Literally Making Money

The Gist: 4 ways that conservatives might handle monetary policy to grow the economy and limit government.


For 73 years, from 1886 to 1959, you could buy 6.5 ounces of Coca-Cola for a nickel. Customers may have just come off a horse or a jet, but the price did not change. Today, more than six decades later, glancing at my neighborhood grocery shelves, you might pay more than eight nickels for the same amount of the same product.


Figure 1. Though it lacks the pep of the original formula which, of course, contained cocaine. You also would be hard-pressed to find just 6.5 ounces to purchase as the nation’s waistlines have inflated along with its currency.


On a surprisingly related note, you probably dislike writing a check to the government (or having the government directly take money out of your paycheck). If a politician were to advocate for an increase in your personal taxes (rather than the always promised increase in taxes on someone else), you likely would not be happy with them. Worse, if a politician advocated a tax not just on your income but on your wealth, perhaps 2-3% a year, you’d be outraged. And yet that’s not too different from what actually happens with inflation: all of the money in your bank account is worth that much less in Coca-Cola.

Inflation is a hidden tax and an especially clever one because you might think you have more when you in fact have less. But, of course, it does not affect just you. As Murray Rothbard observed, “By creating illusory profits and distorting economic calculation, inflation will suspend the free market’s penalizing of inefficient, and rewarding of efficient, firms. Almost all firms will seemingly prosper.” As F.A. Hayek added, “including some which ought to fail.” Beyond distorting the price system at the heart of our economy, inflation also punishes savers. At its most extreme, during the Weimar Republic, factory workers were given multiple breaks a day to rush out and buy anything they could with their rapidly depreciating currency. But even at its most gentle: the same number in your account gets less than last year. Rationally, you are tempted to spend it now or even borrow something valuable today to be repaid with something less valuable. The benefits accrue to the nation’s largest debtor, the government, who is largely responsible for inflation. But if one day the government can no longer freely determine the value of its debts, then it faces a reckoning with its profligate spending.

“Monetary policy” can sound oblique and intimidating but it’s the least familiar, most important topic in American politics. Beyond its hiding behind technical gobbledygook, it’s probably especially unfamiliar because inflation has been fairly low since the 1980s so people aren’t crying out for reform. If (when?) more noticeable inflation makes a comeback, that’s an opportunity to consider alternatives. The ideal system grows the economy, not the government, by sending clean signals to businesses and consumers while restricting the government’s ability to borrow. As a conservative, here is your menu of options:


  1. Appoint the right God-King to run the Federal Reserve

This is actually the easiest route under our present system and about as far as conservatives have ever gotten. It helps considerably if you surround the God-King with like-minded nobility (those anonymous other members of the Federal Reserve that 99.9999% of Americans would not be able to pick out of a line up). The idea is that, at least for the time he is in office, the God-King will astutely manage the nation’s money supply to avoid inflation and, in particular, pursue potentially unpopular policies like the classic example of taking away the punch bowl when the party gets too rowdy or, to continue the analogy, refusing to bail out the friend who gets arrested for drunk driving out of fear that it might prompt other friends in the future to not better manage their own drinking.


Figure 2. You might, for example, look to see if there’s some dispositionally unthreatening radical who once served as Ayn Rand’s personal economist


The trouble is that the President appoints the God-King and Senators confirm him and their job security can be intimately related to the God-King’s decisions, which makes them extremely interested in his being pliable to goosing the economy whenever an election is around a corner (which is always). But that’s not all. Because the nation’s elected representatives want to deliver goodies at minimal cost (for maximum re-electability), they want to borrow ever greater amounts and have a compliant central bank aid them along their merry way. 

This is why conservatives tend to dislike the God-King system, which is basically rigged against sound money – indeed, a nickel in 1913, when the Federal Reserve was created, had more purchasing power than a dollar does today. Insofar as the God-King system is preserved, there is no guarantee (in fact, little hope) that you’d get the right God-King (indeed, you might even get one swept up with magical monetary theory). 

Importantly, even if you have an extremely smart, fairly independent, very well-meaning God-King, any hint of crisis will tempt him (as fallible as any man) to use the heavy-handed powers of the Fed – to lend out money at generous rates, to buy and sell bonds in vast quantities, to regulate how much reserves banks have – to try to fix the problem. Conservatives generally think that the Fed has no idea what the right interest rate ought to be and should get out of that business altogether to let the market work it out. Conservatives also have very different perspectives from the mainstream on banking reserves (to be discussed later). The power to buy and sell bonds – intimately related to printing more money and the ability of the government to finance its operations – is where there is some acknowledged room for maneuver. But Milton Friedman feared there were excessive, destabilizing lags between a problem like unemployment arising; central bankers discovering and interpreting the problem through statistic collection; and central bankers finally conjuring and applying unpredictable, bespoke, and ham-handed responses. Adeptly deploying sledgehammers with discretion proves impossible.

And yet, among the options we are going to discuss, this is how things will probably work for the foreseeable future. At the very least, conservatives ought to pay a lot closer attention to who gets nominated to the Fed. Indeed, we probably need a Federalist Society for monetary policy. Who knows if any alternative will ever be politically palpable but one thing is significant: the advocacy of alternatives tends to make the God-King behave.

andrew jackson

Figure 3. You can replace Fed Soc’s James Madison silhouette logo with a similar one depicting the magnificent mane of Andrew Jackson. Motto: “The Bank, Mr. Van Buren, is trying to kill me, but I shall kill it!” Since a central bank came back, might as well bring back AJ, too. 


2. Compel the Federal Reserve to follow a simple rule

The theoretically easiest change to make to our system would be to impose upon the central bank a rule it must follow. The trouble comes quickly in determining what the exact rule ought to be. The Fed currently is supposed to maintain stable prices and “full employment”, the pairing of which actually gives the Fed more discretion as it pursues two goals that tend to require opposite practices. Conservatives tend to favor eliminating the Fed’s goal of reaching full employment not because more people working isn’t great but because the Fed has only so much to do with achieving the dang thing (i.e. is there unemployment because businesses don’t have easy access to capital… or because of regulations or unemployment subsidy or workforce suitability or what?) Nevertheless, Stanford’s John Taylor came up with a mathematical formula that takes into account both goals and spits out a rule that the Fed could follow – but Republican presidents have passed over appointing him God-King because even that limit on discretion has proven too controversial. 

Conservatives are far more attracted to a rule that simply tracks stable prices or purchasing power. While attractive in principle (isn’t reducing inflation what we want?), there are two significant problems: first, there is substantial disagreement on what prices the Fed ought to track and how it ought to do so. Second, deflation (i.e. cheaper prices) is not necessarily a bad thing – it could be that the cheaper prices are the results of gigantic productivity improvements. Note two things about this chart: healthcare, education, and housing are major and escalating costs for Americans but are not included in the typical government inflation index; screened devices have dropped their prices like a rock. How should the Fed deal with prices moving in opposite directions? It would be silly for the Fed to print more money so that you always had to spend $1,000 on a television even as the manufacturers figured out how to make it for less and less. Simultaneously, increasing healthcare costs may be partially the result of loose money – but they also are more likely to be reflective of a broken system simultaneously subsidized and regulated by the government. Milton Friedman ultimately concluded that such a rule was “too loose and too imperfect” – and that it, too, would easily invite central bankers to tinker. 


Figure 4. Central bankers are constantly self-conscious about deflation and so they often needlessly take “corrective” actions. But when their inflation lasts for more than four years, they don’t bother contacting anyone, they just pile on.


Reflecting his belief that money was responsive to the laws of supply and demand, Milton Friedman instead suggested that the Fed should simply increase the money supply by a small amount every year – equal to the long-run growth rate of the United States, or about 4%. Interestingly, by doing so, Friedman was actually targeting 0% inflation, hoping that the increase in the money supply would be taken up by economic growth. Relatedly, one of the big worries about a monetary rule is that the Fed would not have discretion to react to a crisis. At first glance, Friedman’s rule looks unresponsive but, because a crisis is often accompanied by a shrinkage in the money supply, a constant 4% increase in the nation’s money supply over last year’s total would actually result in a bigger cash infusion to make up the difference. The trouble with this rule is that the money supply is surprisingly difficult to determine and, due to the constant innovation of the banking system, determination gets harder all the time (Of course money is cash in your hands and your savings accounts – but does it include the surrender value of a life insurance policy?) Notably, this is the rule that has come closest to adoption in the United States, as Paul Volcker broke inflation by letting the market set interest rates and instead managing the money supply. But the God-Kings didn’t stick to it.

The newest conservative proposal is for the Federal Reserve to target a certain percentage growth in how much is spent in the economy (nominal gross domestic product). That number would combine both inflation and actual economic growth, thus policy would be attempting to balance the two. While it may suffer from some problems we’ve seen before – errors in statistic collection, lags, perhaps punishing good deflation – it tends to be the presently favored rule. There are still other rules out there – smaller countries might, for example, peg their exchange rate to the currency of a country better at fighting inflation than they. Ideally central banks around the world would have different rules and we’d see what happens to their currencies – but because they are subject to the same political pressures as us, we have not seen that level of experimentation in restraint.

George Selgin argues that “Of countless monetary rules that have been proposed at one time or another, the vast majority would eventually have led to some extremely undesirable outcomes, if not to outright disaster.” He continues, “The argument for a monetary rule isn’t that sticking to such a rule will never have adverse consequences. It’s that the adverse consequences of sticking to a rule may be less serious than those of relying upon the discretionary choices of fallible monetary authorities.” And yet that brings up an important question: even if there was a Constitution for the Fed, would they actually follow it in an emergency when the temptation is greatest to deviate? Milton Friedman mischievously suggested that the Fed be replaced with a computer preprogrammed with the rule – and yet even he suggested that maybe Japan ought not to have such a rule until they break out of their slump. And who is feeding the computer its information? Still, there was once a quasi-automatic standard.

Hal 2001

Figure 5. “Grow the money supply by 30% in one year? I’m sorry, Jerome. I’m afraid I can’t do that.


3. Define the dollar as a certain amount of a commodity (such as gold) and require the government to exchange that commodity for anyone who shows up with a dollar.

The more you think about a fiat currency, the more your head might hurt. The dollar is worth something because you and other people believe it’s worth something and are willing to trade goods and services for it. But that value might change at any time in the future, such that your dollar is worth considerably less (indeed, your nickel might buy 8x less Coca-Cola). Government is responsible for managing the value of the fiat currency but it instead irresponsibly mismanages, mostly because it does not share the same incentives as other users of money. To keep the government honest and limit its ability to infinitely and freely increase the money supply at any time, you could restore the requirement that the government convert the dollar to a preset amount of commodities for anyone who demanded it. This was in fact how paper currency originally worked – the British pound earned its name by once being defined as a pound of silver – the name of the currency was simply a weight and measure, like a yard of yarn.


Figure 6. A dollar was originally an ounce of silver. No longer. But how familiar are you with the Imperial system’s next smallest unit of weight measure? A dollar is now worth an awkward 1.5 drachm. Only a few more years until we have to measure the dollar in grains of silver!


Attractively, a currency backed by commodities almost inherently cannot undergo hyperinflation – and, indeed, has a ceiling on the amount of inflation it can experience based on how much of the stuff there is. For 500 years between 1260 and 1760, English prices rose 0.38% a year, topping out at a whopping 1.28% a year with the massive influx of Spanish colonial silver. Michael Bordo reports that  “Between 1880 and 1914, the period when the United States was on the ‘classical gold standard,’ inflation averaged only 0.1 percent per year… It was also a period of unprecedented economic growth with relatively free trade in goods, labor, and capital.” No wonder Andrew Carnegie agreed to sell his company in exchange for fifty year bonds. Little did he know what was to come: the U.S. dollar was once pegged at $20.67 per ounce of gold. In 2020, an ounce of gold crossed $2,000.

The principal trouble for consumers is that a commodity-based currency can undergo short-term volatility in its value. For better or worse, the supply of a commodity-based currency can only be increased by an increase in the commodity. If the economy as a whole grows faster than the money supply, the money will actually increase in value – for advocates of the gold standard, this is a virtue: the increased value invites miners to find more gold and for foreigners to export more gold to the country under the standard. Milton Friedman argues that, before World War I, “The blind, undesigned, and quasi-automatic workings of the gold standard turned out to produce a greater measure of predictability and regularity — perhaps because its discipline was impersonal and inescapable — than did deliberate and conscious control exercised within institutional arrangements intended to promote stability.” Mark Skousen argues that, somewhat intriguingly, the supply of gold grows at about the same rate as historic U.S. growth, even during the big shocks, between 1-5% a year, and that it functions more similarly to Friedman’s favored rule than you might guess, though obviously it would not grow at the same rate every year. 

But the short-term volatility of money’s value has a particular problem with sticky wages: nobody likes to get paid less, even if “less” actually buys more. You tend to think in terms of the stated amount – “I’m paid $30,000 a year” not “I can buy this amount of groceries.” Rather than reduce employees’ wages (which are increasingly expensive), companies might fire them and try to hire someone else. But that someone else might not have mentally adjusted for purchasing power themselves and not be willing to work for less than a certain price. It’s a problematic cycle. Murray Rothbard suggests that money inherently can’t have price stability as a commodity but that if businessmen, consumers, employees were interested in it, they could contract around it by tying their payments to some mutually agreed index.

A conventional criticism of a commodity standard is that it wastes resources. Austrian economist Roger Garrison seems to have undermined the critique by demonstrating that after the gold standard was abandoned, contrary to Keynesian predictions, substantial resources were still expended pursuing precious metals – in fact, more than before, because of fears about paper currency being worthless. But even were resources specially expended for the purposes of money, George Selgin argues, “Trying to save resources by forcing a switch from a commodity standard to a fiat standard is like trying to save resources by forcing people to take off the locks on their doors and give them to scrap-metal dealers. It is obvious that the cost of making locks is far less than the cost of losing one’s property.” 

The fact that a commodity standard actually employs resources is what keeps the government honest. If the government wants to expand, it can raise taxes (never popular), borrow (usually at a good rate from its central bank), or it can just overprint money (which is cheap and even gives people the temporary illusion of prosperity). The last is the easiest – unless the government is obligated to exchange its money for a commodity, thereby requiring it to use real resources. Notably, this is something the Founders appeared to understand –  the U.S. Constitution says that “no state shall… make any thing but gold and silver coin a tender in payment of debts” (alas, unincorporated against the federal government) and also gives Congress the power to “coin” alongside, not coincidentally, the power to fix weights and measures. (For what it’s worth, the Federal Reserve itself is of questionable constitutionality, as are all “independent” agencies)

Though it may sound fairly simple, there are several ways to run a commodity-backed currency and how it’s run affects how “good” it might be. The biggest question is this: does the dollar supply equal the government’s gold supply? For the period that America was supposed to be on the gold standard, the answer was no. The government overprinted dollars on the hope that not everyone would show up at once to claim physical gold. During the Great Depression, the government not only closed the opportunity for citizens to get gold for their dollars, they made private gold ownership illegal. But to at least maintain the fiction we retained the standard, we allowed foreign governments to exchange dollars for gold. But by the time of the Nixon administration, we had overprinted so much that foreigners were rationally demanding gold redemptions for their depreciating dollars. Rather than painfully reign in the money supply, we ended redemption. Given this record, can you really trust the government to maintain the gold standard in a crisis? In the past, the gold standard only really worked because it was considered a source of national shame to abandon it. No longer.

Isaac Newton

Figure 7. Isaac Newton spent a good portion of his life trying to figure out alchemy when the secret was right in front of him the entire time: as master of the Royal Mint for 30 years, he just needed to convert to a fiat currency and start printing!


If we were somehow convinced of the government’s benevolence (perhaps through a Constitutional amendment), the economic transition would be a challenge because we have overprinted so many dollars. For maximum benefit, gold standard advocates tend to favor 100% backing, but it’s also 100% theoretical. Indeed, Hayek feared that the global economy was too large for everyone to be on the gold standard. The U.S. government has trillions of dollars of gold in its vaults but not as much as the supply of dollars, which means that it would have to expend resources to get more gold (or, dangerously, restore the gold standard at not 100% backing, thereby tempting the government to gamble on lesser and lesser reserves and you’d quickly get into the problem of defining the money supply). There’s even some questions about whether the government could secure enough gold to back our current money supply. An intermediate step might be the U.S. government selling bonds which promised interest payments in gold ounces, but the U.S. government defaulted on its last issue of those, again raising the question of government trustworthiness. 

Of course, the dollar does not have to be backed by just gold – gold just happens to have been historically demonstrated over a long time, relatively convenient as a medium of exchange, and somewhat mystical in the public imagination. This last part is fairly intriguing: does gold really have much intrinsic value or does it, like the fiat currency that replaced it, have value because people believe it has value? Some economists have argued for the currency to be backed by a basket of goods, thus limiting the impact of any one commodity’s shortage or glut. But like the problem of determining the price index, what should be in the basket? Relatedly, some supply siders have suggested that the government need not keep any gold at all, just use its powers to try to get an ounce of gold to equal a certain amount of dollars. But, given the short-term volatility of the price and the Fed’s heavy-handed imprecision, implementation would be challenging – and the most significant benefit of a commodity standard is that convertibility keeps the government honest.


Figure 8. Has anyone in the history of rock, paper, scissors ever really thought that paper beats rock?


As Hayek sums up, “The gold standard… served no other purpose than to impose upon the issuers of money such a discipline and, by making its regulation automatic, to deprive them of the power arbitrarily to change the quantity of money. It is a discipline that has proved too weak to prevent governments from breaking it.” But Hayek points to a fourth option: “so long as the management of money is in the hands of government, the gold standard with all its imperfections is the only tolerably safe system. But we certainly can do better than that, though not through government.”


4. Restore private currencies to compete with and perhaps replace the government one.

Fundamentally, if you don’t think the government does an especially good job of anything, why trust it with the fundamental responsibility of maintaining currency? Or, at the very least, why require that the government have a monopoly on currency? As Hayek observed, government’s exclusive control over currency “has the defects of all monopolies: one must use their product even if it is unsatisfactory, and, above all, it prevents the discovery of better methods of satisfying a need for which a monopolist has no incentive.” Friedman thought that the law of supply and demand applied to money in managing the supply – but why not take the perspective further? Whatever you personally want out of money – stable purchasing power, for example – the free market might be able to deliver if left to its own devices. Hayek argued we should have “the control of money in the hands of agencies whose sole and exclusive concern [is] to give the public what currency it liked best among several kinds offered, and which at the same time staked their existence on fulfilling the expectations they had created.”

Why the heck would you want a Deutsche Bank mark rather than the United States government dollar? Well, Deutsche Bank would have to convince you that their currency had value. In the real historical examples of free banking, private currency issuers operated on their own commodity standards, offering to convert their currency to a commodity, usually gold, whenever a customer showed up and demanded it. Essentially, your Deutsche Bank mark is really just a claim on something in Deutsche Bank’s vaults, while your Chase yen is a claim on something in Chase’s vaults, etc. You would accept a salary in DBM because Amazon would accept payment in DBM because ultimately it could be converted into something tangible and useful as a medium of exchange. What sounds novel and scary at first seems a lot more grounded than the system we have.

Hayek strongly believed that the free market would deliver an inflation-resistant currency: “Money is the one thing competition would not make cheap, because its attractiveness rests on it preserving its ‘dearness’.” Free banking allows money to be chosen by consumers – you and me – not imposed by the nation’s largest debtor. Politicians not only can be but want to be irresponsible with a monopoly state currency. Bankers have to be responsible or else no one would use their currency and they might go out of business. Hayek concludes, “Blessed indeed will be the day when it will no longer be from the benevolence of the government that we expect good money but from the regard of the banks for their own interest.”

But just how free ought to be banking? An interesting aspect of historic free banking systems is that they were largely self-regulating. Currency issuers not only competed for consumers with better offers of service and reliability but, due to the magic of redeemability, they also were constantly testing their competitors by redeeming other currencies for their promised gold. In other words, a customer might deposit Chase yen with Deutsche Bank, who would then trade Chase for any marks it held – but if the trade were uneven, Deutsche would demand Chase turn over additional gold. As Lawrence White notes, “The overexpansive bank will discover that its specie reserves are draining away, a situation it cannot let persist.” An aggressive bank might quickly get to the point where no competitor would accept their deposits, no credit card would process their currency, no merchant would accept it, no consumer would use it. Contrast this against the experience of the Savings and Loans industry heavily regulated by the U.S. government: in the 1980s, over 2,800 banks and S&Ls failed.


Figure 9. In a professional soccer match regulated by refs, a light tap inspires an Academy Award caliber performance of a career-ending injury. In a self-regulated street game, players play on, lest they not be able to play again.


The United States once had private currency issuers but over-regulation produced more problems than benefits. Rural banks feared that city banks would gobble them up and so successfully lobbied state governments to impose branching restrictions that limited any bank from opening many locations, sometimes not more than one. As a result, banks were not big nor diversified enough to deal with crises and often failed. Furthermore, state governments attempted to make banks partners by requiring that they carry state debt as their reserves – but that debt often was not worth very much, thus leaving banks with a fundamentally unstable foundation. Finally, entry into the banking industry was tightly controlled by state legislatures, meaning that one had to be a better lobbyist than a banker in order to get a license to print money. 

