Literally Making Money

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

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

Coke

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

 

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

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

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

 

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

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

Greenspan

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

 

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

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

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

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

andrew jackson

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

 

2. Compel the Federal Reserve to follow a simple rule

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

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

Viagra

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

 

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

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

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

Hal 2001

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

 

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

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

Scales

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

 

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

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

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

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

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

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

Isaac Newton

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

 

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

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

Scissors

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

 

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

 

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

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

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

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

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

soccer

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

 

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

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

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

Jail

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

 

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

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

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

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

Walmart

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

 

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

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

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

vienna chicago

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

capitalism and freedom

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

What has gov done to our money

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

denationalisation

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

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

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

    Invisible Hand or Iron Fist

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

    A review of Vienna & Chicago by Mark Skousen.

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

    Acme Time Machine

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

     

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

    Home

    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.

    smeagol

    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.

    Collectibles

    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.

    gator

    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).

    barbell

    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.

    sun

    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. 

      Axe

      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).

      commencment

      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.

      Mondale

      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?

      Pengo

      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.

      Scrooge

      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.”

      Rocket

      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!

        Warren Piece

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

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

        Read the first part here: My Warren Report.

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

        Sale

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

         

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

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

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

        Troubadour

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

         

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

        Wilson

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

         

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

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

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

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

        Flight attendant

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

         

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

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


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

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

        Football

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

         

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

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

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

        Coke

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

         

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

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

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

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

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

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

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

        Knight2

        Figure 7. For Solomon Brothers, twas but a scratch

         

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

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

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

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

        Caveman

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

         

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

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

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

        Porche

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

         

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

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

        Snowball

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

        Damn Right

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

        The Outsiders

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

        Value investing

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

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

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

          My Warren Report

          The Gist: The origin story of an investing superhero.

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

          Access the second part here: Warren Piece.

           

          A few years ago, a close friend invited me to a weekend enjoying the finest that his home state of Nebraska had to offer: steak, a unicameral legislature, and the Berkshire Hathaway annual shareholder meeting.  We ate well, ran into the Governor while he was out walking his dog, and mostly had a great time shooting guns and talking by the evening fire at the farm.

          Carhenge

          Figure 1. Sadly, we missed Carhenge, a Nebraskan’s reconstruction of Stonehenge using cars.

           

          But the weekend opened with a visit to the Woodstock of capitalism. By the time we arrived at the basketball arena where it was held – before 6 AM, more than an hour before doors were to open – the line circled the million-square-foot building several times and appeared to include the entire population of Nebraska (and perhaps a couple neighboring states). Once finally inside, you could partake in the Berkshire conglomerate’s diverse products: Dairy Queen Blizzards, cowboy boots, auto insurance, private jet gift cards, and much more. Yet the real treat was being able to ask any question you’d like of Warren Buffett, one of the greatest investors of all time. In this email, we’ll explore the origin story of this investing superhero.

          Make money

          Figure 2. The vibe was a bit different than 1969. Less hippies, more yuppies. Less heroin, more ritalin. Less free love, more free markets. 

           

          Warren was born in Omaha in 1930 and his earliest “hobbies and interests revolved around numbers.” He saw their magic everywhere, even becoming skeptical of religion when he calculated in church that hymn composers did not live longer than average. Wall Street Journal reporter and biographer Roger Lowenstein relates that the jump from math to money was early: “When Warren was six, the Buffetts took a rare vacation to Lake Okoboji, in northern Iowa, where they rented a cabin. Warren managed to buy a six-pack of Cokes for twenty-five cents; then he waddled around the lake selling the sodas at five cents each, for a nickel profit.” By age 7, Warren begged Santa to give him the nearly 500 page then-definitive book on bonds. At age 10, his father Howard offered to take him on a trip to the east coast (something he did with each of his kids) and Warren naturally wanted to see the New York Stock Exchange. At 11, Warren was confident enough to buy his first stock – and got his sister in on the deal. She tormented him as the stock price dropped and, when it recovered, he sold at $40 for a small profit. The price then zoomed to over $200 and he vowed never again to be so oriented toward the short term. 

          There was one idea in particular that gripped Warren’s young mind: compound interest. He understood and appreciated early on what Albert Einstein called the most powerful idea in the universe: every nickel he saved might, with enough time, benefit from growth and growth on that growth, and end up being worth much more in the future. Warren would imagine his future riches and ask, “Do I really want to spend $300,000 for this haircut?” With that in mind, Warren soon announced he would be a millionaire by 35 – the equivalent of a kid today saying he’d be worth $18 million.

