the 15-year average, we are also bringing in all the contracts created (and still in existence) over the last 30-years, because all mean prices between 15 and 30 years are $400 oz. This process would respect all the contracts set in dollars over the past 30 years.

Eventually the fifth zone would become permanent future monetary policy and gold prices would fluctuate between $420 and $400, with a middle target of $410. As you move from the first zone to the fifth zone, the volatility also sequentially falls. This means future gold volatility would range between 0% and 2.5%.

The result of eliminating monetary errors is that the wages that lag inflation would catch up to the ever-increasing prices that factor into daily living. Once this benefit is realized, the American people would act as a check on any FOMC seeking to impose monetary errors of inflation and deflation on the public’s wages and business contracts.

Stable monetary policy would also increase the forecasting ability of businesses. Prices often change due to monetary error, and when they do, false signals are sent to the marketplace, which exacerbates the business cycle. As time goes on, forecasting models will increase in accuracy: therefore, the business community will also act as a check on Fed activity when it comes to the dollar.

The Fed would become fully transparent by posting its daily open market operations on its website. Ultimately, these checks and balances on the Fed would get stronger as time goes on, thus making monetary errors a thing of the past.

For decades after it gained its independence in 1947, India remained an economically stagnant country whose leaders tried to manage its economy with a combination of European socialism learned from the British and Soviet-style central planning. Nehru, the country’s first prime minister and patriarch of a family that ruled India off-and-on for some 40 years, nationalized key industries and put them in control of a few families who had vigorously supported the Indian independence movement. He also set up the notoriously bureaucratic and eventually corrupt License Raj, a regime built around a series of regulations and permits that made it difficult to open a new business in the country without first gaining the permission of a central planning commission.

The results were predictable. Incomes stagnated and the economy barely grew. Hundreds of millions of people were stuck in poverty and the graduates of India’s elite technical schools, the pride of the country, went elsewhere to pursue their dreams, especially to the United States, Canada and Great Britain.

That all began to change in the late 1980s, ironically under Nehru’s grandson, Rajiv Gandhi, who succeeded his mother, Indira, as prime minister after she was assassinated. Unlike his mother, who had continued her father’s heavily centralized control over the economy, Rajiv opted for liberalization. Looking out over the rapid economic gains of countries like China and South Korea, and frustrated because little in Indian society worked as well as it did in the West where he was schooled, Rajiv and his successors began dismantling the License Raj, making it easier to start a business in India. That not only brought home some expatriates, it attracted foreign direct investment into the country. The country also liberalized industry, inviting private carriers to compete with the monopoly power of Indian Airlines, for instance. And India reduced tariffs that had isolated the country economically. The collapse of the Soviet Union made it easier for India to accept these changes because it neutralized critics of free markets within the country, and prompted India's leaders to improve ties with the United States.

Indian economic growth has been impressive since then, averaging annual gains in the double digits for much of the 1990s, making it the fastest growing developing economy next to China’s. Although about a quarter of the country’s population lives in poverty, according to the World Bank, that’s down from 60 percent in the early 1980s. India now has its own thriving information technology sectors in places like Mumbai and Bangalore, and its agricultural sector, bolstered by the use of genetically modified seeds, has turned the country into a net exporter of foods. Bollywood, based in Mumbai, is one of the world’s largest entertainment producers. Its films earn on the order of $100 million in the United States alone.

But India’s economic growth hasn’t attracted the attention of China’s, in part because China’s leadership has created a few economic enclaves where they have channeled much new investment to showcase their gains, including diverting resources to attention-grabbing attractions like the Summer Olympics. In democratic India, by contrast, capitalism has been messier. New building programs, like giant infrastructure initiatives, have to pass environmental review and are influenced by public sentiment, which can derail projects in a way that they can’t in China. It would be virtually impossible in India to reroute massive resources toward something like the Olympics, when so much else needs to be done there.

The attacks on Mumbai temporarily derailed the Indian economy. Its stock market closed , just as New York’s did in the wake of 9-11. Airlines have cancelled flights, and the city’s main business district has seemed like a ghost town. The most pessimistic of Indian observers are predicting that the attacks will reverberate for the next year on India’s economy, especially in Mumbai.

On the other hand, if you had stood looking over New York’s giant hole in the ground shortly after 9-11 and witnessed the mess that was Lower Manhattan, you might have imagined, as some did, that the city’s future as America’s financial capital had been severely compromised. But New York turned out to be amazingly resilient. Now it’s Mumbai’s turn. Its stock market opened on Friday after being closed only a day. We may discover that the embrace of free markets that’s been going on there will serve the city well in the wake of these attacks.

GM’s business plan would be lucky to earn a C at a respectable business college. That might be better than sending your CEO to Washington on the corporate jet and having him explain that you just really, really need the money, but it’s still not good.

What’s more, what little substance the plan contains, GM is in no position to deliver.

First, why is GM asking for $18 billion now, when it was only asking for $12 billion in November? You have to remember, this is a company that went from reporting a $1 billion-a-month cash burn to reporting a $5 billion-a-month cash burn in a matter of weeks, so this sort of thing is hardly unprecedented. GM says it needs to borrow the original $12 billion by March, just to continue operating, but wants access to an additional $6 billion line of credit, just in case the economy is bad.

Gee. You don’t think there’s a chance the economy will be bad, do you? This is what happens when someone makes you go back, sit down, run the numbers and come back with something resembling reality.

But even within GM’s attempt to grasp reality, we find significant indulgence of typical auto-industry fantasy.

First, GM presumes that the auto industry, which is expected to see sales fall to 12 million units in 2009, will bounce back to sell 15 million units by 2012. And what is the basis for this expectation? Who knows?

Second, GM insists that it will have its labor costs “competitive” with those of transplants like Toyota and Honda by 2012. Really. Aside from belaboring the definition of “competitive” (equal to? no longer 200 percent of?), there is the sticky little fact that the United Auto Workers has agreed to no such thing. Indeed, even as GM was submitting its plan, UAW officials were hurriedly huddling in Detroit to consider whether they would be willing to make further concessions (or “givebacks” in Detroit labor movement parlance) to give GM a ghost of a chance of keeping this pledge. The UAW agreed to delay, but not forgo, the gigantic payment upcoming from GM to the newly formed Voluntary Employee Benefits Association. Other concessions? They’ll think about it.

UAW President Ron Gettelfinger said in November that the UAW has given enough, which is perhaps why GM’s request from the taxpayers has risen 50 percent. Will the union reverse course? And if it does, what does that do to the larger American labor movement, which would be essentially admitting that it had demanded too much from the employers it always portrayed rhetorically as greedy fat cats hording unlimited reserves of cash?

Within the document, GM admits something onerous – something that should raise a huge red flag for any thinking member of Congress. Up until recently, GM had financed more than half its customers’ purchases through its GMAC financing arm, and the vast majority of the customers it financed had credit scores under 700. Now that the credit markets have become stingy, GMAC can no longer finance those customers, and that means it can now self-finance only 6 percent of all its sales.

This is crucial. GM reports its market share at 22 percent (oddly up from 20.5 percent just weeks earlier), but it appears that some 44 percent of its sales were self-financed deals with customers who pose at least some risk of default. Now that the credit markets are no longer willing to take the risk of underwriting such madness, GM asks the taxpayers to do so.

The rest of the document is typical political pandering and emotional appeals about GM’s past, none of which make a bailout of the company from this point forward a smart business move.

One thing the plan is missing is any actual profit projections, which is perhaps the plan’s one bow to reality. But hey, they might as well have pulled some fat profit numbers out of thin air and thrown them in there. It would have been as feasible as anything else in the plan.

Is Congress really dense enough to use taxpayer money to prop up this fiasco? GM claims it needs the first $4 billion by the end of this month or it will collapse, so we will presumably find out very soon.

We only just started. I can't see bottoming out until sometime in 2010," said one economist. "The fundamentals of the economy still look like things are going to weaken still further," said another. "This one," added a third, "has the potential to be longer and deeper than other postwar recessions."

All this in the first few paragraphs of a single newspaper story headlined: "Recession Could Last Into 2010."

Then Treasury Secretary Hank Paulson, architect of the government's financial rescue plan, had to chime in. "The journey ahead," he said, "will continue to be a difficult one" — a remark co-architect Ben Bernanke, chairman of the Federal Reserve, reworded thus: "I am not suggesting the way forward will be easy."

Even President Bush got into the act during an interview with ABC anchor Charlie Gibson: "When you have the secretary of the Treasury and the chairman of the Fed say, if we don't act boldly, we could be in a depression greater than the Great Depression, that's an 'uh-oh' moment."

No wonder the market plunged 9% on Monday.

It's worth noting, however, that two-thirds of that has since been recouped, and that before the big sell-off, stocks turned in their best one-week performance in 34 years.

This is not to say the bounce of the last two days isn't of the dead-cat variety, or that we think the market has bottomed or the recession ended. (Tuesday's follow-through, however, was the kind of action that really grabs our attention.)

Still, the deafening silence that has greeted the Dow's 1,142-point rally off its Nov. 21 low is testament to how far we've fallen, and how depressed we've become.

Savvy investors, however, try not to avert their eyes even when things get really ugly. They know how dark it can be before proverbial dawn — like at the market lows that coincided with the ends of nine of the last 10 recessions.

To repeat, we have no idea when this recession (if it has continued uninterrupted since last December) will end. All we know is that when it does, the NBER won't be there ringing a bell. That job usually devolves on the best indicator of all — the stock market.

Why are VCRs cheap? Not because there are too many of them; instead they go for near nothing due to the fact that they’re no longer useful. DVD technology is faster and easier, so nowadays it’s the rare person looking to buy an appliance whose utility was last relevant in the early part of this decade.

But when we consider the value of money much of the commentary today boils down to supply. At times of currency weakness, the conventional wisdom usually blames some monetary authority for creating too much money. Conversely, when a currency is strong, it is often said that money creation is not enough.

At first glance all the above makes a lot of sense. The supply/demand balance is a certain factor in the pricing of goods and services, and seemingly it should apply to currencies.

But with currencies, history tells us that supply is overrated as a cause of strength or weakness. It would be hard to create too much of a useful currency, and it would be hard to create too little of a currency no-one wants.

Monetarism. Ronald Reagan was elected in 1980 on a platform of tax cuts, deregulation and a return to stable money. Though he never achieved his goal of a dollar redefined in terms of gold, Reagan’s stated policy of stable, non-inflationary money led to a collapse in the price of gold before and after his election. Then followed a turnaround from accelerating to decelerating inflation.

This is notable considering commentary from the late Milton Friedman, the father of modern monetarism, in 1983 and 1984. A believer that M1 (currency in circulation and money in checking accounts) told the tale of inflation and economic growth, Friedman pointed to 27 percent annual M1 growth in 1983, and predicted an inflationary outbreak. And then, analyzing a slowdown in M1 growth later in the year, he predicted that a recession would reveal itself around the 1984 presidential elections.

Even though the U.S. economy had begun a bull run in late 1982 that coincided with increasing dollar strength, Friedman’s adherence to measures of supply had led him to make two predictions that proved incorrect. He later admitted, “I was wrong, absolutely wrong” and “I have no good explanation as to why I was wrong.”

The explanation for Friedman’s mistaken predictions was, with hindsight, that monetary aggregates, or the Ms, can be very misleading. In times of inflation, consumers and businesses would be less willing to hold onto money that is quickly losing value. Instead, they would seek to protect their capital in high-interest deposit accounts, or they would invest it in hard assets such as gold. So the monetary aggregates might show a decline in money growth. While that would alarm monetarists as a signal of “tight money,” the reality would be quite different.

Conversely, a strong dollar policy would likely push up monetary aggregates as consumers and businesses would feel more comfortable holding onto money balances secured by a credible unit of account. The aggregates might logically rise in this scenario, and for those wedded to the monetarist doctrine, this would be a signal of inflationary pressures. This signal would be false.

Empirically, the various money aggregates are not accurate as inflation signals. Even if they were, a basic question remains. Most who profess a belief in monetarism decry the fatal conceit of governments when it comes to knowing how to manage the economy. How, then, in an economy comprising infinite numbers of decisions, could they confidently know how many or how few dollars the Fed should create?

Furthermore, 2/3rds of all dollar money balances are held overseas. This means that if the Federal Reserve were to try and curb the amount of dollars in the fifty states, its efforts wouldn’t amount to much. Think of it this way: if the Fed drains one pool of dollars, pools around the world will overflow into the pool just drained.

Interest-rate targeting. Interest-rate targeting by central banks has traditionally been a Keynesian rather than a monetarist prescription. The monetary authority seeks to boost or contract the economy with rate machinations, and many who profess a belief in a strong dollar argue that rate targeting can be used to manage and stabilize the value of the currency. Put simply, to weaken a currency is supposedly to lower the target rate, and to strengthen it is to increase the rate.

It is implicit in the above reasoning that rate targeting is a currency-supply mechanism. This thinking could also be seen as a variant of monetarism.

It all sounds appealing, but then how would rate-targeting advocates explain the fact that the Fed’s monetary base grew just as much in percentage terms in the ’70s as it did in the ’80s? This occurred despite the fact that rates were rising in the ’70s while falling in the ’80s. They also argue that high rates are synonymous with “tight” money. But what would then explain the weak dollar amid high rates in the ’70s, or the fact that the dollar fell more versus gold in percentage terms this decade when the Fed was raising, not cutting rates?

The Bank of Japan has targeted a low bank rate for the last twenty years, and Japanese rates across the yield curve have since the ’70s been much lower than rates stateside. But far from fostering a currency that is cheap relative to the dollar, the yen has risen over 130 percent versus the greenback over the time in question. If high rates signify monetary tightness, or currency strength, then why is it that weak currencies are traditionally lent out at high rates of interest while strong currencies are normally lent out more cheaply?

It’s demand rather than supply that drives the quantity of money. Treasury Secretary Henry Paulson has said that currency values merely reflect the economic outlook of the country issuing them. But how then would we explain the yen’s strength since the ’80s amid a seemingly never-ending recession? Germany has long been said to be the “sick man of Europe” with high rates of unemployment, but the Deutschemark prior to the issuance of the euro was the very picture of strength and stability.

What this tells us is that neither “supply,” nor the health of the economy, nor the level of rates matters much when it comes to the value of money. Whether the Bank of Japan issues a lot of yen or very few, at high rates of interest or low, the Japanese currency will remain relatively strong versus the dollar as long as markets see this scenario as preferable to American protectionism.

Conversely, a country like Argentina might issue very little in the way of Argentine pesos, but given the country’s historical ineptitude when it comes to currency management, the peso would remain cheap and unused owing to its bad reputation as a store of value. To focus on the supply of pesos is to miss the point altogether.

Looked at from the U.S. perspective, the Fed’s balance sheet has expanded by hundreds of billions since the spring, and although the world is allegedly awash in dollars, the greenback’s value has actually risen in terms of most foreign currencies, as well as gold and other commodities. Once again, money supply doctrine has proved wanting when it comes to explaining the value of the dollar.

Even the one traditionally monetarist agency of the U.S. government, the St. Louis Federal Reserve Bank, has shifted from its historically exclusive focus on the money aggregates: “Our models and our discussion focus not on the quantity of money but on the purchasing power of the dollar … We do not have to pay attention to the quanitity of money today because policymakers are paying attention to its price, by focusing on inflation and inflation expectations.”

So what makes money useful? And why do certain currencies hold their value relative to others, compared to others that become cheap?

Consider two scenarios involving the definition of the dollar. In the first scenario, the dollar issued by the Federal Reserve possesses a “hard” definition communicated by the U.S. Treasury department. For simplicity, suppose that U.S. dollars were defined as 1/500th of an ounce of gold and that the Treasury would redeem them for gold at that price. In that scenario, it’s a good bet that the various monetary aggregates would skyrocket.

In the end money is significant only as a measuring rod enabling the trade of real items. So if the dollar had a stable value, it’s safe to say that many around the world would be eager to hold, and transact in, dollars. And for those presently holding gold, there would be a big rush out of the yellow metal in favor of a currency defined in terms of the metal.

Not only would M1 go through the roof, which would scare those in thrall to monetarism, but rates across the yield curve would likely fall given the dollar’s newfound reliability as a store of value. Rate-target advocates would see low rates as a signal of “cheap” money, but with the dollar possessing a gold definition, that wouldn’t be the case at all.

In short, the world would be awash in dollars, awash precisely because the greenback would attain its greatest use as a stable “ruler” of sorts fostering all sorts of dealmaking and trade. The supply of dollars would be irrelevant so long as Treasury backed its definition.

Conversely, consider a dollar lacking such a definition. Imagine a Treasury that has no opinion when it came to the dollar’s value, that it should be free to float to various price points free of intervention, verbal or otherwise. And imagine that over a 7-year period the dollar’s value bounced from 1/253rd of an ounce of gold, to 1/480th oz. in October of 2005, to 1/1000th oz. last July, to 1/780th of an ounce as of this writing. The policy just described is ours today.

It’s fair to say that such a currency lacking any kind of definition or monetary authority support would quickly lose utility. Remember, money is a measuring stick. When its measure is variable and directionless, it would be understandable that irrespective of supply, it would have diminishing use in a world economy that values certainty.

The consensus of many in the hard-money world has been that there have been too many dollars issued by the Fed, that we’ve had a situation of “too much money chasing too few goods.”

Far from it. Rather than too much money in our economy, we’ve had a currency that lacks definition. Not excessive quantity, but insufficient quality. That is why, seeking to protect their wealth in a floating environment such as ours, investors naturally move to the sanctuary of hard assets, including gold, art and property.

Policy implications. Returning to VCRs, they aren’t cheap due to oversupply, but because they’re no longer useful. In much the same way, today’s U.S. dollar isn’t cheap thanks to the supply of too much money. Instead, the dollar is cheap owing to a lack of definition, or the absence of an official policy which makes it dependable as a medium of trade.

In short, any policy meant to reduce the supply of money in order to boost the dollar will fail if not met with a specific Treasury commitment to preserve a strong and stable unit of account. If we make the dollar useful, its value will stabilize.

As a consequence, in choosing which narrative to believe with regard to the origins of this crisis, you and I are in many respects choosing the shape of our future. Make no mistake, the dominant narrative that comes out of this financial crisis will have a direct impact on our liberty, our prosperity, and the kind of society we become.

During the presidential campaign, you probably heard John McCain blame the crisis on “greed and corruption on Wall Street.”

Barack Obama went even further, saying that the crisis shows that the philosophy of free markets and lax regulations is fundamentally flawed.

Or as liberal columnist Thomas Frank asked, “Why did government stand back and permit all the misconduct that generated all this bad debt? What particular ideas led us to believe that our government should just keep its hands off and let markets run their course?”

There is plenty of blame to go around – from Wall Street to Main Street. And, Congressional hearings will assure that we all learn about the errors and poor judgments on Wall Street and to a lesser extent, about the poor decisions made by many who took out loans that they had little chance of repaying.

But, what those hearings are unlikely to explore is the fundamental role played by the federal government itself in creating the financial crisis that is impacting all of our lives.

And yet, failing to take fully into account government’s role constitutes a clear and present danger to our future.

I use the word “danger” because the interpretation of these seismic events will influence the electorate and policymakers for years to come. If we ignore the central role of government in creating this crisis, and place blame solely on private markets and free people, then we are likely to end up with a more intrusive government, less freedom, a lot less prosperity, and future crises caused by government that will be blamed on the private sector.

On the other hand, if we acknowledge the contribution that well-intentioned, but unsound policies had in creating this crisis, then we will have an opportunity to achieve a better balance between the role of government and the private sector. The benefit would be more liberty to live our lives the way we choose, more opportunity to achieve success and to take care of our families, a greater level of prosperity from which we can take care of those in need, and a reduced risk of future financial crises.

Free markets did not bring the world’s financial system to the edge of collapse. Rather, the epicenter of the crisis was a massive dose of state capitalism. By state capitalism, I mean that the state, in this case the federal government, used its vast powers to intervene in, and distort capital markets in a manner that led directly to the creation of trillions of dollars in bad loans. Moreover, in the pursuit of a social policy to increase affordable housing and home ownership, the federal government engaged in policies that disrupted the financial market’s ability to be self-regulating; that is to attenuate if not avoid the crisis we are in.

In particular, the federal Government through Fannie Mae and Freddie Mac directed $5.2 trillion (that is trillion with a "t") of capital to increase the supply of mortgages. In addition, it passed a law that required banks to make billions of dollars in loans to individuals who were unlikely to pay off the loans, in the end with 0% down.

In 1998, Fannie Mae announced it would purchase mortgages with only 3% down. And, in 2001, it offered a program that required no down payment at all. Between 2001 and 2004, subprime mortgages grew from $160 billion to $540 billion. And between 2005 and 2007, Fannie Mae’s acquisition of mortgages with less than 10% down almost tripled. These loans are now known as “subprime” and “alt A” loans. At the time they were made, Fannie Mae and Freddie Mac encouraged their issuance by lowering their standards and buying them up from the now vilified mortgage brokers, S&Ls, banks and Wall Street investment banks.

This activity was not due to a lack of regulation or oversight. Both companies are under the direct supervision of a federal regulator and Congress. At the time these loans were being purchased by these two Government Sponsored Enterprises (GSEs), their actions were defended by many in Congress as a successful government initiative. Below is a link to a u-tube video that provides clips from a 2004 Congressional hearing in response to a report by Fannie and Freddie’s regulator that identified specific irregularities, and which warned of trouble to come. In one priceless clip, Congresswoman Maxine Waters approvingly noted that Fannie had made it possible for individuals to purchase homes with 0% down. Efforts by the Bush administration to reform these two institutions and restrain their growth were thwarted by a coalition led by Democrats and joined by more than a few Republicans. Sadly, if action had been taken then, there is a high probability that the current crisis would have been avoided completely, or would be far less in magnitude.