Across the border, Canada’s contemporary free banking experience was a model of stability (and, indeed, their lack of branching restrictions meant that in contrast to the thousands of American banks that failed after 1929 in the Great Depression, zero Canadian banks failed). Scotland had a free banking system for about 150 years with considerably less regulation and, in particular, zero barrier to entry, such that one of the largest ultimate banks began as a linen exporter. Our modern world feels so vastly different from a proliferation of currencies that it can be hard to contemplate. Hayek began thinking about the idea in the context of border towns and tourist centers that took multiple government currencies. Cryptocurrencies give you a bit of insight but ultimately differ in their lack of redeemability for a commodity as well as their very limited present use in purchases of goods and services. But consider your possible enthusiasm for airline miles or credit card points or any number of other practically private currencies in effect today, where you can redeem them for some product, perhaps only at their offering store – but why should they not be allowed to trade on the open marketplace? There’s a small secondary market for gift cards, where Amazon trades basically at par and less popular retailers you can get at a discount. To the degree that you’re afraid the airline will devalue your miles on the open marketplace, that’s the point: you would not want to be paid in such a currency. But if a merchant found that its rewards program was circulating at par around the economy, perhaps because it offered redeemability in a commodity, then it might quickly find out that it’s actually a currency-issuing bank.

Notably, most Scottish banks had a feature that is very unusual in today’s world: they were unlimited liability corporations, meaning that shareholders were completely on the hook for their problems. As you can imagine, this led to a great degree of prudence in their operations. Even when Scottish banks did (rarely) fail, currency holders were made whole. While the purest free bankers believe that banks should be able to choose their liability exposure and then advertise to customers to choose between them accordingly, this is one simple, significant regulation that could head off a lot of future issues while not even requiring any regulators.


Figure 10. As if personal liability was not enough, this was also a time of debtors’ prisons!


The more contentious bank regulation – something that is considered across all four possible ways to reform our monetary system we’ve been discussing – is how to deal with regulating bank reserves. Conservatives have tended to believe that the financial system relies on a myth that money can be in two places at once – you have your money in a bank account that you can withdraw entirely at any time, but the bank is simultaneously using that money to lend out to others. That’s why a run can ruin a bank. Presently, the government requires that banks hold a certain relatively small percentage (about 10%) of their outstanding loans in reserve in case depositors need it and, through the FDIC, it also guarantees that, eventually, accounts under a certain size will be restored to full value by taxpayers in case of the bank’s failure.

Conservatives have tended to consider this a pre-bailout inviting banks to moral hazard and have for a long time favored 100% reserve banking (also called single-purpose banking). Banks would be split between two functions, warehouses for money and lenders. You could either have total access to all of your money at any time (as if it was in a safe deposit box) or you could agree to eliminate your access in exchange for an interest payment (as if you bought a bond). An unpopular feature of this is that you may have to pay to store your money – but perhaps not if banks ran it as a loss leader to attract customers. But conservatives have nevertheless advocated for the position as a way to stabilize the banking system (if your bank must keep 100% of your money, no reason to make a run on on it) and (especially for Friedman) control the money supply (banks no longer have discretion on what proportion of their reserves to lend out). Notably, no lender of last resort is necessary.

If banks were legally able to issue their own currencies, the outstanding currencies would be, from an accounting perspective, very similar to the liabilities that banks possess in savings accounts. The freest bankers insist that the government really ought to have a 0% reserve requirement and let competition work out the problems. Notably, in the Scottish system, this occasionally meant that banks were down to as little as 2% of their reserves – and, as a result, they sometimes instituted policies that meant customers might have to wait 6 months from a redemption request in order to get their gold. Interestingly, though this delayed redeemability was unpopular and attracted some limited regulation, the notes circulated at par in the interim and were indeed redeemed as promised. While no restrictions on reserves worked for the Scottish banking system, it might have been due to other factors like their unlimited liability and (eventual) convertibility to gold. If we had instant totally free banking today, there might be more risk if consumers were prepared to accept, say, cryptocurrency, as a reserve. Compared to our current system, though, Selgin suggests, “If consumers were willing to accept a fiat standard voluntarily, banks could induce them to do so by offering higher interest rates than competitors who still held commodity-money reserves, reflecting the lower operating costs of not having to hold non-interest earning assets. If this does not happen, one must conclude that consumers perceive a commodity standard as a higher-quality good than a fiat standard.” Notably, if there is no reserve requirement, there is dramatically less pressure on having the exact amount of resources to match the money supply.

Mark Skousen asks, “On a practical level, who wants to deal with potentially dozens of different kinds of privately issued bank notes?” Hayek responds, “If the public understood what price in periodic inflation and instability it pays for the convenience of having to deal with only one kind of money in ordinary transactions, and not occasionally to have to contemplate the advantage of using other money than the familiar kind, it would probably find it very excessive.” The point is that there is no natural monopoly in currency where competitors are allowed to produce. Hayek continued, “in the field of money I do not want to prohibit government from doing anything except preventing others from doing things they might do better.” Sweden for seventy some years had a system of begrudging free bank acceptance in addition to a government-preferred bank with a very explicit policy that no private bank would be bailed out. But the government favoritism backfired: the private banks were so responsible that none failed – indeed, despite the facts that their currency was not legal tender and was actually taxed, they were so successful at attracting consumers that the preferred bank successfully lobbied that it could only survive if given a monopoly on currency issue, thus ending free banking in Sweden.


Figure 11. On a practical level who wants to deal with potentially dozens of different kinds of private grocery stores or newspapers or anything else free enterprise competitively offers? Very probably: You.


I must conclude with the sad story of the Liberty Dollar. For nine years, Bernard von NotHaus sold tens of millions of dollars in gold and silver medallions to hundreds of thousands of Americans who either could take delivery outright or receive a certificate that allowed them to redeem their precious metals at any time. The George W. Bush administration responded by raiding his vault, seizing nine tons of precious metals (some medallions depicting Ron Paul), publicly accusing von NotHaus of “domestic terrorism,” and trying him for counterfeiting. Tragically amusing, his lawyer insisted “the last thing Mr. von NotHaus wanted was for Liberty Dollars to be confused with coins issued by the United States government.” We shall see what happens to cryptocurrency, but the U.S. government does not appear to be interested in currency competition in the near future. 

As stated near the beginning, the ideal monetary system sends as clean signals as possible to business and consumers while restricting government’s ability to grow.  If government’s growth was fueled by central banks, then reverse engineering the process means eliminating the central bank. As Hayek noted, “There can be little doubt that the spectacular increase in government expenditure [-] with governments in some Western countries claiming up to half or more of the national income for collective purposes [-] was made possible by government control of the issue of money.” So, “Unless we restore a situation in which governments (and other public authorities) find that if they overspend they will, like everybody else, be unable to meet their obligations, there will be no halt to this growth which, by substituting collective for private activity, threatens to suffocate individual initiative.” Indeed, “Under the prevailing form of unlimited democracy, in which government has power to confer special material benefits on groups, it is forced to buy the support of sufficient numbers to add up to a majority. Even with the best will in the world, no government can resist this pressure unless it can point to a firm barrier it cannot cross.”

Adam Smith, the father of modern economics, wrote eloquently about the power of capitalism to bring us wealth. Perhaps not surprisingly, he lived right in the middle of Scottish free banking with redeemability for commodities. At the time that he wrote, he considered his advocacy of free markets practically utopian, and yet within the coming decades Britain embraced most of his agenda. If you desire limited government and sound money, don’t be deterred by what is seemingly politically possible. Fight for the firm barrier that government cannot cross.

vienna chicago

Figure 12. For background about conservative economic approaches, check out Mark Skousen’s Vienna & Chicago: Friends or Foes? Chicago tends to prefer a rule-based solution to our monetary predicaments, though Milton Friedman softened on gold and free banking in his later years. Austrians tend to be split between those who favor a gold standard and those who favor free banking. See my two part review: first, about the history of how the schools came to be; second, about what their differences are. For a primer on what the Fed actually does, Steven Horwitz’ introduction from the Mercatus Center is quite good, though the Fed’s response to covid will require an update.

capitalism and freedom

Figure 13. For more details on a monetary rule, check out Milton Friedman’s Capitalism and Freedom, which tackles a lot of topics but also explains his preference for a rule slowly growing the money supply. You should also read Scott Sumner’s case for NDGP targeting. You can also read George Selgin’s caution about monetary rules in this blog post. 

What has gov done to our money

Figure 14. For more details about a commodity based standard, check out In Search of a Monetary Constitution, an anthology of various bright conservative scholars arguing about different potential monetary systems in 1962. Ben Graham favors a basket of goods, James Buchanan playfully argues for a brick standard, someone else argues for a fractional reserve gold standard, and Murray Rothbard argues for a 100% gold standard (and there are still others, including Milton Friedman, arguing for various non-commodity standards). Though this book is quite good, it can be hard to pin down. If you’re eager to read something on this, try Murray Rothbard’s What Has the Government Done to Our Money?, which includes both his contribution to In Search of a Monetary Constitution and an additional essay.


Figure 15. For more details on free banking, check out F.A. Hayek’s Denationalization of Money; Lawrence White’s Free Banking in Britain; and George Selgin’s The Theory of Free Banking. Hayek revitalized interest in free banking and his book is a smart, speculative take on what free banking might look like. White did significant research into how free banking worked in practice during his longest run: some 150 years in Scotland. Selgin surveys other historical examples but spends most of his book digging deep into the theory of how it might work. Notably, the works of White and Selgin are available for free!

Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone interested in economics or history? How about someone who wants limited government? Or do you know anyone who ever uses money to pay for things?

I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

    Invisible Hand or Iron Fist

    The Gist: How the ideas of free market capitalism triumphed over Marx and might still over Keynes.

    A review of Vienna & Chicago by Mark Skousen.


    If you desire limited government, there are a couple of things you need to get right first. 

    Acme Time Machine

    Figure 1. Time travel and/or a well-regulated militia ready to tar and feather select politicians.


    The first prerequisite of limited government is the law, and in particular, a governing constitution. Why is kind of obvious: if you actually enforce the rules that say the government can only do a finite number of things, you’re already there. The trick is setting up institutions that will see that project through. The second is the most important, least familiar topic in American politics: sound money. Here, the relationship to limited government might not be immediately clear – but so long as government can unilaterally determine the value of its debts (i.e. the value of the dollar), it has a lot of flexibility around its supposed limits.


    Figure 2. Pro tip from governments and little kids when they discover they’re losing a game: next time you arrange a mortgage with a bank, surreptitiously add a clause to the contract that indicates that all payments are to be made in your very own currency. Whatever the interest rate, print off whatever denomination of your own portrait you’d like!


    We have a long ways to go on restoring the original meaning of the Constitution, but we’ve at least spent decades trying to build a farm team of potential jurists with the right mindset while winning over the public to the need for them. Nominees to the Supreme Court attract mass attention and intense scrutiny to match their importance. Nominees to the Federal Reserve, on the other hand, barely get a notice beyond the financial pages of dying newspapers. Can you name any currently serving governors, beyond the chairman? That kind of quiet would be fine if we were getting what we wanted but, until we do, money is too serious a matter to be left to the central bankers.

    But what is a “conservative” view of money and what should we want? At a very high level, conservatives have tended to be skeptical of both inflation and intervention, which in the last few centuries typically means limiting the discretion (or existence) of central bankers. Because unrestrained central banks empower further already powerful interests – the government and banking industry – conservatives have always fought an uphill battle. (Not to mention that bankers often support much of the rest of a conservative financial agenda, so they’re thought to be friends). But conservatives have also faced a significant challenge in that they’ve never been able to agree on exactly how to limit central bank discretion. In 1962, a collection of essays was released by a number of prominent free market oriented economists, including future Nobel prize winners, called In Search of a Monetary Constitution – and their smart proposals were all over the map, often contradicting each other. 

    I want to dig into the potential solutions to this problem in another email, but to really understand them, you have to be familiar with two schools of economic thought associated with the right, how they came into being, and why and where they disagree with each other. What follows is primarily a review of Mark Skousen’s Vienna & Chicago: Friends or Foes?, describing the histories of the Austrian and Chicago schools of economics. 

    For several centuries, there was a general “mercantilist” understanding that there was only so much gold and silver and worthwhile objects in the world and so national economic policy was about trying to get and keep as much of that value as possible. Loath to give away precious metals to potential rivals, royals aggressively taxed and restricted international trade, instead preferring to pursue self-reliance, initially to the microscopic point of individual agricultural manors, eventually at a national level that spurred global colonialism. At one time or another, there were substantial debates about the morality of lending at any interest rate (even the morality of freely-set prices) or about the value of private versus public property. Royals were often keen to deal with convenient, cooperative, taxable economic actors like guilds or monopolies. Mercantilism’s virtue was that it embraced savings (but only because they didn’t want any gold to leave the country). Economics was understood to have very clear winners and losers, especially internationally, and every state naturally wanted to be a winner.


    Figure 3. Among the most famous mercantilist economists is Smeagol, known for putting the precious in precious metals.


    1776 saw the popularization of a different model. The year may not point to what you think. Though America was founded by free trade radicals, what started to alter government officials’ perception of how much they should intervene was a book: the Wealth of Nations by the Scottish philosopher Adam Smith. Smith famously argued that the path to national (and personal) riches did not come through careful management by government officials but instead from allowing people to be free to pursue their own interests through which they might be guided, as if by an invisible hand, to efficient ends for society at large. “It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.” Smith advocated for low and simplified taxes, open business competition free of subsidy, “free trade, limited government, balanced budgets, the gold standard, and laissez faire; in short, maximum economic freedom.” Smith’s views would generally be adopted by the British government, spurring the industrial revolution and massive wealth creation (as well as imitation around the world). Remarkably, there even emerged a powerful political lobby for the freest market possible that only began to fray as Britain faced trouble paying for its new promises of welfare.

    But tangential to Smith’s variety of good points, he also advanced a theory that the value of anything came from the labor that went into it. You yourself only have so many hours in a day to do your own job, to raise cattle and butcher and prepare it to eat, to grow cotton and fashion it into clothing, etc. With wealth, however, you could pay for others to do this for you – i.e. their labor. “The real price of everything, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it,” Smith claimed. 

    Within a few decades, free market economics faced its most serious theoretical challenge: Communism. Earlier than you might think, in fact: the infamous Manifesto was published in 1848. Karl Marx built his critique of capitalism on the foundation of this labor theory of value – clearly the rich were exploiting the poor! People were contributing their labor without capturing all of the profit! Marx seized on a flaw in Smith’s analysis and came to radically different conclusions as a result: “While Adam Smith views the commercial world as harmonious, progressive, and socially stabilizing, Karl Marx sees capitalism as brutally exploitative, alienating, poverty-stricken, and crisis-prone.” There was no invisible hand of the free market – just an iron fist wielded by greedy capitalists. In essence, Marx insisted, laborers were slaves. Proclaiming that he had discovered scientific laws of economics, Marx promised a better system – if only workers of the world would unite and seize control of the means of production. Then a workers’ paradise might emerge, where resources might be extracted and distributed “from each according to his ability, to each according to his need.” This perspective proved more popular than was beneficial for those who would live under it.

    The Austrian School of economics emerged to defend capitalism in its first great crisis of credibility. Carl Menger, an economist literally from Austria, argued that the whole labor theory of value is wrong. Products and services are not valued on the basis of how much work is put into them – they’re valued differently and subjectively by every consumer. In particular, if you’re hungry, that first bowl of ice cream looks delicious and you will readily pay handsomely for it. But the 11th bowl of ice cream may require the exact same amount of labor to produce but you may be willing to pay NOT to eat it. Or as Menger himself noted, if people stopped smoking tobacco, the tobacco would lose value in the marketplace even though the amount of labor that went in didn’t change at all. “He noted that farm land used to grow tobacco doesn’t fall to zero, but is valued according to its next best, or marginal, use, such as growing wheat or raising cattle.”  This “marginal revolution” pioneered concepts like marginal utility and opportunity cost.


    Figure 4. If you’ve ever been puzzled by your grandmother devoting substantial resources and countless hours to collecting obscure knick knacks or by your grandson devoting substantial resources and countless hours to following an offensive musical genre easily confused with totally random very loud noises, then you’ve discovered the subjective theory of value. 


    But the Austrians didn’t stop at correcting Smith’s error. They proceeded to demolish the whole Marxist framework. Another literally Austrian economist, Eugen von Bohm-Bawerk, argued that the Marxist theory of exploitation ignored the plain fact that capitalists were efficiently contributing capital to projects that would otherwise not exist. In particular, a capitalist was willing to forgo the use of his money in the short term to pay a construction crew to build a factory and workers to manufacture products in the hopes that he’d eventually get paid back (and hopefully more), thus bearing a risk that the presently-compensated workers do not. In the Marxist model, should workers forgo wages, possibly for years as initial costs are paid off, until and unless the profits come in? To ensure that every worker captures the full value of his labor according to Marx, how should any profits be split between the workers who built the factory, the workers who supplied the raw materials, the workers who manufactured the end product, all the other workers who somehow contributed to the outcome? True slave labor would emerge in self-titled Marxist economies where workers did not have much choice about how to deploy their efforts; by contrast, in a free market, workers could offer their labor to the highest bidder, before their work even produces profit to pay for it. Free to contract, both worker and employer benefit – otherwise, they wouldn’t make the deal. Skousen argues that this “critique of Marx’s exploitation theory is considered so devastating that Marxian economics never really took hold of the economics profession as it did in other fields. He demonstrated that entrepreneur/capitalists deserve the fruits of their labor because they take greater risks than workers fulfilling a vital creative use in the market system.”

    As if that was not thorough enough, another literally Austrian economist, Ludwig Mises, took on the reality of centrally planned economies as they came into existence. Marx never got a hold of the national means of production himself, but he inspired others who did. Setting aside their tendencies toward mass murder, their practical application of Marxist ideas involved a small number of central planners replacing the spontaneous agreements of consumers and capitalists as deciders of how to distribute resources. Mises pointed out that, in a complex national economy, this was not only extremely difficult but actually impossible to do well -“without prices and competitive bidding, a centrally planned totalitarian state could not operate an efficient, progressive economy.” Real, unsubsidized, unregulated prices instantly demonstrate to everyone the economic value of a product or service. As F.A. Hayek expanded on how this works in a capitalist system, 

    Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. 

    In contrast, a central planner must decide how much resources to devote to mining tin and how to disperse the tin across the entire economy – but how would they know how valuable tin is to users without knowing what they’d pay for it? Or, as Mises simply asked: how does a central planner know whether to build a bridge? If it should be built, where along the river? With what materials? How does he weigh the opportunity cost of countless alternatives? How will he be held accountable for the decision? The far better solution was to empower capitalists to put their capital at risk when prices signalled that a profit could be made. Or, to paraphrase Winston Churchill, socialists criticize profits but the absence of profits is far worse. 

    All of these arguments helped restore laissez-faire to a position of preeminence in the late 19th and early 20th centuries, at least among economists, and certainly versus Communism. In practice, British and American politicians were more or less pursuing the right path, but were also pursuing fresh socialist schemes, central banks, tariffs, antitrust, and any number of economic interventions that Austrians found anathema.

    But in addition to savaging Marx and salvaging Smith, the Austrians were promulgating new ideas about economics, including a theory of the business cycle, wherein the drunken hazes of booms are followed by the correctional hangovers of busts. In the Austrian view, the booms were fueled by over-aggressive bankers (later, central bankers) who lent out too much money at rates that fooled consumers into overspending and capitalists into malinvestments. When money is cheap to acquire, everyone is tempted by (marginal!) buys that wouldn’t normally make sense. Busts were the inevitable outcome where people realized their mistakes.


    Figure 5. When money is cheap (and you’re drunk), suddenly the numbers on that real estate deal upgrading alligator-infested swampland start to look real promising.


    Throughout the roaring 1920s, Mises and Hayek were predicting that a big crash was coming – a fairly easy prediction, given the theory, and why Austrians are known for predicting 8 of the last 2 recessions. When the crash did come in 1929, Austrians were suddenly the belles of the ball – everyone wanted to know what the economists who called the crisis recommended what to do next. But the response of the Austrians did not satisfy their listeners: Don’t just do something, stand there! The Austrians insisted that the bust would work out the problems of the boom – and if the bust was especially severe, it was because the boom was especially irresponsible. Austrians warned that government intervention would actually make the economy less stable because you would be sending the wrong signals, again, to capitalists about the desirability and safety of possible investments. Instead, the harsh medicine of the Austrians was to let the pain happen: every unemployed person would be willing to work for less and less over time and capitalists would eventually look at the bargain offered by labor and rebuild the economy on a firmer foundation. Relatedly, all in accordance with supply and demand, any product already produced would eventually drop in price to become consumed. Creative destruction would replace old, inefficient firms with new, spry ones.

    This was not what government officials wanted to hear. “In the United States, industrial output fell by 30 percent and nearly a third of the commercial banks failed. The unemployment rate soared to 25 percent. Stocks lost nearly 90 percent of their value. Europe and the rest of the world faced a similar fate.” Capitalism faced its second major crisis of credibility. Unable to withstand the pain, many governments turned to John Maynard Keynes to try to “fix” rather than fully replace capitalism. “Keynes’s principal thesis is that financial capitalism is inherently unstable and therefore inescapably flawed” – a free market economy could not always guarantee full employment, for example. Keynes offered the flattering and enabling solution that brilliant government officials only needed to tinker with the economy – at its most basic, in rough times, government should borrow against the future and stimulate by spreading money around (perhaps the money would be used frequently, thus you’d be getting a multiplier of the effect!) When the crisis was past, when prosperity returned, governments could raise taxes and reduce spending, paying off the debt. (Except somehow otherwise dedicated Keynesians mostly forget about cutting spending in the good times).