          Scissorsz

          Figure 3. Presumably back then each strand of hair was individually cut with bejeweled gold scissors by specially imported barbers who required luxury accommodations and all-expenses-paid during the multiple day process. No wonder kids wound up growing their hair out!

           

          Warren’s hero was his father Howard, whose portrait would hang prominently in his office. Howard’s principal passion was politics and he had wanted to become a journalist but his father Ernest, having paid his college tuition, insisted that he get a more commercial job. So Howard joined a bank – which turned out to be not to be as stable as imagined once the Great Depression took hold. When the bank failed, Howard asked for a job at his father’s grocery store. Ernest replied he already was employing one son and couldn’t hire another – but he’d let Howard run a tab at the store so his family could eat. Howard then made the extraordinarily bold move to start his own stock brokerage at a time when no one wanted to buy stocks. Despite the headwinds, the business quickly turned a profit and served as an early hangout for young Warren, who often fled the house to escape the wrath of his mother, who had significant mental health issues.

          Fishing pole

          Figure 4. The Buffett clan was known for their God-fearing debt-fearing pinch-every-penny austerity. After a long day’s work, Ernest would dictate to Warren a memoir – “How to Run a Grocery Store and a Few Things I Learned About Fishing, feeling these were “the only two subjects about which mankind had any valid concern.” Buffett reported that “I’d write it on the back of old ledger sheets because we never wasted anything at Buffett and Son.”  

           

          In 1942, Howard volunteered to be the sacrificial Republican nominee for Congress and, to the surprise of everyone, including the candidate, won. Richard Nixon would soon be the Buffetts’ neighbor but Howard was the Ron Paul of his day and “considered only one issue in voting on a measure: ‘Will this add to, or subtract from, human liberty?’” Concluding that most proposals were subtractions, Howard voted for very little, instead hopelessly crusading for a return to the gold standard and a more humble foreign policy. Above all, Howard was known, in politics and out, as a man of unflinching ethics, refusing “a raise because the people who elected him had voted him in at a lower salary.” He always carried a piece of paper inscribed “I am God’s child. I am in His Hands. As for my body—it was never meant to be permanent. As for my soul—it is immortal. Why, then, should I be afraid of anything?”

          Warren initially did not like Washington but soon made the most of it by insisting that his father get him every book – literally, the number ended up being in the hundreds – the Library of Congress had on horse handicapping. While Warren made some money at the tracks, he made far more with a paper route, eventually delivering “almost 600,000” papers. Not content with merely delivering the Washington Post, “he asked all his customers for their old magazines as scrap paper for the war effort.” Warren then checked the magazines for their subscription expiration dates, established a card system for tracking all his customers, and sold them renewals for commission. From these efforts, Warren was making more money per year than any of his teachers and, bored at school, taunted them by shorting the AT&T stock they had their retirement savings in. Despite his smarts, Warren’s grades were mediocre – until Howard told him he’d have to give up his profitable paper route and instantly the marks improved. Yet Warren was still entrepreneurially restless, redirecting his paper profits into operating pinball machines in local barbershops, renting out a 40 acre tenant farm back in Nebraska, and experimenting with whatever money-making scheme he could conjure. By 16, he wondered why the heck he would want to go to college when he was making so much money.

          Spite

          Figure 5. A deeply under-studied strategy is investing for spite. Thumb your nose / stick out your tongue / see how it goes / in the long run!

           

          Howard insisted, so Warren went off to Wharton, where he was, again, completely bored. “His professors had fancy theories but were ignorant of the practical details of making a profit that Warren craved.” About the only notable aspect of his time there was his arrangement “with the Philadelphia Zoo to ride an elephant” down a main avenue to celebrate the expected victory of Republican Thomas Dewey in the 1948 presidential election. Dewey, of course, did not beat Harry Truman, and the carnival stunt had to be canceled. More close to home, his father Howard lost his congressional seat, probably due to his rare vote for successful legislation – Taft-Hartley – which, among other related labor reforms, forbade unions from compelling employers to only hire their members. Though Howard would briefly return to Congress, he was part of the Robert Taft wing of the Republican Party and Dwight Eisenhower’s Nebraska allies oversaw the end of his career. Howard would spend the remainder of his life back at the stock brokerage, worried about the country’s bad choices.