Yes, mortgage brokers and banks encouraged reckless borrowing. I bet that we will learn of some fraudulent behavior among some of the more aggressive mortgage brokers. And, I state emphatically that I neither condone nor excuse their behavior in any way. Nor, do I excuse the lack of responsibility exhibited by many who, with a little honest reflection, could have known that they would be unable to meet the financial obligation of paying the mortgage that they were using to buy a house that they could not afford.

But, the culpability of those in the private sector should not be used to cover-up or excuse the irresponsible behavior of the federal government. The self-regulatory check normally provided by markets on activities that are likely to loose money -- lenders backing away -- was over-whelmed by first the perception, now validated, that Fannie Mae and Freddie Mac debt was backed by the full faith and credit of the Federal government, and second, by the use of this guarantee to borrow trillions of dollars at rates only slightly above that paid by the U. S. Treasury itself to fund purchases of trillions of dollars of mortgages that they kept on their balance sheets. When you have a willing buyer backed by the federal government with unlimited access to credit markets and a trillion dollar budget, markets should not be blamed for responding by providing that buyer, effectively a government agency, with what it was seeking.

For example, Countrywide Bank, now criticized as one of the perpetrators of the financial crisis, in 2000 was lauded by the Fannie Mae Foundation for its leadership in providing flexible lending standards. The report stated: “Countrywide tends to follow the most flexible underwriting criteria permitted under GSE and FHA guidelines…When necessary – in cases where applicants have no established credit history, for example – Countrywide uses nontraditional credit, a practice now accepted by the GSEs.”  (emphasis added).

The easy credit terms also fueled a rise in residential home prices that took on a life of its own. Rising prices caused more buyers to jump in with risky mortgages that stretched their finances so as not to be left behind, further boosting prices. The easy terms also attracted speculators who, without the need to put significant amounts of money down, purchased houses and condos, sometimes renovating them, all with the goal of selling them at a profit in a year or less.

Once the party got going, the investment banks on Wall Street piled in and created new ways to splice, dice and otherwise package these mortgage-backed securities. They created different “tranches”, some that the received the highest (least risky) AAA rating, and other tranches that were more speculative and offered the prospects of higher returns. Fannie Mae and Freddie Mac did not originate these securities. But they effectively made their creation possible by being the biggest buyers of the AAA tranches of pools of subprime mortgages in the 2005-2007 period. Bankers all over the world followed, buying these securities under the illusion that they were as good as the “investment grade” label that they had been given by rating agencies (designated by the federal government), and, in any event, could be sold easily in what then were very liquid markets.

In 2006, U.S. housing prices stopped going up, and defaults started heading higher. In the end, junk is junk. When the cash flow is not forthcoming, it matters little how good your intentions were, or how socially desirable the goal. The loans go bad. And, in this case, banks all over the world go bankrupt, and the world’s credit markets freeze up.

Fortunes have been lost. Thousands of homes are in foreclosure. All of the major independent investment banks on Wall Street have either gone bankrupt (Lehman Brothers), become part of a large bank holding company (Bear Stearns, Merrill Lynch and Wachovia) or – in the case of Goldman Sachs and Morgan Stanley, put themselves under the regulatory authority of the Federal Reserve by becoming bank holding companies themselves.

The point that is easy to lose in the midst of all of this drama and 24-hour news cycles is that the force behind all of this stupidity and bad judgment, the force behind the so-called market failure, was the federal government’s demand that lenders ease their lending standards.

Moreover, by standing ready to buy the AAA tranches of the subprime mortgage pools created by Wall Street investment banks, they made possible the creation and marketing of these securities to financial institutions around the world. Once again, the center of the global financial crisis can be found in the state capitalism pursued by the federal government through its GSEs, Fannie Mae and Freddie Mac.

Greed and Corruption? Here are just a just a few items that are not likely to be discussed at congressional hearings, or on the 6 p.m. news.

Let’s start with the irresponsible behavior on the part of the politicians who encouraged and cheered what they now criticize as predatory lending. Rather than accept at least some of the responsibility for the crisis, they shamelessly shift the blame to “free” markets that had been, in fact, doing their bidding.

• Corruption? Both Freddie and Fannie were found to have committed accounting fraud, making their profits higher, and their CEO bonuses richer.

• Executive compensation: Fannie’s CEO, Franklin Raines, made $90 million between 1998 and 2004.

• Buying influence: Fannie and Freddie were two of the biggest campaign contributors to congressmen and senators. According to the American Enterprise Institute study, “The Last Trillion Dollar Commitment: The Destruction of Fannie Mae and Freddie Mac,” between the “2000 and 2008 election cycles, the GSEs and their employees contributed more than $14.6 million to the campaign funds of dozens of Senators and Representatives, most of them on committees that were important to preserving the GSEs’ privileges.” The study goes on to point out that Fannie Mae in particular enhanced its power by setting up “partnership offices” in the districts and states of important lawmakers, often hiring relatives of those lawmakers to staff the local offices. It doesn’t stop there. In the ten years ending 2008, Fannie Mae spent $79.5 million, and Freddie Mac spent $94.9 million lobbying Congress, often hiring lobbyists that their opponents might otherwise have employed. Countrywide Credit also made available special arrangements for influential members of Congress and their staffs, including Connecticut Senator Chris Dodd, now Chairman of the Senate Committee on Banking, Housing and Urban Affairs and a perennial advocate for both Fannie Mae and Freddie Mac.

Here is the way Oklahoma Senator Tom Coburn put it: “The root of the problem is political greed in Congress. Members…from both parties wanted short-term political credit for promoting homeownership even though they were putting our entire economy at risk by encouraging people to buy homes they couldn’t afford. Then, instead of conducting thorough oversight and correcting obvious problems with unstable entities like Fannie Mae and Freddie Mac, members of Congress chose to…distract themselves with unprecedented amounts of pork-barrel spending.”

In mid-September, the federal government seized both Fannie Mae and Freddie Mac, adding $5.2 trillion in debt to the government's balance sheet, and assets worth potentially $1 trillion less in value.

Then, realizing that only the government had enough market power to solve a
$5 trillion plus problem that government had created, Democrats and Republicans voted to put up another $700 billion to stabilize the financial sector and end a credit freeze that threatened a cascading collapse of the U.S. economy. European governments have followed in a coordinated effort to prevent the possible collapse of the global economy.

The harm to our economy and way of life will be recorded over the months and years ahead.

• Trust in our financial institutions and in securitized credit markets has been horribly undermined, and it will take time and a lot of money to rebuild. That will slow our credit system’s ability to function, making credit less available to businesses and individuals, and economic growth slower than it otherwise would have been.

• Hundreds of thousands of individuals in the U.S. alone will loose their jobs in part because of the lack of credit from banks whose capital has been impaired. Millions will suffer around the world.

• The government now has a significant investment in the five largest banks in the U.S. Not surprisingly, in exchange, politicians are seeking to exert political influence over the lending practices of those banks.

• Millions of low income and minority individuals have become victims of a false promise fostered by federal agencies, and delivered by banks, S&Ls, mortgage brokers, and other market participants. For them, the dream of home ownership has been dashed, breeding resentment and anger.

• Half of America’s households, which have investments in equity markets, have seen the value of their 401(k)s, IRAs, and taxable holdings fall 25% or more.

• American taxpayers have already been stuck with $54 billion in combined losses reported by Fannie Mae and Freddie Mac in the September quarter alone. The $100 billion pledge by the U.S. Treasury authorized by Congress likely will prove insufficient. As of August 2008, they held or had guaranteed subprime loans with more than $1.011 trillion in unpaid balances.

• Leaders in Congress are considering proposals to effectively do away with 401(k)s owned by individuals, and to replace them with a program that would effectively force individuals to purchase low yielding government bonds through the Social Security Administration.10

This financial crisis is first and foremost a failure of crony capitalism that fed the greed on Wall Street, fueled the housing bubble and the reckless borrowing by well-intentioned individuals and more than a few speculators.

The biggest danger to our long-term economic well-being and liberty is that those responsible for this failure of state capitalism are using this crisis to discredit free markets and free people. Already the understandable anger of the American people is being tapped in support of policies that will take from “the rich” in order to give to everyone else.

While seductive, such policies in the United States and other places in the world have been associated with poor economic performance, above average unemployment, below average equity market returns, and stagnating to falling living standards, especially for the most vulnerable parts of society. The longer run costs of the narrative that the financial crisis was caused by free markets will be less freedom and less prosperity for all, especially those businesses and individuals facing increased competition from the global economy.

I encourage you to watch the attached u-tube video. And, for those of you who want to dig deeper, I have provided links to the two academic type papers cited below, each of which provides extraordinary detail and evidence for much of what I have said above. They are the best two studies I have read in terms of explaining how we came to this point.

If after reading this article, viewing the video on U-tube and reading one or both of the attached studies, you are as concerned as I am about the danger to our prosperity and liberty created by ignoring the Federal government’s role in creating the current financial crisis, please forward this article to at least two individuals who would find it of interest, and ask them to do the same.

 Thomas Frank, “It’s Judgment Day for McCain,” The Wall Street Journal, September 24, 2008, p A27.
 Stan J. Liebowitz, Anatomy of a Train Wreck, Causes of the Mortgage Meltdown, Independent Policy Report, Oct 3, 2008, pp 7-15.

http://www.independent.org/publications/policy_reports/detail.asp?type=full&id=30

 Peter J. Wallison and Charles W. Calomiris, “The Last Trillion-Dollar Commitment: The Destruction of Fannie Mae and Freddie Mac,” American Enterprise Institute for Public Policy Research, September 2008, p 6.

http://www.aei.org/publications/filter.all,pubID.28704/pub_detail.asp

 Liebowitz, p. 10
 James Lockhart, “Reforming the Regulation of the Government Sponsored Enterprises” (testimony, Committee on Banking, Housing and Urban Affairs, U.S. Senate, 110th Cong., 2nd sess., February 7, 2008, 6 as cited in Wallison and Calomiris, p 8.
 Wallison and Calomiris, p 3.
 Wallison and Calomiris, p 3.
 As quoted by Peggy Noonan, “Playing Frisbee on a Precipice,” The Wall Street Journal, October 11-12, 2008, p. A13.
 Wallison and Calomiris, p 8.
10 See for example Teresa Ghilarducci, “Saving Retirement in the Face of America’s Creditd Crises: Short Term and Long Term Solutions,: (testimony before the Committee on Educations and Labor, October 7, 2008.

If you guessed the dismal science – economics in general and macroeconomics in particular – you win the my-mom-didn’t-raise-a-fool prize. Never in the course of human events have so many been misled by so few. Yet we blithely accept the prognostications of this puffed-up priesthood, many of whom have never so much as run a corner candy store. Why?

Macroeconomics is the practice of looking for correlations between poorly defined and badly collected aggregates over cherry picked time intervals meticulously ignoring inconvenient factors in order to justify preconceived notions. What makes this different from astrology?

Why is it easy to believe that some muttering gnome in Washington sets interest rates for the entire economy yet impossible to believe that all he’s really doing is engaging in signaling so competing banks can collude when pricing debt without earning the wrath of anti-trust enforcers?

Remind me again which federal funds rate we’re watching this month? Has this whole kabuki show started to feel curiouser and curioser?

What, your inflation analysis isn’t giving you the answer you need to support your favored policy prescription? No problem, change the variable! M1 is no good anymore we need M2. No M3. Wait … nevermind.

Deficits are a dire calamity! Deficits are absolutely required! You don’t even need two economists for this one, just hang around the same guy long enough for the administration to change in Washington.

In what other field but economics can practitioners say with a straight face – “Well that didn’t work, let’s have some more of it!”

Oh my gosh, we built too many houses and prices have cratered. It takes an economist to recommend that the solution is to stimulate the house building industry. Won’t those extra houses further depress prices? Not to worry, another economist will come along and recommend that we build them on rafts, float them out to sea, and have the Navy use them for target practice. And if they did, a third economist will tell us that the program increased GDP and reduced unemployment!

When is a person who doesn’t have a job unemployed and when is he retired or “permanently discouraged” or self employed but keeping mum about it so he can hold on to his income rather than be forced to share it? Ask an economist, he’s trained to make something up to suit your every need.

Are we in a recession? No, silly, you can’t look at those flaky aggregates for yourself, even if they are seasonally adjusted and post-corrected. Calling a recession is the exclusive province of some cloistered brotherhood of soothsayers.

Don’t misunderstand, microeconomics can be incredibly valuable. Want to forecast how a change in your product’s pricing strategy might shift market share? Eager to learn how different factory overhead loading schemes might impact your optimal product mix? Want to decide when it makes sense to trade off capital costs against labor expenses? Private companies do this every day. If they get it right they thrive and if they get it wrong they are the only ones who suffer. Only macroeconomists have the power to make us all suffer.

Who gives them this power? Follow the money. Today’s politicians collect favored economists the way princes of yore gathered court astrologers. But princes of yore never had handmaidens of media to amplify their special wisdom. How many physicists can you name that became TV and newspaper darlings? OK, maybe Carl Sagan. But all he did was ask us to marvel at billions and billions of stars. He never provided cover for congressmen trying to shift billions and billions of dollars from Peter’s pocket to Paul’s.

Raise corporate taxes to fund a consumer stimulus giveaway and some economist will salute your decisive action. How about instead we encourage shoplifting and cut out the middle man? Did you just laugh? Where has your common sense gone that you can laugh at the latter and not the former? Maybe some economist stole it.

OK, let’s get serious for a moment. How much outright death and destruction does it take to discredit an economic theory? 1 million bodies? 100 million bodies? Apparently that’s not enough for the university professors who still teach Karl Marx. It’s the implementation that was flawed, not the theory! A compelling argument, no doubt … to the defenseless mind of an 18 year old.

I confess that the only Hayek book I made it through without my eyes glazing over was “The Fatal Conceit.” It’s a slim volume written later in life, apparently after Hayek discovered humbleness, an unusual discovery for an economist. His thesis is simple – “I don’t care how smart you are, you can’t keep track of all this s**t.”

Economists who believe they can centrally plan a national economy and optimize – what, some flaky set of poorly defined aggregates? – are deluded. Politicians who promote these delusions to arrogate power to themselves are knaves. And voters who buy this fantasy are dupes. Yet Hayek be damned, here we go again.

In the final analysis, what possesses us to dignify these economists with arguments rather than laugh them off the stage the way we would a doctor who recommends leeches to drain phlegmatic humours? What will it take to pull back the curtain and reveal that there is no wizard, that we’re going to have to muddle along for ourselves using our own resources to solve our own problems?

I don’t know. Maybe someone should buy Obama a dog named Toto.

He followed up by saying, in the last 15 years or so, "You've seen a huge shift in terms of resources to the wealthiest and the vast majority of Americans taking home less and less. Their incomes, their wages have flatlined at a time that costs of everything have gone up, and we've actually become a more productive society."

Our new president might want to talk to some of his sterling economic advisers about this, because he got virtually all of it wrong.

Start with the notion that our economy grows "best" when its benefits are most widely spread.

In fact, America's fast-growing economy has always bred differences in income. Some people are smarter, more talented, better educated and trained, or more entrepreneurial. In a free-market society — or relatively free, anyway — they'll do better. But they make the rest of us richer, too. We may envy them, but we're better off.

As for spreading the wealth, the definitive data come from the Gini ratio, calculated by the Census Bureau. Simply put, the Gini ratio measures income dispersion in a society — that is, inequality.

Go back to 1947, as the U.S. emerged from World War II and the Great Depression. Since that year, the U.S. has had the most amazing run of wealth and income creation of any economy ever. We are today the richest country on earth, and No. 2 isn't close.

Yet, over that time, according to the Census Bureau, U.S. income inequality has risen by 15%. Why? Fast-growing economies are almost always accompanied by income inequality — it was true of the U.S. in the past, and it's true of India and China today.

This isn't a bad thing. We benefit from this. The rich earn a lot of income, yes, but they pay even more in taxes. They also create thousands of businesses, millions of jobs and trillions in income.

That said, it's shocking to discover a little-known truth: The U.S. today has one of the most progressive tax codes in the industrialized world. And it's gotten more so over time.

As IRS data show, in 1980, the top 1% earned 8.5% of all adjusted gross income but paid 19% of all taxes. By 2006, that same group's share of AGI had risen to 22%, but its share of taxes had soared to 40%. That is, their tax bill rose faster than their income share.

A recent OECD study looked at federal tax rates paid by the rich vs. low-income workers in rich countries. The U.S. ratio is 1.3 — vs. an average of less than 1.2 for other wealthy nations. As American Enterprise Institute economist Kevin Hassett noted, "the U.S. redistributes far more than the typical developed country."

Unfortunately, the focus on inequality obscures a key fact: Americans aren't taking home "less and less," as Obama says. Nor have wages "flatlined." Indeed, incomes are growing for everyone.

Again, census data tell the story.

Incomes for the poorest one-fifth of all earners have grown on average 3.9% a year since 1994. Meanwhile, those in the middle three-fifths of incomes — broadly speaking, the middle class — have grown by 3.4% to 3.6% a year. Incomes grew after inflation, too. So it's simply wrong to say there was no growth.

To correct these imaginary inequities, Obama talks about hitting the top 5% of incomes with new, higher taxes. But guess what? That'll only punish the millions of Americans who rely on the top earners for jobs and incomes. During a time of national recession, such policies aren't only unwise — they could prove disastrous.

Given that the Fed has been offering banks an above-market return for sitting on their money, it is not surprising to find that this has been exactly what they have been doing. Bank lending has plunged. The velocity with which money circulates through the economy has also plunged, taking demand, output, and employment with it.

The Fed’s goal in paying interest on bank reserves was to improve the technical accuracy of its Open Market operations in managing the effective Fed Funds rate and holding it close to the Fed’s target rate. This has not been achieved. The effective Fed Funds rate has been far below the target rate since the new policy was instituted.

What the Fed’s new policy has accomplished is to “sterilize” the massive increases in the monetary base the Fed has been engineering in an effort to prop up demand and the economy. From August 1 to November 1 (the last data point available) the monetary base increased from $871 billion to $1.482 trillion. This 70% expansion in just three months is more than the percentage increase over the preceding ten years.

Despite this enormous increase in the supply of dollars, gold prices fell from $912.50 on August 1 to $729.50 on the first trading day after November 1, a decline of 20%. Meanwhile, the economic decline threatened to turn into a rout, with the economy shedding 533,000 jobs in November—the most for a single month since 1974. Stores have been closing, unsold inventory has been piling up, and the prices of oil and other commodities have crashed.

It is interesting to note that major stock market declines started just before each of the two Fed press releases mentioned above. The Dow Jones Industrial Average plunged 2400 points (22%) during the first 10 days of October. Then, after recovering almost half of this by November 4, the Dow plunged again, losing almost 2100 points by November 20. As of this writing, the Dow is still down more than 1900 points since the beginning of October.

Clearly, aggregate demand is falling. The velocity with which money is circulating through the economy is declining, taking demand and economic output down with it. We have seen this phenomenon before, but never to this degree.

When people are fearful about the economy, they try to hold on to their money. Both individuals and companies seek to become more liquid. This causes the velocity of money to fall.

From 1929 to 1930, the velocity of the monetary base fell by 9%. This decline, coupled with a 3% reduction in the size of the monetary base, touched off the Great Depression. By 1933, base velocity had fallen to less than half of what it had been in 1929. By then, the Fed had increased the monetary base by 16% over the 1929 level, but this was not nearly enough to offset the fall in velocity.

In contrast, with the monetary base expanding at a 70% annual rate over the three months ending November 1 and GDP contracting at an estimated 4% rate in the fourth quarter, it appears that base velocity has fallen by more than 40% in just a few months.

However, rather than the circulation of money in the economy truly slowing down by more than 40%, the Fed’s policy of paying interest on bank reserves has effectively immobilized a large part of the monetary base. Money that is sitting in an account at the Fed earning risk-free interest is not out in the economy driving transactions.

Normally, the Fed can increase demand by simply buying Treasury bonds and creating additional money. Take a simplified example where the excess supply in the economy consists of a $30,000 Buick sitting on a dealer’s lot. If the Fed buys $30,000 of Treasury bonds, the person who sold them will now have $30,000 in cash. That person will turn around and do a transaction of some kind, thereby passing the money onto someone else. At some point, someone will buy the Buick because, on the margin, there is nothing else available to buy. The sale of the Buick will show up as an increase in GDP when the factory builds a new Buick to replace the one that just got sold.

The Fed’s policy of paying interest on bank reserves at an above-market rate alters this basic mechanism of money. Once again, imagine that there is a $30,000 Buick sitting unsold on a dealer’s lot. Now imagine that “A” has a $30,000 worth of 12-month T-bonds that are currently yielding 0.50%). The Fed buys the bonds from A for $30,000. The newly created $30,000 is deposited into A’s checking account at XYZ Bank. The same $30,000 also shows up as an increase in XYZ’s reserves at the Fed.

Now, with the Fed paying 1.00% interest on bank reserves, XYZ has no incentive to lend out the $30,000. However, XYZ can afford to pay A (say) 0.75% interest on his checking account balance. Because of FDIC insurance, the interest-paying checking account is as safe as the bond that A used to own—and it has a higher yield. In essence, the Fed has “sterilized” its Open Market operation. Under these conditions, the Fed could buy up the entire national debt without having any effect upon demand.

If we want the economy to recover, the Fed has to stop paying interest on excess reserves. When the Fed Funds rate is near zero (as it is now), it may even be necessary to charge banks for holding them. Once this is done, attention should turn to fundamental monetary reform. To have a stable economy, we must have a stable U.S. dollar.