    Figure 6. The motto of the Austrian Gym is “No pain, no gain”. No trainers, of course: you just hit the machines and build those muscles. Result: Arnold Schwarzenegger. The motto of the Keynesian Gym is “No judgment.” There are no trainers, either, just “Buddies” assigned to encourage you between opulent snacks at the in-house ice cream bar whenever you’re tired. Result: Chris Farley.


    But that wasn’t all. Austrians insisted that people needed to be free to save their money because saving itself represented a valuable signal as to whether profit opportunities were worthwhile. Keynes instead called this the paradox of thrift: saving might be nice for an individual but, according to Keynes, was bad for the economy at large because money was on the sidelines during a crisis. Furthermore, Keynes charged, the wealthy were disproportionate savers and so must be induced through progressive taxation and estate taxes and whatever other penalties can be politically applied to get them to go out and spend. As a result of Keynes winning this argument, America has built nearly a century of policy on the very successful attempt to get our citizens to consume – never mind the Austrian insights about saving for the right opportunity or “that an increase in consumer spending is the effect, not the cause, of prosperity”; never mind the general benefits of saving for a rainy day; never mind practically no one puts their money under their mattress, so money in a bank means loans to others are cheaper.

    conjunction junction

    Figure 7. Consumption function, what’s your injunction? 


    Austrians dismissed Keynes as a passing fad – and were stunned that not only governments but that the economics profession embraced his theories wholly and at length. Though the pioneering earlier work of Austrian economists on marginal utility, opportunity cost, price signals, and other concepts were integrated into mainstream economics, Austrians’ continued belief in the true freedom of markets amidst and after the Great Depression invited – pun intended – marginalization. The Austrians made occasional headway in popular books – in very likely the last time that a political movement attempted to win power by distributing a book, Britain’s Conservative Party sent out thousands of copies of F.A. Hayek’s Road to Serfdom in a fruitless attempt to persuade voters to return to the free market – but they were otherwise on the outs for decades as Keynes reigned supreme.

    But in the years after World War II, some questions about Keynesian economics started to come from scholars at the University of Chicago. Whereas the Austrians had tried to engage Keynes on the abstract level of theory, Milton Friedman started to run the numbers on Keynesian formulas, predictions, and theories and discovered… they didn’t actually work. The supposed multiplier of government spending during a recession may not even add. Whether the government taxes or sells debt, it has to take money from somewhere else. Friedman and Chicago School colleagues further unraveled data that demonstrated that consumers did not act like Keynes predicted, specifically that they could not be so easily induced to spend their own money with a temporary prod from the government. “Friedman, a scholar intimately familiar with the Keynesian language, apparatus and policy implications, used Keynes’s own language and apparatus to prove him wrong on every count.”

    Furthermore, whereas Keynes had made government fiscal policy (how much the government spends) the center of his attention, Friedman came to realize that far more important, perhaps the only important thing, was actually monetary policy (how much the dollar is worth). Friedman revived an old theory originating with, of all people, the astronomer Copernicus: money acted according to the same principles of supply and demand as any other product, thus the value of the dollar can be influenced by how many dollars are in circulation. Friedman concluded that the Federal Reserve is generally quite bad at managing their work, partially because they don’t actively manage the money supply but instead try to manage the interest rate at which money is lent, too often excessively favorably to the government; partially because supposedly nimble discretion involves lags between a problem like unemployment arising, central bankers discovering and interpreting the problem through statistic collection, and central bankers finally conjuring and applying unpredictable, bespoke, and heavy-handed responses.


    Figure 8. Both embracing truth attacked as heresy, Friedman fared better than Copernicus’ other disciple Galileo. But then, the Fed doesn’t yet have the power of house arrest. Wait for the next crisis, though.


    Initially, in the prosperous 1950s and 1960s, Friedman’s work consisted of an extremely well-researched historical argument, especially famous for recasting the reasons for the Great Depression (the severity of which he blamed on the central bank bungling the money supply). But soon the argument became very real. After Keynes’ death, the next generation of his followers had come to believe that there was a fundamental relationship between inflation and employment – and that the trick of the bureaucrats was to have full employment with manageable inflation. But in the 1970s, something impossible seemed to occur: high inflation and unemployment happened simultaneously! Keynesians grasped for solutions (wage and price controls?) but lost serious credibility as “stag-flation” continued unabated. Chicago’s thoroughly backed research revived the credibility of laissez-faire economics. Eventually, the Fed (and the British equivalent), having exhausted Keynesian suggestions, under the threat of the Austrian recommendation to return to the gold standard, managed the money supply for long enough to bring inflation under control. But, significantly, Chicago did not fully win the debate: whereas Milton Friedman ideally wanted the Fed replaced with a computer that would automatically grow the money supply by a small amount, he otherwise suggested that the Fed be constrained by rules they must follow. Though Chicago remains deeply influential to the Fed (which did not start publishing estimates of the money supply until Friedman estimated and published them himself), it operates under no especially binding rules.

    Great lakes

    Figure 9. Because the University of Chicago is proximate to the Great Lakes and its Keynesian rivals tended to be based at universities near the coasts, the debate was amusingly referred to as a battle between “freshwater” economists and “saltwater” economists. In case you didn’t realize, drinking saltwater is hazardous to your health (and wealth).


    While Friedman was a giant of the Chicago school and the primary debunker of the Keynesian challenge to laissez-faire, the Chicago School also diligently and numerically advanced the principles of free market economics across a wide range of disciplines, prompting them to win a cornucopia of Nobel Prizes for work on transaction costs, regulatory capture, law and economics, public choice, the efficiency of the stock market and more. Chicago’s work may not yet have cut government, but it has certainly made lots of government programs less credible. As Friedman argued, “One of the great mistakes is to judge policies and programs by their intentions rather than their results.” To describe their role in the battle of ideas, George Will once quipped, “The cold war is over and the University of Chicago has won.” 

    Today, our economic battles are often impenetrable debates between math nerds in the Chicago School or Keynesian persuasion, the latter freshly ascendant after the 2008 financial crisis shook faith in the capital system (never mind the massive government involvement in housing). Keynes can never quite be killed off because he is Santa Claus to politicians (except that he rewards the especially naughty ones). But the Austrian way of thinking never went away – the Austrians are not merely Chicago’s predecessors. The two schools have important, notable disagreements that we shall explore in our next correspondence.

    vienna chicago

    Figure 10. Click here to acquire Mark Skousen’s Vienna & Chicago, a good overview and introduction to its subject matter. If you have not already, check out the entertaining and insightful rap battles between Marx and Mises, Keynes and Hayek.

    Free to choose

    Figure 11. Click here to acquire Milton Friedman’s Free To Choose (also a miniseries well-worth watching), a powerful introduction to Chicago by its most famous member. Click here to acquire Howard Baetjer’s Free Our Markets, a modern introduction to the Austrian way of thinking.

    Red plenty

    Figure 12. Click here to acquire Francis Spufford’s Red Plenty, a revealing exploration of Soviet central planners trying their best to work without prices. (Spoiler: It doesn’t work.)

    Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone interested in economics or history? How about someone who wants limited government? Or do you know anyone who ever uses money to pay for things?

    I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

      Worse Than a Stock Market Crash

      The Gist: You’ll eventually recover from a crash. Not so much from confiscation, inflation, deflation, and devastation.

      A review of Deep Risk by William Bernstein.

      The easiest ways for our government to dispatch its massive and increasing debt are not especially pleasant for you – Uncle Sam could either take your money through ever more taxation or make it worth less (or worthless) through ever more inflation. If you’re a U.S. bondholder, you could even see a default, which is really just another form of confiscation. Such actions aren’t likely to be salubrious for the economy around you, either. 


      Figure 1. Or, of course, the government could cut spending, but what are the odds?


      Worse, these are financial risks that you don’t really recover from. A 90% loss in the Great Depression might have been a disaster for your U.S. stock portfolio but, if you held on, you would have eventually not only completely recovered but also made substantial gains. Far less likely: the government imposes a wealth tax, seizes your assets, and then somehow makes it up to you in the future.

      So, how do you insure your personal portfolio against these risks? Paying premiums to the Republican Party only gets you so far – the party’s undying enthusiasm for tax cuts is not appropriately matched with undying enthusiasms for spending cuts and sound money. Even if the GOP’s platform was perfect and vigorously pursued, it does not enjoy the political hegemony of Singapore’s People’s Action Party, which has ruled for six decades without interruption. 

      William Bernstein gives advice in his brief book “Deep Risk,” which identifies four threats to your portfolio that could result in a “permanent loss of capital” over 30 years: inflation (especially of the hyper variety), deflation (especially if you’re a debtor), confiscation (primarily by your government), and devastation (primarily by someone else’s government).


      Figure 2. As one Boglehead quipped, Bernstein missed “tuition


      Bernstein’s book is partially inspired by the Permanent Portfolio created by former Libertarian presidential candidate Harry Browne and articulated for present audiences by Craig Rowland. The Permanent Portfolio is a conservative, uncorrelated asset allocation recommendation designed to weather a variety of economic conditions. Boldly, Rowland claims that “the four economic conditions (or some combination of them) are the only ones that can exist in a modern economy. In other words, at any point in time, the economy is either expanding (prosperity) or contracting (recession) and the money supply relative to the supply of goods and services is either expanding (inflation) or contracting (deflation).” Browne recommended an even split of assets he thought would do well in each environment – gold to counter inflation, long-term U.S. bonds to take advantage of deflation, an index of U.S. stocks to ride prosperity, and cash or short-term Treasury bills for flexibility in a recession. Bernstein notes “For the 37.5 years between 1976 and June 2013, the PP, rebalanced at year end, returned 8.66%”; further, “the PP shone in [the financial crisis of] 2008, with a nominal loss of just 1.38%.” But while Bernstein is impressed with elements, he believes the allocation is both too conservative (not enough exposure to the real long-term gains available in stocks) and miscalculates the risks (not all four of the economic conditions are equally likely and recessions are recoverable). In particular, inflation is the deep risk our wealth is most likely to face.


      Figure 3. “Here at Mondale & McClellan, we believe that the portfolios of presidential losers can make you a winner! Try out our Willkie Forty – a value-tilted portfolio of dividend-distributing private utilities – or perhaps our Hoover Hundred – an international collection of precious metal miners. If you’re looking for a bargain, our Landon Energy Fund is the place for you! If you’re seeking more excitement, the Perot Growth Index offers the chance to get in early on the hottest information technology; the DoleMcGovern Fund captures the whole pharmaceutical sector; and the Gore Group offers a mix of green bonds and stocks. For the discerning investor, Mondale & McClellan is also pleased to announce the special opportunity to participate in our private equity fund of funds – the Romney Fund – as well as our KerryMcCain Matchmaking Services (primarily consumer-products oriented)”


      Americans of my generation have no earthly idea what really bad inflation can look like. Millennials might have waited hours for the latest iPhone or Harry Potter book – but none have had to wait for gasoline. But my father’s double-digit interest mortgage payment in the late 1970s was nothing compared to the horrors of living through hyperinflation, infamously captured in the German Weimar years with the image of a man using a wheelbarrow of cash to pay for basic groceries. At the time, industrial workers were given multiple breaks a day – not to smoke or grab coffee – but to run out and buy anything they could before prices multiplied again. Sadly, that’s not our only example. Milton Friedman recalled traveling around Europe right after WWII and people preferring American cigarettes to local cash (Bernstein notes that “The highest denomination banknote ever printed was the Hungarian 100 quintillion pengõ bill, issued in 1946”). And we’ve seen what happens with Venezuela and Zimbabwe in more modern days. So what do you do, stockpile cigarettes?


      Figure 4. Do you happen to have 100 billion trillion-pengo bills? I am looking to break 100 quintillion.


      Here’s the remarkable thing: if you had had been a German stockholder before Weimar’s hyperinflation – and you managed to hold on to your stocks throughout the crisis “when the nation’s currency inflated by a factor of one trillion” – you would have come out with a real return. In the early stages, there was a large sell-off as people were desperate for cash but as the crisis endured, people realized: high inflation is certainly not ideal for stocks but ultimately you own pieces of businesses that have sustainable value. Now, caution is merited: Americans enjoyed no real return from holding stocks in the 1970s and Bernstein cites one study that found that when inflation breaks 4% in the US, stock valuations fall off. But,

      “Interestingly, while severe and persistent inflation seemed to reduce equity returns, it did not always savage them: over the 70 years between 1927 and 1996, Chile experienced 33.16% annualized inflation, enough to produce a 508-million-fold rise in prices. Yet its stock market sported real price-only returns of 2.99% per year, within shouting distance of stocks in the United States. Similarly, over the 40 years between 1957 and 1996, Israel had 33.02% yearly inflation and 3.03% real price-only stock returns.”

      But there’s an even better asset allocation decision for Germans in the 1920s and Americans in the 1970s and you today: own a basket of international stocks. When you buy an index of them, you may be warned that there’s a risk that you’ll be exposed to international currencies – but when it comes to protecting yourself against the inflation of the American dollar, that’s a feature, not a bug. (In fact, were I in Zimbabwe I am not sure I’d want any domestic stocks!) Contrary to the popular phrase, Rowland argues “The world is not flat. Each country will have its own unique economy and economic cycles that are not necessarily going to match up with other countries around the world.” Bernstein concludes that hedging the biggest deep risk is both easy and profitable, perhaps not coincidentally echoing precisely what financial theory would suggest you do otherwise: own an index of global stocks, tilted toward value (because cheaper stocks tend to be overleveraged and thus would benefit from the reduced debt burden). If you were especially concerned, you might further tilt your stocks toward companies that produce commodities and profit from natural resources (though those won’t necessarily do as well outside an inflationary environment.)

      Simultaneously, you need to be aware that the apparently ultra-safe part of your portfolio is most threatened by inflation’s deep risk: bonds and cash. At its most basic, when someone – government, corporation, or brother-in-law – owes you money, and that money becomes worthless, you’re the loser. Bondholders in the Weimar republic collected a fraction of the original value of their holdings – and only that much because the government bailed them out. Bernstein cites a study that “amalgamated the 2,128 country-year returns and found that the returns for stocks and bonds, unsurprisingly, were negatively correlated with inflation: during the 5% of country-years with the highest inflation, stocks did badly, losing an average 12.0%, but bonds did even worse, losing 23.2%.” Of course, if you are the debtor, then this might be great – just make sure you have a fixed-rate mortgage and the rest of your assets are invested in overseas stocks. You may also benefit from inflation-protected securities, like the TIPS U.S. bonds or even your Social Security payments. Rowland is more skeptical, noting the example of  how Argentina understated their consumer price index adjustments and warns “Don’t buy inflation insurance from the people causing the inflation.” Bernstein, for what it’s worth, responds that messing with the adjustments will make new debt much more difficult to issue as the bond market would view such shenanigans as a form of default.

      Notably, Bernstein omits two classic inflation hedges from his advice: real estate and gold. Real estate really does go unmentioned – unfairly, in my view, but I may be biased. Gold’s absence is intentional and especially interesting because it is the asset recommended by the Permanent Portfolio to withstand inflation. As Rowland relates, 

      “Gold doesn’t change over time and a government can’t print more gold when it starts to run low on funds. Gold does not rack up massive debts and unfunded government liabilities. Gold does not care about political speeches or promises about the strength of any particular currency. Gold to a politician is like holy water to a vampire. In terms of purchasing power protection, gold has a long track record of preserving wealth that is unmatched.”

      All very well and good. The problem is that, while gold has maintained its value over a very long time, say, a century, it has not been quite as neat a store of value over a shorter term: from 1981 to 2001, gold lost 80% of its real value (even as the U.S. merrily inflated away). Bernstein also happens to think that gold is overvalued by conservatives in the same way that green energy companies are overvalued by liberals – not necessarily always judged rationally. And, of course, gold produces no income and does not magically multiply – Warren Buffett once quipped that gold involved digging a hole to find it then digging another hole to store it with no additional utility. Also notable is the large proportion of the global gold supply owned by governments that could one day flood the market.

      But gold should not be written off entirely: Bernstein cites a study by researchers from the London Business School who looked at 19 nations over 112 years and found, surprisingly, in “deflationary years, gold returned an average of 12.2% in real terms, and in the 5% of country-years with the highest inflation, its average annual return was actually slightly negative. In other words, although gold bullion provided little protection against inflation, it did superbly with deflation.” Close to home, “During the three-year period between 2007 and 2009, for example, when inflation was nearly nonexistent, gold’s price rose by 71%.” Bernstein summarizes, “gold does best when the public loses faith in the financial system; this happens during panics, which are almost always associated, at some point, with low inflation or deflation.” Rowland echoes the point “Some investors believe that a basket of commodities will work just as well (or better) than holding gold. They won’t.” Specifically he relates that in 2008, “some commodity funds lost more than 45 percent of their value compared to the 5 to 10 percent gain that gold had for the year. When the financial system was teetering on collapse, people wanted gold, not oil futures.” The mining companies that Bernstein himself prefers didn’t do that great either.

      James Bond

      Figure 5. The more you contemplate the dastardly plan of Goldfinger’s “crime of the century”, the more you appreciate the genius of his villainy. 


      All of which brings us to the much less likely second potential deep risk to your wealth: severe, prolonged deflation. Whereas inflation effectively reduces any of your debts, deflation effectively makes your debt bigger. As a result, the Permanent Portfolio’s response is to hold long-term U.S. bonds, trying to take advantage of not only actual deflation but also reductions in inflation because the plan requires you to continuously sell your bonds on the secondary market before they become medium term. Part of the reason the Permanent Portfolio did comparatively well in 2008 is that while the stock market was crashing, its bond portfolio was up 30%. But while 2008 involved brief deflation, the severe and prolonged version is not an experience many Americans are familiar with. Bernstein suggests that the last time it was experienced anywhere was when countries were on the gold standard (including during the early years of the Great Depression) and that a much milder version has been present since 1990 in Japan. There are arguments about whether deflation is good or bad for the economy as a whole – Austrian economists argue that deflation is a correction to the economy’s irrational exuberance or the result of productivity gains, other economists argue that deflation holds back investments as people weigh keeping a dollar that is of increasing value versus spending it. 

      Regardless, Bernstein argues that deflation isn’t good for your stock holdings – but is it especially bad? Between 1866 and 1896, America’s “price index fell by an astonishing 41%” and over about that same period, “stocks returned 5.4% per year in nominal terms.” After accounting for deflation, stocks returned about the historical average, though Bernstein worries that a large part of that was in dividends that are not as widespread and generous as they once were. If you accept that Japan is subject to this specific problem (where prices fell, but only by about 2%, over 25+ years), then you should be worried that your Japanese stocks lost more than half their value – but is that the only thing going on in Japan? According to Bernstein, the only other incidents of deflation have been in Hong Kong between 1998 and 2004, where 17% deflation came alongside “low but positive real stock returns” and modestly in Ireland after the great financial crisis. 

      So, deflation’s harms may not be terrible – unless you’re a debtor – and deflation itself is rather unlikely in today’s inflation-happy world of fiat currencies. Still, there’s an easy way to hedge against it: international stock diversification (again, because of the currency differences). If you accept the Permanent Portfolio thesis, long-term bonds will also work (again, with decreasing inflation as well) but most other advisers recommend against going long term with bonds. And, according to Bernstein’s data, gold might perform well as well. Regardless, you might want to hold gold to insure against another deep risk: confiscation.

      Bernstein argues that “the confiscation scenario is very unlikely, but if you think it’s impossible, you haven’t read enough history.” At its most benign, the government will tax 20-50% of your income, estate, capital gains, or whatever else they can. Bernstein “tend[s] to view taxes more as the dues [he] pay[s] for membership in a club with a billion person waiting list.” At its most severe, Marxists seize 100% of your assets. Shareholders in the once-thriving St. Petersburg stock exchange, sugar plantation owners across Cuba, export-importers in China never recovered. There are in-betweens: in 2001, Argentina froze all bank accounts, converted any held in foreign currencies into the local peso, then devalued the peso by 2/3. Citizens weren’t even allowed to collect what was left for a year. In the 1930s, the United States government demanded citizens turn in all their gold at a discount. Bernstein argues that “even Bernie Sanders supporters cannot doubt that their retirement savings are at risk from a federal government hungry for revenue. During the 1980s congress arbitrarily imposed a 15% tax surcharge on retirement plan distributions of over $150,000, an unexpected penalty on those who chose to save rather than consume; it was quietly repealed in the mid-1990s.”

      Your only solution is to situate assets outside your country that plausibly might resist confiscation by your government. You also, naturally, need the ability to escape and actually access said assets if things go really south. Under our current regime, citizens “are saddled with onerous taxes” on foreign investment accounts and have to fill out gobs of paperwork or risk felony prosecution. Bernstein warns, “over the past few years, the United States government has made life so miserable for foreign banks and brokerage houses that most are loath to take on American clients.” There may also be motivations beyond taxing every dollar they can: “Think of it as a form of ‘soft capital controls,’ or perhaps a subtle attempt by United States banks, which generally provide a much lower level of service than their foreign competitors, to keep their business at home.” If you wanted to bid farewell to the land of the free, “United States citizens are, in any case, liable for substantial ‘expatriation taxes’ on personal and retirement assets on renunciation of citizenship.”