          Elephant

          Figure 6. Modern zoos are really missing out on the profits involved in renting out their animals to college students.

           

          Warren thus transferred home to the University of Nebraska and graduated at 19 to get it over with. Warren considered an alternative education far more practical than college: Dale Carnegie. Till now, Warren had always been an argumentative contrarian but 

          “He decided to do a statistical analysis of what happened if he did follow Dale Carnegie’s rules, and what happened if he didn’t. He tried giving attention and appreciation, and he tried doing nothing or being disagreeable. People around him did not know he was performing experiments on them in the silence of his own head, but he watched how they responded. He kept track of his results. Filled with a rising joy, he saw what the numbers proved: The rules worked. Now he had a system. He had a set of rules [for winning people over]”

          More significant to his future, Warren would soon get the practical financial education he craved. Still running his various side rackets, Buffett confidently applied to Harvard Business School – and got rejected. Reconsidering his options, Buffett successfully applied to Columbia Business School, where he could study with the Wall Street legend of that era now known as the father of value investing: Ben Graham. Graham would become his personal mentor and give Buffett the intellectual foundation for his future success. 

          Born in 1894 to a comfortable life, Ben Graham’s introduction to the stock market had been unpleasant: his widowed mother had over-borrowed to play the market and been wiped out in the Panic of 1907. His family was saved, in his own words, “from misery, though not from humiliation” by the generosity of relatives. Undeterred by his childhood experience, Graham went to Wall Street and started making a name for himself – then lost 70% when he assumed Black Tuesday 1929 was the bottom and borrowed to buy in. Still undaunted, with everyone else scared of stocks, Graham saw bargains. Over the rest of his career, he assembled one of the best long-term Wall Street records ever, beating the market average by about 2.5%. Buffett biographer Alice Schroeder advises “That percent might sound trifling, but compounded for two decades, it meant that an investor in Graham-Newman wound up with almost sixty-five percent more in his pocket than someone who earned the market’s average result.” Incredibly, Lowenstein reports that “the figure, though, does not include what was easily its best investment, its GEICO shares, which were distributed to Graham-Newman’s stockholders. Investors who kept their GEICO through 1956 did twice as well as the S&P 500.”

          Graham made no secret of his approach and in fact considered investing just another intellectual exercise along with the study of classics, the suggestion of novel inventions, and the seduction of women. He claimed that he wanted to do something foolish, something creative, and something generous every single day. Graham endlessly annoyed his business partner by sharing in real time his insights about stocks with his Columbia business school class. His still-popular book, the Intelligent Investor, inspired Buffett to apply to the school in the first place

          At the core of Graham’s philosophy is the attempt to buy a dollar for fifty cents. Graham advised that all companies have an intrinsic value derived from their actual business operations but detached from the price that people are willing to pay for them at any given time. Graham intoned that “you are neither right nor wrong because the crowd disagrees with you” and that “in the short run, the market is a voting machine. In the long run, it’s a weighing machine.” At the most basic level, a value investor would look for companies trading at a small multiple (say, 1.5x) of or even less than their book value – that is, the value of the company if all of its assets were liquidated. Graham initially got famous in the 1920s by buying lots of shares in an oil pipeline company who he realized owned bonds of 50% greater value than the company was selling for on the stock market – and then putting himself on the board and distributing an enormously profitable dividend. Buffett quips: “Price is what you pay, value is what you get.”

          Graham conjured the analogy of an obliging but manic Mr. Market who is always prepared to buy or sell stocks, often at nonsensical prices. Jason Zweig summarizes: “The intelligent investor is a realist who sells to optimists and buys from pessimists.” “The secret of getting rich on Wall Street,” Buffett told a class of his own, is “try to be greedy when others are fearful and… very fearful when others are greedy.”

          Capitol

          Figure 7. Unfortunately, while we can often profit from Mr. Market, we can often suffer from Dr. Democracy, who is subject to similar nonsensical swings unless slowed down. 