The mistake Roubini and other economists make is in tying changes in consumer prices to changes in the broad price level. More realistically, the price level can only change as a result of a decline or increase in the value of the monetary standard, and with the dollar still historically weak, all signs point to inflation. But to show why simple changes in consumer prices can’t in and of themselves alter the price level, it’s best to look at rising prices first.

A few years ago Nintendo released its revolutionary Wii game consul. Having failed to account for frenzied demand in the U.S., Nintendo didn’t manufacture enough, and the consoles quickly sold out. If one had been desperate to buy a Wii, they were available for resale, but at prices much greater than the original advertized price.

Was this a signal of inflation? Not at all, and the reasons why are very clear. If demand for certain items is driving their prices up, it must be that demand in other areas is falling. By the same token, if hotel-room rates quadruple in Washington, DC during the Obama inaugural, visitors to the District will have that much less money to spend on other items once in town.

The basic point here is that demand-driven price increases are in no way inflationary. If consumer demand is causing price spikes in certain categories, there must be a falloff in others. In this sense, the price level remains unchanged over time owing to the reality that all prices must adjust to changes in consumer preference.

When we look at consumer-price decreases, the same phenomenon applies. If for instance production enhancements make formerly expensive flat-screen televisions cheap, there’s no deflation to speak of. That is so because falling prices in certain areas merely expands the range of purchasable goods within reach of the consumer. Thanks to money saved on the flat screen, the average consumer now has more money to buy other goods previously unnattainable. Once again, the net effect on the price level is zero.

Oil's lower price is frequently cited as further evidence of deflation, but at $44/barrel, oil has simply reached its normal, historical price per one ounce of gold. And just like the flat-screen example, if cheaper oil means lower gasoline prices, the consumer now has greater access to other goods previously too expensive.

Some economists who believe economic weakness drives down prices would still disagree. They would and do contend that when an economy is flagging, the prices of goods fall to match lower demand.

The above sounds nice, but the thinking is rooted in the faulty assumption that one can consume without producing first. In short, economists suppose a logical impossibility.

In the real world, we trade products for products. We’re only able to demand things to the extent that we’ve produced first.

And given the basic truth that supply is the path to demand, any falloff in the latter is by definition a decrease in supply. In that sense, falling demand for all consumer goods means there’s been a commensurate drop in supply.

This is why classical economists have regularly noted that money itself is insignificant except as a means of exchange. When we’re earning less money it really means we’re producing less in such a way that we possess less demand. As a result, there’s no broad pricing change when demand shrinks.

So when true deflation and inflation are considered, both are a change in the value of the monetary unit (in our case, the dollar) that over time impacts the prices of all goods measured in the currency. While commodities reacted to the debased 1970s dollar almost instantaneously in the form oil “shocks”, other consumer prices took years to adjust to the weaker greenback. The CPI inflation measure is truly faulty, but it continued to rise into the early ‘80s despite a much stronger dollar thanks to prices of lagging goods still adjusting to the old value.

Looked at today, we know we don’t have deflation by virtue of looking at the value of the dollar. To compare it to other foreign currencies isn’t terribly effective owing to the fact that we live in a world of currencies that lack any objective definition. But gold still serves its useful purpose as an historically stable measure of value. And with the dollar worth 1/770th of an ounce of gold today versus 1/253rd per gold ounce in 2001, it’s fair to say we don’t have a deflation problem. Quite the opposite.

People in the Roubini camp point to “debt deflation”, but unless most Americans took out big loans last July, it’s far more true that they’re making out like bandits for paying back dollars significantly weaker than what they borrowed. We’ve had deflation before in this country, but not now.

Why this isn’t more obvious has to do with how certain economists read economic weakness. When we inflate, the economy recedes thanks to investors going on strike. With capital moving into hard assets, the entrepreneurial economy suffers, production drops, and retailers put on big sales to move inventory in an economy lacking demand due to a lack of supply.

So while the economy is presently deflated thanks to inflationary monetary policy this decade, don’t fall for the popular and empirically untrue delusion that is deflation. That is something else altogether, and will only reveal itself when the dollar is significantly stronger than it is at present.

“Send federal money to the states, but make sure a lot of it goes to state universities,” wrote New York Times columnist David Brooks, channeling Harvard’s Michael Porter. “Higher education should not be left out...as lawmakers and other leaders debate stimulus plans for the economy,” a spokesman for the New Jersey Association of State Colleges and Universities told a local newspaper. “Making college affordable benefits everyone,” a spokesman for a nonprofit that “promotes access to college” told that same newspaper. “Public higher education should be at the center of any ‘new deal’ created to address the current economic situation,” the California Faculty Association (a typical disinterested group consulted by the media) declared to approving nods from the press, while a West Coast newspaper editorial assured us that “every $1 invested in the [California State University] returns nearly $5 to the state's economy.” Without new investments in public education in Florida, an advocacy group quoted by the Wall Street Journal declared, some 40,000 kids might be denied access to college by 2012 alone. There’s much, much more, all pretty much along the same lines.

What was missing in this media barrage, however, was any evidence that investing substantially in public universities actually pays off economically for a state, or that expanding access to college really results in more people getting degrees (and better jobs), or that state universities use their public subsidies wisely in the first place. No doubt all of this seems so self-evident that not one journalist I can find bothered asking whether any of it was true.

A few researchers, however, have asked these questions, and the answers aren’t always pretty, nor are they part of the conventional wisdom. One of the skeptics is Richard Vedder, distinguished professor of economics at Ohio State University and head of the Center for College Affordability and Productivity. He’s spent years observing the upward spiral of tuition at American colleges and universities and the increase in government’s subsidies for higher education. His research suggests we are already over investing in our public universities.

For one thing, Vedder has found little evidence that government spending on higher education stimulates an economy. He has run hundreds of regression analyses trying to understand the relationship between subsidies for public universities and local economic growth, and what he’s found is that at best the spending produces no gains, while at worse, “the more states spend on higher education, the lower the growth” over time. Vedder suspects this is because the “growth-impeding effects of taxes that finance higher education spending are greater than the growth-enhancing effects of that spending.” Thus the argument many public university administrators are making in the midst of state budget crunches, that maintaining subsidies to universities will pay off, is without much substance.

Still, shouldn’t we be taxing people who can afford to pay a little more (the rich? corporations?) in order to expand access to college? And doesn’t public funding of universities accomplish that? Not necessarily. For one thing, state universities devote a small proportion of incremental public financing to keeping tuition low. In one study, the Center for College Affordability determined that on average public universities use only 30 percent of public funding increases to hold down tuition costs. Instead, public universities have been pouring more money into intercollegiate athletics and student services, raising salaries rapidly and increasing hiring of non-instruction personnel. In 1975, for instance, the ratio of non-instructional staff to instructors at America’s colleges and universities was about 4.5-to-10. Today, it’s about 8-to-10.

But even devoting the money to lowering tuitions doesn’t necessarily pay off. While the press worries about whether rising tuition at state universities will deny some students the opportunity to attend college (“New Barriers to Entry” read a recent headline in the Wall Street Journal about higher tuition), few in the media wonder whether expanded access actually leads to more college graduates.

As Vedder points out, many of our public universities have a high attrition rate, where well under 50 percent--and in some cases, under 40 percent--of those who enroll earn a degree. Those stats aren’t particularly surprising if you examine college readiness rates in the United States. Education researchers Jay Greene and Greg Forrester did that back in 2003, and they judged that while only 32 percent of all high school seniors had the necessary skills and coursework to be college-ready, about 34 percent of all young adults are enrolled in college. Vedder’s conclusion from such data is that incremental government funding is encouraging some relatively unqualified students to pursue college, and that the attrition rate among those students is very high.

Still, access to college has become part of the narrative of how to make America a more just society. Higher education can do this by closing the income gap between the rich and everyone else, so the idea goes, because college graduates earn substantially more than those who don’t graduate from college.

The problem with this reasoning is that it confuses correlation (those who graduate from college earn more) with causation (graduating from college means one will earn more). In fact, there may be any number of reasons why those who graduate from college earn more that have little to do with a degree. For one thing, college graduates have higher IQs, on average, than those who don’t have degrees, and maybe IQ is what’s behind the income differential, not a college degree.

There is a message in the financial woes of state universities, but it’s not the one that we’re hearing from the Academy itself, or its advocates, or the press. The current economic and fiscal mess represent an opportunity to reassess and reform our state university systems. That means targeting savings by reducing administrative personnel and increasing course loads for instructors. It also means taking a hard look at public institutions with low graduation rates. Some probably need to be closed. And it means focusing assistance on needy students who are academically qualified to attend college while eliminating aid, like low-cost loans, for affluent students. This is the real opportunity before us.

Both the Miami Herald and Rocky Mountain News are reportedly for sale, and it's possible they won't find any buyers. In Minneapolis, the Star-Tribune is apparently in financial trouble and has asked its unions to concede to $20 million in salary and wage cuts.

With the survival of network news also in question, the future of the legacy media is bleak. Yet there seems to be no shortage of reporters writing and talking in almost gleeful terms about the possibility of economic ruin. They're careful not to overtly welcome a depression, but in much of the reporting the tone gives it away.

Steven Pearlstein, then a Washington Post business reporter and now a Post columnist, wrote in February that "the best thing that could happen to our economy is for a dozen high-profile hedge funds to collapse; for investment banking to enter a long, deep freeze; for a major bank to fail; and for the price of a typical Park Avenue duplex to fall by 30%."

"For only then," he said, "might we finally stop genuflecting before the altar of unregulated financial markets and insist that Wall Street serve the interest of Main Street, rather than the other way around."

At the Nation, a left-wing magazine that has long supported the sort of economic policies that would bring another depression, Katrina Vanden Heuvel isn't shy in yearning for the central planning of the 1930s. The public, she wrote Monday, should "expect to hear more of this line of attack on public spending as conservatives fight tooth and nail to prevent a new New Deal."

The blogosphere has a name for this syndrome: "depression lust." Virginia Postrel, an Atlantic Monthly columnist who invented the phrase, contributed to a Boston Globe story published in November that collected ideas from various people to (allegedly) give readers some insight into what a 2009 depression would look like.

The conditions "sounded pretty damned good to some people," Postrel writes on her Dynamist blog, "a sure sign of an affluent society, or at least affluent commentators," who, we should add, appear to be operating under the illusion that things would still be rosy for them in a depression because they always have been.

Journalists "seem positively giddy with anticipation at the prospect of a return to '30s-style hardship — without, of course, the real hardship of the 1930s," Postrel blogs.

Jim Miller, who writes a political blog, has made a similar observation. "I can't count the number of times I read hopeful pieces in the New York Times saying that a recession might be coming soon, so now that one is actually here those people have to be pleased."

Did any of those New York Times stories come from David Carr, whose "Stoking Fear Everywhere You Look" appeared Monday?

"Every modern recession includes a media seance about how horrible things are and how much worse they will be," noted Carr, who did a bit of his own communicating with the dead spirits of the Great Depression.

As Postrel notes, journalists, whose industry is teetering and "who are already the equivalent of 1980s steelworkers," should be among the most fearful of a depression.

But they can't help themselves. Their contempt for the capitalism and free markets that have made so many of them comfortable is strong enough to make them wish for economic conditions not in their best interests — and it comes through loud and clear almost every time they report.

Fast forward six years, and something similar with regard to the U.S. carmakers has revealed itself. Desperate for federal money to save that which investors have left for dead, the CEOs of the Big Three have with the exception of resigning, proven willing to compromise on anything and everything to secure more welfare from Congress. Unfortunately, those compromises explain why the looming bailout will not work.

Doubtless playing to television cameras and to “wavering” politicians empowered by the money of others, Messrs. Mulally, Nardelli and Wagoner professed their supposedly “altruistic” desire to cap their compensation at $1/yr. The “seen” there is the commitment of all three to improving the fortunes of these gasping monuments to past business success, but the “unseen” or unspoken is what the compromise says about all three. Put simply, they’re making the implicit point that their value as CEOs is slim to none.

The above is surely unfortunate when we consider each company's future, because the basic truth is that quality CEOs are priceless. And when they succeed, their nominally enormous pay works out to a small fraction of the total wealth they create. If Mulally, Nardelli and Wagoner truly felt they had the skills necessary to right these sinking ships, they would have properly asked for handsome pay packages that included a great deal of equity upside should they succeed.

That they’re willing to work for nothing shows they don’t honestly believe they can fix what is broken. Based on their childish compensation requests alone, it’s a certainty that the money handed them will be wasted.

Sadly, their personal compromises weren’t just limited to pay. Embarrassed for having arrived at last month’s congressional hearings in their respective company jets, they left them behind for their latest D.C. foray; Ford CEO Alan Mulally driving to Washington in a hybrid.

Considering private jets, Warren Buffett has named his “The Indefensible”, and other corporate chiefs seek to keep their luxury travel accommodations out of the public eye. Their faux "man of the people" preening is absurd. Buffett has created staggering wealth for shareholders over the years, and to the extent that private travel keeps him of sound mind, The Indefensible should be re-named “The Very Necessary”. In much the same way, as a shareholder of Microsoft and Amazon, this writer would be furious if airport security and connections at hub cities kept Steve Ballmer and Jeff Bezos from concentrating on growing the two companies they oversee.

Returning to Messrs. Mulally, Nardelli and Wagoner, that a little bad press would scare them into cars or commercial travel shows yet again how little they believe in their turnaround strategies. Good CEOs with good plans would ignore the catcalls from reporters and populist politicians given their certain belief that their time is truly valuable. That the Big Three chiefs would so willingly give in to a childish form of peer pressure is more evidence that they’re not worth even one dollar of taxpayer charity.

But even if the above compromises hadn’t been made, the one made with regard to the imposition of an “auto czar” insures that the bailout will be a stupendous failure. According to the Wall Street Journal, the “czar” appointed by President Bush "would act as a kind of trustee with authority to bring together labor, management, creditors and parts suppliers to negotiate a restructuring plan. He or she also would be able to review any transaction or contract valued at more than $25 million.”

As we learned so clearly while watching the implosion of the communist bloc countries nearly twenty years ago, the whole reason companies and economies grow is precisely because there’s no government bureaucrat overseeing the myriad decisions that lead to the production of anything, let alone a car. The former Soviet Union had all sorts of product czars, and the result was horrendously bad products of insufficient supply. As Hedrick Smith noted in his essential book, The Russians, Soviet citizens waited in line for every consumer item, and were regularly unsatisfied assuming they were able to purchase anything at all. Thanks to a policy crack-up in Washington, we’ll now get to see the failure of Soviet-style planning up close.

But when it came time to “save” the Big Three this week, the inevitable happened even though the terms are still being “negotiated.” When you combine a chastened Republican minority bereft of market principles with a Democratic majority eager to pay off its union support, some sort of bailout was always as sure as the Detroit Lions having another losing season.

The Lions will seemingly always lose, and U.S. carmakers will never be allowed to die. But make no mistake about either because while new management could someday make the Lions great, the Big Three are as good as dead no matter the dollar amounts handed to them. The terms of the coming bailout insure as much.

And it is not just any variant of the left. It is the Old Left, the mid-20th-century left of public-works giantism, ham-fisted labor union protests, and command-and-control central planning.

By the end of the 20th century, the failure of all of these policies had caused the Old Left to splinter into two groups. The New Left hippies rejected industrial socialism in favor of anti-industrial socialism, adopting environmentalism and holding up a neo-primitive lifestyle as the ideal, while the New Democrat centrists sought a "Third Way" compromise between capitalism and socialism.

But now the discredited Old Left seems to be making a roaring comeback. We can see the signs all around us.

Consider Barack Obama's plan for up to $700 billion in New-Deal-style "public works" boondoggles. It is a good old-fashioned Keynesian "stimulus" based on the premise that you can revive the economy by spreading paper money around at random.

Yet it is now widely acknowledged that the original New Deal did not actually revive the Depression-era economy. Even under Keynes's failed theory, the amount of FDR's spending was not enough to stimulate the economy—and neither is the amount proposed by Obama.

But that hasn't fazed the revived Old Left. Alan Brinkley, a professor of history at Columbia University, says of the New Deal that "they didn't spend nearly enough" and laments that "They were constrained by all kinds of traditional ideas about balanced budgets." With Obama set to run a trillion-dollar deficit in his first year in office, it looks like those old-fashioned hang-ups have been overcome.

There is, however, one concession to the New Left in Obama's New New Deal. Obama tries to sell the New Left environmentalist crusade as if it were an Old Left, heavy-industry, make-work program.

When FDR poured enormous sums of government money into projects like rural electrification, he "created jobs" at the expense of the far greater prosperity that would have been achieved if the same money had been left in private hands, to be employed more productively. But at least the Tennessee Valley Authority actually produced electricity on an industrial scale, so the money poured into it was not entirely wasted.

The new "green energy" make-work program, by contrast, will pour billions of dollars into speculative technology that is extremely unlikely to produce power on the industrial scale required to support the American economy. It is a plan for a TVA that fails to generate electricity. But at least it will still fit the essential Old Left criterion. One expert names the main selling point of this proposal: it is "quite labor-intensive"—whether that labor is actually employed productively or not.

And that brings us to an attempt to revive the central institution of the Old Left: the labor union. Recent news has brought us live footage on our flat-screen plasma TVs of a phenomenon many of us have read about in history books but did not expect ever to see again in our lifetimes: an old-fashioned factory sit-in, with union members occupying a factory and seizing its equipment to protest the closing of a door and window manufacturer.

The Washington Post describes this as "a throwback to tactics hardly seen since the 1930s that labor experts and union leaders say may become more common if the economy continues its downturn."

Speaking of tactics not used since the 1930s, Illinois Governor Rod Blagojevich immediately seized on this case in an attempt to bolster his sagging reputation by engaging in a populist, Bonnie-and-Clyde-style raid on the Bank of America, threatening the bank with the loss of millions in state government business if it did not immediately grant a new loan to keep the unprofitable factory open. Blagojevich's blackmail is a blatant abuse of government power, an illegal shakedown for which the governor ought to go to prison. Too bad he's already going to go to prison for something else.

This bank shakedown captures the basic irrationality of the attempt to return to a command-and-control economy. In the middle of a financial crisis caused when banks were encouraged to make too many loans to unsound enterprises, Blagojevich wanted to force a bank to make a loan to an unsound enterprise. How is this supposed to produce any result except disaster? The assumption is that reality will simply bend to orders issued by government officials. It is precisely the kind of brazen arrogance Blagojevich displayed in every aspect of his administration.

Blagojevich may be an extreme and particularly unsavory case, but his attempts at playing economic dictator are tiny compared to the latest initiative out of Washington, the climax to date of the Old Left revival.

The real story of the bailout of the Detroit auto industry is not simply the waste of taxpayers' money on failing enterprises. Rather, the real news is Congress's apparent confidence that the way to revive Detroit is to impose central planning on the auto industry. This would be done by appointing a "car czar" empowered to "act as a kind of trustee with authority to bring together labor, management, creditors and parts suppliers to negotiate a restructuring plan. He or she also would be able to review any transaction or contract valued at more than $25 million."

The term "car czar" is not quite right. As a metaphorical description of the bailout, it evokes the right location—Russia—but the wrong era. "Car commissar" would be much more exact. Perhaps he will begin his work by issuing a five-year plan for the revival of the Big Three.

The Christian Science Monitor describes this as a comeback for "industrial policy." "The notion that government would pick economic winners and losers gained support among Democrats in the early 1980s, when it appeared that Japan, with its well-developed industrial policy, was America's No. 1 economic rival. The approach later lost its luster as the Japanese economy settled into a deep slump." And yet, here we are trying it again.

"Industrial policy" was always just an evasive euphemism used to describe the latest variation on the old theory of central planning. But central planning and nationalization of industries was a dead end when the old Soviet Russians tried it—and it is still a dead end now that Russia is trying it again.

The 20th century experimented with every possible variant of socialism. We had democratic socialism in Western Europe, totalitarian socialism in Eastern Europe, and fascist socialism in South America. We had atheistic socialism and we had "liberation theology." We had the "scientific socialism" of the Soviet central planners and the chaotic jungle socialism of the Khmer Rouge, who executed anyone with an education. We had "socialism with Chinese characteristics" and socialism with African characteristics and socialism with Hindu characteristics.

We tried it all, and every time it led to poverty and oppression.

Those results have been proven with scientific thoroughness. There is no excuse for trying it all again.

But deregulation must allow for failure in order for the discipline of the market to work. When deregulation and bailouts coexist, then fear of the consequences of risks is diminished, and crises such as the current one are inevitable. The government must choose regulation and bailouts or deregulation and failures; there is no third option. Specifically, the government must enact regulatory legislation as quickly and effectively as possible, or stop its haphazard lending to financial institutions and let the market do its job of punishing failure with bankruptcy and liquidation.

In regards to regulation, many opinions are expressed on how greater regulation is needed in the future. People envision a world in which commercial banks are regulated heavily and not allowed to engage in business activities that are considered too fundamentally risky and potentially catastrophic to the rest of the market. No more will mortgage-backed securities and collateralized debt obligations haunt the balance sheets of commercial lenders and wreak havoc on the financial system. Many people hope this vision will become a reality within a few months. But it already was a reality for over six and a half decades and it was only in 1999 that it was changed.

The Glass-Steagall Act of 1933 was a reaction by the government to the huge losses in, and systemic failure of, the commercial banking system. It is almost eerie to read the description of a provision of the law given by Milton Friedman and Anna Jacobson Schwartz in A Monetary History of the United States, 1867 – 1960. “[T]he Banking Act of 1933 made member banks subject to severe reprisal for undue use of bank credit ‘for the speculative carrying of or trading in securities, real estate, or commodities, or for any other purposes inconsistent with the maintenance of sound credit conditions.’” This stipulation prohibiting trading in assets and securities of dubious credit-worthiness may sound familiar, for it is exactly what many believe the government should have been doing to prevent this crisis, and what those same people believe it should do in the future.

