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.

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