           

          Because you can’t anticipate when Mr. Market will be manic or depressive, Graham says “selling short a too popular and therefore overvalued issue is apt to be a test not only of one’s courage and stamina but also of the depth of one’s pocketbook.” The market can remain irrational for longer than you have capital. The opposite side of the equation is preferable, but “buying a neglected and therefore undervalued issue for profit generally proves a protracted and patience-trying experience.” Graham’s advice to derisk was to buy so cheaply so as to create a “margin of safety.” As Buffett would later say in one of his famous shareholder letters, “This is the cornerstone of our investment philosophy: Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.” For Graham, to do otherwise would be a game of chance – or speculation that some greater fool would pay more than you. “An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” And, if the stock market is too expensive, trading at large multiples of an average of the past few years’ earnings, Graham advised to buy bonds instead (indeed, Graham instructed never to own less than 25% bonds nor less than 25% stocks, adjusting the exact split in contrarian spirit to buy low and sell high)

          Fight club

          Figure 8. Buffett would also say that the first rule of investing is don’t lose money. The second rule is to remember the first rule. But the truth is that the first rule of value investing is that you don’t talk about value investing. Don’t let other people in on your bargains. The second rule is the same. The third rule is that someone yells “STOP!” when the market is too high and buying is over. The fourth and fifth rule have to do with concentrating your investments. The sixth rule: No shirts, no shoes. The seventh rule is that investments will go on as long as they have to – be patient for that return. And the eighth and final rule: if this is your first time value investing, you have to buy something cheap.

           

          When Buffett met Graham, Schroeder records that “the rest of the class became the audience to a duet.” Lowenstein relates what happened after graduation: “Having racked up the only A+ that Graham had awarded in twenty-two years at Columbia, Buffett made what seemed an irresistible offer: to work for Graham-Newman for free.” But Graham turned him down – the Wall Street firms did not hire Jews, so he only hired Jews. Deflated, Buffett returned to his father’s company to be a stockbroker, unhappily a salesman rather than an investor. But Buffett kept in contact with Graham and, after a couple of years, Graham relented and invited Buffett back to New York.

          In that era, market information was relatively scarce – there were no quick Google searches to discover endless reams of data about stocks. So instead Buffett was put to work endlessly reading annual reports and financial information to discover bargains in the depths of the market. Graham’s methods were remarkably mechanical. He was almost myopically focused on a company’s balance sheet and almost indifferent to what a company actually did for its money – if anything, knowing more might constitute a distraction from the opportunity. When Buffett or another would present a stock, “Graham would decide on the spot whether to buy it. It wasn’t a matter of persuading Graham. A stock either met his criteria or it didn’t. He did it by the numbers… when anyone tried to talk to Graham about a company’s products, ‘Ben would look out the window and get bored.’” Buffett soaked up everything he could but, within a couple of years, Graham decided to quit while he was ahead and returned capital to investors.

          Buffett was not going to return to stock salesmanship so, despite cautions from his father and Graham that the stock market was overpriced, he opened up his own investment partnership. It had two unusual aspects. First, he based himself in Omaha at a time when “no serious American money man worked anywhere but New York City.” Second, Buffett offered not the friendliest terms: he would give investors an annual summary of results but not tell them anything they were actually invested in and he’d only allow them to take out money once a year on December 31. Otherwise, investors would receive 100% of profits up to 4% and 75% of any profits that Buffett generated thereafter. Around Omaha, the initial whisper was that he was a sophisticated conman. And, to be fair, this is the kind of thing that lured investors to crooks like Bernie Madoff. 

          But Buffett wanted to spend more time analyzing stocks than having to explain and defend to his average investor why he had money in unwanted, problematic, or broken companies that were therefore cheap to buy shares in. As incredible as it may seem, by then, “Buffett was familiar with virtually every stock and bond in existence. Line for line, he had soaked up the financial pages and the Moody’s books; day after day, he had built up a mental portrait of Wall Street.” He later advised that the secret to success was to read “Read 500 pages every day. That’s how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.” It wasn’t easy but “intensity is the price of excellence.” That intensity, Schroeder says,

          made him burrow into libraries and basements for records nobody else troubled to get. He sat up nights studying hundreds of thousands of numbers that would glaze anyone else’s eyes. He read every word of several newspapers each morning and sucked down the Wall Street Journal like his morning Pepsi, then Coke. He dropped in on companies, spending hours talking about barrels… or auto insurance… He read magazines like the Progressive Grocer to learn how to stock a meat department. He stuffed the backseat of his car with Moody’s Manuals and ledgers on his honeymoon. He spent months reading old newspapers dating back a century to learn the cycles of business, the history of Wall Street, the history of capitalism, the history of the modern corporation. He followed the world of politics intensely and recognized how it affected business. He analyzed economic statistics until he had a deep understanding of what they signified. Since childhood, he had read every biography he could find of people he admired, looking for the lessons he could learn from their lives… He ruled out paying attention to almost anything but business—art, literature, science, travel, architecture—so that he could focus on his passion. He defined a circle of competence to avoid making mistakes… He never stopped thinking about business: what made a good business, what made a bad business, how they competed, what made customers loyal to one versus another. He had an unusual way of turning problems around in his head, which gave him insights nobody else had… In hard times or easy, he never stopped thinking about ways to make money. And all of this energy and intensity became the motor that powered his innate intelligence, temperament, and skills.