But these regulations proved problematic to a large extent. The stifling legislation led to inefficiencies among U.S. banks, as well as to loss of business to foreign banks, which had greater independence. The final repeal of Glass-Steagall came in 1999 with the Gramm-Leach-Bliley Act. Many hailed the repeal as ushering in a brave new world where banks were free from intrusive regulation and could invest in areas that would strengthen their bottom lines, and hence the value of their shares. Truly, many felt, the best and the brightest of Wall Street would be able to use their new freedoms to compete with foreign banks and to improve market efficiency in this country, while simultaneously earning positive returns on behalf of their investors. A more deregulated system thus came into being.

So what went wrong with deregulation? Put simply, investment banks and commercial banks alike undertook bets that either were not well understood or were well beyond acceptable limits of risk, or both. Some will quip that great reward comes only with great risk, but it is unlikely that the average investor would have been onboard with these concentrated and leveraged positions in markets as arcane and risky as subprime mortgages, for instance. One of the beauties of allowing banks to branch out into other businesses in the first place was to allow for greater diversification of their portfolios and thus lower the probability of a bank failure or banking crisis. Yet it is precisely this venture into uncharted territories that became the banks’ undoing. The diversification did not happen adequately and the positions proved to be untenable.

Moreover, when disaster struck, the banks were coy to describe their financial health, and the pronouncements that were made often turned out to be misleading or false. If it seems like only a few weeks ago that Citigroup’s CEO Vikram Pandit was reassuring the world that Citi had “plentiful capital, abundant liquidity” and strong revenue, it’s because it was only a few weeks ago, shortly before Citigroup’s bailout. Now, $250 billion of taxpayer money later, those “reassuring” comments are rather frustrating to re-read.

The question thus becomes what is to be done about the failures of the financial institutions. To be sure, a revised Glass-Steagall is not necessarily the answer. What is necessary is for the government to decide whether banks are too important to the overall economy to be allowed to fail. Moreover, commercial banks’ freedom to dabble in areas outside of those traditionally associated with bank holding companies (i.e. activities other than borrowing and lending) should be debated, given that that freedom has led to problems. The government must answer these questions definitively and clearly in order to avoid further market turmoil. The government must not continue to pick winners and losers as it has seemingly done rather haphazardly with the investment banks.

If it is determined that these institutions are too essential to the economy and the financial markets to be allowed to fail, then they must be regulated. As painful as it is to admit, there is no other option: businesses that are vital to our continued economic survival cannot be left to laissez faire economics, which allows for failure, because such failure would consequently destroy the economy. The regulations in question must limit the scope of the banks’ enterprises or limit the various assets that can be held, or both. This would amount to a revised Glass-Steagall act. The potential inefficiencies that such heavy-handed regulation would result in must be weighed against the cost of a catastrophic collapse.

But if banks are not too important to fail, then fail they should when the time comes. The FDIC has already increased to $250,000 from $100,000 the amount in a savings or checking account that is insured by the government. That is more than enough to prevent the run on banks that some people puzzlingly seem to believe may happen if banks are allowed to fail. Moreover, those who seek more discipline for the banks should realize that the market provides the most discipline of all. Setting an example of allowing banks to fail will provide much more of a disincentive to take excessive risk than enacting more legislation to regulate the banks. In fact, the current system of buying troubled assets is simply rewarding the banks for their misguided ventures into risky and complicated markets.

The government therefore must choose regulation and bailouts or deregulation and failures. It cannot have deregulation and bailouts without creating perverse incentives for financial institutions to undertake even greater and riskier positions, knowing that there is limited possibility of failure. It can either prevent these risky ventures with legislation, a la Glass-Steagall, or through the threat of failure.

While regulation existed in the past and led to a limit on crises, it also led to market inefficiencies and loss of business to foreign banks. In addition, regulations, unless perfectly crafted, also lead to the profitable business of finding regulatory loopholes, which nullifies the effect of legislation in the first place. Such loopholes would not exist to a large extent when the market is the ultimate regulator and enforcer.

There is no better place to punish and reward risks than in a free market. Deregulation is preferable for this reason. However, the problems and poor decisions of the deregulated commercial and investment banks over the last few years cannot be understated or condoned, let alone rewarded with bailouts. Several banks have failed their investors, the government, and the American people. It is time that we leave them to fail.

If Sen. Corker’s plan had prevailed, with UAW support, many believe it would have had 90 votes in the Senate. GM could have gone forward with a clean-as-a-whistle balance sheet under a three-part restructuring plan that included a $60 billion bond-refinancing cram-down, a renegotiation of the $30 billion VEBA health-care trust, and a pay-restructuring plan that would put Detroit compensation levels in line with those of foreign transplants Honda, Toyota, Nissan, and BMW.

Average compensation for the Detroit little three is $72.31. Toyota’s average wage is $47.60, Honda’s is $42.05, and Nissan’s is $41.97, for an average of $44.20. So Corker’s idea was to bring that $72 a lot closer to that $44. (Corker notably knocked out Korean carmaker Kia, which has super-low wages.)

Corker’s plan also was constructed in true compromise fashion. Among the negotiators were reps from GM, Chrysler, and Ford, and bondholders like fixed-income giant PIMCO. Critically, UAW representatives also were in the negotiating room, with an open line to Gettelfinger back home.

During the negotiations Corker tried to be as compromising as possible on the tough question of wages, benefits, and overall compensation. He asked the union to be competitive, but he never specified parity or complete equality with the foreign transplants. And Corker provided that the comp-package would be certified next year by the secretary of Labor -- an Obama selection. In addition, the Senate governing the package would be made up of 58 Democrats, rather than today’s 50.

All Corker asked was a 2009 date for union pay restructuring. Sen. Corker never specified his date. He asked the UAW to name its date for a new pay package. But it had to be in 2009. In return, union members would get a lot of stock in this deal -- up to $10.5 billion of new equity as GM’s heavy debt burden would be converted into common shares.

But the UAW refused to make concessions. Instead, it insisted it would only renegotiate its current contract when it ends in 2011. That was the sticking point that killed the deal.

You have to ask this question: If the Detroit carmakers are in dire straits, going broke in two weeks, right now in late 2008, how can the UAW wait until 2011 to make its concessions? The financial problem is today, not two years from today. The threat of liquidation, with perhaps a few million autoworker, supplier, and car-dealer jobs lost, is today’s threat, not a 2011 threat. So what’s the UAW waiting for?

That’s easy. Gettelfinger is waiting for President Obama and a Senate with 58 Democrats. He also was playing a game of bluff with President George W. Bush. He knew Bush had $15 billion of TARP money ready to go, meaning the TARP was Gettelfinger’s trump card. The tough-minded union leader never believed the White House would let GM sink and possibly force millions of job losses in the middle of a recession.

So while Sen. Corker was negotiating in good faith (even with the support of Democratic big-wig Chris Dodd), Gettelfinger doomed the deal, knowing full well that the Democratic Senate conference would never walk away from the UAW.

What happens now is anybody’s guess. The White House has suggested that TARP may be called into play, although the Treasury is in no rush to make a decision. The Treasury is going to kick the tires to see if a TARP bailout for Detroit really works. However, a TARP auto bailout may require new legislation. And ironically, a Treasury TARP loan may carry the very same conditions proposed by Sen. Corker, including a “car tsar” to supervise the whole operation.

Whatever the outcome, Bob Corker has emerged as a Senate star. As a former businessman who ran his own construction company and built shopping centers, and a former chief operating officer for the state of Tennessee, Corker knows finance and the economy. He even was a long-time union member -- beginning as a 19-year-old bricklayer -- and a trustee of the carpenter’s union fund in his home state.

So while Mr. Corker may have lost this battle, he will be heard from again.

Back when I was an engineer with a job in the real world, whenever we screwed up someone would stop to check whether we got the problem statement right. Do you want it fast, cheap, or good? Pick two.

Give me better gas mileage! Give me desirable cars! Give me lower gas prices! But not too low!

Why live in the real world when you can live in Washington where you can just pass a law to get what you want? And if you can't actually pass a law, just bypass one. The body politic wants everything, and they want it now. Our duly elected representatives shall wish it so.

The only things more broken than Congress are the Detroit car companies.

They're out of money because their customers won't give them any and their employees, executives, and retirees have gobbled down so much they can barely waddle to the jobs bank.

But they need money, and they need it fast before the repo man arrives.

What better place to get some than from the people who print it? If it's good enough for crooked mortgage brokers and incompetent investment bankers, it's good enough for General Motors!

"Fetch me some Car Czars!" snaps the Red Queen. Jack Welch is apparently unqualified seeing as how he's not a "public sector" type who will deliver what Congress wants. Perhaps King Canute is available.

Where has my Climate Czar run off to? I'd better not catch her making whoopee with the Energy Czar.

Feeling depressed and confused, I consulted my handy pocket edition of the US Constitution. It talked a lot about the duties of the President and Congress, spelling out limits on their power. After looking really hard I couldn't locate the Czar amendment.

Did we really elect all these people? Have any of them actually read the constitution or were they one of the popular kids who got geeks to do their homework in return for getting them prom dates? Are they really planning to fob off poorly defined intractable problems that don't belong to them to vaguely empowered policy wonks whose reputations can only be squandered when this house of cards comes crashing down once the bills come due?

Is it enough to make you start smoking something overlooked by the Drug Czar?

Reality is a funny thing. Try as you might to banish it, it insists on biting you back.

The economy only grows when you pay someone to do something that delivers more value than it cost to make. If you pay someone $100 to make something that sells for $50, the economy shrinks. Do you think that equation changes if you multiply it by a trillion and launder the money through Washington?

Does it seem inconvenient that value can only be determined by customers who actually buy stuff? Or don't buy stuff, which seems to be what's happening to the Detroit car companies.

What a pity that every individual has his own ideas about what things are worth. Wouldn't the economy work better if value could be assigned by congressional committees or editorial boards?

That giant sucking sound coming from Washington swallowing our present and future income to "create jobs" according to the dictates of a parade of Czars may make for great theater. But it's hard to see how the economy will grow by spending $100 to make $50 stuff a trillion times.

Unless they pass laws telling us exactly what stuff we have to buy, when, from whom, and for how much.

Forget I said that. It might wake up the Wage and Price Control Czar.

Who do we call after the Czars fail? History usually serves up a choice between the Committee for Public Safety and the Man on a White Horse.

Imagine how much fun that's going to be.

In a recent article for Vanity Fair, Stiglitz engaged in falsehoods and contradictions in order to blame capitalism for our present troubles. It would perhaps be better for him and other elite economists to simply look in the mirror.

Indeed, while Alan Greenspan’s light trashing of free markets has surely earned him a place in economic purgatory, the blame being passed his way for the housing boom and bust is not rooted in reality. Many even on the Right blame low nominal rates of interest on Greenspan’s watch for the latter, but then history shows housing has traditionally done best when interest rates are rising.

More realistically, weak currencies are the biggest drivers of nominal home-price gains, and for evidence we need only study Richard Nixon’s second presidential term and Jimmy Carter’s lone term to find that much like this decade, housing was frothy under both. Stiglitz argues that Greenspan had a role here for turning on “the money spigot” with “full force” earlier in the decade, but then money supply is vastly overrated as an indicator of a currency’s direction. For evidence, we need only compare the ‘70s and ‘80s when money creation by the Fed was the same, but achieved opposite results. If Stiglitz is looking for someone to blame here, he would do better to finger a Bush Treasury that embraced a weak dollar with great vigor.

Stiglitz says Greenspan should have been more vigilant about curbing “predatory” lending to low-income households and “liar loans”, but when we consider how the Right talked up “America’s Ownership Society” in concert with politicians from the Left eager for Fannie and Freddie to expand their mandate into the subprime space, it seems folly to assume that Greenspan could have blunted this bipartisan bout with political correctness. Stiglitz decries the innovation that made these loans possible, but then loans are always risky, and they’re only problematic when the very regulators and politicians whose actions he espouses seek to privatize the gains from same, while socializing the losses.

While he served President Clinton, Stiglitz claimed he did not support the repeal of Glass-Steagall, and that repeal changed the culture of banking, thus making way for the various failures in our midst. What he ignores is that with the exception of Citigroup, the majority of financial failures involved investment banks lacking a commercial-bank affiliation. Indeed, imagine what might have happened if regulations had kept commercial banks from serving as White Knights in this whole financial mess (see J.P. Morgan & Bank of America), and more broadly, what a shame that regulations kept other cash rich companies such as Wal-Mart from buying greatly weakened financial institutions in order to enter the banking space themselves.

Stiglitz regularly seeks to elevate regulation as the path to financial health, but then contradicts himself in decrying a 2004 SEC decision in which investment banks were allowed to increase their debt-to-capital ratios “from 12:1 to 30:1, or higher”. The question Stiglitz fails to ask is whether regulation was in fact the problem. Indeed, the ’04 SEC decree essentially allowed risk-oriented banks to hide behind the very regulations that Stiglitz would like more of. Did it ever occur to him that absent a muscular SEC, self-interested investors with their money on the line might have regulated the investment banks themselves; allowing firms with a history of investment success higher debt-to-capital ratios, while curbing the activities of those thought to be unworthy?

On the tax front, Stiglitz claims that the 2001 and 2003 Bush tax cuts “played a pivotal role in shaping the background conditions of the current crisis.” According to him, “they did very little to stimulate the economy.” About the 2001 “reductions”, he would have a point in that stimulus and tax breaks for select industries are by definition an economic retardant. But there again lies a contradiction in that while he correctly decries the imposition of Henry Paulson’s awful TARP, his reasoning has to do with Paulson’s failure to do anything “about the source of the problem, namely all those foreclosures.” Put simply, Stiglitz didn’t like the welfare that characterized Bush's Stimulus I, but somehow welfare for irresponsible homebuyers is a good thing.

Regarding the ’03 cuts, if economic growth is the certain result of productive work effort bolstered by investment, and it is, how is it that lower penalties on both would harm ours or any economy? More important, Stiglitz contradicts himself again in noting the massive amount of “foreign” oil that reached our shores in subsequent years. Indeed, imports of any kind are merely a reward for productive economic activity. If the ’03 cuts had hurt the economy, this would have revealed itself through less, not more in the way of imports. Stiglitz would also do well to remember that we’re not “independent” when it comes to all manner of goods, but far from economically enervating, this lack of self-sufficiency is a positive for Americans mostly doing that which they do best. Put simply, self-sufficiency of the economic variety is merely a kind term for poverty.

Stiglitz argues that “if you can’t have faith in a company’s numbers, then you can’t have faith about a company at all.” He notes that company issuance of stock options exacerbated the latter, and that the SEC failed to rein this practice in. While this writer would disagree with his position on options, if they’re toxic as he says then the discussion is irrelevant. If stock options give management “every incentive to provide distorted information”, why would CEOs need regulators to tell them to stop issuing them if investor faith is of paramount importance?

With regard to TARP, Stiglitz correctly notes that the whole concept “was an act of extraordinary arrogance” on the part of Paulson and the Bush administration. So true, but in a piece rife with contradictions, Stiglitz contradicts himself yet again. Indeed, in the same paragraph in which he decries banks that “made too many bad loans” he notes that the Paulson plan was faulty for failing to ensure that those same “banks would use the money to re-start lending.”

Stiglitz concludes by drilling down to the supposed “one” mistake that caused this crisis. To him it resulted from the “belief that markets are self-adjusting and that the role of government should be minimal.” What he misses in a column full of misses is that markets were never free to begin with, and they certainly were never allowed to adjust.

A better conclusion would be that free markets are best for wrenching capital away from the destroyers of it so that it can be placed in the hands of those who will treat it well. Put simply, in a true free market there would never be government bailouts precisely because a system of free exchange is too important to be wrecked by the blunt hand of government.

The Sarbanes-Oxley Act is a recent example of reactionary regulation. In July of 2002, the Act was passed in the Senate with a 99-0 vote and in the House with 423-3 vote during the same month as the WorldCom collapse.

Since its passage in 2002, for many, Sarbanes-Oxley has become the poster-child of unnecessary regulation, inept Congressional interference in the capital markets and a failure by the Securities and Exchange Commission to promote efficient markets. The principle criticism of the Act relates to the unnecessary and negative impact many presume it to have upon the competitiveness of the U.S. capital markets and the resulting impact of companies preferring to raise capital overseas.

The mere reference to, or mention of, Sarbanes-Oxley often evokes an instant negative reaction by finance and business people. Since its passage, Sarbanes-Oxley has now become the focal point around which many deregulatory arguments are made and many of these arguments had gained support, until the onset of the current liquidity crisis.

The deregulatory tide of the past few years has now turned and the credit crisis has given substantial strength to a pro-regulatory movement. Fed Chairman Bernanke, Treasury Secretary Paulson and SEC Chairman Cox – previously regular supporters of deregulation – seem to have each conceded that there have been failures in one way or another of the regulatory structure. Given the current crises, any other position would seem absurd. Nevertheless, Congress and the new administration must be reserved when they begin to consider new regulations in 2009.

In 2002, a lack of confidence in market information and transparency was at the heart of the crisis. As a result, regulatory action to re-establish market confidence was the order of the day.

The crisis of this day is one of liquidity. Actions such as TARP and other governmental bailouts are the manner in which the liquidity crisis is being addressed in the short-term. Many are currently criticizing TARP and the other government bailouts, and there will be many instances where hindsight will reveal mistakes associated with these bailouts.

Hindsight has also revealed mistakes in the passage of the Sarbanes-Oxley Act.

A defense in 2002 of quickly enacting Sarbanes-Oxley without thorough review and consideration of the unintended consequences, sounds a lot like the tone of the current defense of TARP and other bailouts. The argument generally goes, “better to do something in a time of crisis to restore confidence and get it partially right, than to do nothing at all.”

When Congress returns to consider new regulations, they need to remember that regulation is not the short-term fix to the current problems and speed is not the principal concern. Forcing unnecessary regulations will only further stifle a market recovery. Regulations impose a real and immediate increase in the cost of doing business, further feeding recessionary forces in much the same way that a tax increase could stifle economic recovery.

Congress and the regulators now need to thoughtfully and carefully consider any changes to be made and be cautious not to enact regulatory reform simply because reforms are popular following a crisis. There were clearly some regulatory and legislative failures leading to the current problems, but these problems are not in every corner and they do not need to be addressed by excess regulation.

Much criticism has been aimed at the SEC and Chairman Cox for the SEC’s failure to be at the forefront of actions taken in response to the current crisis. This criticism highlights a misunderstanding of the SEC’s powers and the cost of new regulation during a time of economic crisis. In a liquidity crisis, money is the way to address the short-term issues.
Unlike the Treasury Department and the Federal Reserve, the SEC has no money to spend to address the liquidity issues. Enacting or pursuing reactionary regulation simply in the name of doing “something” would inevitably lead to detrimental and unintended consequences and may assist in prolonging the recession. The SEC’s restraint should be applauded instead of criticized.

In the frenzied political and regulatory environment in which we currently live, it is easy to get caught up taking action without deep analytic review and there is substantial pressure from constituents to take action …. any action, simply to avoid criticism for doing nothing. When it comes to enacting new regulations, a decision to take action simply for the sake of doing something is, in this case, worse than doing nothing.

These companies would fold, millions of jobs would be lost, and America would lose a national-security linchpin. To top it all off, the survival of the middle class may be at stake, or so we're told.

Michigan's senior senator, Carl Levin, acknowledged on National Public Radio earlier this month that taxpayers may be reluctant to bail out Detroit. But he added: "I think everybody wants the middle class to survive, and the manufacturing centers of this country — wherever they are — have been a great source of the middle class to this country."

Fellow Senate Michigander Debbie Stabenow has said: "To fundamentally have a middle class in this country, we need to support the people who started the middle class: the automakers."

Both Levin and Stabenow may be taking a cue from UAW President Ron Gettelfinger, who has told union delegates that "the real issue is the backbone of America — an industry that does more for the economy than any other industry and, quite frankly, made the middle class what it is today."

Did Detroit really do all that? If so, then America had no middle class to speak of until the early 20th century.

Most historians would find that idea strange, but it springs from a view of history that seems widely held in the labor movement and the Democratic Party. This is the theory that unions essentially created the modern middle class in the mid-20th century by boosting the wages and benefits of millions of manufacturing workers.

You might call this the liberals' Middle Class Creation Myth. The auto industry is central to that tale not because of its bosses but because of the UAW, whose lavish contracts set the standard for the rest of organized labor. So all the talk today about saving the auto industry in order to save the middle class is really about preserving those union contracts.

The Big Three could survive and maybe even thrive by cutting their wage and benefit costs to the levels enjoyed by Toyota, Honda and other foreign companies that make cars in the U.S. Bankruptcy protection (or a similar government-supervised process) would release Detroit from its current UAW contracts and enable it to speed up the process, now far too slow, of closing that labor-cost gap.

We doubt if that is what Stabenow and Levin want. It's certainly not what Gettelfinger would want. But it's what Detroit needs to become competitive again. It's also what autoworkers need if they want to keep their jobs for the long term.

History teaches a couple of lessons here. One is that, as the labor movement boasts, wages and benefits did indeed rise in the late 1940s and 1950s, when private-sector unions were at their maximum strength.

But another lesson is that American industry had unusual advantages during that time, when Europe and Japan were still rebuilding and offered no serious competition. It was a phase that could not last, and unions could not stem the drain of jobs out of the U.S. manufacturing sector.

No fact makes this point better than the UAW's own dramatic shrinkage, from 1.5 million members in 1979 to fewer than half a million today. Such is the downside to a strategy of raising wages through collective muscle. When labor gets priced to a point where a machine can do a job more cheaply than a worker, the worker is out of a job.