      As a practical matter, what all this means is that your options are to buy foreign real estate or store physical gold bullion abroad – with the idea that they are both difficult to seize and produce no taxable income unless you sell them. Cryptocurrencies like Bitcoin might also be of interest in that they are accessible worldwide but their intrinsic value is so hard to gauge (and their resulting volatility is so high) that they may not serve your needs. And, indeed, you have to gauge for yourself how likely confiscation is, how inconvenient international dealings are, and how much you can really afford to put somewhere else (is it enough, for example, to start over if your domestic assets are seized by the new Red Guard?).

      On gold, Craig Rowland has some rules of thumb:

      1. Only deal with first-world countries with stable governments and legal systems that provide strong protections of private property.

      2. Avoid dealing with institutions where accountability rules are opaque or unclear.

      3. Try to do business in legal jurisdictions that support financial privacy.

      4. Always follow all legal disclosure requirements.”

      Specifically, “the first choice” for your holdings should be “physical gold bullion stored in a safe location and insured against loss.” Think Gringotts. When Harry Browne was writing, Switzerland was the natural home for foreign assets, where apparently the Swiss treat financial privacy as seriously as we treat free speech. But that all changed during the Obama administration, which cracked down so hard on Swiss banks that they now are actively disinterested in US consumers. Instead, Rowland suggests buying and storing standard gold coins – such as the delightfully named Australian Kangaroo – at the New Zealand Mint (a private group insured by Lloyd’s of London), the Perth Mint (founded in 1899, backed by the government of Western Australia, advertised as akin to Texas), or Das Bank (an Austrian safe deposit box company with robust anonymity protections, including cameras that monitor but don’t record). Amidst this, don’t forget: acquiring and maintaining gold does have costs, is not terribly convenient, and, just like what happened with Switzerland, conditions can change that affect the security of your assets.


      Figure 6. Scrooge McDuck proved you either die a villain or live long enough to be a hero. As befitting his name, Scrooge was originally intended to be an antihero but proved so popular that he was given a rags-to-riches backstory as he dispensed advice on thrift. Today, the New Zealand Mint will sell you an actual gold coin featuring him but it is unclear whether they allow you to swim through your collection.


      Rowland also recommends holding at least some of your gold holdings instantly accessible:

      “Gold can be an asset of last resort. Which means that gold is an asset that you need to be able to access when there may be significant disruptions occurring within the economic or political system. In order to have ready access… you should aim to have as few pieces of paper and people between you and your gold possible.”

      This is, of course, part of gold’s appeal – a “benefit of gold is that it is a compact and universally recognized form of wealth.  Gold can be owned directly by an investor and is not a paper promise as other investments are.” For the purposes of the Permanent Portfolio’s rebalancing, this also makes it easier to sell off over-allocated gold. Notably, there are various reports of people using their gold to get out of a country – or sewing it into their clothes to have it when they get out.

      Treasure chest

      Figure 7. Discreetly bury your precious metals in a national park and, if you get bored, invite everyone to participate in a treasure hunt. 


      But there may be one other consideration when it comes to gold: how expensive is it relative to its historic price? That answer is what prevented the person who wrote the otherwise kind introduction to the Permanent Portfolio from diving full in. Rowland insists,  “A common question about the Permanent Portfolio is whether it is better to buy all of the assets at once or wait and move in slowly over time. Go all in. Waiting is a euphemism for market timing.” And that may be true for the specific benefits of the Permanent Portfolio. But as an insurance policy, you have to weigh the risks of confiscation versus the risk that gold is going to have only 20% of the value that you bought it at. It’s also debatable how much value gold would have in various scenarios involved in our final deep risk: devastation. 

      My parents are in their seventies and have lived through about 30% of American history since 1776 – it’s been a spell, but it has not been too long since Atlanta was burned (or certainly not since New Orleans was flooded). Bernstein sensibly notes that this is of much greater concern to South Koreans and Israelis – were the United States to be devastated in this nuclear age, the world might have ended. But just for historical context, let’s revisit the losers of World War II as we again think about how deep risk affects our “safe” assets:  

      “Japanese and German bondholders saw losses of more than 95% during and immediately after the Second World War; stocks in both nations fell by about 90%. Whereas the bondholders held what was, in most cases, nearly worthless pieces of paper that never regained their real value, the stockholders owned claims on the assets of the likes of Siemens, Daimler, Bayer, and Mitsubishi, which when recapitalized and rebuilt regained their real prewar value in less than a decade in Germany, and in about a decade and a half in Japan.”


      Figure 8.  Bernstein recounts “During the Cuban Missile Crisis of 1962, when apocalypse seemed more than possible, an apocryphal story has a young derivatives trader asking an older one whether to go long or short equity options. The immediate reply, ‘Long, of course. If things turn out all right, we’ll make a ton of money.’ Quavered the younger trader, ‘And if they don’t?’ To which the older trader cheerfully replied, ‘Well then, there won’t be anyone on the other side of the trade to collect from us!’”


      Ultimately, Bernstein suggests you insure against local devastation in similar ways to previous descriptions: if only your hometown is destroyed, your global stock index is probably fine. If you’re Israeli and your country is destroyed, you need assets situated outside your country just as if you were ensuring against confiscation. The only scenario Bernstein doesn’t really discuss is if we’re in more Mad Max post-civilization territory where gold is of really debatable value (will it still be treasured by whatever traders remain?) If you’re inclined to prepping for the apocalypse, do your best to rationally calculate the odds but, if you remain afraid, bullets may be your best bet!

      Inflation, deflation, confiscation, and devastation are the four deep risks Bernstein says threaten your portfolio. Figure out what you should fear and plan accordingly. Bernstein recommends that “Capital managed for near-term liabilities should be guided by shallow risk, while capital managed for very long-term liabilities should be guided by deep risk; the stickiest problems occur in the no-man’s land, very roughly between 10 years and 30 years, where both have to be considered, as well as in those rare situations where shallow risk evolves into deep risk.” And in fact, for the rare “25 year old saver” reading this, “not only should you protect against deep risks, you should actively seek shallow risk, since it will enable you to buy at lower prices.” Bernstein insists: “Younger investors should navigate by the deep-risk lighthouse.”

      Deep risk

      Figure 9. Click here to acquire William Bernstein’s Deep Risk, a short brilliant booklet (10/10). Indeed, every book of Bernstein’s is worth reading. See my previous review of his work, on general asset allocation, here: Get Rich Slow

      Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone interested in keeping the government away from their money? How about keeping their money generally?

      I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

        The High Cost of Good Intentions

        The Gist: Don’t trust Congress – they raid funds, their cost estimates are atrocious, and their promises of future restraint are lies.

        A review of The High Cost of Good Intentions by John Cogan.

        The third of three parts. Click here for part one and here for part two.

        In 2012, Mitt Romney got into a lot of political trouble when he asserted that 47% of Americans did not pay taxes.

        But how about the other side of the ledger?

        “Fifty-five percent of all U.S. households receive cash or in-kind assistance from at least one major federal entitlement program,” says John Cogan, the author of The High Cost of Good Intentions.

        He further colors in the picture as of 2017:

        Among all households headed by a person under age 65, over 40 percent receive entitlement program benefits. Eighty percent of all people living in households headed by single mothers receive entitlement benefits, and nearly six out of every ten children in the United States (58 percent) are growing up in a family on the entitlement rolls. The labyrinth of overlapping entitlement programs, each with its own eligibility rules, allows 120 million people, two-thirds of all entitlement recipients, to simultaneously collect benefits from at least two programs. Forty-six million people, nearly one-third of all recipients, collect benefits from three or more federal entitlement programs simultaneously…These numbers, remarkable as they appear, are likely to understate the true extent of the entitlement system’s reach. It is well known that the CPS significantly underestimates program participation, particularly among means-tested entitlement programs.”

        Endangered Species

        Figure 1. Still, the government has a plan. The U.S. Fish and Wildlife Service has identified the American taxpayer as eligible for endangered species protection. 


        Incredibly, the amount the U.S. government spends each year annually on entitlements is enough to give $7,500 to every man, woman, and child in the U.S. – “an amount that is five times the money necessary to lift every poor person out of poverty.” 

        And if the amount of money wasn’t scary enough, our aid to families breaks up families, our aid to the poor discourages work, and our medical aid drives up medical costs. In one estimate, the main medical program of the federal government drove up costs 50% in the first five years after enactment – never mind the next fifty. And of course ObamaCare has made things worse.

        Fed U

        Figure 2. Most likely the next major government program will provide a college degree for everyone while rendering them unemployable poet sociologists.


        There are programs that can do good – like Social Security – but that politicians have lied about, abused, and robbed for decades. A brief tour of the program is worthwhile.

        FDR enacted the largest tax increase in American history to pay for it: 6x as many people were paying taxes after Social Security was passed, including 95% of workers. And he had a theory: “We put those pay roll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program. Those taxes aren’t a matter of economics, they’re straight politics.” Still, FDR wanted the program to be self-financing – taxes would initially be a little higher than they needed to be so that a reserve of money could be built up, gain interest, and new recipients would reap the reward. This was put in place rather than a tax rate that would change based on what the commitments were. Trouble awaited.

        Well into the 1950s, lots of recipients of Social Security paid nothing into the system. The vast majority of those who did could expect not only to get a return from Social Security that exceeded a parallel private account but also would get back all they put in (plus their employer contribution) within a matter of months. A well-worn observation is that life expectancy at the time of Social Security’s enactment was smaller than today, and that is true but overstated. More interesting is that the original program only covered 50% of the workforce and, in 1946, only 1 in 6 people over 65 received benefits. Because there was little inflation, there were no cost-of-living adjustments. 


        Figure 3. To give you an idea of price stability at the time, the price of Coca-Cola did not change between 1886 and the late 1950s: 5 cents. Let’s hope that the ineptitude and wrongheadedness of politicians and central bankers does not lead again to 1 in 6 receiving benefits.


        As with every surplus the U.S. government had produced in any fund, the Social Security surplus became extremely attractive to politicians. So they decided to use an accounting gimmick to claim that it was still in the fund while using it to finance other government expenditures. Since that seemed to work, and the Social Security balance sheet looked so healthy on paper, Congress regularly voted to increase the benefits (almost always in an election year, with the bigger check arriving just before voting, mostly redistributing bigger payers’ dollars to smaller payers.) In the late 1960s, a powerful Senator hijacked a must-pass debt-ceiling vote and added an amendment that dramatically altered the Social Security payouts – making multiple significant mathematical errors along the way: (1) it dramatically misunderstood what was available; (2) it added a particular inflation measure that did not account for the problems that lay ahead; and (3) it did not take into account shifting demographics where Baby Boomers had fewer kids. Soon, the program was headed for bankruptcy.


        Figure 4. There is immense irony in our reliance on the government to teach kids math


        Ronald Reagan delayed the day of reckoning but Social Security trustees say it will not be able to make full payments in just over a dozen years. So now may be a good time to reform some other things to allow us to ensure Social Security’s solvency, our defense needs, and whatever else you find important. This is not easy. Reagan quipped that the closest thing to immortal life on this earth is a government program. Luckily, there are some lessons.

        To remind you what happens when entitlements begin:

        Congress identifies a really worthy recipient of aid and proposes something to try to help them. While doing so, Congress dramatically underestimates cost and often structures the aid in such a way that it actually hurts the people intended to be helped. Over time, if good times produce a surplus, Congress feels that there’s money to be spent and that another worthy recipient should benefit. If there are bad times, Congress feels that the needs of worthy recipients are great and they should get more. At some point, sometimes at the beginning, Congress realizes that there is great politics to giving stuff away – both to the voters themselves and to the places that might be indirect beneficiaries who would be happy to write checks to keep the program going. Rinse and repeat until  “Financing this expenditure burden will require either massive borrowing or economically crippling taxes. Reliance on borrowed funds would cause the national debt to soar past 100 percent of the nation’s output of goods and services by 2032. Reliance on higher taxes would require a 33 percent increase in every federal tax. Middle-class households would face combined federal income and payroll taxes of nearly 40 percent”


        Figure 5. In the Congressional coin flip, it’s heads they win, tails you lose. Are you ready to play? It only costs 33% more taxes than you owe now.


        So what can we do?

        If something new is being considered, don’t trust Congress: their cost estimates are atrocious and their promises of future restraint are lies. Assume that programs will only get bigger and think about the long term financial impact. Look very hard at the unintended consequences where helping hurts. Try as much as possible to give responsibility over to states: they can’t print money and are far more compelled to balance their budgets.


        Figure 6. Congress has broken so many promises it could easily feature in country song.


        Very few federal entitlements have ended and all marginally successful efforts can be summarized in a paragraph: Revolutionary War pensions, and very eventually Civil War pensions, ended because all recipients ultimately passed away. The Freedmen’s Bureau was eliminated completely – but was wrapped up in the politics of a Civil War that we hopefully never have to repeat. Benefits for World War I veterans without wartime injuries were dramatically reduced – but FDR simultaneously pursued an aggressive spending program that might have benefitted them in other ways (and, despite FDR’s efforts, they received their bonus years early). Cogan considers a program where the federal government shared general revenue with the states to be an entitlement but that’s highly debatable. The Reagan Administration eliminated it with the President asking, “How can we afford revenue sharing when we have no revenues to share?” Yet states to this day rely on the federal government for between 20 and 50% of their budget. The 1980s also saw the passage and the prompt repeal of a Medicare program whose recipients already felt they had private insurance to cover their needs and were paying higher taxes. With practically no one a fan, it was a simple repeal. Trade Adjustment Assistance was supposed to help those displaced by free trade agreements but, in the late 1970s, a majority of recipients were already back at their original jobs by the time they received money. Its costs were reduced by over 90% by the Reagan Administration after some changes that, among other things, forced recipients to use up their unemployment insurance before receiving help from the program. Both Ronald Reagan (disability payments) and Grover Cleveland (Civil War veteran pensions) attempted to aggressively curtail particular programs they thought were subject to abuse – and, in each case, the backlash resulted in the programs becoming larger. Finally, in the 1990s, welfare reform was passed that made a substantial difference in one program – but was quickly undermined by the unrestrained growth in other programs.

        So what are we to make of that?

        Presidents must prioritize reform from the very beginning and be willing to spend political capital. Grover Cleveland, FDR, Ronald Reagan, and even Gerald Ford were willing to vigorously use their veto power and their political skills to fight for reform they desired. Cleveland ended up failing, FDR succeeded in the area of reform he desired, Reagan substantially slowed growth, and Ford managed to stop the onslaught of new programs. But, at least since FDR, all other presidents have taken the opposite approach: often choosing to expand programs instead of contracting them and, if they manage to target reform, only too late.

        Highlight the unsympathetic but reach out to the sympathetic: ultimately, public anger is the primary driver for reform – so note how crazy the abuse can be and how harmful the everyday aid can be. At the same time, always keep in mind that you are really trying to help people. Even if they did not fix all the problems, realize that Civil War pension reform and welfare reform were built on literally decades of bad stories. Welfare reform in particular was driven by the fear that the help was hurting. On the flip side, know that public anger can fuel the opposite impulse: food stamps were created in response to a extremely emotional national television special that began with video of a child supposedly dying of hunger and reported in a grave voiceover that the child did die. Startlingly, the child not only had a different ailment but ended up very much alive – yet by then, the searing image was stuck in people’s minds. Today, a teacher friend of mine witnessed kids on free and reduced lunch taking Bentleys to prom.  Whatever the debate, clarify the terms and make sure you are actually helping people in need – which may mean people helping themselves.


        Figure 7. We have come a long way since Cadillac


        Appoint the right judges (and central bankers). Never underestimate how much impact these players can have on our entire culture.

        Cogan suggests you have to “Go slow.” Examples abound where proposed immediate large cut-offs are not executed and it may be more realistic to wean recipients off over time. Still, FDR’s experience with the World War I veterans is a counter-example where speed was its essential quality. Did the national emergency of the Great Depression and the cornucopia of other FDR spending make that the exception that proves the rule?

        Know the battlefield of lobbyists. The G.I. Bill proved resilient not just because returning soldiers were able to benefit – but because the money passed through the hands of banks and schools who instantly became advocates themselves. The American Medical Association has routinely been the biggest player in fighting government takeover of healthcare because they fear the effect on doctors. Whatever the program, find out who benefits and who hurts.

        Ultimately, starve and distract the beast. FDR wanted a big expansion of the New Deal in 1944 but Congress was in no mood while fighting for national survival in World War II – and spending nearly 20% of GDP. A spendthrift Congress in the 1960s and 1970s was only tamed by large structural deficits and inflation. As Nixon economist Herb Stein observed, “anything that can’t go on won’t.”

        The High Cost of Good Intentions is perhaps the most important history book you can read because it covers what very well may end the American dream. Read it.

        High cost of good intentions

        Figure 8. Click here to buy The High Cost of Good Intentions 10/10. The book does not provide as much detail about events since the Reagan administration as it does prior years but, especially since the framework of the welfare state has been with us since the 1970s, you will get a pretty clear picture.

        Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone interested in America’s entitlement programs? How about history generally?

        I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

          When Help Hurts

          The Gist: Federal entitlements have routinely punished work and marriage while displacing community help.

          A review of The High Cost of Good Intentions by John Cogan.

          The second of three parts. Click here for part one, and here for part three.

          In 1974, Linda Taylor was arrested in a Cadillac “on suspicion of defrauding the state of $154,000 in welfare benefits. She allegedly used twenty-seven aliases, thirty-one addresses, twenty-five phone numbers, and three Social Security numbers.” She was the original “welfare queen” and became “a national symbol of welfare fraud and abuse.”


          Figure 1. To be fair, this was just keeping up with the Standard of the World. Her mistake was being a U.S. citizen. 


          Taylor was just one notorious example of fraud and abuse that continue to this day. But there are deeper moral problems at the heart of our welfare state. Yes, entitlements are the biggest drivers of our growing debt that is leading toward national catastrophe. As Ronald Reagan observed, “Many of these programs may have come from a good heart, but not all have come from a clear head—and the costs have been staggering. We can be compassionate about human needs without being complacent about budget extravagance.”


          Figure 2. Ronald Reagan would have been a good coach on Friday Night Lights. Especially if he asked them to win one for the Gipper


          But perhaps more significantly, the High Cost of Good Intentions includes robbing Americans of the sources of dignity in their life: federal entitlements have routinely punished work, punished marriage, and displaced community help – all at the cost to those we were trying to help.


          Until well into the 20th century, local governments were the primary providers of aid – and they did so only to those who had been members of their community for a long time. State governments stepped in to help the roving poor that locals did not want to attract with generosity.

          The prevailing Constitutional interpretation was that the Founding Fathers had specified a finite, precise number of things that the federal government could do – and aid to citizens who had not served their country was not one of them. Of course, that didn’t stop people from trying to adjust that arrangement: There was a multiple decade effort to involve the federal government in the care for the mentally ill. The closest the movement came to success was Congress voting to sell federal land to states for the construction of asylums. President Franklin Pierce vetoed it as noble but unconstitutional.


          Figure 3. That was not the whole story regarding the federal government’s responsibility. The American people have long considered Congress the proper venue for housing the crazy.


          There is one exception where the federal government did play a role: helping freed slaves after the Civil War. But the creators of the Freedmen’s Bureau always thought it was a temporary postwar measure and as soon as Southern states re-entered the union (and regained federal legislators), the Bureau was defunded and abolished. Still, over seven years, the Bureau taught and provided healthcare for hundreds of thousands while giving millions food rations. Yet, in the story of American entitlements, it appears to have had no impact on the debate.

          Local governments were still the lead, and they attempted to be very careful in dispensing aid:

          Throughout colonial times and well into the late nineteenth century, welfare administrators and social reformers distinguished between two groups. The first consisted of poor people who through no fault of their own were unable to provide for themselves and were viewed as worthy of help: the frail elderly, the disabled, and children of single mothers unable to care for them. The second group consisted of able-bodied adults who could work but were nevertheless destitute. Welfare administrators and social reformers believed that poverty among the latter group resulted from human frailties: idleness, intemperance, and immorality. Great care, therefore, was taken in providing government aid for fear that it would encourage greater dependency.

          At first local governments pursued institutions: “almshouses for the elderly poor and disabled, orphanages for children, mental asylums for the insane, and workhouses for the able-bodied poor.” The thought was that they would help the needy and deter the able-bodied. But the institutions were chronically underfunded and conditions became scandalous.


          Figure 4. There was a missed opportunity to turn close-talkers into bubble boys but who knows where it would have ended before we had to double dip into reserves? Amplifiers for low-talkers? Sponge subsidies? Puffy shirts for the homeless? What we need is federal government shrinkage to achieve serenity now. Giddyup.


          By 1900, reformers were keen to provide direct assistance to the poor, relying on local knowledge to determine the worthy, but they were desperate to avoid incentivizing moral misbehavior – and larger welfare rolls. As a result, states for decades extended direct assistance almost only to widows. Though they gradually softened their position, “in the early 1930s, 82 percent of families receiving assistance were headed by a widowed mother… By 1934, only three states specifically granted eligibility to children of unmarried mothers, and fewer than half the states granted eligibility to children of divorced parents.”

          FDR changed things. “The New Deal broke new ground by extending entitlements to people in the general population who had performed no particular service to the federal government” – and, indeed, curtailed entitlements to those who had performed service. Our courts caved to intense political pressure, allowing new programs and regulations that were never thought legal.