          Some friends, family, and acquaintances – around Nebraska or associated with Graham – saw something in that intensity and invested. If you had been crazy and lucky enough to invest $10,000 at the beginning and had stubbornly stuck with him, you’d have over $500 million today (versus over $5 million if you had gotten the market return). But even by the sixties, Omaha now whispered that Warren Buffett could make you rich. Per Buffett’s childhood vow, by 35, he was a millionaire – worth over $50 million in today’s money. 

          Buffett was doing it by applying Graham’s principles about intrinsic value – but also learning new things along the way. As a new generation started trading on the stock market, fears of another crash disappeared and the market began to get frothy – especially about new technology. With tech trading at crazy multiples, Buffett pledged to his partners that “We will not go into businesses where technology which is way over my head is crucial to the investment decision.” (And while you hopefully can see that this was prudent, you also should know that he declined the opportunity to invest in Intel when given a special opportunity to do so at the beginning). At the same time, with an ever-increasing amount of capital to put to work, it was harder to find bargains that Buffett could take advantage of without moving the entire price – so he contemplated buying entire companies. But as Buffett got more involved in the operations of the companies he bought into, he understood better why they were so cheap: they really did have significant problems. And yet he’d be hesitant to get rid of a company that still generated a return – even if it was measly – because he resisted confrontation and enjoyed the collection.

          Mcdonalds

          Figure 9. Turns out the incredible savings of eating every meal at McDonald’s are overwhelmed by later medical expenses.

           

          But Buffett thought that if he could get management right that the value would pay off. Knowing relatively little about the underlying businesses, even after much research, he tried to find the right kind of obsessive. He loved to tell the story of when he bought a grocery store chain and convinced the owner, Ben Rosner, to stay on to manage the asset. Rosner was so consumed with his business that, when he went to a black tie event at the Waldorf Astoria and ran into a rival, he started asking him all about what prices he paid for different goods and discovered that he was paying a lot cheaper price for toilet paper. Rather than gloat, Rosner thought something was wrong and immediately left in his tuxedo, drove out to one of his warehouses, tore open a box and individually counted the sheets of toilet paper, discovering that his vendor had screwed him over, providing less sheets than promised.

          Following the Graham playbook, Buffett would eventually acquire a controlling stake in a Massachusetts textile manufacturer called Berkshire Hathaway, whose stock was selling at a 2.5x discount to its liquidation value – presumably plenty of margin of safety. But Berkshire was in an extremely tough industry that would eventually leave the United States but by then had already basically left the northeast and fled south. Partially because of uncooperative management who was idealistic about making textiles and not money, Buffett got mad enough to buy them out. Putting in his own team, he explained “the basic theory of return on investment. He didn’t particularly care how much yarn [Berkshire] produced, or even how much [it] sold. Nor was Buffett interested in the total profit as an isolated number. What counted was the profit as a percentage of the capital invested.” This was wise direction, but there was too much headwind in the industry. He would ultimately reflect: “I would have been better off if I’d never heard of Berkshire Hathaway.” 

          And yet Berkshire would be his destiny: in 1970, after years of warning investors that he could not sustain his track record amidst the Go-Go years of an overheated market, he closed his partnership and offered to return all capital. With the market so crazy, Buffett said he would invest his own money in municipal bonds – and Berkshire Hathaway. For some lucky investors, knowing that Buffett would be in control was enough to roll over their investment into Berkshire. When the market came down again, Buffett told people now was the time to get rich and he would use Berkshire to propel his further investments. But he also partnered with the man who would redefine his investment style, building on and adjusting from Graham: Charlie Munger. 

          More on that partnership and the rest of Buffett’s career in our next correspondence.