So there has to be a better way to build an enduring middle class. In fact, there is. Long before the UAW was founded or the first car rolled off the assembly line, Americans were working their way into the middle class through education and individual initiative. Many have made that move up by way of Detroit. But Detroit is only one of myriad routes that the enterprising can choose.

In the ensuing years we’ve rolled much of our infrastructure spending into politically popular but ineffective anti-poverty and “community development” programs. We’ve redefined “infrastructure” to mean everything from senior citizen centers to “historic renovations” of old, unused train stations. In the process we’ve neglected basic, essential investments in roads and bridges, so that even when the feds do ante up new money every few years, much of what the states and cities do with it is fill potholes and pave over neglected roads. As the Washington Post recently observed, this is not exactly “the stuff of history,” not spending that will secure our long-term economic future.

To understand what I mean, take a look at one of the biggest lists of “to do” projects handed to the Obama team. In a report dubbed Ready To Go, the U.S. Conference of Mayors lists thousands of spending proposals totaling a whopping $73 billion. The aim of the report is to answer critics who say that infrastructure spending rarely helps the economy in the short term because it takes so long to get projects off the ground. By contrast, these projects have already passed the planning stage, gotten their approvals and are just awaiting a federal tooth fairy.

But in the process of trying to impress us with this list, the mayors do the opposite. They help demonstrate how we’ve managed to trivialize infrastructure spending. If this is what our municipalities have been devoting their planning energies to, they need to go back to the drawing board.

The first clue that something is seriously awry is the fact that a big chunk of these projects, more than 2,400 of them, have been conceived as part of the Community Development Block Grant program, a repository of ineffective federal spending at best, and patronage and corruption at worst. Conceived during the Nixon years, the CDGB was meant to help urban municipalities rebuild deteriorating neighborhoods. But billions in federal dollars went into places where crime was rising, schools were failing, working people were fleeing, and local officials didn’t have a clue how to address these problems. The new construction did little to offset such powerful forces and the money was largely wasted. To save the heavily criticized program, the feds did the only logical thing: They expanded it to middle and upper income municipalities, thereby quieting criticisms and setting off waves of spending on tennis courts, recreation facilities, cultural centers, historic downtown preservation projects and the like. In the process we also made CDGB one of the biggest homes of Congressional pork.

Looking over the latest list of CDGB projects proposed by our cities, one can’t help call to mind New York City Mayor Michael Bloomberg’s comment that massive new federal infrastructure spending could help America become more competitive internationally. Surely when he said that, the mayor wasn’t referring to the several dozen community pools and recreation centers that are on the list handed to Obama by the mayors. Gastonia, North Carolina, for instance, wants $22.4 million for something called Big Splash, which includes an aquatics center (which at least sounds fancier than a pool), a fitness facility (is that a gym?) and “quality meeting space.” Maui in Hawaii, where the temperature is almost always in the 70s, wants $6 million to install solar heating systems in its community pools. Tulsa wants nearly $10 million to renovate three town pools. Jackson, Mississippi, seeks $10 million to construct four ‘natatoriums,’ that is, indoor swimming pools. Dayton, Ohio, wants $13 million to build a complete recreation complex that is “region class,” which means competitive with recreation facilities in the suburbs. Atlanta wants $39 million simply to renovate rec centers throughout the city. The report doesn’t explain why the feds should finance such projects.

When Uncle Sam is your sugar daddy, you can justify spending money on lots of marginal projects of questionable economic value, ranging from cultural centers that can’t support themselves to “heritage” tourism trails to “greenways” (Wikipedia definition: a long, narrow piece of land, often used for recreation and pedestrian and bicycle traffic. ) Orlando needs a mere $245,500 for a Center for Multicultural Wellness & Prevention, which is small change compared to Dallas, looking for $18 million for phase II of a Latino cultural center (the report doesn’t say how much Phase I cost, or whether there needs to be a Phase III). Livermore, California, wants $1.6 million to renovate an historic farm, while Savannah is asking for $3.6 million to refurbish the historic building that houses its tourism information center. Philadelphia is one of more than a dozen cities looking for money for greenways. It wants $5.1 million for a pedestrian bridge to allow its citizens “unobstructed access” to something called the East Coast Greenway trail network. Can’t you just hear the economy humming along once these projects get off the ground?

To be fair, there are also thousands of projects on this list organized under the basic heading of “streets/roads.” Yet taken together they hardly amount to a 21st Century version of the federal highway program. In fact, much of the spending is for repairs and renovations that cities and states have been neglecting—pot hole filling, in other words. Birmingham needs $12 million to install ramps on streets around town which would make the city’s streets comply with the Americans With Disabilities Act. Anchorage wants $15 million for “rut repair,” while St. Louis wants $4 million to reconfigure an on-ramp on I-55.

If this stuff doesn’t inspire you, too bad. Obama has said states and cities will have to “use it or lose it,” meaning that the federal dollars will flow to places that are ready to spend them. That’s not exactly a blueprint for spending that will matter over time. It is rather a prescription for a gusher of federal dollars that will delight the construction industry and local politicians but produce the same kind of fleeting stimulus as those rebate checks the IRS sent us earlier this year.

Of course, Obama doesn’t need to let all of this spending go forward. He can attempt to do what every president since Ronald Reagan has promised but failed to do, which is to narrow the scope of federal spending in cities and states by more carefully defining what Washington is willing to invest in, with an emphasis on spending that has some long-term purpose beyond recreation or cultural edification. And he can fight to end the Congressional earmarking process that infects these programs. That would be the kind of change that many Obama voters thought they were lining up to support. And it might provide a legacy that was, if not as impressive as the federal highway construction program, at least not as inconsequential as the stuff that’s being proposed to Obama today.

However, the really big news is not the fed funds target. It’s this sentence:

“The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level.” (Italics mine.)

The Fed goes on to say it will purchase large quantities of agency debt -- meaning Fannie and Freddie -- and more mortgage-backed securities (quite possibly toxic assets). In other words, it wants to drive mortgage rates down. What’s more, the Fed may buy long-term Treasury securities, also to drive bond yields lower. And it will purchase the Term Asset Backed Securities Loan Facility in order to finance consumer-related bonds and pump liquidity to consumer lenders.

The message here is that Bernanke & Co. is locked and loaded, ready to shoot every last bullet to help credit markets and the economy. In particular, the Fed is formally adopting a Milton Friedman-type approach that is directed at expanding its balance sheet and stimulating the economy.

The Fed’s balance sheet already has more than doubled from roughly $900 billion to $2.2 trillion. For all we know it may soon double again. Money-supply measures are already growing at 7 to 8 percent.

And while some economists worry about higher future inflation from all this money-creation, Tuesday’s consumer price report actually showed deflation of 10 percent annually over the past three months. That gives the central bank ammunition to ignore inflation and aim instead for a massive monetary easing.

Will it all work? In the short-run it may. But is a near-zero interest rate, and even more pump-priming, really the best longer-term solution? It’s still troubling that Fed policy lacks a true anchor or compass. In the past, targeting the economy alone has resulted in higher inflation. That’s why many conservatives wish the central bank would keep a sharp eye on the value of the dollar and commodity prices (including gold).

While energy and other commodity prices have experienced a wicked plunge since the summer, in recent days -- ahead of the Fed’s new policy decision -- the dollar has fallen and commodities have rebounded. But the question is this: In the future, will the Fed be able to unwind its huge cash-liquidity injections? The same can be asked about government bailouts for banks and quite possibly Detroit. Yes, this is an emergency. But it’s also unprecedented government intervention in the economy. How we restore traditional free-market capitalism remains unsaid and unknown. That is worrisome.

Stocks cheered the Fed’s move by rallying nearly 400 points on Tuesday. Savvy investors Ken Heebner and Robert Doll -- two financial and political conservatives -- strongly endorsed the Fed moves on CNBC. This massive easing almost certainly underscores the likelihood that stocks bottomed on November 20. Both the monetary surge and the upturn in equities are pointing to economic recovery next spring or summer.

Meanwhile, on the fiscal policy front, everyone has been focusing on Obama’s huge big-government-spending infrastructure play. But Team Obama is also drawing up plans for a massive purchase of mortgages in order to get long-term borrowing rates down to 4.5 percent -- a full percentage-point drop. The specifics are sketchy, but there’s no question the Obama Treasury, led by Tim Geithner, will be working hand-in-glove with Geithner’s former Fed boss Ben Bernanke to drive down mortgage rates and stop the housing slump.

Perhaps Bernanke himself scored a few points with his historic shock-and-awe easing move. It’s as though Bernanke is telling the new president: Hey, I’m on your team.

But I still believe the best economic stimulus would be a move to cut tax rates across-the-board for individuals and businesses. No matter how much money the Fed prints, or how many roads or mortgages Uncle Sam buys, none of it creates new incentives for private enterprise, risk-taking, and investment.

To complement the Fed’s easy money, permanent tax cuts would increase the production and investment that would soak up the excess money and create non-inflationary growth. Alas, supply-side tax cuts are nowhere to be found right now.

For the first time, the government is supporting mortgages and consumer borrowing — up to $800 billion worth. As critics complain that banks have lured consumers into mountains of unaffordable debt, the government is seeking to shore up credit cards, auto loans and other consumer debt.

Timothy Geithner, president of the New York Federal Reserve Bank, has been a key player in these bailouts. He is Obama's choice to be Treasury secretary. Obama himself wants to extend the government's new programs to support specific companies, including the major car manufacturers, bailing them out at a cost that would begin at $25 billion.

In all these cases the government is seeking to support existing businesses. That isn't laissez-faire. It isn't what free-market advocates support. But it is what Bush is doing and Obama wants to continue.

Corporatism has a history in American economic policy, but it has generally been advanced as a guiding philosophy only in other countries. Corporatism was seen as an alternative to both the egalitarianism of the French Revolution and the laissez-faire economics of Adam Smith, with the state working closely with the different elements of society, especially labor and business.

As the Nobel laureate Edmund Phelps wrote: "The fundamental corporatist idea was to retain the private income, private wealth and private ownership of firms that (were) so central to capitalism (and found in avant-garde examples of market socialism too) but to remove the brain of capitalism — to curtail and to modify the mechanism of experiments and discoveries undertaken by unorganized entrepreneurs and financiers on which capitalism relied. . . . Corporatism sought to interpose the interests of the whole society in a range of decisions affecting the directions taken in the business sector."

We've always had some elements of the corporate state in America — subsidies, tariffs, monopoly privileges, regulatory cartels — but we've prospered because of the freewheeling entrepreneurship and creative destruction that characterizes most of our economy.

In a few short months, the Bush administration has turned the focus of our economy to corporatism. Every day brings another story about businessmen seeking their profits in Washington, not the marketplace:

• Life insurance companies are seeking to buy savings and loan institutions in order to qualify for a piece of the $700 billion bailout fund.

• Realtors and homebuilders are asking for mortgage subsidies, tax credits and interest-rate "buydowns" to stimulate demand for their product.

• Recently "the health insurance industry said" — a pretty corporatist phrase right there — that it would support regulations requiring insurers to accept all customers, regardless of illness or disability, as long as Congress would require every American to buy insurance.

• After Congress turned down a bailout for the car companies, the firms are asking the Bush administration to fund them on its own authority.

Meanwhile, Obama advisers are saying that if the federal government invests billions of dollars in businesses, it should get some influence on company policies regarding foreclosures, lending, executive compensation, environmental effects and product lines.

So politicians would be making important corporate decisions, which means less attention to meeting consumer demands and more emphasis on satisfying outside interest groups.

Some bailout advocates want to go even further.

Jonathan Cohn of the New Republic suggests that the federal government use its new power over the auto companies to fire a General Motors vice chairman who has expressed skepticism about the catastrophic effects of global warming, and congressional Democrats wanted to forbid the firms from filing lawsuits against state environmental regulations.

That's corporatism for you: Big, established corporations get taxpayers' money as long as any dissenting scientific or political opinions are suppressed.

Socialism is dead even in Moscow and Beijing.

The real choice Americans face is whether we want a free market or a corporate state.

Now that the countries of the west have agreed to a three-trillion dollar bailout programme to rescue their banking systems, it is time to look forward and to draw lessons from the crisis. To do this we must understand the causes of the crisis.

The claims that the model of American capitalism has self-destructed are just as misguided as putting the blame on the greed of investment bankers and other groups in society. They only touch the surface of the problem.

The core of the crisis lies in the legal provisions of limited liability. Creditors of corporations have no claims against the personal assets of the owners (shareholders) of these corporations. These liability constraints lead to a systematic disregard of disaster risks – occurrences with only a slight probability bring about gigantic losses. Investors that opt for high-risk projects with high potential gains and losses instead of safe projects with similar average profits can expect to gain, since they only have to bear a portion of the possible losses. If things go well, investors reap the full profit. If things go badly, at worst their losses would be limited to the stock of equity invested, because claims against private assets have been ruled out. This asymmetric situation encourages bold behaviour and risk-taking.

The conclusion that the limited-liability constraint should be eliminated would be too rash, however, because risk-taking also has its merits. Limited liability was introduced in the nineteenth century in the US and Europe in order to avoid uncontrollable burdens being placed on equity holders and to enable entrepreneurs to make enterprising economic decisions that they otherwise would not have had the courage to make. It brought about the productive forces that have created the wealth of today’s generations.

In times of great economic insecurity, however, limiting liability can become a problem because it induces entrepreneurs to become gamblers. As always it is a matter of weighing up the advantages and disadvantages and finding the proper middle ground. The problem of gambling is particularly serious when corporations are allowed to determine the extent of their liability themselves by choosing the ratio of equity to business volume as they see fit. Then they tend to operate with too little equity and distribute to their shareholders too large as fraction of their profits as dividends. The five large US investment banks, of which three have already fallen victim to the crisis, unscrupulously pursued this strategy, their motto being that you can’t lose what you don’t have. The risks created incentives to minimise the stock of equity kept inside the firms, and the small amount of equity capital in turn created incentives to pursue overly risky operations. The interplay of these incentives is the actual cause of the crisis – and this is where reform must begin.

The privilege of limited liability is not a creation of the market; it was granted by the legislator, and because this is the case, the legislator himself must define his real intention. He cannot allow the beneficiaries themselves to make this definition. If they can, they will define the limitation in such a way that they assume almost no liability, as we have seen. US investment banks, which were not subject to American bank supervision, practised their business with equity-asset ratios in the region of 4%, which is much lower than the rate at which private commercial banks operate. In addition, they carried out very complex credit operations outside of their balance sheets, placing them thus away from investor control.

Some may point out in defence that gambling is prevented by the rating agencies. They argue that rating agencies give poor ratings when risks are excessive, forcing the banks to pay higher interest for the money they themselves have borrowed. In this way, so the argument, the market corrects itself and creates the proper amount of caution. The miserable failure of the rating agencies during the present crisis shows, however, how illusory this reasoning is. The agencies did not give sufficient warning, and their AAA ratings were only withdrawn when there was no other alternative. Since they live on the fees they collect from the financial institutions they rated and were dependent on their good-will, they could not afford to tell the truth. The nearly bankrupt major customers of the rating agencies in America were glamorised while comparably robust but smaller customers in Europe were downgraded. This is also how the credit packages with claims against American homeowners, which were already in risky territory, were offered to the world far above value.

The best proof that the rating agencies and other information channels do not function and are not able to reliably inform purchasers of bank bonds and credit packages about the true circumstances lies in the fact that on the capital market equity capital is always more expensive than debt capital. If the purchasers of bank bonds had been correctly informed about the true repayment probability, they would have demanded adequate risk premiums on interest or sufficient reductions in the prices of these bonds, which would have made these liabilities just as expensive for the banks as equity. Finance theory designates this finding as the Modigliani-Miller theorem, after its authors. But this theorem fails to match reality. Everyone uses the leverage effects of debt capital up to the limit that the rating agencies establish in order to achieve higher yields from equity capital. Whoever does not do this and instead raises his equity-asset ratio to increase repayment probability is not rewarded for his virtue by the capital market.

Bank bonds and securitised risks are entwined in a cascade of interlinked legal claims at whose end there is somewhere a real investment project. These are products that even specialists cannot properly appraise. The purchasers are almost never able to assess the true repayment probabilities correctly. Only the sellers that assemble the securitised packages have some idea of what they are selling. In the language of economists, these bank products are lemon goods, that is goods whose quality can only be partially assessed by the customers at the time of purchase and for this reason are usually offered at inferior quality. The sellers exploit the customers’ lack of information by reducing their costs at the expense of quality, knowing that the customers are not able to punish them by refusing to purchase or by demanding price discounts. Quality declines below the quality that would prevail in a market of informed customers. In order to prevent lemon markets, most countries have, for example, food regulators who set the lower limits for quality in food in the form of upper limits for unhealthy ingredients. In the case of pharmaceuticals, quality is safeguarded by the licensing procedures. The loans given to homeowners in the US – and that ended up as mortgaged-backed securities and collateralised debt obligations – are lemon products. In America higher rates of indebtedness are more common than in Germany. But the banks do not have the same claims to the private assets or income of homeowners than in Germany. If a low-income US homeowner chooses, he can hand over his house keys to the bank and has no repayment obligation. Conscious of this limited liability, US homeowners were much too cavalier in taking on real-estate which they could only afford if housing prices continued to rise. The real-estate bubble that began to burst one and a half years ago and that gave rise to the banking crisis arose this way.

Since the Reagan presidency a quarter century ago, Americans have increasingly become indebted to foreign creditors and have made a good life for themselves. They financed their investments from the capital streaming in from foreign countries and instead of saving relied on the increasing value of their real-estate. The deficit on the current account balance, that is the surplus of imported products and services over exports, reached a peak of 5.5% of GDP. This was financed with increasingly more sophisticated investment products that were certified with the stamp of the rating agencies – in the end even the last investment manager of the German state banks noticed what junk was being sold here. The wheeling and dealing has now come to an end. No European bank escaped the painful experience that the expensive value-at-risk models of the investment bankers were just as worthless as the agency ratings.

Politicians must finally face the task of defining legal liability limitations for corporations by establishing strict minimum standards for equity capital requirement for the various business models of the banks, both in America and in Europe. Stricter rules are not a disadvantage for the economy, since the apparently so much more expensive equity capital, whose use is thus made compulsive, is not economically more expensive than debt capital, as shown by the burdens that the taxpayers must now bear. Furthermore, no scarcity of funds would arise as a result, since the savings of the world just suffices – independently of such rules – to finance the investments.

The necessary steps are as follows:

The US must finally participate in international agreements on the harmonisation of banking supervision. These agreements can be based on the Basel-II system, which must be under government control.

Europe needs a common system of financial supervision. Every state must pay for the losses of its own banks.

Investment banks, hedge funds and private equity firms must be subjected to the same rules as commercial banks.

Personal liability limitations for mortgages and other real-estate loans must be lifted in the US and wherever else they exist.

Conduits and other constructs for the shifting of investment banking business from the bank balance sheets should be limited in such a way that the risks that the banks take on are transparent in the bank balance sheets.

Free market advocates that argue against these remedies, without which a market economy cannot survive, confuse the market economy with anarchy. The market economy can only function when it is subjected to traffic regulations. Civil codes in many countries are full of rules that limit private contracts. Only a portion of the contracts that an uncontrolled market economy would develop is allowed, and because of this the system functions. Europe and the world need stricter rules for financial traffic. Such rules do not constitute a systemic break. They are vital for the functioning of the financial capital markets.

Editors’ note: Published originally in German as 'Ende des Verwirrspiels', WirtschaftsWoche, no. 42, 13 October 2008, p. 64-65.

Hans-Werner Sinn is Professor of Economics and Public Finance at the University of Munich, President of Ifo Institute for Economic Research and Director of CES.

Thanks to the modern division of labor that is happily comprised of more and more self-interested individuals the world over, the average person can “know very little and still look like a genius.” And when we’re allowed to freely exchange the fruits of our work specialties irrespective of country border, the range of life-enhancing goods we're able to access grows exponentially. In short, the self-sufficiency that the protectionists in our midst sell us is in the words of Roberts, “the road to poverty.” That is so because we couldn’t possibly make all that we now enjoy without myriad inputs from around the country and around the world.

Roberts’s story takes place at Stanford University in Palo Alto, CA. On the night of an earthquake, Stanford senior and Wimbledon Men’s finalist Ramon Fernandez goes with girlfriend Amy to a local Home Depot to buy flashlights due to a power outage in the area. But with flashlights sold out, Ramon and Amy have to travel to the nearest Big Box.

Flashlights and all manner of goods are plentiful at Big Box, but in response to the post-earthquake surge in demand, Big Box has chosen to double the prices of its most desirable products. Ramon and Amy buy the marked up flashlights, along with batteries and milk, but Ramon is none too happy, and he flies into a rage when he witnesses an immigrant mother being gouged for baby food and diapers.

Soon enough Ramon is leading a protest outside Big Box, and thanks to his notoriety as one of the best tennis players in the world, a variety of local activists, including the grizzled Heavy Weather, attach themselves to his cause. A demonstration is planned at Stanford, and the problem for the school is that Big Box and its CEO are major financial supporters.

At this point, retiring Stanford provost and economics professor Ruth Lieber enters the picture. Amy is a student of hers, and Ruth’s lectures about the remarkable organization that occurs free of bureaucratic oversight is beginning to interest her. One of Lieber’s examples involves the creation of a simple pencil, and in noting the wide array of individual human action that results in one, she shows the class that spontaneous specialization is in fact highly organized.

And what organizes all this remarkable symmetry? It’s not a government appointed director, or a pencil “Czar” if we’re to use present Washington lingo; instead it is prices. Ruth explains that “prices steer resources around the economy” and they “send signals to suppliers in the economy to expand or reduce what they’re making.”