          Along the way, the New Deal “permanently altered the balance in the federalist system that the founding fathers had carefully constructed by profoundly changing the relationship between the federal government and the individual… Today, it is hard to think of a single traditional state government activity that has not also been undertaken by the federal government.” Still, it’s noteworthy that the bulk of the New Deal was designed to supplement states rather than replace them, providing federal matching dollars to locals for helping the poor and the elderly while relying on locals to determine worthiness.


          Figure 5. One Tennessee activity I wish the federal government would copy is not taxing my income


          But with the Great Depression happening and free money from the federal government, states went on a spending spree and liberalized their aid. From 1934 to 1948, the share of welfare going to households headed by widows dropped from over 80% to around 25%. And aid started playing a dramatic role in rearranging relationships: “By 1948, the U.S. divorce rate was 35 percent higher than its prewar level in 1940; the out-of-wedlock birth rate was 44 percent higher…  Welfare’s incentives made it too easy for fathers to avoid their parental responsibility and for poor mothers to rely on government aid rather than their own resources to meet their living expenses… By 1961, only 8 percent of… families were on the rolls because the mother was widowed.”

          But not only family stability was affected: for every dollar a woman worked, a dollar was reduced in aid, meaning that recipients were taxed 100% on earnings until they made more money than they received from the government. But why bother? By the 1960s, only 20% of the unmarried women on the government dole worked.  Another program for the poor had a “sudden death” provision that immediately cut off all aid once someone hit a certain income threshold – if someone hit the minimum, they’d lose the equivalent of four months of pay! Unfortunately these kinds of disincentives are only a couple of the more dramatic of the past – the problem still exists!

          States realized they had been too generous as their budgets busted and scandalous stories started appearing: One woman was “the recipient of $50,000 in public aid over thirty-four years on welfare (over $400,000 in today’s dollars). She had given birth to twenty-two children fathered by seven different men, none of whom had ever been married to her.” So provisions were variously introduced (or started to be enforced) prohibiting aid recipients from living or carrying on with an unrelated man, banning welfare if an additional illegitimate child was born, limiting welfare to no more than 3 months a year, requiring a job, or providing aid only to those who had been residents for years. In fact, 2/3 of states required recipients of old age assistance to have lived in the state for 15 years or more. Arizona required 35!

          But instead of reform, the federal government – through both political parties and all three branches of government – declared total war on poverty. While it’s been joked before that poverty won, significant collateral damage included states’ rights and the federal budget.

          First, the legal maneuvering: this was not the result of private actors coming forward to advance their case with their own dollars. LBJ financed an army of attorneys to sue his own government (and the states): “The initial legal services’ $42 million budget in 1965 was nearly ten times the total amount spent by all civil legal aid offices in the United States in 1959.” By the beginning of the next decade, the Supreme Court found that states’ “suitable home” provisions were illegal. And struck down state residence requirements for welfare as a violation of an individual’s unspecified constitutional right to travel (but said in-state tuition and state occupational licenses were ok).


          Figure 6. Out-of-state college students suddenly discovered a passion for the Constitution as they heard about the right to travel, only to discover that particular penumbra excluded them. 


          Most significantly, the court discovered a right to government benefits, “fundamentally transforming welfare from an act of legislative charity—a government-granted gratuity—into an entitlement that ensured all eligible people a legal right to benefits. This radical change, occurring without any accompanying legislation, overturned nearly two hundred years of established welfare policy.” Later, courts would find that disability benefits could extend to “virtually all noncitizens whom the Immigration and Naturalization Service was not aggressively seeking to deport” and “loosened eligibility requirements to allow alcoholics and drug addicts to qualify …regardless of whether recipients made any attempt at rehabilitation. By 1994… Only 10 percent of addicts and alcoholics receiving [disability from supplemental security income] were in treatment and only 1 percent of substance abusers on SSI ever recovered sufficiently to get a job. In some instances, SSI had become an enabler of continued substance abuse rather than being a gateway to rehabilitation.”

          Second, the joint efforts of Congress and the President. From 1950-1975, “every president proposed to expand at least one existing entitlement or create additional ones” and, simultaneously, every two years Congress “enacted at least one such expansion.” But LBJ, Richard Nixon, and the Great Society hypercharged things. The federal government asserted its role as supreme and “state governments were reduced to acting mainly as administrative agents for these federal programs.” More people were covered than ever – new social workers, food stamps, even coal miners got a piece of the pie. In a cruel irony, the federal government thought that central control might actually curb costs. They failed spectacularly. Some half hearted efforts were tried – they introduced a work requirement in 1969 but the exceptions were massive, including stating that women would only have to work if states provided nonexistent daycare programs. It was still considered too much and was repealed. Another time Congress tried to control future growth of programs. And then repealed the caps two years later.


          Figure 7. Millions of little girls were excited by legislation that only placed work requirements on owners of unicorns but they and fiscal conservatives were ultimately disappointed by the results.


          From 1964 to 1980, entitlement spending grew 13% a year. The budget was balanced once despite an annual 10% growth in federal revenue: Revenue came in fast but Congress spent it faster. As a result, in 1980, “entitlement spending accounted for over half of all federal government expenditures. So rapid was the growth that the federal government was spending more on entitlements in 1980 than it had on all government activities combined just six years earlier.” And whom were we serving? “By 1981, one-quarter of all recipients of means-tested entitlements lived in nonpoor households, including 40 percent of all food stamp recipients… Half of all U.S. federally subsidized meals were served to students in families with incomes near or above the median family income in the United States.”

          Ronald Reagan came in with a new agenda. He tried a lot, failed a lot, and in the end saved Social Security, held spending to a fraction of its former growth, and repealed a few programs along the way. 

          One of the biggest projects the Reagan Administration took on was weeding out abuse in disability benefits. In the first term, “over 1 million disability benefits were reevaluated and benefits for over 400,000 were terminated.” Nothing like it had occurred since the Roosevelt Administration’s tackling World War I veterans’ benefits half a century earlier. But unlike with FDR, the backlash was immense. The press highlighted recipients whose disability had been revoked, Congress was outraged, and by 1984, “about half of the states were refusing to conduct disability reviews. Disability cases swamped the federal courts. An astonishing 20 percent of all cases pending before all U.S. federal district courts” were from folks removed from disability. “Under siege, the Social Security Administration announced a moratorium on all reviews… by the late 1980s, the program was larger and more generous than it had been when the disability reviews started.”

          But that was the only spectacular failure. “Ronald Reagan’s success in reining in entitlements, though modest, is unmatched by any other presidential administration in U.S. history. Legislative actions reduced benefit levels or tightened eligibility rules in all but three entitlement programs.” Two entitlements were eliminated altogether (a program to share money with states, a special Medicare program that the recipients themselves hated) and another (trade adjustment) was reduced by 96%. “Although entitlement spending continued to increase throughout the president’s two terms in office, its growth slowed dramatically.” Compared to the 13 percent annual growth from 1964 to 1980, the Reagan administration saw only 1.4%. “During Reagan’s presidency, the percentage of U.S. households that received assistance from at least one federal entitlement program actually declined.”


          Figure 8. Forget Tom Brady or Jerry Rice. Defeating the Evil Empire and making Americans more prosperous and less reliant on government makes Reagan a serious contender for GOAT. But better than Washington, Lincoln, or Polk? Maybe not, but it’s noteworthy that his nearest competition is separated by a century.


          Reagan’s approach was restarted by Republicans who took over Congress in 1994 through welfare reform: “The law reversed decades of federal welfare policy by eliminating an individual’s entitlement to Aid to Families with Dependent Children (AFDC) benefits and transferring program policymaking authority to the states. The reform measure was motivated not so much by fiscal concerns but by a bipartisan realization that the AFDC program was encouraging recipients to act in ways that were harmful to the long-run interests of themselves and their families.” They further tackled abuses brought on by the courts by disallowing disability benefits for drug addiction and alcoholism and “denied eligibility for all three welfare programs to almost all legal immigrants.”

          The impact was significant: the number of AFDC households plummeted over 50% in five years and nearly another 50% in the next ten. “This remarkable reduction is unprecedented among major entitlement programs in U.S. history.” What’s more: over 60% of adults who left the program became employed and the poverty rate among both children and families headed by women dropped by 20% in 10 years. “Among African American single heads of households, the results have been even more striking. Prior to 1994, their poverty rate had never fallen below 50 percent. By 2001, their poverty rate had declined to 41 percent and has remained below 50 percent every year since, including during the Great Recession.”

          And yet the 1996 welfare reform was the exception rather than the rule, even among Republicans. Since then, Republicans and Democrats, Congress and Presidents have continued to expand government commitments, making existing programs more generous to more people and even creating new ones like ObamaCare. Within two years of welfare reform, a Republican Congress had reversed itself and made immigrants eligible for Medicaid benefits, AFDC, social security disability, and food stamps. Food stamps once required recipients to actually pay something for them but became free in the Carter Administration. Since the 1990s, food stamp eligibility expanded and expanded, where “liberalizations increased the amount of personal expenses applicants were permitted to deduct from their countable income, allowed certain types of income to be excluded from countable income, and increased the value of allowable assets.” In other words, Congress kept increasing the value of the cars, housing, retirement accounts, and education accounts recipients could own while still qualifying – and allowed states further ability to waive asset requirements. By 2009, “Congress suspended restrictions on the amount of time an able-bodied person could spend on the food stamp rolls without working” and “waived the food stamp work search requirement.” Welfare reform was a shadow of what it once was.

          In my final email (for now) on entitlements, I’ll talk about broad lessons – and how politicians have abused and lied about Social Security.

          High cost of good intentions

          Figure 9. Click here to buy The High Cost of Good Intentions 10/10, perhaps the most important history book you can read to understand America’s current and future problems.

          Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone interested in America’s entitlement programs? How about history generally?

          I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

            Pensions Made Fun

            The Gist: 2 of 3 of your federal tax-dollars are spent on entitlements. It all started in 1776…

            A review of The High Cost of Good Intentions by John Cogan.

            The first of three parts. Click here for part two, and here for part three.

            The American Civil War was fought between 1861 and 1865. Take a moment and consider: when do you think the U.S. government paid out its last related pension?

            < cue Jeopardy theme >

            As of 2017, over 150 years after the war ended, the U.S. government was still paying a Civil War pension.

            Snake Oil

            Figure 1. Turns out those snake-oil cure-alls did dramatically extend life.


            How the hell does that happen? John Cogan’s The High Cost of Good Intentions recounts the history of American federal entitlement programs. Now you may be thinking that this is a boring topic and that you’d rather be reading about pirates or willpower or even sleep. But make no mistake: this may be the most important history book you can read to understand America’s current and future problems.


            Figure 2. Unless aliens invade. Then they can handle all of our fiscal problems.


            Why is this so important? Because the federal government spends over 2 out of every 3 dollars on entitlements and will only spend more going forward. 

            Since World War II ended, spending on entitlements grew an average annual rate 33% faster than the economy, a jump from $500 being spent per American in 1947 to over $7,500 in 2015. And that’s adjusting for inflation! In fact, “entitlements have accounted for all of the growth in federal spending as a percent of” our national economy. “The chronic deficits produced by these excesses have caused the outstanding public debt to rise to about $40,000 per U.S. resident in 2015” – more than 4x the debt per citizen in 1965 in today’s dollars.


            How did this happen? John Cogan relays the pattern:

            “When first enacted, entitlement laws, for policy or fiscal reasons, confine benefits to a group of individuals who are deemed to be particularly worthy of assistance. As time passes, groups of excluded individuals come forth claiming that they are no less deserving of aid. Pressure is brought by, or on behalf of, excluded groups to relax eligibility rules. The ever-present pressure is magnified during periods of budget surpluses and by public officials’ imperative to be elected and reelected. Eventually the government acquiesces and additional claimants deemed worthy are allowed to join the benefit rolls. That very broadening of eligibility rules inevitably brings another group of claimants closer to the eligibility boundary line, and the pressure to relax qualifying rules begins again. The process of liberalization repeats itself until benefits are extended to a point where the program’s purposes bear only a faint resemblance to its original noble intentions.”

            It started at the very beginning, in 1776. The Continental Congress promised that those soldiers and sailors of the Continental Army and Navy injured in the Revolutionary War could expect a pension in tribute to their service.

            hundred dollar bill

            Figure 3. If only the Founding Fathers had been funding fathers.


            Things quickly grew from there. Over the coming years, Congress expanded the program to include “members of state militias, then to disabled wartime veterans regardless of whether their disability was related to wartime service,” then to practically everyone who fought, regardless of whether they had any disability. And then to their widows – first, only those married during the war, then married before 1800, then ever-married. Then to survivors. And, frequently along the way, the pensions got bigger.


            Figure 4. The federal government eventually drew the line at pets.


            In 1819, when the program was still confined to veterans, “the number of applicants exceeded the entire number of Continental Army veterans who were thought to be still alive.” This prompted John Quincy Adams to comment “Uriah Tracy, thirty years ago, used to say that the soldiers of the Revolution never died—that they were immortal. Had he lived to this time, he would have seen that they multiply with the lapse of time.”

            Zombie Soldier

            Figure 5. The demands for payment in brains prompted the discovery of the Zombie Crisis of the early 19th century.


            Feeling somewhat guilty, Congress proposed a means test but did not want to insult veterans by requiring proof. So the law simply stated that the pensions were for those “in need of assistance from [their] country for support.” The only time the program was curtailed was in 1820 when budget cuts compelled Congress to require recipients to swear an oath of poverty. The vast majority of pensioners did so – and any that did not had all their benefits restored two years later when Congress had a surplus. 50 years after the war ended, at a time when adults could expect to live to 60, the costs were still growing. But hey, maybe the vigorous exercise of soldiering extended life.

            One other foreboding note: Army pensions were paid from general taxes collected by the federal government but the Navy pensions were supposed to come from the sale of goods seized from pirates and enemy ships. The original idea was that the money would be in a protected account and that the pensions would slowly draw from it. But in especially good raiding years, Congress got excited and generously voted to give surpluses away – including retroactively. One Navy widow received the equivalent of $600,000 in today’s currency. Simultaneously, Congress opted to invest half of the Navy pension in a supposedly high-yield fund controlled by political cronies. While promising 3x returns, the fund went bankrupt. Too generous in awarding benefits, too corrupt in investing the principal, Congress was forced to bail out the fund with general tax revenue – all the while claiming that the program was in good shape.


            Figure 6. Pirates proved the financial model for at least workman’s comp. Maybe the secret to solving our budget woes is declaring war on Carnival Cruise Line.


            By the time the Revolutionary War pensions were (mostly) off the government books, the Civil War was on – and the pension escalation, despite the benefit of hindsight, followed a similar path. As is the case with practically every government program, and especially those covered in this book, Congress vastly underestimated the cost – in one expansion, its prediction was off by more than 10x in the first two years. By 1896, Civil War pensions were 40% of the federal budget – despite excluding Confederates. You might say “Well, to the victor go the pensions” but Confederate widows were eventually included – in the late 1950s! We still had a 2017 payout due to a 78 year old Civil War veteran marrying a 28 year old in 1924. Their daughter, born in 1929, was the recipient of promised survivor benefits.

            Importantly, Civil War pensions were the first to become politically charged. “Vote as you shot” was the slogan of a dominating Republican Party that won 10 out of 12 presidential elections between 1860 and 1912 – and expanded Civil War pensions the whole merry way. The Grand Army of the Republic was America’s first real lobbying organization, consisting of Civil War veterans across the country ready to clamor for benefits. And the government allowed claim agents to help veterans secure their pensions – agents who themselves quickly became a powerful (and corrupting) lobby for new and more distributions they could profit from.


            Figure 7. The massive success of that campaign slogan inspired others. Among free traders, “Vote as you bought.” In Baltimore, “Vote as you squat.” In Chicago, “Vote as you rot.” 


            The two presidential elections the GOP lost were in large part due to public anger about pension abuse. A report in the late 1870s suggested over 25% of the claims were fraudulent. In one election, Republicans expedited claim approvals in the swing state of Ohio, sometimes in exchange for a vote promise. When the general program was not sufficiently generous, veterans turned to their legislators to get what they wanted in individual pieces of legislation: in one two year period in the 1880s, 40% of all House bills and a majority of all Senate bills were designed to help individual Civil War veterans.

            Grover Cleveland was fed up with pension abuse, campaigned against it, and, fighting a pension-happy Congress, ended up being the President with the most vetoes ever. He explained every one in detail: One pension supposed to help a disabled war veteran was vetoed after Cleveland discovered the veteran was injured falling off a swing well after the war. But after only one term, the GOP came roaring back — and restored all the benefits Cleveland had denied while controversially promising even more. Cleveland then became the first and only president ever to lose office and then come back to win a second term. But, learning his political lesson, his second term ended with more pensioners than when he entered. The first executive to fight back ultimately lost.

            Swing Set

            Figure 8. The swing voters turned against Grover. 


            With World War I, Congress admirably attempted to learn from past experience and implemented two programs designed to curb future costs. First, as usual, Congress guaranteed a pension for those injured in the war but, differently this time, provided the opportunity for all soldiers to sign up for insurance if they became disabled for any reason after their service was up. Second, Congress gave a certificate to soldiers entitling them to money in 1945, when they might require old-age assistance (though the average soldier would only be in his fifties – and they couldn’t predict what costs 1945 might bring).

            The insurance program was popular – until soldiers left service and the government no longer could automatically deduct premium payments. “Ultimately only 10 percent of soldiers who had made regular premium payments during the war continued to do so afterward.” Instead, per usual, Congress expanded the pensions to include veterans with disabilities unrelated to war efforts (and then, predictably, to relatives who had not served themselves).

            The old-age assistance program proved to be one of the most controversial programs of the Great Depression. As money continued to grow in the account designed to pay out the benefits, there was immense pressure to spend it. Even in the roaring 1920s, Congress tried to give it away multiple times only to face President Calvin Coolidge’s vetoes. But Congress did manage to slip in the opportunity for veterans to borrow against the value of the certificate.  As the Great Depression took off, over half took advantage.

            Meanwhile, a “Bonus Army” of veterans engulfed DC and demanded that, in light of economic conditions, they should receive their 1945 payment early – never mind that the money wasn’t there. President Herbert Hoover reasonably refused, but then violently broke up the protest in a publicity nightmare.

            Through this, an unlikely budget cutter emerged: Franklin Delano Roosevelt. Despite being helped in his election by outrage over Hoover’s handling of the Bonus Army, FDR wanted not only to ensure that no early payouts occurred but also to reform the disability pension program which was costing over a quarter of the federal budget. Controversially, “He shared the founding fathers’ belief that all citizens had an obligation to serve their country in wartime and therefore did not represent a special class of individuals entitled to government benefits merely because they had served during wartime.” Immediately upon taking office, FDR proposed Congress grant him significant power to curb the pensions. This was a heavy political lift which he managed to get past the House but the Senate looked sure to filibuster. Determined to get what he wanted, FDR pushed through the House repeal of Prohibition, a piece of popular legislation the Senate could only pass once they dealt with the veterans’ pension. 

            Cogan summarizes the extraordinary legislation the Senate then passed:

            “President Roosevelt signed the most consequential legislation in pension history… The law repealed all entitlements to pensions that had been granted to veterans of World War I, the Spanish-American War, the Boxer Rebellion, and the Philippine Insurrection. The entitlement repeal applied with equal force to pension entitlements for veterans who had suffered disabilities in wartime service and to those with disabilities unrelated to wartime service. It applied equally to entitlements for widows and orphans of veterans killed in battle. It also applied to entitlements for veterans currently on the rolls and new applicants. The new law gave the president discretionary authority to set new eligibility rules. He could continue pensions for some or all of the affected veterans if he so chose, but he was under no legal obligation to provide pensions to all veterans who met statutorily prescribed eligibility rules. The Economy Act abolished all of them. Monthly benefits for veterans of all wars prior to the Spanish-American War were reduced across the board by 10 percent. The president could also set new monthly pension levels for all other veterans within the broad guidelines established by the law. The Economy Act prohibited the executive branch’s new rules and monthly benefit levels from being challenged in federal court and specified that the delegation of authority to the president would last two years. Regulations then in effect could be changed only by an act of Congress. For the first time in U.S. history, a large-scale entitlement had been repealed.”

            FDR went on to use his power to cut the number of recipients in half and reduced the monthly benefit:

            “His principal policy goal was to eliminate pensions for veterans with disabilities unrelated to their wartime service. He largely achieved this goal, at least for World War I veterans. On June 30, 1933, 412,482 veterans with nonservice-connected disabilities were on the pension rolls; a year later, there were only 29,903, all of whom were permanently and totally disabled. The pension entitlement for World War I veterans with disabilities unrelated to war had been all but terminated. These veterans were no longer a special class of people to whom the government was obliged to assist. Overall, the Economy Act’s reduction in the veterans’ pensions program is the largest ever taken in any entitlement program in U.S. history.”

            Amazingly, it stuck. Over the coming years, FDR vigorously used his veto power to protect his reforms, going so far as to become the only President in history to deliver a veto message in person at the U.S. Congress, insisting that the nearly $8 billion that had already been spent and $450 million ongoing annual expenditure was more than enough.

            And yet, despite all of FDR’s efforts, a hurricane hit Florida in 1936 and killed over a hundred World War I veterans who were working on a government project. Congress immediately passed legislation to distribute the bonus that had sparked all the initial controversy and then overrode FDR’s veto. The veterans would get their bonus nearly a decade early – but the pension reform limiting payments to those originally intended still stood, almost entirely due to the President’s determination.