          Snowball

          Figure 10. Click here to acquire Alice Schroeder’s the Snowball (9/10), titled to evoke the wintry sphere growing in size as it rolls down a mountain – just like what compound interest does to your money. A former insurance analyst, she spent over 5 years working on this book, interviewing hundreds of people who knew Buffett. More or less authorized, Buffett told her “Whenever my version is different from somebody else’s, Alice, use the less flattering version.” Unfortunately for their relationship, she apparently used a few too many versions different from Warren’s memory – but it still comes across as a tribute to the man. Published in 2008. 

          Buffett

          Figure 11. Click here to acquire Roger Lowenstein’s Warren Buffett: the Making of an American Capitalist (8/10). A Wall Street Journal reporter and Berkshire investor, he spent three years working on this biography, published in 1995. Some of his descriptions of politics seemed off and he is very dismissive of academic commentary on Buffett’s investing history, but it’s a good book!

          Intelligent investor

          Figure 12. Click here to acquire Ben Graham’s The Intelligent Investor (8/10) – appropriately, Buffett’s purchase of the book had an outstanding rate of return. This version has commentary from Wall Street Journal columnist Jason Zweig after every chapter offering additional context through the early 21st century. Graham distinguished between an entrepreneurial investor – like Buffett – who would have to put in a ton of work to find bargains and a defensive investor who was just trying to get the market return. While there is timeless wisdom here, Graham found it harder and harder to apply his mechanical rules even in his day and it’s only become harder. Toward the end of his life, he recommended the average investor defensively invest in index funds, then a new-fangled instrument of John Bogle’s, now a standard offering.

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

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

            A Very Different Idea for Ending Spending

            The Gist: Turn bondholders into loan sharks.

            A partial review of 10% Less Democracy by Garett Jones.

             

            How do you get the government to be responsible with your money?

            The conventional answer is a constitutional amendment that requires a balanced budget, forcing politicians to spend no more than they collect in taxes in any given year. As early as 1798, Thomas Jefferson wanted to constitutionally prohibit debt – but soon thereafter discovered its merits when Louisiana went on sale. As recently as 1995, the Senate came just one vote short (a Republican vote, no less) of sending a balanced budget amendment to the states for ratification. 

            Presumably the states would have ratified: 49 claim to have a balanced budget amendment, though they vary in strength. Some amendments are more suggestive than mandatory and quite a few permit “casual” deficits which is a perfect term for our present attitude toward debt. A surprising number permit debt for such necessities as repelling invasion which, based on some states’ balance sheets, appears to be a regular occurrence. Colorado and Oregon have features that not only discourage debt but also surpluses: excess collections are redistributed back to taxpayers. But Alabama should inspire the nation: one provision of its constitution calls for the imprisonment and personal fining of officials who spend more than is available.

            Stadium

            Figure 1. Texas probably just needs a little nudge to make unbalanced budgets a capital offense. But if we really want fiscal responsibility, that’s not enough: balanced budgets could be an annual precondition of state universities’ participation in football.

             

            While few officials actually want to run a deficit, fewer still are willing to give up something they like to reduce it. One man’s waste and inefficiency is another’s vital project for the security and prosperity of the nation – and vice versa. The two end up coming to a perfect compromise at the favor factory: keep both projects, borrow money to buy votes for re-election, worry about the problems later (maybe they’ll even be retired by then!)

            Marshmello

            Figure 2. Forget party sponsorship, fees, and voter signatures. Ballot access should be limited to those who pass the marshmallow test.

             

            Though some states have thus made extravagant expenditures (and profligate pension promises), their debts and obligations are all in United States dollars, the value of which is beyond their control. Who does control the dollar’s value is of course the federal government, which has a significant debt burden of its own. Other nations, finding themselves drowning in debt, might suddenly make the 27 trillion pesos they owe just enough to buy a Big Mac.

            Confederate

            Figure 3. Before you judge, know that, despite experiencing hyperinflation, the Confederate dollar has actually held its value better than the United States dollar since 1865. 

             

            Economist Garrett Jones proposes an intriguing but politically challenging alternative that answers a basic question: in whose incentive is fiscal responsibility?

            His answer is bondholders – that is, owners of government debt that fear not being paid back if states recklessly spend beyond their means into default or if governments inflate away their debt by overprinting money. Though all citizens should worry about their government’s debt, a majority too often can be bribed with immediate goodies. Bondholders are the only ones with a disproportionate and direct financial stake in ensuring that the government is responsible.

            James Bond

            Figure 4. “Bond, James Bond. I take my risks on baccarat, not government debt. I am here to give you a dose of Scottish frugality in between martinis, shaken, not stirred. From now on, your monetary policy will be determined by Goldfinger and you’ll need to submit your budgets to Dr. No. With your risks, I expect much more than 0.07% yield!”