But with a protest against one of Stanford’s biggest benefactors looming, and an even larger donation possibly hanging in the balance, Ruth has a problem. She figures she can’t stop the demonstration against Big Box, but perhaps she can get to know Ramon and in talking to him she can lightly show him the wonders of the profit motive.

Luckily Amy had already told Ramon about this interesting professor, and due to a meeting meant to discuss graduation ceremonies at which Ramon is to speak, Ruth has her opening to get to know him. And from there a series of “chance” encounters between Ruth and Ramon occur.

What’s fun is that since this is a novel, Roberts is able to explain economics within an intriguing storyline. Ruth in no way demands that Ramon cancel the anti-Big Box demonstration, and her failure to do so serves as a positive lesson for him; one in which he develops a greater trust in her wisdom.

And in the series of meetings that follow, both Ramon and reader become the recipients of an engrossing economics lecture told in story form. Ramon lauds Home Depot for not gouging consumers during a time of need, but rather than argue, Ruth acknowledges that “They didn’t profit from you. But then again, they didn’t save a flashlight for you either.” Big Box perhaps “gouged” him, but they also had what he was looking for.

Ramon decries a profit-based society in which the “poor get the dregs”, but instead of running from what is a very real (and positive to this writer) wealth gap in this country, Ruth shows him that what’s important is the lifestyle gap between the rich and poor. Indeed, 100 years ago the vast majority of Americans lacked central heating, or refrigerators or cellphones, whereas today, rich and poor alike generally enjoy all three.

Ramon is the son of a deceased baseball great from Fidel Castro's Cuba, and a Miami-based mother who cared enough to get him out of the country as a child after his father died. But when he defends Cuba for being a “fairer society”, Ruth reminds him that “Traffic only flows in one direction. To America. Nobody’s swimming south trying to get into the worker’s paradise.”

When Ramon suggests that his generation perhaps values happiness over money, Ruth doesn’t so much chastise him as she reminds him of the undeniable good that results from the profit motive. From her standpoint, “Without money and the motivation it provides, we’d have no idea how to serve our fellows.”

And to show him how the drive for profits is highly compassionate, she tells the story of an Israeli entrepreneur who spent twenty years developing an artery-clearing device that did not require open-heart surgery. The entrepreneur did this for profit, but the compassionate result was that many lucky recipients of his innovation got to live longer.

Ruth’s various encounters with Ramon naturally lead to graduation, and the question of whether he’ll use the forum to bash Big Box, and in doing so, possibly create a fundraising problem for Stanford. But rather than ruining a good story, readers would do best to buy a novel that combines an interesting storyline with essential economic lessons.

Indeed, central to Roberts’s book is that market prices bring order to our actions. “Play with prices and you will bring disorder.” A more important statement could not be made, and not just to the casual reader, but to a Washington political class eager to play with all manner of prices in order to “fix” our economy. That being the case, is it any surprise all the disorder presently in our midst?

But since you seem determined not to let General Motors (and maybe Chrysler) collapse on your watch, let’s talk terms.

GM and Chrysler – and more importantly, the United Auto Workers – think they dodged a bullet last week by refusing to give in to the demands of Tennessee Sen. Bob Corker that they bring wage and benefit costs in line with those of the Japanese transplants by a date certain, and soon. They were confident they could let the Senate bill collapse because you would save them without insisting on the same conditions Corker wanted.

Insist. Please. If you do, you give Michigan a shot at an economic future brimming with possibilities. If, by contrast, you save them now without forcing them to change dramatically – even if only to keep them alive until this becomes the Obama Administration’s problem – you will miss an historic opportunity.

This is consistent with your decision-making style, don’t you think? You’re the president who sent the troops into Iraq because you had no confidence in the feckless platitudes of the UN and the International Atomic Energy Agency. You had the courage to fix the problem once and for all. Fixing Michigan requires nothing less.

Since you have GM, Chrysler and the UAW over a barrel, here’s what you need to demand from them:

1. Labor cost parity with the transplants by no later than the end of 2009. UAW president Ron Gettelfinger is trying to insist that they’re already competitive, but in making this argument he conveniently leaves out the cost of retiree health benefits. Most likely, the retirees are going to have to accept major concessions on their health packages. There’s no avoiding this. Labor-cost parity is a must.

2. Work-rule reform. This is a huge hidden cost. Everyone in Michigan has heard the stories of the assembly line that was clacking away until the union steward came running up, complaining that the line was “too productive,” and ordered the whole thing slowed down. Everyone has heard the stories of workers who are under orders to spend every 18 minutes sitting for 17 and working for one. These are not urban legends, as implausible as they sound. Get to the bottom of it, and put a stop to it.

3. Concessions from debt-holders and suppliers are surely necessary, but recognize this: Many of the suppliers have worked for little or no profit for years because the Big Three, unable to control their labor costs, try to compensate by squeezing suppliers on price. That has denied the suppliers capital they could have used to diversify and become less dependent on the Big Three. Reforms in procurement, which would allow suppliers to operate their own business models more rationally, would prevent the kind of crisis in which one company’s potential collapse can bring down so many more.

4. Don’t let Michigan’s state government off the hook. Michigan’s high-tax, high-cost-of-business policies are designed to prop up the Big Three, which gets the exemptions and abatements it needs, at the expense of entrepreneurial ventures. Meanwhile, labor laws here continue to empower unions at the expense of workers who care about productivity. Michigan policymakers are among the beggars. Make them clean up their act as well.

By no means should you stop with these four items, but you should start with them. Michigan will remain a mess unless it is forced to change, and you’re in a uniquely powerful position to wield force. If they protest that a short-term $14 billion lifeline isn’t worth completely reforming our way of life here, say fine. Let your state die, then.

If you play this right, the last act of your presidency could be to bring a state out of its economic dream world and into a position from which it can become competitive in the future.

If you’ve made up your mind that you’re going to do this – and we all know how you get when you’ve got your mind made up – at least impose the kinds of reforms that just might make this $14 billion a decent investment after all.

Since the savings and loan crisis of the late 1980s, regional banks have relied on both deposits and the sale of mortgages and other loans to money center banks in New York to finance home and business loans. Loans sold to money center banks, for many years, were securitized—that is bundled into bonds for sale to insurance companies, pension funds and other fixed-income investors. Those investors have very predicable cash flow requirements, as defined by actuarial tables, and are ideal investors for bonds backed by mortgages and other loans.

In recent years, fixed-income investors were burned by the sharp practices of New York bankers and investment houses. The latter packaged shoddy subprime mortgages into bonds, insured those bonds through the sale of questionable derivatives, and then pawned off shoddy bonds as high-quality investments. The bankers got big bonuses from the wide spreads on subprime loans and derivatives fees.

These schemes were the central to subprime crisis, housing bubble and collapse, and now the crisis of confidence on Wall Street that has poisoned credit markets globally.

Now, fixed-income investors have lots of cash to invest, but are reluctant to buy mortgage and other loaned-backed bonds. The large New York banks are not much interested in creating bonds from loans made by regional banks, because securitizing high quality loans into bonds don’t create the opportunities to write fancy derivatives that pay bankers huge bonuses.

Instead, the New York Banks have taken the massive amounts of loans and capital provided by the Federal Reserve and Treasury to go hunting for new high profit businesses and acquisitions. The presence of federal regulators in their offices keeps them from getting involved in many new schemes but does not solve the shortage of funds regional banks have to lend.

The Fed has other options. It can go out on the yield curve and buy 10-year Treasuries to pull down long rates, such as conventional mortgage rates. That would lower the rates banks pay for deposits but would not increase their deposits; hence, it would not increase the amount of money they have to make loans.

The Fed is buying mortgage-backed Fannie and Freddie Mac bonds, pulling down their rates. However, lowering rates on Fannie and Freddie securities does not make them more attractive to investors.

Ultimately, Ben Bernanke should gather the CEOs of the large money center banks, which have received direct infusions of capital from the Treasury and huge loans from the Fed, together with the biggest fixed-income investors to define the parameters of acceptable mortgage-backed securities. Then, it should require its wards on Wall Street to buy loans from regional banks and bundle those loans into bonds for sale to fixed-income investors.

The Fed could also buy bonds backed by conventional mortgages, just as it has Fannie and Freddie securities. In the end, though, the Fed may have to start lending to the regional banks against solid, prime conventional mortgages and hold the mortgages or securitize those for sale to fixed-income investors directly or through primary securities dealers. The latter are among the banks now receiving Treasury injections of capital and generous Fed loans.

This is all well outside the limits of what the Fed has done since World War II and perhaps ever done, but these are dangerous times.

Simply, the Fed is running out of conventional monetary policy and bond market options.

In the end, if the New York banks won’t do their job, the Fed may have to do it for them.

As far as the Fed’s shock-and-awe, pump priming is concerned, I wrote about it yesterday. But already, the U.S. dollar is plunging. Gold is rising. How much will the Fed prime the pump? There’s no evidence that Bernanke cares one wit about the dollar. Not now, not yesterday, not tomorrow. If the greenback keeps falling, it can’t be good. I thought we learned that in recent years. Let’s not go to palm trees on the trading floor. A zero interest rate and massive pump priming reminds me of Argentina, not the United States.

Look, if we keep depreciating the dollar, the Chinese (our bankers), are going to boycott our bond markets. And then, at some point, longer-term interest rates are going to go up, not down. That includes mortgage rates.

The Fed’s balance sheet, reserve bank credit, is already expanding at 107 percent over the past 52 weeks. The monetary base is rising at a 41 percent pace. M1 and M2 at 8 percent. It’s enough already. Money lags are long and variable, but there’s more than enough stimulus in the system. Banks have more than $500 billion in interest bearing excess reserves. Enough already.

At least Harvard economist Greg Mankiw is being honest when he says the Fed should drop its price stability rhetoric and just come out and say it wants to raise the inflation rate to at least 2-3 percent.

But if we really want to jolt the economy, there’s a tried and true way to do it. Lower marginal tax rates across-the-board for individuals and businesses. Labor and capital costs will be reduced, risk taking and success will be rewarded, and investment will flow back into the United States. A chronically cheap dollar will simply repel investment, not attract it.

On the other hand, there are some positive mustard seeds that could grow into recovery. For starters, the drop in the CPI is boosting real wages. Of course that is an offshoot of the plunge in retail gasoline prices, which means a $350 billion dollar tax cut for consumers. This may be why core retail sales rose ½ percent in November, the first positive reading since July. It’s also a big tax cut for corporate profits.

In fact, for businesses, the plunge in commodity prices in general has balanced out prices paid and prices received. The CPI/PPI ratio has turned positive in recent months. This is a very good sign for corporate profits. And that may be a key reason why stocks have been rising and the November 20th bottom looks like the real bottom.

Another mustard seed is the big decline in the 3-month dollar Libor rate, along with declining short-term credit market spreads in general. There is a thaw in the money market freeze up.

Still another mustard seed is the decline in mortgage rates. This, along with lower home prices, has raised housing affordability to its best level in many years.

In other words, the excesses of the recession are gradually healing. The mis-investment of the recession is gradually being absorbed. The Fed is adding liquidity and that is another plus. I just don’t want them to go hog wild and destroy the dollar in the process. If we maintain a steady currency and provide a much needed tax rate reduction for large and small businesses, and if we allow market forces work out the rest, then the economic patient will heal. That’s my message.

Drilling down: in the wake of the Fed’s shock-and-awe easing, the 3-month dollar Libor rate has dropped 27 basis points to 1.58 percent (the lowest since June 2004), the TED spread has narrowed 25 basis points to 157 basis points (down 307 basis points from the peak), and the Libor-OIS spread has narrowed 30 basis points to 137 basis points (down 227 basis points from the peak).

What’s more, the 2-year swap spread, a market risk indicator, followed up yesterday’s 17 basis point drop with another 4 basis points today. In the process, the swap spread has broken below a support trend line that has been in place since August of last year.

Plus, the Dow Jones and the S&P 500, which have rallied about 20 percent from the lows, have broken above their 50-day moving averages, a bullish sign.

It's a lousy deal that rewards bad management and a stubborn United Auto Workers union. Together, they've made a series of bad decisions led to the U.S. industry's precipitous decline. American automakers were once dominant; today, they control less than half the market. This bailout will do nothing to change that.

Worse, as with the recent bank bailout, the U.S. government might soon become a controlling shareholder in the auto industry, since part of the deal requires GM and Chrysler (Ford isn't taking part) to give the government stock warrants in exchange for loans.

In giving his reasons for, in effect, nationalizing the car companies, Bush was blunt. "Allowing the auto companies to collapse is not a responsible course of action," he said, calling bankruptcy "an unacceptably painful blow to hardworking Americans."

But the fact is, the industry will now get money for doing nothing. No restructuring and no rewritten labor contracts, which are what the industry needs. This deal only buys time for the industry until March, when the loans come due.

Mark Zandi, chief economist at Moody's Economy.com, estimates the automakers will need $75 billion to $125 billion to stave off bankruptcy. Better to bite the bullet now with bankruptcy than have this massive bailout cost hanging over a struggling economy.

So why did Bush buck his party in Congress and accept a bailout? With a month left in office, no doubt he has governing fatigue. After the financial crisis and nonstop battering by the left-leaning mainstream media, he has little political capital to spend. He can't force the auto companies and unions to make concessions.

And being the decent man he is, Bush is keen not to hand President-elect Obama a major crisis on his first day in office.

That said, this bailout comes up short in a number of areas, starting with the fact it might not even be legal. Remember, the money will come from the $700 billion Troubled Asset Relief Program. But TARP was explicitly created to bail out financial institutions.

Moreover, though the bailout deal limits executive pay and, symbolically, forces the Big Three to mothball their fleet of corporate jets, it really requires them to do little else.

What it does do is set "targets" for future action, such as getting rid of the UAW's notorious "jobs bank," slashing dividends and cutting workers' pay to make them competitive again with profitable foreign car companies. But no one can force them to accept this.

The loans can be called in as early as March, if the auto industry isn't deemed "viable" by then. So expect the Big Three to be back for more cash in just a few months, with little to show for what they did with the last chunk they got.

It's true, as bailout supporters say, that the auto industry is very important to the U.S. economy. It accounts for 4% of GDP, 20% of manufacturing GDP, and employs more than a million workers.

That said, the Big Three together are losing $6 billion a month, and all of those jobs are now in peril. This bailout doesn't improve the picture one bit. Bankruptcy would have been better.

Let me first set the scene by making three observations on where we are today. First, in the advanced countries, we have probably seen the worst of the financial crisis. There are still land mines, from unknowable credit default swap (CDS) positions to hidden losses on balance sheets, but the worst days of frozen money markets and obscene risk spreads are probably over.

Second, and unfortunately, the financial crisis has moved to emerging countries. In crossing borders, the sharp portfolio reallocations and the rush to safer assets are creating not only financial but also exchange-rate crises. Add to this the drop in output in advanced countries, and you can see how emerging countries now suffer from both higher credit costs and decreased export demand.

Third, in the advanced economies, the hit to wealth, and even more so the specter of another Great Depression, has led people and firms to curtail spending sharply. Not only have they revised their spending plans, but, in many cases, they have delayed purchases, waiting for the uncertainty to clear. The result has been a sharp drop in output and employment, reinforcing fears about the future, and further decreasing spending.

Let me now turn to policy. If my characterization of events is correct, then the right set of policies is straightforward:

First, the measures put in place earlier to repair the financial system must be refined and consolidated. One silver lining of the worst days of the crisis in October was to scare governments into action on the financial front. Central banks generously provided liquidity.

But governments soon realized that the main issue was solvency. They pledged to implement programs aimed at asset purchases (to clarify the balance sheets of financial institutions), recapitalization (to make sure that, if solvent, they could operate and continue to lend), and guarantees (to reassure depositors and some investors that their funds were safe).

The basic architecture for these measures is now in place, but the implementation has been often haphazard. Lessons from previous banking crises around the world could have been learned faster. The twists and turns in some of the programs, most notably in the United States, have left markets confused, and have led private investors to stay on the sidelines, waiting for policy clarification before taking a stake in financial institutions. I have little doubt that learning by doing will eventually lead to coherent programs. But time has been lost.

Second, emerging market countries must get help in adjusting to the financial crisis. It is not just a question of providing them with liquidity so that they can simply maintain their exchange rates in the face of a large capital outflows. Many investors who want out will not return for some time, and countries must accept this fact and adjust accordingly.

In some cases, they can do this on their own, so all that is needed is liquidity support to avoid a collapse of the exchange rate and allow for the adjustment to occur. In other cases, the capital outflows only worsen already difficult situations. These countries need more than liquidity; they need financial help to carry out the necessary adjustments.

Are the proper help measures in place? Yes and no. For a few countries, the main central banks have provided access to liquidity through swap lines. The International Monetary Fund, for its part, has created a new liquidity facility, enabling countries that pre-qualify to apply and get funds with little or no conditionality.

For the time being, these arrangements have been sufficient. But liquidity provision needs to be provided on a more coherent and comprehensive basis. As for countries that need more help, this is the IMF's natural function. A number of countries have already obtained funds under program lending. One may reasonably worry that the available funds will be depleted before the crisis is over.

Third, governments must counteract the sharp drop in consumption and investment demand. In the absence of strong policies, it is too easy to think of scary scenarios in which depressed output and troubles in the financial system feed on each other, leading to further large drops in output. It is thus essential for governments to make clear that they will do everything to eliminate this downside risk.

Can they credibly do it? The answer is yes. With interest rates already low, the room for monetary policy is limited. But the room for fiscal policy is wider, so governments must do two things urgently. First, in countries in which there is fiscal space, they must announce credible fiscal expansions; we -- the IMF -- believe that, as a whole, a global fiscal expansion about 2 percent of world GDP is both feasible and appropriate.

Finally, and just as importantly, governments must indicate that, if conditions deteriorate, further fiscal expansion will be implemented. Only with such a commitment will people and firms be confident that we are not headed for a repeat of the Great Depression, and start spending again.

My strong belief is that if these policies are followed, by the end of 2009, if not sooner, the world economy will start recovering from the crisis.

Olivier Blanchard is chief economist of the IMF and a professor of economics at MIT.

While honest businessmen drown in SarbOx compliance costs, reaching into their pockets to pay swarms of accountants, Bernie Madoff was reaching into the pockets of pudding-for-brains investors robbing them blind right under the SEC's nose.

Is it possible that there are not already enough regulations on the books to uncover an old fashioned Ponzi scheme? What have the people we pay $900 million dollars a year at the SEC been doing? Perhaps they should find jobs better suited to their talents. Would you like fries with that?

Did you ever try to complete a FAS 157 mark-to-market valuation for a startup company consisting of a professor, a pending patent, and a PowerPoint presentation? What is the "fair market value" of a business so close to infancy that it has no saleable products, no revenues, and no customers? Beats me, perhaps we should consult General Motors.

But savvy investors don't just put their faith in regulators, do they?

Independent accounting firms and bond ratings agencies help inform decisions. Heaven forbid anyone should take the time to do their own due diligence.

A Danish IT entrepreneur recently confessed that he has been running a $185 million sham operation whose only business was to swindle banks. Were you surprised when you learned that two of the big four public accounting firms had audited his books finding no problems and a third awarded him an entrepreneur of the year award on the very night he went on the lam?

A Credit Default Swap is an insurance product. We have more insurance regulations than Illinois has unconvicted felons. These require insurance companies to acquire and prudently manage portfolios of diversified assets large enough to pay anticipated claims under the worst possible circumstances.

How is it that not a single insurance regulator blinked when every boiler room operation on the planet started selling insurance on complex mortgage securities spit out by Government Sponsored Entities that everyone knew were out of control? Hey, they were government sponsored, what could go wrong? Instead of prudently investing the premiums, the dealers backed their commitments with ... IOUs from other boiler room operators peddling insurance written on the identical underlying securities! How could this risk-kiting scheme have done anything else but implode?

Once exposed, surely regulators would levy fines on the miscreants to discourage this from every happening again? Don't be silly. Congress wrote them all checks made out on your account! Albert Einstein once stated, "the problems we face will not be solved by the minds that created them." Is it possible that the same Congressmen who were the primary facilitators of Fannie & Freddie could really be the lead dogs slavering to write all the new regulations that await us? But of course!

They give such natty tongue lashings on TV. Is this what Menken meant when he said that in a democracy voters get what they deserve - good and hard?

"Deregulation" is largely a media fantasy. The absurdity and ineffectiveness of our ever expanding regulatory universe knows no bounds.

The FDA is in charge of preventing drugs from reaching the market that might have adverse side effects on one in a million people. Who protects the thousands of people who die every year waiting for drugs that never get approved?

Have you ever petitioned the Medicare gatekeepers for reimbursement approval on a new medical product or service? Have you read Kafka's novel "The Trial?" Kafka clearly worked for a healthcare startup.

I once looked at investing in an entrepreneur who figured out how to inexpensively track and uniquely bar code every strawberry you eat. It's pretty clever, and I can see why grocers might be willing to pay a penny more for fruit they can intelligently pull off the shelves, or not, should CNN report a salmonella outbreak in Duluth. How long do you think it will be before this novel innovation becomes mandatory? And how soon after will the four hundred pages of fruit-tracking regulations churned out annually by the new Bureau of Diarrhea Protection metastasize into a club that a handful of agribusinesses can use to bludgeon smaller competitors to death with compliance costs?

Once carbon footprint accounting becomes law, can paperwork requiring farmers to track cow flatulence be far behind? Can we at least make the big four personally audit those?

Cast your eyes around your room and count the number of products that have been touched by a regulator. Email me the number, and drop me a line if you find one that hasn't. Yet why is it that there are never any consequences when existing regulations don't deliver the intended benefits? Instead we get a clamor for more regulations, ignoring the predictable unintended consequences that regularly drive whole industries either into bankruptcy or out of the country.