            FDR’s fiscal prudence extended only so far. For the one entitlement he reformed, the rest of his New Deal set America up for significant fiscal and constitutional challenges I’ll explore in my next email.

            High cost of good intentions

            Figure 9. Click here to buy The High Cost of Good Intentions 10/10, perhaps the most important history book you can read to understand America’s current and future problems.

            Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone interested in America’s entitlement programs? How about history generally?

            I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

              An Argument With My Father

              The Gist: How the British Empire wrestled with decline.

              A review of The Weary Titan by Aaron Friedberg.

              I occasionally get into an argument with my father. He insists that America has always solved our problems and we always will. I hope so, but I point out that a citizen of Britain (or Rome) might have said the same thing a couple centuries (or millennia) ago and things didn’t exactly work out.

              Minute Man

              Figure 1. Ironically, one of the problems Britain couldn’t solve is America.


              “Supremacy is seldom conducive to hard thinking.”

              That is the warning of Aaron Friedberg in The Weary Titan, his study of the decline of the British Empire. Former Speaker of the House Paul Ryan recommended the book to me and it has become one of my favorite histories. Ultimately, the book is a meditation on how leaders come to grips with decline (or don’t.)


              Figure 2. The apparent exception to this warning is Nick Saban.


              “The sun never sets on the British Empire.” Never was that more true after World War I, when London controlled nearly a quarter of the world’s population spread out over 13 million square miles. For comparison, the United States today has about 4 percent of the world’s population concentrated in less than 4 million square miles.

              And yet by then the Empire was in significant decline. The Empire had lost over a million men in World War I, including over 1.5% of the population of the home islands (the equivalent of America losing 5 million men today). Within four decades, the Empire was over.


              Figure 3. Now there are days when the sun never even penetrates the English fog. 


              How did they get there? The real height of the British Empire may have been in the 19th century. Fresh off defeating Napoleon, the British were practically unchallenged across the globe. They expanded their reach further and further – but failed to realize they were losing their grip. 

              Friedberg’s book focuses on the years leading up to World War I and examines how British Imperial leaders tackled government budgeting, economic power, Naval reach, and Army strategy.

              Let’s start with the easiest place they went amiss. Incredibly, between 1820 and 1850, British government spending went down! For comparison, the U.S. government spent double the real dollars in 2018 that we did in 1988. And that 1988 budget was more than double what we spent in 1958. (Another lesson from 19th century Britain: keeping inflation to a minimum. The facial budget number of 2018 is more than 40x 1958). The typical, prudent British fiscal management was not to spend more than revenue and pay down debt so that they could easily get loans in any war. It didn’t last.


              Figure 4. You get what you pay for! Americans must live 400% longer than they did in 1958.


              After 1850, government services increased, partially as a result of the expanding number of people voting, and spending jumped every year. By the 1890s, spending had exploded but revenue managed to cover expenses from the increased prosperity of the nation. Interestingly, their estate (death) tax was as important to their revenue as their income tax. But there was no political constituency calling for reduced spending – just disagreement about whether to spend it on defense or more domestic services.

              Then the Boer War started in South Africa and it quickly exceeded costs by a multiple of the original estimate. The old guard was terrified because they believed that a low tax burden had enabled British success and that this was a pretty small conflict to be going into debt over. But new thinking was that Britain was economically strong and not spending as much as its peers (nor as much as it did during the Napoleonic existential crisis). They tried to spread naval costs to the far reaches of the empire (“weary titan” is a phrase from a speech suggesting this), but because their explicit strategy was to control the sea, not protect colonial coasts, the colonies only coughed up half of what London wanted. Britain resorted to more taxes on the home islands to pay for the war, only to face a new crisis in World War I – and with ever-increasing war debt as well as bigger and bigger promises of domestic services, the Empire was soon gone. 

              The second prism Friedberg considers is economic power: 1872 was the high water mark of Britain’s comparative economic strength. Then, only puny Belgium was similarly highly industrialized.


              Figure 5. And Belgium used their head start to… gain an advantage in waffle production. Laugh all you want but Britain never developed a tasty food export.


              Britain kept practically no economic statistics except exports and imports. And as the years went on, the numbers were bigger than ever. The British people felt more prosperous than ever. And they were! But by 1900, Germany, the United States, France, and Japan had done a lot of catching up, with the first two far outpacing British growth.

              Few realized that Britain was in relative economic decline – that is to say, still ahead but less and less so. Because exports and imports were the only data available, all economic arguments in politics centered around them. And the Conservative coalition that led Britain at the end of the 19th century was extremely divided on trade. 

              Incredibly to modern eyes, free trade absolutists were not confined to university economics departments but were the base of the Conservative Party. Maintaining that British wealth was built on zero tariffs and that free trade meant cheaper goods for consumers, they refused to consider any alternative.

              Milton Freidman

              Figure 6. Late 19th century Britain was Milton Friedman’s dream polity.   


              And yet the thirty years ending the 19th century were collectively known as the “Great Depression” in Britain because of uneven economic conditions, often sparked by tariffs imposed by other countries. Joseph Chamberlain, father of future Prime Minister and German-appeaser Neville, was the Colonial minister who feared that British gospel on free trade was wrong. Chamberlain barnstormed the nation and insisted that British trade was essentially stagnant and that the only exports that had really increased were coal, machines, and ships – all things that helped competitors gain against Britain. Britain was alone in the world in embracing unilateral free trade – could everyone else be wrong? Attempting to unnerve the population, Chamberlain pointed out that Spain was more prosperous than ever before – and yet it was now a second (or third) tier power. Most compellingly to a doctrinaire free trader, he argued that free trade may increase global wealth, but did not guarantee a single nation atop the heap.

              But Chamberlain’s solution was unproven, theoretically lacking, and never embraced. He proposed a new trade arrangement that involved free trade within the empire and tariffs outside it. Amazingly, despite Britain’s ferocious free trade stance, there was not free trade within the Empire, with colonies imposing tariffs on British goods. This and the colonies’ refusal to give London revenue are instructive as to how decentralized the Empire was – so much so that Prime Minister Arthur Balfour acknowledged that isolated economic units put the British Empire at disadvantage versus say, the US. Some Conservative leadership tended toward the aristocratic, and they worried that the prosperity of trade empowered the lower classes in politics. Yet Chamberlain was only able to push through tariffs in emergencies, as his opponents only agreed to them because of the need for revenue and dropped them as soon as revenue was secure.

              Prime Minister Balfour ultimately resolved the debate by purging his cabinet of both extremes and tried to forge ahead with his own policy: free trade, but retaliatory tariffs available to goad others into dropping their tariffs. This proposal satisfied neither extreme, and led to a huge electoral defeat that put the Conservatives in the political wilderness for years. Ultimately, what Britain could have done to extend its economic advantage is unclear; nevertheless, the leadership relied too much on its historic strength and lost its innovative edge.

              The third prism Friedberg considers is a point of historic pride for the British: when they ruled the waves. Most naval strategy came down to an aspiration to “control the seas” and exceed the naval power of the next two most powerful nations. But what did either of those aspirations really mean? They ended up sort of combining together to mean a greater number of battleships than Russia and France, Britain’s most feared alliance of enemies, even though friendly Italy had more ships than Russia. As time went on, and other powers grew their navies, the Admiralty realized the two power rule was inadequate to control the seas of the entire world, and they did not have the money to meet the challenge.


              Figure 7. Britain eventually ambitiously shifted its target to ensure it had more ships than Switzerland.


              Realizing their weakness, the Navy did what every business school teaches: delegation. In the 1880s, the United States began a naval build up that led the Admiralty to concede the western hemisphere to a friendly power. One of my favorite anecdotes in the book features the British Army requesting from the Navy the plan to defend Canada against a hostile America. After much prodding and delay, the Navy finally revealed there was no plan – and the Army, proud of a global British Empire, is befuddled and outraged. If only McKinley had known, we could have liberated the 14th colony!

              The Navy was less successful in their choice of delegate in Asia: Japan. Until 1900, most of the Japanese Navy’s ships were built in the United Kingdom. Japan had already proved significant military capability against China but was forced to give up their gains by European powers. This humiliation prompted massive investments that ended up paying off in their defeat of Russia in the Russo-Japanese War. Britain saw an opportunity and signed an alliance with Japan where each promised to fight if the other was attacked by two or more powers. The Japanese hoped to make the alliance the dominant power in East Asia, but the British used it as an excuse to militarily leave Asia nearly altogether.


              Figure 8. It’s sort of like when you were excited to work with a partner on a school project and then he left you to do all the work. 


              At the end of the day, the British managed their changing strategic Navy environment fairly well. They ultimately decided to focus their finite resources on what they considered the five keys to the world: Dover (where they controlled the English Channel), Gibraltar (the Mediterranean), Alexandria (the Suez Canal), Singapore (the Straits of Malacca), and the Cape of Good Hope (around Africa). Although delegating to the Japanese did not work (and ultimately resulted in one of the biggest disasters in British military history at Singapore in World War II), the British were not prepared to commit to East Asia and did not have the resources to stay there. What really paid off, especially in saving the home islands, was cementing the relationship with the United States. Unfortunately for us, there’s not a big friendly naval power that can take on our responsibilities.

              Finally, Friedberg looks at Britain’s approach to its army.  The British army had traditionally been small – conscription had been adopted by every European competitor but was considered against the British spirit. And the Army itself was considered a bad career by civilians. The Boer War required virtually all of British ground forces in the world.


              Figure 9. Notably the British Empire never had to face the ultimate imperial threat


              From 1900-1905, the British thought the most likely next major conflict was with Russia in Afghanistan. Whereas they felt that the Russians could strike at Britain’s “crown jewel” in India at any time through Afghanistan, Russia was considered hard to get at and difficult to blockade. Allies were required, and couldn’t be relied upon, to attack Russia, especially where Britain considered Russia most vulnerable (Crimea, requiring the Ottomans). The 1857 Sepoy mutiny gravely concerned the British, who relied on Indian troops but insisted on a particular white/brown ratio. The Indian troops were financed locally and did participate in British global conflicts, but a certain number were demanded at home to keep the peace. British military for years felt they needed to fight Russia in Afghanistan itself so as to stave off Indian insurrection pouncing on British weakness, but they worried Afghanistan was a logistical nightmare in which the locals would not be too keen to help. Years of arguments occurred between Indian and British planners about how many reinforcements and how much military financial capital could be expected from Britain. Eventually, someone helpfully pointed out that surely the Russians would have as many logistical problems in Afghanistan as the British had. And Russia’s defeat by Japan eased concerns, even prompting consideration of strengthening the alliance with Japan so that Britain would provide ships and Japan troops in case of a war. Even though the coming world wars ultimately were not fought over India, Britain’s concerns were not unreasonable – still, planning for all possibilities, including the unthinkable, tends to pay dividends.


              Figure 10. Good thing we eventually figured out that Afghanistan thing. 


              The Weary Titan was originally written in 1988 but a 2010 afterword reveals that the author did think explicitly of the US-UK comparison, especially in light of the 1970s malaise in the US. While we have plenty of shared problems, including an ever-increasing budget and a decline in economic comparative advantage, Friedberg believes America does have one significant advantage: he thinks we overestimate our peers and underestimate ourselves, prompting us to work harder. As with so many things, insecurity can be the secret to greatness – and hopefully mine justifies my father’s optimism!

              Weary titan

              Figure 11. Click here to purchase A Weary Titan, 10/10, and one of my favorite history books.

              Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone interested in failing dynasties? How about history generally?

              I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

                More Kids = More America

                The Gist: Schedule date nights with your spouse as soon and as often as possible.

                A review of What to Expect When No Ones Expecting by Jonathan Last.

                You haven’t had enough kids.

                At least, not enough to save America.

                Family flag

                Figure 1. Who will wave the flag when you’re gone?


                Even if you beat replacement – that is, you had more than 2 kids to account for you and your spouse eventually departing – there are still too many people like my parents who failed to spread their risk and only had one. And too many people like me, past 30 and childless (Average for postgraduate modernity, an embarrassment in every prior century).


                Figure 2. “30! You should be a grandfather by now. Who will inherit the Duchy?”


                Jonathan Last’s What to Expect When No One’s Expecting is a book about the frightening demography of depopulation.

                Who cares? Couldn’t fewer people mean shorter lines, less traffic, lower pollution, and more stuff for the people left over? If you believe that, move to Detroit.


                Figure 3. No waits for robberies. Only police.


                There are three big reasons why we need to continuously grow our population.

                First, our reckoning is fast approaching from entitlement economics: in the coming years, we will have fewer taxpayers and more demands on government services. If we somehow manage to reform entitlements, there’s still…

                Second, places with smaller proportions of young people tend to be significantly less entrepreneurial and innovative. There is an absolute lower number of creators willing to challenge conventional ideas and able to take risks. Because of their relative population, there are fewer young people in positions of authority. And there is a smaller pool of customers who will instantly adopt new technology, therefore limiting the capital for innovators. 

                Relatedly, Adam Smith observed “the most decisive mark of the prosperity of any country is the increase of the number of its inhabitants.” Nobel prize winning economist Simon Smith Kuznets explains: “More population means more creators and producers, both of goods along established production patterns and of new knowledge and inventions.” This can be taken too far – you’d rather be dealing with Hong Kong’s problems than Pakistan’s. But Hong Kong’s potential is inherently limited by its small size.

                Third and finally, there’s the prospect of war: The Pentagon now spends 84 cents on pensions for every dollar it spends on basic pay. And whatever form our future military does take, families with just one child will be less willing to accept military casualties.” The good news? “The Chinese entitlement scheme is even worse than America is: it covers only 365 million Chinese citizens and it is already unfunded to the tune of 150% of the country’s GDP.” Then again, no data exists on whether ISIS’ pension is fully funded.


                Figure 4. “Our most devious strategy yet: encouraging reservists to retire in Shanghai”


                We are not quite as doomed as most of the industrialized world. Japan and Italy’s “fertility rates (now around 1.4) are within a range demographers call ‘lowest-low.’ This is a mathematical tipping point at which a country’s population could decline by 50 percent within 45 years. It is a death spiral from which, demographers believe, it might be impossible to escape. Then again, that’s just theory. Modern history has never seen fertility rates so low.”

                Our total fertility rate (TFR) is 1.93 children per woman but demographers believe we really need to be above 2. 

                Immigration is the primary reason our population is expanding: Immigrants add to our population when they enter but they also have more children than natives over the course of their lifetimes. “Between 2000 and 2010, the total population of the United States increased by 27.3 million, yet more than half of the entire increase came just from Hispanics. Most of that increase was due to fertility. Between 2000 and 2010, a net of 7.02 million people immigrated to the United States from south of the border.  Which means that, over [that] decade, 30 percent of America’s total population growth was the result of the labors of a group that makes up only 16 percent of the country.” Interestingly, “immigrants to America tended to have higher fertility rates than the country women they left behind.” And yet immigrants bring their own challenges. But for context, “When you break it out by demographic group, you see that black women have a healthy TFR of 1.96. White women, on the other hand, have a TFR of 1.79. Our national average is only boosted because Hispanic women are doing most of the heavy lifting, having an average of 2.35 babies.”

                History offers important context for our fertility decline: “In 1800, the fertility rate for white Americans was 7.04… By 1890, the fertility rate for whites had fallen to 3.87 [before] settling at 2.22 in 1940.” Then the Baby Boom exploded and collapsed. “For 20 years, the fertility rate spiked, reaching a height in 1960 of 3.53 for whites and 4.52 for blacks… From a combined TFR of 3.7 in 1960 (the end of the Baby Boom), the fertility rate in the United States dropped to 1.8 in 1980, a 50 percent decline in a single generation.” We’ve had a decent uptick since 1980 but, again, primarily due to immigrants. 

                So why haven’t we yet seen a population decline? The answer has to do with demographic momentum – and the fact that the Baby Boomers are mostly still alive.


                Figure 5. An attempt at an actually useful though very simplified cartoon. Demographic momentum means that until the last big generation dies off, our population will appear to be growing. Here’s an example that starts with two Baby Boomer couples but ends with their passing.


                So, how did our fertility rate get so low?

                First, parents have fewer kids because children survive longer in America than elsewhere or in the past. The reason the official replacement number has to be above 2 is because kids die. In Third World countries, replacement actually has to be much higher. In America, “in 1850, 2 out of every 10 white babies and 3.4 out of every 10 black babies died during infancy.” Much more died before adulthood. With more children surviving, intentional parents can reasonably plan the number of family members.

                Second, children have evolved from economic assets to family costs. Not so long ago, kids served two extremely practical purposes for parents: they were able to produce additional income for the family while they were young and take care of their elderly parents down the line. Whereas in the past parents were heavily economically incentivized to have more kids, now they’re fiscally punished.

                Kids were once considered useful farmhands; now they’re expensive dependents. “It is commonly said that buying a house is the biggest purchase most Americans will ever make. Well, having a baby is like buying six houses, all at once. Except you can’t sell your children, they never appreciate in value, and there’s a good chance that, somewhere around age 16, they’ll announce: ‘I hate you.’” Apparently as concerned with raising kids as crops, the U.S. Department of Agriculture projects that the cost to raise an American child born in 2015 will be on average the suspiciously precise $233,610 – a more than 20% increase from their 1960 projection in real dollars. And yet Last notes this is a significant undercount because it does not fully consider “three big-ticket items”: “childcare, college tuition, and mothers’ foregone salaries.”


                Figure 6. “You need to start pulling your weight around here. If you can’t explain to me how we can make money off Bitcoin, I guess we’ll just have to think through other ways you can contribute. Are you good enough at Fortnight for endorsements? I’m investing over $200,000 in you and I expect at least an 18% return on such a risky concentration. Otherwise, I should have just put it all into an index!


                Government has made having kids even more expensive. Consider the example of requiring children to sit in special car seats, first enacted in 1977 by Tennessee. “If you had five small children in 1977—a situation not at all rare back then—few vehicles could accommodate enough car seats to transport the entire brood at the same time…  In 1976, when car seat laws were sweeping from sea to shining sea, 16 percent of women had four children and 20 percent had five or more. Today, the percentage of women who have five or more children is 1.8 percent… (As a side note, they didn’t radically transform auto safety, either. The most optimistic estimate is that between 1975 and 2005, car seats saved a grand total of 7,896 lives. Every one of them is a miracle for which we should be thankful. But saving 263 lives a year isn’t exactly conquering polio.)”


                Figure 7. Fertility really plummeted when the safety advocates convinced the government to require that each child be under the supervision of three adults at all times.


                But there’s another fascinating story about entitlements. To quote Last at length: “Since the 1970s, young white men have seen a 40 percent decline in income relative to their fathers (young black men have seen a relative decline of 60 percent), largely because of taxes. So Social Security and Medicare have placed a serious and increasing burden on families, making it more difficult to afford the—also increasing—cost of children… There were two larger consequences of establishing government-funded programs for care of the elderly. The first was that children were no longer needed to look after their retired parents. Where people’s offspring had for centuries seen to the financial needs of their parents, retired people with no offspring now had access to a set of comparable benefits. They could free-ride on the system. This new system undermined the ancient rationale for childbearing. In a world in which childbearing has no practical benefit—the government will care for you if you don’t have children to do so—parenthood becomes a simple act of consumption. People have babies because they want to, seeing it as either an act of self-fulfillment or as some kind of moral imperative… You can spend your $ 1.1 million raising a child to become a productive worker, but an increasing share of his labor will go to the government. And the government hands out equal shares of retirement benefits from his labor both to those who spent the money raising children and those who didn’t.” Demographers guess this decreases the total fertility rate by 0.5 points – the difference between replacement and disaster!

                Third and finally, a constellation of social changes has limited the window in which women have children. Because of workforce participation, time in school, debt, and new norms, women are delaying childbearing toward the close of their biological viability. The invention of contraceptives has given women more control over when they get pregnant. The legalization of abortion has given women control over whether they deliver their kids. Sex outside marriage has led to more kids born out of wedlock, less likely to be joined by others in the same family unit. And “the routinization of divorce allowed married couples to split before they finished having children”

                From the late 1930s until the late 1960s, Gallup asked Americans how many children they’d ideally like to have and nearly two-thirds consistently said three or more. Today, only one third of Americans want three or more kids. Last reminds us: “with easy access to birth control and abortion, increased educational demands, and the rising cost of raising children, the ‘desired fertility’ metric is an upward limit on ‘actual fertility.’ In practice, actual fertility is often much lower than desired.” In 2011, 58% of women wanted two or fewer children – but 72% wound up there.

                The decline in desire can be traced to the new opportunities in the workforce – but also just looking around and seeing what other people were doing. Interestingly, “from 1879 to 1930, American men and women graduated from college at roughly the same rate.” The GI Bill dramatically altered the equation. “By 1947, 2.3 men graduated from college for every woman.” Women started going to college in greater numbers over the coming decades to the point where today more women graduate than men. Simultaneously, until about 1965, the percentage of women working outside the home was about 44%. Today, it’s about 70%. The desires to get educated before having kids, to pay off some debt before having kids, to advance in career before having kids all contribute to delays.