             

            Bondholders presently exercise their substantial power over governments only when they buy their bond. Jones illustrates how:

            If you had lent (to give approximate figures) $100 to the United States in 1972 for ten years, you got back enough money when you were repaid a decade later to buy just $82 worth of goods. Yes, you would have been repaid “one hundred dollars” in 1982 plus interest, but since prices had nearly doubled over the decade, that sum of money bought 18% less than it did in 1972. The bondholders of the 1970s paid for the privilege of lending to the U.S. government, and that experience made investors cautious about lending to the U.S. government ever again… By the late 1970s, after it became clear that U.S. government bondholders might get burned by high inflation, investors insisted on higher yields, higher interest rates, and so they paid lower prices for U.S. government debt. Those low prices were expensive for the government and its taxpayers. The government didn’t have to just repay the money it borrowed; it had to repay investors enough to make up for the fear, the risk, that high inflation could happen again. This pattern continued through the 1980s and 1990s. Even in 1988, six years after inflation had dramatically (and, so far, persistently) fallen, investors were (effectively) paying $100 in 1988 and getting repaid $190 in inflation-adjusted buying power in 1998. The global pool of money that chose to invest in America during the late 1980s and 1990s received a massive return on what turned out to be a safe, fairly low-inflation investment, in large part because the United States had burned its reputation in the high-inflation 1970s. It’s expensive to rebuild a burned reputation.

            Once you’ve bought your bond, however, the government is almost indifferent to you. The most you can do is sell your bond on the secondary market at a discount, which might influence future bond buyers to demand higher yields. And while this pressure has resulted in downward pressure on U.S. inflation, it has had little impact on spending (or the related size of debt taken on). Perhaps this is because at the center of modern finance is a convenient but perhaps fictional foundation that literally insists that U.S. bonds are “riskless” assets when it comes to credit – in fact, all other debt instruments on the globe are compared to it. During times of international crisis, even if it originates in the United States, even if the U.S. government might be responsible, there’s a “flight to quality” as investors abandon risky stocks and alternative debts to buy “safe” U.S. bonds. But with no ending to spending in sight, can the fantasy last?

            What if, Jones proposes, the balance of power was altered? What if bondholders were no longer an impotent mass of individuals and institutions but were instead collectively organized into a group that could actually pressure their government debtors into the right behavior, like a bank might a credit card borrower? What if bondholders were given a veto over government spending?

            carrier

            Figure 5. Expect income tax garnishments, liens on national parks, repo men going after aircraft carriers – and, if that’s not enough, politicians’ kneecaps might be at stake! 

             

            Though Jones does not mention Antonin Scalia, this kind of proposal goes to the heart of what Scalia always thought was the most important part of the United States Constitution. Other countries, such as the Soviet Union, had long lists of guaranteed and wonderful rights but they never got enforced because what actually matters is how power is arranged and divided. James Madison hoped that our government would feature ambition clashing against ambition that would ultimately limit the federal government’s largesse. It hasn’t quite turned out that way – politicians bought off each others’ ambitions with other people’s money but might the answer lie with properly-incented bondholders?

            Jones offers a variety of proposals that range from the toothless to the unconstitutional (at least, until an amendment or an activist judge decides otherwise). The United States could hold “formal annual shareholder-style meetings between elected bondholder representatives and elected government officials” but, of course, the government wouldn’t be required to hold the meeting and we’d see if it resulted in sufficient political pressure. Jones’ most dramatic proposal would add U.S. Senators elected by long-term bondholders, the number to increase “for every 10% in the debt-to-income ratio” that the government enjoyed. Were it debt to GDP, bondholders might have to elect 98% of Senators, though they might be restricted to voting on fiscal issues.

            greed is good

            Figure 6. In the new shareholder meetings of that malfunctioning corporation called the USA, “Prudence is preferred” will be the new “greed is good

             

            Of course, you might be worried about a particular problem associated with empowering bondholders: who owns U.S. debt? The answer might surprise: the U.S. government is actually the largest owner of its own debt – more than a third – another strange aspect of American accounting. For outside pressure to reign and fiscal responsibility to follow, this debt would have to be devoid of voting rights. Instead, we’d want to empower the famously risk-averse, disproportionately curmudgeon individual American investors and institutions that own about a third of our debt. 