Perhaps you believe a magic Change in our federal sausage factory will make the new regulations about to rain down on us more intelligent and effective than the regulations so easily evaded by Bernie Madoff. What do they call someone who expects different results when the same experiment is conducted over and over again?

We are in the midst of the worst financial crisis since the 1930s. The salient feature of the crisis is that it was not caused by some external shock like OPEC raising the price of oil. It was generated by the financial system itself. This fact - a defect inherent in the system - contradicts the generally accepted theory that financial markets tend toward equilibrium and deviations from the equilibrium occur either in a random manner or are caused by some sudden external event to which markets have difficulty in adjusting. The current approach to market regulation has been based on this theory, but the severity and amplitude of the crisis proves convincingly that there is something fundamentally wrong with it.

I have developed an alternative theory which holds that financial markets do not reflect the underlying conditions accurately. They provide a picture that is always biased or distorted in some way or another. More importantly, the distorted views held by market participants and expressed in market prices can, under certain circumstances, affect the so-called fundamentals that market prices are supposed to reflect.

I call this two-way circular connection between market prices and the underlying reality "reflexivity." I contend that financial markets are always reflexive and on occasion they can veer quite far away from the so-called equilibrium. In other words, financial markets are prone to producing bubbles.

The current crisis originated in the subprime mortgage market. The bursting of the US housing bubble acted as a detonator that exploded a much larger super-bubble that started developing in the 1980s when market fundamentalism became the dominant creed. That creed led to deregulation, globalization, and financial innovations based on the false assumption that markets tend toward equilibrium.

The house of cards has now collapsed. With the bankruptcy of Lehman Brothers in September 2008, the inconceivable happened: The financial system went into cardiac arrest. It was immediately put on artificial respiration: The authorities in the developed world effectively guaranteed that no other important institution would be allowed to fail.

But countries at the periphery of the global financial system could not provide equally credible guarantees. This precipitated capital flight from countries in Eastern Europe, Asia, and Latin America. All currencies fell against the dollar and the yen. Commodity prices dropped like a stone, and interest rates in emerging markets soared.

The race to save the international financial system is still in progress. Even if it is successful, consumers, investors, and businesses are undergoing a traumatic experience whose full impact is yet to be felt. A deep recession is inevitable and the possibility of a depression cannot be ruled out.

So what is to be done?

Because financial markets are prone to creating asset bubbles, regulators must accept responsibility for preventing them from growing too big. Until now, financial authorities have explicitly rejected that responsibility.

Of course, it is impossible to prevent bubbles from forming, but it should be possible to keep them within tolerable bounds. This cannot be done simply by controlling the money supply. Regulators must also take into account credit conditions, because money and credit do not move in lockstep. Markets have moods and biases, which need to be counterbalanced. To control credit as distinct from money, additional tools must be employed - or, more accurately, reactivated, since they were used in the 1950s and 1960s. I refer to varying margin requirements and the minimal capital requirements of banks.

Today's sophisticated financial engineering can render the calculation of margin and capital requirements extremely difficult, if not impossible. Therefore new financial products must be registered and approved by the appropriate authorities before being sold.

Counterbalancing the mood of the market requires judgment, and because regulators are human, they are bound to get it wrong. They have the advantage, however, of getting feedback from the market, which should enable them to correct their mistakes. If a tightening of margin and minimum capital requirements does not deflate a bubble, regulators can tighten some more. But the process is not foolproof, because markets can also be wrong. The search for the optimum equilibrium is a never-ending process of trial and error.

This cat-and-mouse game between regulators and market participants is already ongoing, but its true nature has not yet been acknowledged. Alan Greenspan, the former US Federal Reserve chairman, was a master of manipulation with his Delphic utterances, but instead of acknowledging what he was doing, he pretended that he was merely a passive observer. That is why asset bubbles could grow so large during his tenure.

Because financial markets are global, regulations must also be international in scope. In the current situation, the International Monetary Fund (IMF) has a new mission in life: to protect the periphery countries against the effects of storms that originate at the center, namely the United States.

The US consumer can no longer serve as the motor of the world economy. To avoid a global depression other countries must also stimulate their domestic economies. But periphery countries without large export surpluses are not in a position to employ countercyclical policies. It is up to the IMF to find ways to finance countercyclical fiscal deficits. This could be done partly by enlisting sovereign wealth funds and partly by issuing Special Drawing Rights so that rich countries that can finance their own fiscal deficits could cede to poorer countries that cannot.

While international regulation must be strengthened for the global financial system to survive we must also beware of going too far. Markets are imperfect but regulations are even more so. Regulators are not only human; they are also bureaucratic and subject to political influences. Regulations should be kept to the minimum necessary to maintain stability.

George Soros is Chairman of Soros Fund Management.

On Sunday, the Associated Press found that $1.6 billion of bailout cash was converted to gravy for 600 bankers. They got bonuses, club dues, financial planners, corporate jet travel, daily limousines and home security systems, courtesy of the taxpayers.

This is a bad sign of what's ahead if failure continues to be rewarded and government keeps propping up uncompetitive companies and industries in crisis.

It's obvious these banker bonuses had no correlation to productivity or performance. In the real world, enterprises provide such benefits only when executives produce results — that is, profits.

On Monday, for example, executives of Caterpillar gave up compensation to ensure that their firm would survive. The banks — especially investment banks — seem to play by different rules.

AP asked 21 bank spokesmen how their companies were spending their taxpayer money and got only evasive answers. Goldman Sachs told AP it needed to retain and motivate its talent to ensure its "continued success," not mentioning where this talent is threatening to migrate in a global and industry downturn.

To take bailout money, even a mere $1.6 billion, and blow it on bonuses is a violation of the public trust.

We reluctantly backed the bailout because banks' main product, money, is a critical medium of exchange. But to use it for perks makes voters distrustful and cynical, and far more reluctant to save cash for a real crisis.

It also makes other bailout mendicants far less willing to make necessary sacrifices. The United Auto Workers cite the bank bailout as reason to not give back bloated benefits that render the Big Three uncompetitive. Their argument has just been fortified by the bank bonuses.

But with unemployment rising fast, there's a real crisis and real sacrifice is necessary, especially from those who require the federal bailouts. Bank bonuses should wait until these banks are profitable; so should raises in inflated salaries.

Maybe Goldman's $600,000 earners can make do on the $400,000 salary of a U.S. president or the $200,000 salary of a senator to show some sort of leadership. At a time like this, they should be marshaling all their resources to invest in viable growth.

The agreements set goals for automakers: converting two-thirds of their debt into equity; paying company stock to fund one half of the Voluntary Employee Benefits Associations, which fund retiree health care benefits and remove these costs from future liabilities; aligning wages, benefits and work rules with U.S. Nissan, Toyota or Honda operations.

These goals are generally consistent with the conditions I outlined as necessary for the Detroit Three to achieve viability when I testified before the Senate Banking Committee on Nov. 18. For example, laid-off workers could no longer sit in the Jobs Banks collecting 90% of pay and benefits indefinitely and engaging in productive activities like pinochle.

Financial viability requires projecting a positive net present value, taking into account all current and future costs. It does not require a positive cash flow by March 31. Wage and benefit cuts need be accomplished only by Dec. 31, 2009.

Given the depressed auto market, a positive cash flow cannot be accomplished soon, and GM and Chrysler will be asking for more federal loans when they table their plans by March 31. If the auto market stays depressed into 2010, Ford will likely seek assistance. Given the likely duration of the recession, loans of well over $100 billion will be needed. Much of those could prove gifts, with the loans never truly repaid.

Unless the carmakers significantly reduce their debt, jettison retiree legacy liabilities, and align wages, benefits and work rules with those of Japanese transplants, they cannot hope to be consistently profitable.

Yet the agreement permits the automakers to vary from those conditions if they can still demonstrate a net positive present value. Enter the accounting magicians.

UAW contracts are exceedingly complex. GM and UAW leaders have mastered obfuscating the consequences of their pay structure and work rules. Calculations of net present value will hinge on forecasts of future car sales and wages paid by Toyota, Nissan and Honda.

A few quick pen strokes and a lousy business plan can be made a winner, with costs to taxpayers in unpaid loans becoming apparent years later.

Barack Obama owes organized labor a huge debt for his November victory. UAW President Ron Gettelfinger can be expected to try to sell Obama labor agreements that appear to create more concessions than are real and leave the Detroit Three in the red.

Fooling Obama would create loans the Detroit Three never can really repay. The government could force payment at the expense of the next creditors in line — the large U.S. banks — but the federal government is already subsidizing their losses.

One way or the other, ordinary citizens who don't earn nearly the pay and benefits autoworkers receive would be paying taxes to subsidize their rather generous lifestyles, much as taxpayers are financing the bloated bonuses at large New York banks requiring federal dole to stay afloat.

President Bush has punted the auto mess to his successor, and one of three outcomes is possible.

President Obama can require the carmakers and UAW to come up with a contract ordinary mortals can understand, eliminate all the foolish job classifications and work rules, and establish pay rates that make the Detroit Three competitive.

Obama can push the automakers into a prepackaged Chapter 11, perhaps by providing some financing to ensure suppliers are paid and companies can continue to operate, and let a bankruptcy judge impose the essential conditions of the Bush agreement.

He can let the Detroit Three continue their profligate behavior, providing subsidies masquerading as loans.

Obama faces the same kind of tough choice Bush did when he lavished generous subsidies on agriculture at the beginning of his presidency. If Obama caves to union pressures and chooses to subsidize the carmakers, other unionized industries will line up. Market discipline will not apply to the 8% of private work force represented by unions, and damn the majority that really elected him.

Peter Morici is a professor at the University of Maryland School of Business and former chief economist at the U.S. International Trade Commission.

In a 2003 speech made while vice chairman at the Fed, Bernanke spoke of looming inflationary pressures thanks to high levels of U.S.-based capacity utilization, and in a July 2005 op-ed for the Wall Street Journal, Bernanke asserted that there is a “highest level of employment that can be sustained without creating inflationary pressure.” Intriguing thoughts at first glance, but Bernanke’s very assumptions are quickly disprovable once we consider the real-world impact of economic strength.

When labor shortages in a nation’s economy reveal themselves such that wages rise, the latter is a signal to sidelined workers to offer up their services in order to capture higher wages. And since economic strength in one nation is rarely uniform (compare employment rates in Detroit vs. Las Vegas), rising wages in one region of a country also attract workers from areas where jobs are less plentiful. In the end, labor shortages are always moderated by new entrants to tight labor markets.

It should also be remembered that U.S. firms are not solely reliant on workers within these fifty states. As CNN’s Lou Dobbs frequently reminds us, companies with an American address regularly access the world’s abundant labor supply in carrying out their operations. And if that’s not enough, the next time readers pump their own gas or buy gifts and plane tickets on the Internet, they should remember that innovations of the mind allowing self-service are the market’s way of working around labor shortages.

When we consider capacity utilization or what some economists call the “output gap”, the same scenarios apply. If manufacturing capacity is running low in Tennessee, unused capacity in Flint (MI) can be accessed. More importantly, Nike has never manufactured its myriad products stateside, so when Bernanke suggests high capacity utilization in the states could lead to inflationary pressures, he ignores the basic truth that U.S. firms aren’t limited to the available capacity within our nation’s borders.

But of greatest importance is the certain reality that demand is simply the flipside of supply. We can only consume after we’ve produced first. And if we’ve not produced, we must have collateral based on past production so that we can borrow the capital of the productive to facilitate our own consumption.

So while it’s an appealing thought among academics that demand can outstrip supply, the logic is easily disprovable. Our productivity in the workplace is our demand, which means supply and demand in any economy balance. Inflation is always and everywhere monetary in nature, so absent monetary disturbance, demand spikes are by definition preceded by supply spikes.

But with the U.S. economy presently struggling, many are suggesting that deflation is now what ails us. The problem there is that just as strong economic growth cannot cause inflation, flagging economic health can in no way cause deflation. Indeed, all it takes to show why this is the case is to reverse the above scenarios.

If a slowing economy leads to an increase in the supply of available labor, this at first could lead to lower wages and salaries offered by employers. If so, and we’re seeing this already, the number of workers that sideline themselves in response to falling wages rises. There’s also less labor migration from weaker regions, which means falling wages are moderated by a reduction in the supply of workers.

And if wages are falling stateside, there’s less economic incentive for U.S.-based firms to access labor not in these fifty states. “Outsourcing” is the certain result of strong economic growth, but if growth is less than robust, it’s marginally easier for companies to limit their hiring to the states. Lastly, if labor’s plentiful, technological innovations meant to work around labor shortages become less essential.

When the “output gap” is considered, if due to slower growth the alleged gap rises, this simply means unused capacity will no longer be accessed. There would be no pressing need to put mothballed factories in weaker U.S. regions into operation, not to mention production slated for overseas venues would more likely remain stateside.

Most important, however, is the basic truth that supply and demand are one and the same. If discretionary spending among Americans declines, that also means their supply has declined too. And for those who say fear of the future has producers saving more, it can’t be stressed enough that saving in no way detracts from demand. Money saved is merely lent out to others; some with near-term demands. So while it might be appealing to assume that economic declines are deflationary, simple logic tells us that a falloff in demand is nothing more than a decline in supply.

Some of course would reply that clearance and going-out-of-business sales that bring prices down are deflationary, but these examples too don’t pass the most basic of tests. Indeed, falling demand that is met with fire sales is yet another market signal transmitted to producers telling them to manufacture or offer less. So while retail sales are the “deflationary” seen, the unseen is the reduced production that eventually moderates retail pricing. Think the various airlines, and the number of planes they have and will continue to remove from the skies.

In 1992, this writer placed a 30-minute “long distance” call from Austin (TX) to Houston that cost $15. Today, long distance calls anywhere in the U.S. are mostly free. But is this deflation? Not in the least. Thanks to competition making long distance essentially costless, Americans have been able to demand other goods previously unattainable, thus driving up their prices.

And if the theoretical is not enough, we can look at the empirical. If the Fed’s logic were remotely true, recessionary periods in the U.S. would have been deflationary, while strong periods of economic growth would have been characterized by rising prices. In truth, the opposite has always been the case. The U.S. economy experienced no less than four recessions from 1965 to 1982, but far from a deflationary era, there’s a general consensus that we experienced massive inflation. Conversely, from 1982 to 2000, the U.S. economy pretty much grew without interruption, and while the CPI is faulty at best, it registered in the teens in the early ‘80s versus a 2.7% reading at the end of the millennium.

In the end, today’s deflation warnings are a perversion of the concept. Inflation results when the currency is debased, and deflation is the result when the currency’s value rises above a non-inflationary level. With the dollar still testing all-time lows, deflation only exists if we’re willing to completely redefine the notion altogether.

So with the dollar very weak, inflation is our problem, and it’s one that has the potential to get worse if the Treasury and Fed continue to communicate to the markets their nonchalance when it comes to the dollar’s value. Put simply, the Treasury and Fed are presently fighting non-existent deflation with more inflation.

For investors, this is a very bad signal indeed, because stocks despise inflation for it eroding real returns on investments. In short, the deflation delusion foretells many years more of subpar market returns; all this thanks to a misreading of what is a very basic concept.

Not once during the dozens of stories I saw about Buy Nothing Day or about consumers’ general holiday abnegation did anyone, including the reporter or TV producer constructing these accounts, seem to consider that it might actually be counterproductive for those who can afford to spend as much or more this year on gifts to instead spend less. Indeed, many of these stories ran virtually side-by-side with gloomy reports of layoffs, retail bankruptcies, companies cutting wages and eliminating bonuses, and factories going on furloughs because of the difficult holiday shopping environment. Yet it is as if the two stories were virtually unconnected.

Why is it that in tough times it seems rational and even noble to deny oneself, even when doing so only spreads the pain? Much of the reason for this may be that we humans have been living in the modern, consumer-driven economy for just a few hundred years—since the great leap forward of the Industrial Revolution, when technological advances greatly expanded humans’ productive capabilities, vastly increasing standards of living in the process. By contrast, we spent a hundred thousand years or so living in tribes and roving bands where existence was day-to-day and tribal members shared resources to survive. We’re still not always comfortable reconciling the consumerism that’s at the center of our economy since the Industrial Revolution with the egalitarianism of what anthropologists call our deep history.

That’s why during times of economic stress some of us still preach sacrifice and restraint because it appears unseemly to have and consume too much when others are going wanting. Doing otherwise is politically unacceptable. When President Bush, for instance, urged Americans after 9-11 to shop enthusiastically during the 2001 holiday season, critics derided him for emphasizing something as frivolous as consumerism at a time of deep national pain and introspection.

Maybe it’s best that our leaders simply lead by example rather than words. Our President-elect, for instance, is now vacationing with his family in Hawaii after spending nearly two years running a grueling campaign for office. With a hefty bank account thanks to two-best selling books, President-elect Obama isn’t about to deny his family or himself the way those British rich folks are denying themselves their Tobago vacations this year, and our citizens of Hawaii are no doubt grateful to him for his business.

Still, our press and cultural commentators have it in for anyone who spends lavishly during times like this, even if it is a business investing generously in its future. At Major League Baseball’s winter meetings in early December, a number of teams made whopping contract offers to star players who were free agents. The press subsequently roasted these free-spending teams for heaping riches on guys whose only contribution to our society is to hit a fastball at 95 miles per hour, or throw one that fast. What a strange reaction to businesses that are investing to improve their product during a downturn—a perfectly sensible strategy if you have money to spend, talent is available and your competitors are being cautious.

The winter baseball meetings were Christmas come early for a few players, and one hopes they celebrated appropriately by spending some of their new-found wealth and in the process boosting the economy. As one of the 20th Century’s most notable non-believers, Ayn Rand, observed about Christmas, “The gift buying…stimulates an outpouring of ingenuity in the creation of products devoted to a single purpose: to give men pleasure.”

And to give them jobs. There’s still time, though just a little, to renounce your vow of moderation and buy liberally. It’s the least you can do for your fellow man.

This has been the view of the American labor movement for generations. Its perpetuation depends on the rock-solid conviction that labor costs cannot possibly rise so high as to imperil a company – and in any event, it would be wrong to blame the sainted workers if they did.

What separates Mr. Gettelfinger from his predecessors is two things: 1) The folly of his belief in this notion is far more obvious than theirs, given the desperate state of the automakers who have allowed him to help put them on the brink of bankruptcy; and 2) Mr. Gettelfinger, unless someone reins him in, is in a position to completely destroy a state and potentially cripple the other 49.

And thanks to a horrific missed opportunity on the part of George W. Bush, the only person who can rein in Gettelfinger now is Barack Obama.

President Bush, given the opportunity to impose pretty much any conditions he wanted on General Motors and Chrysler in exchange for a lifeline from the Troubled Asset Relief Program, punted. The requirements for “viability” are so vague that they can be redefined to suit almost any progress or lack thereof the automakers make by the March 31, 2009 deadline.

The “targets” in the deal are the right ones – especially the one that requires GM and Chrysler to get their labor costs in line with the foreign transplants by the end of 2009. Supposedly, if the automakers fail to demonstrate their newfound viability by March 31, according to these requirements and targets, the government can demand the loans be paid back immediately, and the companies forced into Chapter 11.

But aside from the fact that the companies will certainly not have the money to repay in March, the weasel words in the not-so-fine-print essentially mean they have complete liberty to fall short of the targets, provided the Obama Administration accepts whatever excuse they offer.

Can you envision any circumstance in which Obama calls in the loans and forces GM and Chrysler into Chapter 11? Neither can I, but maybe the president-elect relishes the opportunity to demonstrate his seriousness and win respect from some of us who never anticipated giving it. If so, there’s no mystery from whence the challenge will come.

Less than six hours after Bush announced he was committing the TARP money to bail out the automakers, Gettelfinger had already declared he would fight to have “unfair conditions” removed. In other words, just as he has said all along, the UAW has made enough concessions and will be making no more.

It must be in a union president’s job description to understand absolutely nothing about how a business operates. Mr. Gettelfinger is well qualified. Not only does he not understand that costs have consequences, he also appears to believe that a business in desperate need of financing to stay alive can play hardball with the lender of last resort.

If Gettelfinger and the UAW successfully resist further concessions, and Obama nonetheless approves the pathetically inadequate restructuring plan that would have to result, he will lock in the suicidal economic model that will then finish off Michigan as a viable state. Worse still, he will ensure that $17.4 billion that could have produced many millions of entrepreneurial jobs as venture capital, was flushed down the toilet – surely to be followed by more.

Ron Gettelfinger is a clueless, obstinate man who cares nothing about economic rationality or about the consequences of his actions. He cares only about resisting “givebacks” and bludgeoning management – because that is his job and that is his universe. If he gets away with it this time, he will take a bad idea and ensure that it becomes catastrophic.

And only Barack Obama can stop him. Joe Biden warned us that Obama would see a challenge early on from a nefarious troublemaker somewhere in the world. We had no idea it would come from Detroit. Ron Gettelfinger threatens America, and now we’ll see if Obama really has that spine of steel Biden told us about.

Count me skeptical, but willing to be convinced. Show us something, Mr. President-elect. The thugs come from the damndest places.

We're not sure Biden could even tell us what the middle class is — in terms of income, wealth, education or any other meaningful measure. But we are sure one thing is certain to come out of this: A greater resentment between economic classes, stirred up intentionally as part of a divide-and-conquer strategy ultimately intended to impose punitive taxes on those deemed "wealthy."

The media and the left, which are often indistinguishable, have spent the last eight years telling those in the middle class that they're "losing ground" or will be the "first generation to have less than their parents did."

It's all nonsense, of course, but it seems to be effective. Obama's pledge to " rebuild the middle class" by giving tax breaks to "95% of workers and their families" no doubt won him a lot of votes.