                But “delaying children is not as simple as it sounds, because while our social institutions are often malleable, biology is not. Between the ages of 24 and 34, a woman’s chance of becoming infertile increases from 3 percent to 8 percent. By 35, half of women trying to get pregnant over the course of 8 months will not succeed. After 35 it gets even dicier. By age 39, a woman has a 15 percent chance of being unable to conceive at all. And by a woman’s 43rd birthday, her chances of getting pregnant are nearly zero. All of which is why today, 1 out of every 100 babies born in the United States is created via in vitro fertilization. You can only push off pregnancy for so long… In 2009, fully 37 percent of all births were to women over the age of 30.”

                Ironically, “Margaret Sanger willed the Pill into existence so that the educated classes would not be ‘shouldering the burden of the unthinking fecundity of others.’ Instead, it has been the educated middle class—Sanger’s people—who have used the Pill to tamp down their fertility.” Surprising to me, only 17% of women aged 15-44 use the Pill; less surprising, that percentage is concentrated in the educated. As a result, the total fertility rate of women who have graduated from college is 1.78. For women with a graduate degree, it’s 1.61. For context, during the period in which China aggressively enforced a one-child policy, forcing women to get abortions or sterilization, their birthrate was 1.54.

                Only so many people use birth control effectively (or at all), and so accessible abortion also prevents childbirth. “In 2000 the RAND corporation tried to estimate the numerical effect of abortion on the TFR. It concluded that for white America, abortion on demand lowered the fertility rate by about 0.08—or 4 percent. Among black Americans the effect was much stronger: the Roe regime pushed fertility down by 0.34—or 13 percent.”

                And finally the instability of relationships has taken its toll on our fertility rate. “There’s a 64 percent chance that a first marriage will last at least 10 years. Fifty percent of cohabitations break down after just the first year…The chance that a person in 1910 who was married would someday be divorced was around 15 percent; by 1960 the odds rose to around 32 percent; and by 2000 to around 45 percent.” Married couples can just have more kids. Finding another partner, especially as a single mom, has big costs that results in fewer children, regardless of desire.

                So what can be done? Last concludes: “The government cannot get people to have children they do not want. However, it can help people have the children they do want.”

                Examples abound from throughout history around the globe of countries trying to spur their populations to have more kids. Almost nothing works. “Comrade Stalin announced the creation of the motherhood medal, given to any woman who bore at least six children… In ancient Sparta, fathers who sired three sons were exempted from Garrison duty and those with the four lads to their name paid no taxes at all. Caesar Augustus levied a ‘bachelor tax’ on unmarried aristocratic men.” Singapore, which waged an incredibly successful campaign to reduce their birth rate, reversed course and attempted to increase it by offering subsidies, preferred entry to good schools, relocating grandparents nearby — and nothing has worked. Just about the only thing that HAS worked is in the country of Georgia, where the local religious leader, Patriarch Ilia II promised that “he would personally baptize any child born to parents who already had two or more children.” The birth rate jumped an astounding 20%. America’s only hope may be Beyonce agreeing to only perform concerts for mothers of three or more kids.

                A significant challenge is that state tax breaks, subsidies, and encouragements tend to influence the timing of kids’ births, rather than the number. If you are delaying having kids because you don’t think you can afford them, a government grant may cause you to have them earlier, but not many more than you already wanted. “The consensus is that subsidies produce returns mostly at the margins: Studies of European countries show that for every 25 percent increase in benefits, fertility increases by 0.6 percent in the short term and 4 percent in the long term.” 

                One interesting suggestion about Social Security which may help alleviate demographic problems but would exacerbate financial ones: “Phillip Longman proposes a ‘Parental Dividend’ system by which a couple’s FICA taxes would be reduced by one-third with the birth of their first child, by two-thirds with the birth of a second, and then eliminated completely with the third (until the children turn 18).”

                Ultimately, Last has “three golden rules for natalism.” First, “Below a certain point, there’s no turning back.” Once you drop below 1.5 kids per woman, it’s practically impossible to get back on track. 

                Second, “any efforts to stoke fertility must be sustained over several generational cohorts… A four-year tax credit is useless. So is a long, but feckless, string of hopscotch initiatives, like Japan’s. What you need is a serious, decades-long commitment to family growth.” And those efforts need to be concentrated on making life easier for parents, as opposed to specifically orienting toward having more kids because…

                Third, “people cannot be bribed into having babies.” Because kids are a lot of work! (I know my parents had their hands full with just one. But that may be a special case.)

                What to expect

                Figure 8. Click here to buy What to Expect When No One is Expecting. 7/10. An amusing guide to a scary subject. The book touches on but does not fully address some big questions: should we be indifferent about who is having kids as we strive to exceed replacement? Is a larger fertility number inherently good or is there a sweet spot above replacement? There are also some interesting insights tangentially related to fertility, like the fact that premarital cohabitation started among the poor in the Depression, not among hippies in the Sixties. The book ultimately makes a subversive argument: society needs to empower women to have the number of children they want, a number higher than they currently have. Of course, the book fails to note the truly correct answer to its title.


                P.S. If you really want a blast from the political past, read Teddy Roosevelt addressing the National Congress of Mothers: “There are many good people who are denied the supreme blessing of children, and for these we have the respect and sympathy always due to these who, from no fault of their own, are denied any of the other great blessings of life. But the man or woman who deliberately foregoes these blessings, whether from viciousness, coldness, shallow-heartedness, self-indulgence, or mere failure to appreciate aright the difference between the all-important and the unimportant – why, such a creature merits contempt as hearty as any visited upon the soldier who runs away in battle, or upon the man who refuses to work for the support of those dependent upon him, and who though able-bodied is yet content to eat in idleness the bread which others provide.”

                Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone with kids? How about anyone without? Know anyone who is concerned with the downfall of America?

                I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

                  Just My Luck

                  The Gist:  Success may be more random than we’d like to think.

                  A review of Fooled By Randomness by Nicholas Taleb.

                  The ambitious are always trying to figure out how to win in life. 

                  Often that search means looking at winners and copying their practices – or investing in their future success. You can read articles by the dozen about how the President won his election with a master communications strategy while his opponent neglected critical voters. You can watch TV after the Super Bowl to find out the diet, exercise regimen, even the sex life that might have contributed to the quarterback throwing the game-winning Hail Mary. You can dial into an earnings call to listen to a CEO diligently explain his strategy for building upon the company’s record-breaking profits from the previous quarter.

                  But what if a secret to success is randomness? As the old saying goes: better to be lucky than good.

                  Crossed Fingers

                  Figure 1. For maximum performance, knock on wood while crossing your fingers and grasping a rabbit’s foot underneath a horseshoe. 


                  This is the question that haunts Fooled by Randomness, the first in a series of books by Nassim Nicholas Taleb, an options trader, about the role of uncertainty in our life. We humans are emotional beings, poorly equipped to evaluate odds, and naturally inclined to construct reasons for events that may not be knowable, much less actually true.


                  Figure 2. If he hasn’t called, it must be that he joined the French Foreign Legion! 


                  To begin to understand performance, you need to know the size of the sample (how many people tried) and the randomness content of his profession (how significant a factor is luck). How much success could luck alone produce?

                  If someone accurately predicts 10 presidential elections, the media hail him as a predictive genius, report with big headlines his latest prophecy, delve into his particular analysis of the electorate or the economy or whatever his formula. But you have to seriously consider whether he is better than someone who accurately predicted 10 coin flips. If a million people try to predict something with (almost always) only two outcomes, some will be right by chance alone, whether they base their predictions on deep analysis, gut feeling, or the weather. To extend the example: If a million people try to predict 10 die tosses, there are more opportunities to be wrong so fewer should be right by only luck — but some still will because there are a million participants!

                  Nate Silver

                  Figure 3. Or, in the case of Nate Silver, you only have to predict one election for the media to rave about you. The next election didn’t quite go as predicted.


                  In more complicated professions, just because the odds can’t easily be defined doesn’t mean they don’t exist. Talent is relevant but we often overestimate it. If you are identifying the ingredients to success, you have to constantly assess the role of luck. Taleb controversially argues: “I am not saying that Warren Buffett is not skilled; only that a large population of random investors will almost necessarily produce someone with his track records just by luck.” 

                  The role of randomness is far easier to understand from the loser’s perspective. You win and you credit your creativity, genius, and industry. You lose and you blame the odds.

                  Of course, there could be very good reasons why you or someone else lost. Losers don’t get biographies. But the reason behind winning or losing may really be luck. And that fact doesn’t satisfy our minds that hunger for a story. Yet winning is worthwhile so we study the winners.


                  Figure 4. Apparently the secret to winning the Powerball is using a combination of the birthday of your first ex-mother-in-law, the number of Budweisers you had last night, your number of unreplaced teeth, and the amount of spots on your coonhound divided by 25.


                  Isolating performance quickly complicates things. The best wide receiver on the planet has real limits that come with the guy throwing to him, and vice versa. Taleb observes that the performance of a cook in the company cafeteria is far easier to evaluate than that of the company CEO. At a certain point, one can only so often confuse salt and sugar, but at the pinnacle of leadership there are a lot more factors that go into success or failure. And the more factors, the more randomness plays a role.


                  Figure 5. Yes, it may be said that a cook can better master the ingredients of success than a CEO.


                  If top performers are identified, analysts will discover commonalities and make the leap: if you share these traits, then you, too, may become a top performer. But the commonalities are rarely put under study. High tolerance for risk is an entirely believable shared trait among billionaires and bankrupt.  Taleb again: “I never said that every rich man is an idiot and every unsuccessful person unlucky, only that in absence of much additional information it is preferable to reserve one’s judgment.”

                  You may also stumble upon something completely unrelated but randomly correlated. Taleb himself is “convinced that there exists a tradable security in the Western world that would be 100% correlated with the changes in temperature in Ulan Bator, Mongolia.”  This is called a spurious correlation, itself an amusing website. The examples are silly, of course, but they point to the possibility that a plausible explanation is actually completely wrong.  

                  Even when true statistics are captured, they are prone to misinterpretation. Just because a majority of American presidents were born before 1900 does not mean that the next President is likely to be over a century old. If a surgery with a 99% survival rate has been performed 99 times and you’re next, you still have a 1%, not 100%, chance of death. Insurance is not necessarily a waste just because you have not had to take advantage of it. Our mind does not easily grasp these ideas.

                  Taleb ends up dividing the world: “I thus view people distributed across two polar categories: On one extreme, those who never accept the notion of randomness; on the other, those who are tortured by it.” 

                  For those who take the red pill: “Probability is not a mere computation of odds on the dice or more complicated variants; it is the acceptance of the lack of certainty in our knowledge and the development of methods for dealing with our ignorance.”

                  What are some of those methods?

                  First, be happy you’re already lucky to live in the greatest country in the world. Psychologists have found that people are happier when they make $70,000 a year when everyone around them makes less than to make $80,000 a year when everyone around them makes more. Whatever your circumstances, if you are reading this newsletter, there are people worse off – and yes, perhaps, because of random bad luck. Inform your envy that its objects may merely be beneficiaries of the odds. And take into account just how lucky you are – and how grateful you should be.


                  Figure 6. Classic financial advice is to own the cheapest home on the block. New happiness advice: own the most expensive home on the block.


                  Second, be skeptical of the explanations behind success and failure – including the ones you conjure for your own – that don’t factor in luck. News is especially bad: Every day every media outlet screams for attention even when the news does not merit it. Analysts offer immediate speculation without subsequent confirmation. On television, anchors are hired based on their charisma and looks, not their crucial insights. Taleb continues the indictment: “To be competent, a journalist should view matters like a historian, and play down the value of the information he is providing, such as by saying: ‘Today the market went up, but this information is not too relevant as it emanates mostly from noise.’ He would certainly lose his job by trivializing the value of the information in his hands.” To attain distance, I personally gather news and read it altogether at the end of the week. I can read the whole story, rather than each daily update, or decide the story isn’t even that relevant. I have other friends who have unplugged from the news altogether. Another reason to read books instead! But even taking a historical view, “Past events will always look less random than they were… Humans are not wired to understand the impact of randomness in our lives, and so we must be constantly vigilant as to not assign greater significance to things that largely happened by chance.”


                  Figure 7. Sources confirm that the dog DID NOT chase the cat today. Will this signal a new era in feline-canine relations? Let’s go to our panel. 


                  Third, remember: Winning does not mean the risk should have been taken. Losing does not mean the decision was bad. Never confuse the quality of a decision with the desirability of the outcome. By all means, try to figure out what happened. But judge decisions based on what was known at the time, not whether the gamble paid off. Taleb even gets philosophical: “Heroes are heroes because they are heroic in behavior, not because they won or lost.” Just because randomness plays a role doesn’t mean you shouldn’t work hard and give yourself opportunities to score.

                  Ultimately, as Robert Heinlein observed, “Certainly the game is rigged. Don’t let that stop you; if you don’t bet you can’t win.” Who knows? Maybe the game is rigged for you.

                  Fooled by randomness

                  Figure 8. Click here to buy Fooled by Randomness. 8/10. Taleb’s writing is best characterized as wanderlust, as it does not fit neatly together and he has a unique voice that not everyone will appreciate. But there are outstanding insights scattered throughout, complemented by vivid thought experiments and playful language. He is more famous for Black Swan, but I consider this a better book. His work resists summary and I’ve done my best above – though he argues that book reviews tell you more about the reviewer than the book, so take that as you will. For a review of more of his work, click here.

                  Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone with bad luck? or good? how about anyone who needs to understand risk?

                  I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!

                    Warren Piece

                    The Gist:  How the Oracle of Omaha refined his investment strategy to become a billionaire.

                    The second of a two-part review of multiple Buffett biographies.

                    Read the first part here: My Warren Report.

                    Where last we left off, Warren Buffett was just starting to get back into the stock market as it underwent a sustained downturn during the 1970s. In other words: businesses were on sale! 


                    Figure 1. “C’mon down to Wall Street because EVERYTHING MUST GO! Your favorite brands are 50 – 70 – even 90% off! We are SLASHING prices MARKETWIDE for this decade only – so get in while you can and tell ‘em Cowboy Pete sent you!” 


                    His vehicle was rather unusual: the publicly-traded Berkshire Hathaway, originally and ostensibly a northeastern textile manufacturer. Yet Buffett was using the profits of the manufacturer to invest in other companies – and those investments were paying off far better than the troubled underlying business. His partner in success – the man who refined Buffett’s investing approach from the pure bargain-hunting that had led to Berkshire’s acquisition in the first place – was Charlie Munger.

                    Munger was also an Omaha native but, unlike Warren, was determined to get out. Bouncing around different colleges but never getting a degree amidst military service in World War II, he was at one point assigned to California and quickly concluded he preferred western winters. As the grandson of a federal judge, Munger was able to solicit a family friend’s help in getting into Harvard Law School without the college prerequisite – and, despite the dean’s skepticism, wound up graduating in the top 10% of his class. Soon making a sizable income at a California law firm, Munger began investing with a notable caution: he did not want to put his money into people and companies that made good law firm clients because they had so many legal problems. 

                    While Munger was a great lawyer – he even co-founded a super-star law firm – he was an outstanding investor and soon was investing other people’s money. Wall Street Journal reporter and Buffett biographer Roger Lowenstein reports: “Munger was no Ben Graham disciple. In his view, troubled companies, which tended to be the kind that sold at Graham-like discounts, were not easily put right.” As Buffett would sum up, “Time is the friend of the wonderful business, the enemy of the mediocre… It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner.”


                    Figure 2. Literally bought for a song from a troubadour, Ye Olde Renaissance Fair franchisor turned out to have an array of pending lawsuits related to its attempt to genuinely recreate its time period with Bubonic plague infections, burning of heretics, malnutrition for most participants, and explanations of danger only available in hand-drawn Latin brochures sold for hard currency.


                    But what was a “wonderful company”? Munger was on a mission to find out and asked everyone he met “What’s the best business you’ve ever heard of?” In 1959, Munger was back in Omaha to settle his father’s estate when he got to ask his favorite question to a new acquaintance, the grandson of the owner of the grocery store he once worked at (in his words, “slaved” at) as a teenager: Warren Buffett. It was an instant friendship that would last a lifetime and they began talking every single day by phone. Soon, Buffett would be asking a variant of Charlie’s question: “If you were stranded on a desert island for ten years, in what stock would you invest?”


                    Figure 3.  Among those actually castaway on a desert island for years, the answer was Anta Sports Products Limited, traded as ANPDF on the Hong Kong Stock Exchange, perhaps better known for its subsidiary, Wilson Sporting Goods. 


                    The understanding that drove the intensity of the duo’s search was that concentration on the right bets – the equivalent of putting it all in on the royal flush – would pay off better than diversification. The difference, of course, is that you know a royal flush is the best hand while you don’t know the future of a company. Diversification is really risk management because concentration can mean you lose it all as well – maybe you’re really putting it all in on a pair of twos. Buffett would later advise students that “You’d get very rich if you thought of yourself as having a card with only twenty punches in a lifetime, and every financial decision used up one punch. You’d resist the temptation to dabble.” 

                    For Buffett, that meant staying within your circle of competence and being as sure as you could be, after much intensive and obsessive analysis, that every decision was right. From Graham, Buffett understood that he needed a margin of safety and that Mr. Market might provide it to him at the right time. From Munger, Buffett began to see that there might be more to intrinsic value than merely the price at which a company could be liquidated. Munger wanted businesses that continuously threw up easy decisions rather than hard ones. But he also became interested in a specific feature: “Munger had a Caterpillar tractor dealership as a client. To grow, the business had to buy more tractors, gobbling up more money. Munger wanted to own a business that did not require continual investment, and spat out more cash than it consumed.”  

                    The business that fit the bill and fueled Buffett’s success would be insurance. Buffett had first gotten to know the industry through studying Ben Graham’s greatest payoff, Geico, which originally and brilliantly sold insurance through direct mail (thereby removing the commissions and costs of agents) only to government employees (who, on average, filed fewer claims). While Buffett would eventually buy Geico, he started out with a profitable Nebraska insurer whose owner was a bit moody and had a reputation for getting irritated enough to threaten to sell the business – but only for about fifteen minutes once a year before calming down. Buffett let it be known that if he could get in during those 15 minutes, he’d buy. Soon enough, he did – or, as one might put it, 15 minutes saved him 15% or more on insurance.

                    What Buffett understood faster and better than the rest of the insurance industry was the opportunity to invest the float – that is, the money available between when premiums are paid in and claims were paid out. Most of the industry then just stashed it away in long term bonds (conventionally safe but soon ravaged by inflation). Buffett, while insisting on relatively safe and conservative underwriting, put the float to work in the market and in piecing together his own conglomerate. The float meant he did not have to take on debt but instead had access to his own cash source: “Charlie Munger has said that the secret to Berkshire’s longterm success has been its ability to ‘generate funds at 3 percent and invest them at 13 percent.’”

                    Flight attendant

                    Figure 4. “Welcome aboard the New York Stock Exchange! Thank you for your attention while important margin of safety information is reviewed. Your cash may be placed in an overheard compartment or completely under the seat in front of you – but taking on additional leverage is prohibited. In case of an emergency, please follow the lighted ticker signals reflecting a downward price movement and buy as much as you can. If you are an insurance company, your float is an approved cushion device. If you are seated in an exit row, you may be called upon to get as many bargains as you can as terrified sellers pass you by. If you are unable or unwilling to perform that function, you will lose a lot of money.”


                    Buffett’s success ultimately came from laddering up his investments and, as he put together a conglomerate, redistributing capital to its best and highest use. Buffett had a single goal: for every dollar he could get from profits or float or wherever, where would it go the farthest? Buffett insisted “I’d rather have a $10 million business making 15 percent than a $100 million business making 5 percent… I have other places I can put the money.” William Thorndike authored a study of Buffett and other unconventional CEOs with outsized returns and concluded that their success related to this magic of capital allocation. “Whenever Buffett buys a company, he takes immediate control of the cash flow, insisting that excess cash be sent to Omaha for allocation.” Once Buffett had all the cash in one place, he would decide where to invest in existing operations, whether to acquire a new business altogether, whether to invest in Berkshire’s own stock if it was cheap, whether to pay off debt, or whether to keep powder dry – all depending on what might have the highest return.

                    Buffett’s style had another related feature: “Except on June 30 and December 31, when [a CEO of a subsidiary] was obliged to transfer his profits to Omaha, he felt as if the business were his. In a practical sense, he was free to run it for the long term, as a private owner would.” Buffett’s corporate offices had an anorexic staff – even by the time it was a Fortune 500 company, HQ had less than a dozen people. One CEO reported that he “delegated to the point of abdication” and would “always praise [his team] while he gave [them] more to do.” But “while remarkably tolerant of others’ quirks and flaws, he was less so of quirks and flaws that cost him money.” It was all about the return – and if you couldn’t deliver, none of the profits would be given back to you. 

                    Given the attractive features of the insurance business, you won’t be surprised by the business that ultimately brought together Munger and Buffett as partners: Blue Chip Stamps. Essentially a rewards program, super-markets paid Blue Chip for the ability to distribute stamps that their customers could earn by making purchases and redeem for prizes. For Buffett and Munger, the magic was that they got immediate control over the money that would only have to be given back over time – if at all (lots of customers lost their stamps). “To Buffett, Blue Chip was simply an insurance company that wasn’t regulated” – with a float of almost $100 million.