But guess what? The middle class did get a tax break — a big one, it turns out — under President Bush. As Congressional Budget Office data show, the effective tax rate on the middle fifth of households fell from an average of about 17.1% under President Clinton to 14.4% under Bush. That's a 16% tax cut for the middle class.

Another oft-heard claim is that middle-class incomes are stagnant or shrinking. But a study last year by the Minneapolis Fed concluded that "incomes of most types of middle American households have increased substantially over the past three decades."

Class warriors such as Biden like to cite median household income as evidence of stagnation. And on the surface, it seems convincing: Real household income did grow just 18% over the past 30 years.

But after correcting for distortions in the data, Terry Fitzgerald, a Fed senior economist, found something else: "Median household income for most household types . . . increased by 44% to 62% from 1976 to 2006." And per-person income surged 80%.

Rather than stagnating, income has grown at an extraordinary pace. Yet that story never quite gets told.

Instead, we hear about another myth: "growing inequality." But according to the accepted measure, the Census Bureau's Gini ratio, there was virtually no change in inequality from 2000 to 2007.

Yes, many Americans are suffering in this recession, including the middle class. But the last thing we need is another general in a phony class war telling people how bad they have it.

I don’t disagree with Biden that the economy is in recession. But every time he speaks about it, he seems to leave a lasting impression of doom and gloom. I just don’t see how that’s helpful. I suppose Obama supporters think they’re getting even with Dick Cheney who said in early 2001 that the U.S. was on the front end of a recession. Turns out that he was correct. But neither he nor President Bush blathered on endlessly about how bad everything was.

And then in Tuesday’s meeting Biden talked about the stimulus package with all that new spending. It’s going to be an avalanche of government spending.

In Tuesday’s Wall Street Journal, Nobel Prize winning economist Robert Lucas said all this spending isn’t necessary. Let the Fed take care of the economy, he argued. He wrote, “It entails no new government enterprises, no government equity positions in private enterprises, no price fixing or other controls on the operation of individual businesses, and no government role in the allocation of capital across different activities. These seem to me important virtues.”

Lucas is right. We do not need bailout nation. Nor do we need the government picking winners and losers in some massive new New Deal industrial policy. In fact, the absorption of scarce private resources by the government may very well make economic matters worse, not better.

And then of course Biden went on about how Obama is going to help the middle class, and how it’s the middle class that’s going to get us out of this jam. While I listened carefully, I never heard him say anything about rich people, or successful earners and investors. No mention of businesses. Irving Kristol taught us 3 decades ago that the top earners are the “economic activists”. They are the ones with the highest propensity to consume and invest. They’re the ones who purchase the yachts, which are subsequently constructed by blue-collar workers. And they’re the ones who run the small businesses and provide the capital for new entrepreneurial startups that are the lifeblood of this economy.

If we had an economy without rich people, we wouldn’t have much of an economy. That is why lower tax rates to reward the economic activists—that is, the most prominent capitalists—would be ever so helpful. Or slashing business tax rates that would create investment inflows to promote high wage earning new jobs. And, it would give consumers a break since they’re the ones that bear the brunt cost of high corporate taxes.

As it happens, there was a story in Sunday’s Washington Post that indicated Team Obama is considering some kind of business tax breaks. Now that would be a very good thing indeed. But mostly I want to put a good word in for rich people. Can’t do without them.

Stem cell science might become a miracle of modern medicine. Or not; that’s why they call it science. So far, the prime virtue that makes stem cells unique is their potency as a wedge issue in the culture wars.

Were you among the good citizens of my blue-tribe state that thought harnessing anger against the red-tribe president might be a clever way to advance the cause of science? Are you happy with the outcome? Have you given it a close look?

By the time our state legislature got through with the Stem Cell Initiative it had evolved into the Life Science Initiative, which then morphed into $500 million dollars of construction union pork festooned with countless earmarks like highway interchanges, sewage treatment plants, and new buildings for empty life science “incubators” in remote corners of the state. The true miracle will occur if one dollar out of a hundred actually ends up supporting stem cell scientists.

I can't help but ask my colleagues, did you really think you could outsmart professional politicians? While you were busy studying physics and chemistry they were racking up decades of experience taking advantage of well meaning rubes who thought they could show up at the statehouse and get something for nothing. Did your superior intellect and advanced educations convince you that you could use them rather than the other way around?

Like me, are you one of the many people who honestly believe that our governor's heart was in the right place when he started down this road? Too bad his head went missing. Maybe it was kidnapped by the legislators-for-life that actually run this state.

What happens when you ask a state official at a public biotech forum to share some talking points that might mollify angry citizens after they figure out where their taxes have gone? You get a five minute non-answer that boils down to 1) don’t worry about the budget; we're going to borrow the money, and 2) well, not all the money is going to be wasted.

“Not All The Money Is Going To Be Wasted.” If legislation came with truth in labeling laws, this would make the top ten.

At least this billion dollar “Life Science” program paid for with money we don’t have will be guided by the wise counsel of the 550 member industry trade group that pushed this initiative from the outset. They are the experts, right?

Well, the current trade group’s President, a former state representative who may or may not have ever taken a biology course, was recently fined $10,000 for ethics violations stemming from his successful secret effort to land this $350,000-a-year plum position while serving as the governor’s top economic development aid. His role for the governor? Designing the $250 million in tax credits that form a key part of this package. I wonder if his ethics fine is tax deductible.

But hey, at least he’s an improvement over the last president this trade group hired, a former state House speaker who was “forced to resign under a cloud after pleading guilty to federal obstructions charges.”

As this story plays out, what can the business executives involved do? Should they admit that they knew this was a con game all along so it was important to hire a con man to run it? Or should they confess to being naïve bumpkins? If they do anything other than grit their teeth and brazen it out they will have to watch all that free money disappear along with their reputations.

If you're a scientist that actually receives a bit of the money that is not wasted, do you tell yourself that your work is so important that having three out of four dollars consumed by perfectly legal institutional corruption is a small price to pay? Or do you just shrug and say, “Hey, I got mine?” If feeding at the public trough is good enough for bankers, it’s good enough for biologists!

Are we all so bamboozled by the Red vs. Blue permanent campaign that we haven’t noticed that our legislative system has been redesigned to suborn integrity? It's not an accident. And it's not just the wicked who succumb. While the wicked will always be with us, they are thankfully few. But when vast armies of well meaning people march into the mire they can only fall silent once trapped, lest they end up implicating themselves. What happens to our country when industry after industry falls into the honey pot?

What magical power will protect my governor’s good buddy, the President elect, from meeting the same fate after he moves into the White House? When this well-intentioned billion dollar state fiasco goes federal and scales up by a factor of a thousand, why would we expect the outcome to be any different?

The limits on power built into our constitution were put there by our founders for a reason. They bequeathed us a system purposely designed not to do the most good but to do the least harm should it fall into self-serving hands. Each time we dismantle these limits motivated to do more good, would it make sense to pause and reflect on how these powers might be used otherwise as they accumulate over time?

There are so many worthy challenges facing us as a society, from figuring out how to generate clean energy to making our healthcare system as technologically advanced and economically accessible as, say, the personal computer industry. Do we really think that 535 Congressmen perpetually seeking re-election are going to accomplish this without sending three dollars out of four down the rat hole? Why do we think that? Has Reason retired to make room for Hope?

In my business we have a saying. "Hope is not a strategy."

Perhaps someone can forward this column to one of the 8,000 policy wonks busily packing their bags to move into the White House. They may survive a week or two before the Washington culture works its magic and they become part of the problem.

Be forewarned. There will be no real Change until each of us confronts the shortcomings in ourselves, rejecting the temptation to serve as willing accomplices in a game rigged to serve only our gamemasters, be they Red, Blue, or Green.

The once mighty St. Louis Post-Dispatch, flagship of Joseph Pulitzer’s publishing fleet, announced in a small online posting December 17 a warning from its company’s accountant that it may no longer be, by the year’s end, a “going concern.” The value of stock in the Post-Dispatch’s publisher, Lee Enterprises, Inc., has dropped by about 97 percent since the beginning of the year. The company has lost more than 65 percent of its market value during the past 30 days alone. Lee Enterprises publishes more than 50 daily newspapers and more than 300 weekly newspapers and specialty publications.

Less than four years ago, Lee Enterprises purchased the entire Pulitzer company, then publishers of 14 daily newspapers, for $1.5 billion in cash. A share of Lee stock then sold for $45; today a share sells for 34 cents. (Note how prescient the Pulitzers were to sell for cash, not for stock.) With the parent company’s market capitalization now only $22 million, what might the Post-Dispatch be worth by itself -- $200,000? Maybe $400,000 at most?

Michael Pulitzer, head of the family company and grandson of the founder, said at the time of the sale: “Lee and Pulitzer share similar cultures and values, beginning with our long history in, and passion for, the newspaper business. We both care deeply about our employees, communities and the public trust, and we manage our newspapers in the same devoted ways. In short, we couldn't have found a better steward to continue Pulitzer's 125-year legacy of journalistic excellence.” Mary Junck, Chairman and CEO of Lee Enterprises, hailed the acquisition of Pulitzer as “an exciting and logical next step” for her company.

That was then; this is now.

The Post-Dispatch announcement came a week after the privately held Tribune Company, publishers of such leading dailies as the Chicago Tribune, Los Angeles Times, and Baltimore Sun, filed for bankruptcy protection. E.W. Scripps Company, whose stock has fallen nearly 90 percent in 12 months, is trying to sell its Denver daily, the Rocky Mountain News. McClatchy, owner of the Miami Herald and other properties of the former Knight-Ridder chain, has seen its stock drop by more than 90 percent this year. The Herald reportedly also is for sale. This month the New York Times Company, owner of the eponymous Gotham daily as well as the patrician Boston Globe, sought to mortgage its new headquarters building and sell its partial stake in the Boston Red Sox baseball franchise to meet urgent cash needs. Detroit's two newspapers announced they would curtail daily circulation of the print edition. One will cut back home delivery to three days a week, the other, only two days a week.

An institution, once grand and powerful, is vanishing into the ether, with no small assist from the Ethernet.

It may be that, as said the innovative political consultant and agitator of “Netroots,” Joe Trippi, “the revolution will not be televised.” But the newspaper business, notably the New York Times, is performing a valiant role for the moment at least in writing its own obituary. Nearly every day, the Times publishes one or more informative and mostly insightful reports on the demise of the newspaper medium. New York Times Company stock, one of the better (that is, less abysmal) performers among newspaper stocks, is down about 60 percent for the year.

The public philosophy behind government efforts to “preserve” – or more specifically, to prevent monopolies in -- metropolitan daily newspapers was reflected 64 years ago in Oswald Garrison Villard’s book, The Disappearing Daily. Villard was editor of the liberal/progressive opinion magazine The Nation. The newspaper business, wrote Villard, “is unlike most others in that it is ‘affected by a public interest.’ It is a vital public need that the people in a democracy shall have the news and the opportunity to read all sides of political debates of the hour. As Thomas Jefferson put it, the best way to head off unsound opinion in a democracy is ‘to give them [the people] full information of their affairs thro’ [sic] the channels of the public papers and to contrive that these papers should penetrate the whole mass of the people.’ To establish a press monopoly in a locality is to restrict the field of public information or to narrow its vision, or even perhaps to put an end to the presentation in the remaining dailies of anything but a partisan aspect of the national political or economic situation – and this despite the coming of the radio.” (op. cit., pp. 4-5).

Villard’s view was not confined to liberals of the 1940s. United States Representative Kevin Brady, a conservative Republican from Texas, expressed a similar outlook in an interview in the December 18, 2008 New York Times concerning the shrinkage of Washington bureau staff of his hometown metropolitan daily, the Houston Chronicle, from nine to three people in two years. “From an informed public standpoint, it’s alarming…. They’re letting go those with the most institutional knowledge, which helps reporters hold elected officials accountable.”

The Illusion of Legislating ‘Newspaper Preservation’

The newspaper market in St. Louis, my native city, was central to the drama over the Newspaper Preservation Act. In 1959, a lengthy labor union strike by The Newspaper Guild, representing editors and writers at the St. Louis Globe-Democrat, crippled that enterprise financially. The paper’s owner, S.I. Newhouse, sold its relatively modern printing plant to its competitor, Pulitzer’s Post-Dispatch. The afternoon Post-Dispatch and the morning Globe-Democrat formed a “joint operating agreement” to print their papers in the same plant at different hours of the day while keeping separate ownership and distinct “editorial voices.” The Justice Department provisionally relaxed antitrust applications to allow this and some other metropolitan joint operating agreements.

The Newspaper Protection Act of 1970 gave the legal certainty of a Congressional act to publishers who wished to consummate arrangements such as the St. Louis joint operating agreement. Government’s remedy to “preserve” newspaper competition from monopoly was to exempt newspapers from anti-monopoly (antitrust) laws. This was the desperate, upside-down mentality of warfare: To save the village (or competition) we will have to destroy it.

Where other businesses were forbidden to conspire against customers to fix prices and otherwise circumvent competition, local newspapers were allowed, even encouraged, to do so. In St. Louis and dozens of other big American cities, the trend of the metropolitan newspaper market toward monopolies was arrested temporarily by imposition of government-arranged duopolies.

My involvement in the Newspaper Preservation Act and its predecessor arrangements, since I was a toddler not yet able to read, has been intimate: Martin Duggan, my father, worked for 44 years for the St. Louis Globe-Democrat, as copy editor, news editor and editorial page editor. My family’s livelihood was artificially sustained – for a time – by the Newspaper Preservation Act. While I am appreciative of how this contributed to my family’s financial well-being and the fulfillment of my father’s vocation as a writer and editor, I still have to acknowledge that, in the long run, government “rescues” of industries tend to fail.

In St. Louis, the Newspaper Preservation Act simply postponed the monopoly for a number of years. In Miami, Cincinnati, Pittsburgh, and many other cities, the Newspaper Preservation Act also proved to be only a temporary life support. In 1983, the St. Louis Globe-Democrat gave way to a monopoly for Pulitzer’s Post-Dispatch. But much as my father and I and many others cherished the nocturnal roll of the presses and the warm smell and smudge of the greasy black ink on the cheap pulpy paper, there is life after the newspaper business: When the newspaper that employed him failed, my father started his own political discussion program on a local television station in St. Louis. Today, at 87 years of age, he still hosts the program every week. His program remains popular and consistently makes profits for the television station. It is a weird irony, but my father’s small and quixotic enterprise of an independent television program as something with which to busy himself instead of the boredom of premature retirement might outlive what once was the multimillion-dollar newspaper juggernaut of the monopoly Post-Dispatch. Such is the power of technological change.

Unremarked in much of the discussion of the newspaper industry’s woes is the powerful role of labor unions. The political economics of government attempts to “rescue” obsolescent industries usually involve a Faustian bargain involving corporate management and the unions. Government’s role is either direct taxation or the de facto taxation of government-imposed market distortions. The newspaper unions involved were those representing writers, typographers, pressmen, and delivery truck drivers. In like manner, a United States taxpayer bailout of the automobile factories of Detroit would involve a subsidy to the United Auto Workers Union at the expense of able, but less costly workers in Mexico and the Orient, not to mention workers in our less union friendly southern states. And what are the chances of Detroit’s automakers achieving any greater success against technological change and competition than did Detroit’s two formerly daily newspapers?

Major government “industrial policies” tend to have unintended consequences. Some, relevant to the communications media, have been beneficial. Cold War defense spending by the United States to create a communications system that could survive a nuclear war gave birth to ARPANET (Advanced Research Projects Agency Network), the precursor to the Internet. But everyone should stay mindful of negative unintended consequences – usually in respect to schemes designed to “save” jobs or industries from the logic of supply, demand, and technological development.

As everyone knows by now, Madoff -- once one of the most respected financiers on Wall Street -- stands accused of being perhaps the biggest swindler in history. Before his arrest this month, he reportedly told his sons that he had defrauded investors of up to $50 billion. He allegedly followed the playbook written more than eight decades ago by the elegant grifter Charles Ponzi, who used money from new investors to pay juicy returns to old investors. That works fine for a while, but every Ponzi scheme eventually collapses in ruin.

Wall Street veterans recall how investors once begged to be allowed to invest their money with Madoff. Unlike Ponzi, he didn't promise to deliver flashy double-digit returns overnight. He "earned" his investors 1 percent or 2 percent a month, bull market or bear, rain or shine. Because he didn't overpromise, and because he limited his clientele, he was able to keep the scheme going for decades.

Such steady gains, unsullied by the occasional bad year or disastrous quarter, are patently impossible. Some potential investors took one look at Madoff's operation and took a pass. Some of the millionaires, billionaires and professional money managers who unwisely gave their money to Madoff were guilty of allowing greed to overwhelm their powers of observation and reason.

But not all of Madoff's investors could have been in the dark. Some must have realized how unlikely it was that he had found some sort of magical strategy or technique that would always make money, no matter what the financial markets were doing. Some investors, I would wager, must have calculated that they could get in, get their return and get out before the whole thing fell apart.

Which makes me wonder how many of us had our eyes open when housing prices were soaring in Ponzi-like leaps -- by 10 percent or more a year, in some parts of the country -- while middle-class incomes were largely stagnant. How many of us stopped to ask just who was supposed to be able to pay $1 million for a standard suburban split-level, even if it had an upgraded kitchen with a Sub-Zero fridge?

The whole subprime mortgage industry was based on the idea that housing prices would always rise. Given that assumption, it was perfectly rational for first-time homebuyers to sign up for adjustable-rate mortgages that they couldn't really afford. From the moment they signed the loan papers, they would be building equity -- through appreciation -- that soon would make it easy, and lucrative, to refinance or sell.

In other words: Get in, get their return and get out before the whole thing fell apart.

I'm not saying that average Americans were as culpable as Wall Street in creating this financial and economic crisis; our sins were venial, whereas theirs were mortal. Madoff's alleged fraud was at least straightforward. Much worse was the creation of exotic "derivative" investment products -- whose true value turned out to be impossible to ascertain -- that were bought and sold with enormous leverage. As long as real estate values kept rising, it didn't matter what these chimerical investments were worth. What mattered to Wall Street was the ability to collect enormous fees from real people, in real dollars, for trading unicorns and dragons.

After the bursting of the Internet and housing bubbles, I think we're done with bubbles for a while. Obama's first challenge -- and it may take much of his first term -- is to get the economy back into a pattern of tangible, sustainable growth. He will be able to thank Madoff for giving us the simplest possible explanation of what we knew all along but chose to ignore: that there's still no such thing as a free lunch.

The Republican leader is drawing a clear line in the sand. Okay, good. But the GOP has got to do more. It must start talking about tax cuts to grow the economy. And it must get back to the supply-side by talking about lower marginal tax rates on individuals, businesses, and investors.

We don’t need bailout nation. Nor do we need the government picking winners and losers in a massive, Keynesian, new-New Deal spending extravaganza. And it’s not Obama’s middle-class tax cut that’s going to get us out of this economic jam. At best his vision is incomplete. But at worst his aversion to successful earners and investors is a real obstacle to full economic recovery.

Social historian and early supply-side activist Irving Kristol taught us three decades ago that the top earners are the economic activists. They’re the ones with the highest propensity to consume and invest. They’re the ones who buy the yachts, which are built by blue-collar workers. And they’re the ones who run the small businesses and provide the capital for the new entrepreneurial start-ups that are the lifeblood of the economy. It is they who energize free-market capitalism.

If we had an economy without rich people we wouldn’t have much of an economy. That’s why lower tax rates to reward the economic activists -- the most prominent capitalists -- are so essential.

In fact, the GOP has a great opportunity to challenge Obama’s Keynesian pump-priming by insisting there be a major tax-cut component in any new fiscal package. Republicans shouldn’t merely push for somewhat less government spending. They have to make a bold case that tax rates matter for economic growth and job creation. They must insist that any recovery package includes this key element. Shift the debate. Say clearly that a reenergized economy cannot occur without lower marginal tax rates.

In particular, the GOP position should include lower tax rates on large and small businesses. Right now the top federal tax rate for C-corps is 35 percent. Small businesses, which pay the individual rate, also are taxed at 35 percent. These rates should be 20 percent for both C-corps and S-corps (including LLCs). This would make a huge difference. It would be a boon for our global competitiveness, since companies in the U.S. (as well as Japan) are taxed way above the rates of other advanced countries. It also would attract job-creating investment flows to the U.S. at a time when capital is on strike in our financial markets and economy. And while businesses collect corporate taxes, it’s really consumers who pay the final cost.

Republicans also could promote a middle-class tax cut that would reduce the 28 percent and 25 percent brackets down to 15 percent. And of course, the GOP should work hard to maintain the Bush tax cuts on capital gains, dividends, inheritance, and top individual rates.

Senior Obama advisor David Axelrod recently told the Sunday talk-show hosts that the Bush tax-cut package of 2003 is “something we plainly can’t afford moving forward.” Well, in static terms, the sum-total of the 2003 tax cuts comes to somewhere between $25 billion and $40 billion. Compare that to a trillion-dollar spending plan.

In fact, lower capital-gains tax rates will raise revenues, since this is the single most sensitive tax on the Laffer curve. Indeed, many economists -- including Alan Reynolds at the Cato Institute -- argue that the growth and simplification effects of reducing the corporate tax rate would be revenue positive.

But the congressional Republicans have to step up to the plate right now. Me-too-ism on spending is a big mistake in both political and economic terms. Instead, the GOP should argue that fiscal policy needs a choice -- not an echo (to paraphrase the late conservative stalwart Barry Goldwater).

The whole debate in Washington is heavily skewed toward government spending on infrastructure. It’s all spending and virtually no tax cuts. For a more balanced and effective recovery policy, the GOP has to bolster its argument for spending discipline with a loud case for tax cuts.

It truly is time for a choice, not an echo.