                    And yet the maneuvering of Buffett and Munger at Blue Chip did attract the unwanted attention of the SEC. Between them, Munger and Buffett owned 3/4 of Blue Chip and were using the investment committee to pursue more good deals, including making a substantial run at a savings and loan, Wesco Financial, trading at “less than half its book value”. But Wesco’s management soon announced they were going to be taken over at what Munger and Buffett thought to be a terrible price, so they maneuvered to kill the deal and then eventually themselves acquired a majority stake. The SEC, however, suspected stock manipulation and were further suspicious of Blue Chip’s convoluted and complicated ownership structure – often a sign of attempted fraud. The problem was that though Munger and Buffett controlled Blue Chip, they did so through lots of different entities, each of which may have required fiduciary duties, where Munger’s partnership owned a portion, but also a portion of a third company that owned a portion, and that third company was owned in part by Buffett’s Berkshire Hathway, which also owned a portion of Blue Chip, and then there was Buffett himself who personally owned part of Blue Chip along with other companies, and so on and so on.


                    Figure 5. Meanwhile, thousands of kids would kill for some attention from the SEC.


                    An investigation ensued, and Munger and Buffett decided to cooperate in full. By the end, instead of an indictment, the SEC “named [Buffett] to a blue-ribbon panel to study corporate disclosure practices.” By all accounts, they really were totally above board – and unusual in that they each interviewed alone without a phalanx of attorneys. But it may have helped that the SEC had been taken over by a former law partner of Munger’s. Regardless, the duo realized that their structure had organically grown into something too complicated and they decided to consolidate everything into the single entity of Berkshire Hathaway. (And Munger might have had extra motivation because, unlike Buffett, he had not returned all capital in 1970 and so his record took a rough dip as the market declined).

                    In the meanwhile, Buffett found another kind of wonderful business – and this one Ben Graham did not approve of. The specific company was California chocolatier See’s Candy, which Buffett bought at 3x book value – very expensive in Graham’s outlook and Buffett had held his nose to offer that absolute maximum. But one of the problems with book value is that it does not take into account the power of a brand – the difference between whether you’d buy a generic cola or Coke, the difference between the price of machinery on the open market versus what its capable of producing – Mustang or Edsel. See’s had established a consumer franchise where customers were willing to pay an irrational price well above cost. Around this time, Ben Graham invited Buffett to be the coauthor of a revised edition of the Intelligent Investor; Buffett wanted to add a chapter about See’s Candy and identifying great businesses but “Graham didn’t think the average reader could do it.” Buffett ultimately declined – his foundation was still Graham but Munger had helped him go beyond it. And if the stock market was as cheap and inflation as bad as the 1970s, he was ready to invest a far greater percentage in stocks than Graham’s 75% ceiling. Relatedly, 

                    Fear of inflation was a constant theme in Berkshire’s annual reports throughout the 1970s and into the early 1980s. The conventional wisdom at the time was that hard assets (gold, timber, and the like) were the most effective inflation hedges. Buffett, however, under Munger’s influence and in a shift from Graham’s traditional approach, had come to a different conclusion. His contrarian insight was that companies with low capital needs and the ability to raise prices were actually best positioned to resist inflation’s corrosive effects.


                    Figure 6. Pro tip for your budget: look up all the companies considered consumer franchises – and immediately and forever more replace them with generics. With Coke, a cheap alternative generic comes right out of your faucet! 


                    But, of course, people could still buy chocolate elsewhere. What Buffett really wanted was the only toll-bridge in a river town, a business where people had to use the product. The best equivalent he could find was a local newspaper where businesses felt obligated to advertise. He shopped around for a few years, bought an alternative weekly in Omaha and even helped it win the Pulitzer Prize, bought Washington Post shares at a bargain and went on the board to further get to know the industry, and finally he was able to acquire, in his biggest purchase then to date, the Buffalo Evening News. 

                    Acquiring the evening newspaper (with a strong morning rival once edited by Mark Twain) without a Sunday edition (published by the rival) in a declining manufacturing town with unfavorable labor laws did not seem to be the kind of wonderful business that continuously threw up easy decisions – and it’s possible that Buffett and Munger were too influenced by their love of newspapers. And yet what happened next was even more difficult than they could imagine: when the Buffalo News tried to publish a cheap Sunday edition, their rival sued them for antitrust – and a local federal judge, perhaps skeptical of non-local interlopers, held them up in court for years. But Buffett made the bet that his balance sheet was stronger than the owners of the other newspaper and so they bitterly fought it out until the rival went bankrupt. Suddenly, Buffett had his toll bridge and the printing presses at the Buffalo News started figuratively printing money, spurring new purchases for the Berkshire conglomerate. Interestingly, Buffett was very clear on who won the classic newspaper war:

                    Soon after the [rival] Courier’s demise, Buffett attended a meeting for the newspaper’s middle-level managers, in Buffalo’s Statler Hotel. “What about profit-sharing for people in the newsroom?” Buffett was asked. On its face, this seemed reasonable. The newsroom had certainly done its bit. Buffett replied coldly, “There is nothing anybody on the third floor [the newsroom] can do that affects profits.” The staff was shocked, though Buffett was merely living up to his brutal-but-principled capitalist credo. The owners of the Buffalo Evening News had run very great risks. Employees had not come forward during the dark years to share in the losses. Nor, now, would they share in the gains. 

                    The 1980s would be defined by the image of the corporate raider: an aggressive outsider who used debt to buy companies he could not otherwise afford with the hope of paying it off by better management (or liquidation). Buffett hated that this helped Mr. Market go manic: “A raider with access to somebody else’s dough would pay a lot more than a company was worth. And Wall Street’s soaring appetite for junk bonds was providing a vast supply of easy money.” But he soon found that he could secure special deals by being the antidote to the era: as a folksy debt-shy Midwesterner with a hands-off management style, he was the perfect white knight to fend off raiders looking for easy prey. Indeed, this was a business Buffett understood well: he was going to be management’s insurance. 

                    But while pursuing private opportunities and cutting deals of special consideration throughout the decade, Buffett saw less opportunity in the public markets. In 1985, he “sold every stock in the portfolio” except for the “permanent” three: Geico, the Washington Post, and Capital Cities (lots of local television stations that wound up buying ABC). In the same year, he finally ended Berkshire’s textile business: “The equipment would have cost as much as $50 million to replace. Put to the auction block, it sold for $163,122.” For three long years between 1985 and 1988, he did not buy a single common stock. When he did, “he staked a fourth or so of Berkshire’s market value” on the sufficiently cheap consumer franchise of Coca Cola, which had been trying to concentrate on its core business after some bumps in the road. Over the coming years, Berkshire’s holdings would grow in value by nearly $19 billion, up over 1,000%.

                    The New Coke fiasco merely made the company more compelling to him. As Buffett explained it, Coca-Cola knew that Americans had preferred the sweeter New Coke, but when people were told about the switch, they wanted their old Coke back. The drink had “something other than just the taste—the accumulated memory of all those ballgames and good experiences as children which Coke was a part of.”

                    The 1990s began with a white knight deal gone wrong. Buffett had long been critical of the investment banking industry, quipping that “the bankers should be the one wearing ski masks” and “you won’t encounter much traffic taking the high road on Wall Street.” But he had a personally good experience with Salomon Brothers and when they asked for his help to fend off a raider – and offered an extremely sweet deal – Buffett took it. A few years later, however, a rogue trader repeatedly defrauded the worst possible victim: the U.S. government. When management discovered the problem, they dithered and procrastinated until it was too late – the culture of the firm tending to encourage employees to walk the line. But this scandal threatened the destruction of the entire business, either through criminal action or, even more significantly, the cutting of U.S. Treasury bond sales to the firm. As a board member and substantial investor, Buffett realized he was the only one who could put it right and took over as CEO. Quickly finding the right person to run day-to-day, more than anything else Buffett provided moral leadership. Buffett sent a short memo to all employees, “insisting they report all legal violations and moral failures to him. He exempted petty moral failures like minor expense-account abuses, but, “when in doubt, call me,” he told them. He put his home phone number on the letter.” He pledged complete cooperation with the government, stating before a Congressional committee “ I would like to start by apologizing for the acts that have brought us here. The Nation has a right to expect its rules and laws will be obeyed. At Salomon, certain of these were broken.” Through extreme cooperation, Buffett saved the company – and salvaged his investment.


                    Figure 7. For Solomon Brothers, twas but a scratch


                    The 1990s also saw the return of a big bull market led by technology – and many thought that Buffett had lost his touch. The market run had gone on for so long that some thought it could only go up – the old bargains weren’t there and Buffett’s record didn’t look quite as shiny next to the ridiculous instant returns of tech (including from the company of Buffett’s personal friend Bill Gates). In 1999, near the height of the bubble, Buffett gave a famous speech that conceded the internet would change the world – but he wasn’t sure where or even whether money could be made over the long term. Buffett noted two technologies in particular had upended the 20th century: automobiles and airplanes. Of some two thousand auto companies at the beginning, only three had survived: could anyone be so confident that those were the three that would? As for the other innovation, “As of a couple of years ago, there had been zero money made from the aggregate of all stock investments in the airline industry in history.” Buffett had gotten past the mechanical analysis of Graham but he could not get to the magical analysis of Silicon Valley. “Charlie Munger… said that if he were giving a test calling for an analyst to value a new dot-com internet company, he would fail anyone who answered the question.” 

                    Ultimately, what made Buffett truly remarkable was that he became so rich as an investor as opposed to an inventor or someone who plied a specific trade. Rockefeller had oil, Vanderbilt had transportation, Walton had discount retailing, Gates had software, but Buffett didn’t invent anything – he just knew a good deal when he saw it. And knew it from a very young age, so his successes compounded decade after decade, such that over 90% of his wealth has been generated after he turned 65. He had created the structure that fueled still more success, reallocating capital time and time again to quickly take advantage of operations or the market. The books reviewed here end in the late 1990s and early 2000s, but Buffett has continued to apply similar principles sometimes with non-obvious elements: Berkshire’s largest public holding would become Apple, which many think of as a tech company but Buffett prefers to see as a luxury manufacturing company with the customer franchise model he has long sought to invest in. And Buffett continues to pursue private deals – his biographer Alice Schroeder argues that “Buffett’s real brilliance was not just to spot bargains (though he certainly had done plenty of that) but in having created, over many years, a company that made bargains out of fairly priced businesses.” In the final part of his career, he reaps the rewards:

                    Remarkably, Buffett has created a system in which the owners of leading private companies call him. He avoids negotiating valuation, asking interested sellers to contact him and name their price. He promises to give an answer “usually in five minutes or less.” This requirement forces potential sellers to move quickly to their lowest acceptable price and ensures that his time is used efficiently. Buffett does not spend significant time on traditional due diligence and arrives at deals with extraordinary speed, often within a few days of first contact. He never visits operating facilities and rarely meets with management before deciding on an acquisition.

                    Of course, there’s significant academic commentary that Warren Buffett is not necessarily an uber-talent but in fact the winner of an investor lottery. As Nassim Nicholas Taleb has argued, “I am not saying that Warren Buffett is not skilled; only that a large population of random investors will almost necessarily produce someone with his track records just by luck.” The related formal hypothesis – the efficient market theory – has won economists the Nobel Prize. EMT concedes that individual investors can beat the market average – but insists that it’s impossible to predict in advance which investors would do so. EMT insists that the market’s pricing reflects the collective wisdom of participants and that you’re far better off just investing in an index. Buffett himself famously participated in a debate about the topic in the 1980s and argued that if investing really was just coin-flipping but that a certain group consistently got the right side more often, that group’s technique was worth investigating. Buffett related the outstanding records of disciples of Ben Graham and insisted that “observing correctly that the market was frequently efficient,” the academic theoreticians “went on to conclude incorrectly that it was always efficient.” In other words, Mr. Market was a manic-depressive who could be profited from. In subsequent years, the two sides have gotten a bit closer to each other. Academic theorists have found a long-term pay-off to value investing (in fact, one of the very small number of explanations for differing performance) but have differed on whether this was due to increased risk (as conventional economics would insist – perhaps because of the more troublesome companies involved) or due to cognitive biases dismissing cheap stocks (as behavioral economics would argue). Despite Buffett’s move toward Munger’s concept of wonderful companies at a fair price, he dismisses being paid for risk: if the same company with the same assets has a much lower price one day than the day before, Buffett insists that means a greater margin of safety and inherently less risk. And yet, in the end, Buffett has recommended that the typical investor be defensive and just invest in an index fund – and has even gone so far as to successfully bet that active management would not beat a typical index fund.


                    Figure 8. Rather than try to find the next Geico yourself, why not just go with index funds? They’re so easy, a Caveman could do it!


                    Whether Buffett’s intensity had a reward may be debatable, but it did have a price. As a friend put it, Buffett’s “real marriage was to Berkshire Hathaway,” not to his wife Susie. Their original courtship had been uneven, with Susie eventually falling in with Buffett, a family friend, because her father disapproved of her serious college boyfriend. Through the years, as he made more and more money, Buffett was not especially interested in spending any of it (or giving it away). Susie, meanwhile, liked the good things in life and was also a full-hearted philanthropist always giving her time to those she deemed in need of help. As an example, even as a multi-millionaire, when he visited New York he’d stay at a college buddy’s mom’s house. When she came with him, she insisted on their staying at the Waldorf. Buffett has always taken a relatively small salary and refused to sell any of his Berkshire shares – only in midlife did he do some extracurricular investing that gave millions in spending money. When he paid $31,500 for the home in Nebraska he still lives in, he called it “Buffett’s Folly.” Susie would eventually get him to spring for additional properties – but he spent most of his time in Omaha. Buffett would come to enjoy celebrity and high social contacts, and he would eventually even spring for a private jet he dubbed “The Indefensible,” but his principal vice was cheap: playing bridge for 12 hours a week (and even then, he kicked Susie out of his group because she was not competitive enough.)

                    As Buffett made his fortune, “the family swirled around him and his holy pursuit” – his focus was so intense that at one point he came downstairs from his office and asked about “new” wallpaper in the living room that had been installed years earlier. After their three kids went off to college, a neglected Susie rekindled her romance with her college boyfriend while pursuing a new career as a cabaret singer. Within a couple of years, Susie told a shocked Warren that she was leaving him to move to San Francisco (she did not tell him that she was also bringing along her tennis coach, a new beau). And yet the marriage didn’t end. A depressed Buffett called her everyday and part of Susie’s heart was still with him. She wound up encouraging the hostess at an Omaha nightclub she used to sing at to look in on her husband. Soon, apparently unanticipated, the hostess, Astrid Menks, moved in. They wound up in a bizarre arrangement where Astrid would accompany Warren around Omaha, Susie around the world; they’d send Christmas cards from the three of them; and Astrid would become Warren’s second wife upon Susie’s death. When Susie did die, Warren was so emotionally overwhelmed he could not attend the funeral.

                    Meanwhile, all of his kids would drop out of college, enter short-lived marriages, and sell their Berkshire stock for questionable purposes. If they had held, “they could have been millionaires without working a day.” Instead, Susie Jr. sold to buy a Porsche. Later, pregnant during her second marriage, she asked her dad for a $30,000 loan to redo their kitchen, thinking that’d be easier to acquire than a gift. He told her to try a bank. A visiting Katherine Graham was so shocked at her modest living – a black and white television! – she paid for a redecoration. “When Buffett gave his kids a loan, they had to sign a loan agreement, so that it would be plain, in black and white, that they were legally on the hook to him.” (Somewhat relatedly, his sister got herself into over $1 million in debt with some questionable stock speculation and when she asked for help, he declined to bail out her debtors, leading her to default). Howie (Howard Graham, named after Buffett’s two heroes) at least sold his stock to try to finance a business, but it went under. Howie worked for See’s for a while but his real dream was to buy a farm. Buffett tried to argue with him and tell him, based on his insights about franchise businesses, “nobody goes to the supermarket and asks for Howie Buffett’s corn,” but Howie was persistent. “After ‘torturing’ himself,” Buffett “offered to buy a farm and rent it to Howie on standard commercial terms” but insisted on getting a bargain of a price on the land. After about a hundred bids and years of looking, Howie finally got one at the bottom of the market. Buffett’s only non-commercial terms were an agreement to lower the rent if Howie lowered his weight, which never happened. Finally, Peter would wind up quitting Stanford and sold his stocks to help finance a sound studio as he pursued a career in music. Eventually, Howie got swept up into another questionable business, leading his mother to successfully pry open Buffett’s purse strings for million dollar gifts to each child every five years on their birthday.


                    Figure 9.  A great car, perhaps, but has not quite multiplied in value 30x.


                    Buffett had always assumed that his first wife Susie would be the one to give it all away after he died. Because Buffett was so enthralled with compound interest and confident of his own ability to generate outsized returns, he did not give much away for most of his life, insisting “When I am dead, I assume there’ll still be serious problems of a social nature as there are now.” When Buffett did occasionally dabble, he was disappointed. On the board of a small college, he helped grow their endowment substantially through profitable investments – and then was distressed by their spending it down too aggressively, and not to his preferences for students’ actual educational benefits. On the board of a bank chartered with the intention to help minorities with credit, Buffett became frustrated that it was generously lending at the expense of its own sustainability as a business and refused to bail it out. Beyond civil rights, Buffett’s charitable interests were eclectic, controversial, and difficult to finance: population control and the prevention of nuclear war. The first translated into gifts for an unusual combination of abortion providers and immigration restriction advocates. More than anything else, Buffett was looking for a long-term return (as he saw it), even asking friends a version of Munger’s business question, “If you had to give money to one charity to do the most good, which would it be?” Ultimately, for better or worse, Buffett decided his highest and best use was making money and others would give it away: without Susie, he has given more than a billion dollars to each of his three kids’ charities – and the remainder to the measurement-obsessed foundation of his close friend Bill Gates.

                    If you can somehow mimic Buffett’s investment record without his personal life, then you’ve really got something going – but you’re probably better off mimicking his fanatical saving, investing the proceeds with index funds, and spending the saved time with your family!


                    Figure 10. Click here to acquire Alice Schroeder’s the Snowball (9/10), titled to evoke the wintry sphere growing in size as it rolls down a mountain – just like what compound interest does to your money.  Click here to acquire Roger Lowenstein’s Warren Buffett: the Making of an American Capitalist (8/10). These two comprise the foundation of this double review and I’d recommend both, with Schroeder having a lot more detail about his personal life (including covering, before linking up with Astrid, a possible affair with Katherine Graham. Lowenstein has the better anecdote about their relationship though as Warren convinced Katherine to finally visit him in Omaha and, when they got on the plane, asked her to draw a map of the United States and mark the location of their destination. It was so awful she tore it up. Such is the knowledge of our media elites.) I also explained at some length Buffett’s father’s politics because they were central to his life but Warren’s politics are interesting as well, and I don’t know that Lowenstein fairly labels them even as he describes them. Warren drifted away from his father over time, eventually joining the Democrat Party, but, even after hosting George McGovern at his home in Omaha, he wound up voting for Richard Nixon after McGovern announced his welfare policies. Buffett has been especially vocal about taxation, advocating for a confiscatory tax on short term capital gains, a high death tax, and replacing the income tax with a progressive consumption tax – not all ideas easily placed on the spectrum. Perhaps his best idea has been a single constitutional amendment: if the federal budget has not been balanced for the last two years, no incumbent is eligible for re-election.

                    Damn Right

                    Figure 11. Click here to acquire Janet Lowe’s Damn Right! (5/10), a wandering biography of Munger, unfortunately just about the only one. It’s hard to recommend, though I did learn some things, especially about how Munger’s law practice affected his investing philosophy. Also notable: while both Warren and Charlie are voracious readers, Warren is nearly completely focused on financials while Charlie reads extremely widely into psychology, physics, biology, history, etc. 

                    The Outsiders

                    Figure 12. Click here to acquire William Thorndike’s The Outsiders (8/10), which studies a select number of CEOs with outsized return to shareholders and concludes their secret was capital allocation. Remarkably, Buffett is not only profiled but was a key investor in and adviser to others profiled such as Katherine Graham at the Washington Post and Tom Murphy at Capital Cities. Buffett argues that most CEOs get the job due to relatively narrow skills in their previous junior position – they were great at marketing or manufacturing efficiency or legal maneuvering or whatever – but they really have no experience in allocating capital, which Buffett believes is the #1 job of the CEO. The book is most applicable to public corporations and it does have a winners’ bias – among the reasons these CEOs had such a good record was buying back their company’s public shares at cheap prices before their management made them more valuable again, but it’s plausible that other CEOs used the special sauce of buying back shares – but at the wrong time – and their management wasn’t up to snuff. Regardless, a great exploration of capital allocation.

                    Value investing

                    Figure 13. Click here to acquire Value Investing (7/10), an exploration of the concept followed by a series of profiles of practitioners. The Buffett section is almost entirely excerpted from Berkshire annual reports – which are worth reading and very accessible (Buffett liked to imagine that his not-financially-sophisticated sister was traveling for a year and he was updating her on the family business). Of particular interest might be how Graham’s disciples have been jiggering his mechanical rules that are far harder to apply in today’s market. If you’ve gotten this far, you have no doubt repeatedly seen my evangelization of index funds, which most people think of as taking on the whole market, but it’s also worth noting that there are passive index funds that capture the cheapest parts of the market, too (though they are best held in a tax-advantaged account).

                    Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend: know anyone who invests in the stock market? How about anyone who appreciates a good biography? Or perhaps anyone young and needing to benefit from compound interest?

                    I read over 100 non-fiction books a year (history, business, self-management) and share a review (and terrible cartoons) every couple weeks with my friends. Really, it’s all about how to be a better American and how America can be better. Look forward to having you on board!