            The final less than a third is owned by foreigners. While China has frequently been the biggest individual foreign national owner in recent years, Japan has been as often on top or right behind. And, for context, China owns only about 6x as much debt as tiny Luxembourg and only about 1/20th of total U.S. debt. Jones is not especially concerned about foreign-debt holders improperly exercising their voting rights – even to the degree China wanted to dramatically cut our military spending, Japan may want us to increase it. Jones cites the positive examples of international lenders demanding free market economic reforms – and a bit more fiscal pressure from Switzerland (a top 10 foreign holder of U.S. debt) might be welcome. But, to the degree we have any fear at all, we could limit the power of foreign debtholders – we’d just have to be on guard that the U.S. government didn’t suddenly only sell foreign debt and continue its spendthrift ways.

            Pope

            Figure 7. Just wait for the policy changes when the Vatican starts buying our debt!

             

            Of course, the Founders designed the Senate to be a bastion of states’ rights and Senators failed miserably to protect them. Perhaps bondholders would be terribly represented by their newly empowered representatives – or there may be unpredictable perverse incentives where bondholders demand the US take on debt merely for the sake of creating an income stream for its owners and not for any especially useful national project. Giving bondholders genuine power would probably require a constitutional amendment and if a fairly popular balanced budget amendment can’t get passed, then the exotic empowerment of bondholders might face much more trouble. Within our present system, we might give bondholders more power over the constitutionally ambiguous Federal Reserve but, as we’ve seen, the bond market has already successfully put downward pressure on inflation with no visible success on spending. Perhaps there might be additional, positive pressure – debt might be limited only to inflation-protected securities so that bond-holders would be focused entirely on credit risk – but bondholders might also go too far, not content to contain inflation, they may push personally profitable but nationally questionable deflation. 

            Relatedly, neither empowering bondholders nor a balanced budget amendment necessarily decreases government spending – either move might instead increase taxes (to pay the bondholders and/or balance the budget’s heavy spending). To the degree you think that’s a problem (as I do), it’s worth considering how to increase the number of people or points at which spending could be cut, such as giving the President a direct line-item veto. Or, for that matter, a bondholder-elected National Comptroller whose only power is to veto spending. Back during the 2011 debt ceiling crisis , I worked for the U.S. Senate Steering Committee, which tried to push something called Cut, Cap, and Balance – cut the budget now, cap it forever at a percentage of GDP, and balance the budget henceforth. It’s a fine idea, but the devil’s in the details – legislators were demanding exemptions, GDP and projections can be fiddled around with by bureaucrats. In the meanwhile, the President ought to reassert his impoundment power and we all ought to give serious thought to how properly aligned incentives and clashing ambitions might result in a responsible government.

            10% less democracy

            Figure 8. Despite the focus of this email, empowering bondholders is actually just one chapter of the reviewed book: 10% Less Democracy by Garett Jones. I am not confident all of his proposals would lead to desirable results – in some, I am confident of the opposite – but they are at least interesting to think about. His fundamental point is that in rich democracies around the globe, some insulation from total democracy (a republic, perhaps?) might result in better economic policies leading citizens to enjoy a multiple of their current income. Jones quips that Singapore – ruled by a single free-market-oriented political party for decades – has thrived with 50% less democracy. Among his suggestions:

            1. Enact longer terms to get braver politicians – but what if “bravery” means banning fossil fuels, seizing the means of production, packing the Supreme Court, etc?
            2. Elect fewer officeholders, i.e. why elect a dog-catcher or coroner? But, to the degree those are irrelevant, it may not change much. The real question is whether fiscal authorities should be elected and, if not, how should they come to power.
            3. Especially, don’t elect judges. He claims that, around the world, this is correlated with freer economic systems but my experience in the United States is that the type of system he recommends results in lawyers’ guilds choosing judges who aren’t faithful textualists.
            4. Maintain or strengthen central bank independence. He again finds that central bank independence is correlated with low inflation and strong economic growth and insists that this is due to isolating conservative technocrats from whimsical politicians who want to juice the currency ahead of an election. But what if the independent central banker discovers magical monetary theory?
            5. Tighten voter eligibility. He argues that voters who have more education are more likely to support free markets and directly challenges William Buckley’s quip that he’d rather be ruled by the first 2,000 names in the Boston telephone directory than the faculty of Harvard. Jones has a variety of proposals: increase the voting age to 40, disenfranchise criminals, weight people’s votes based on their education and military service. He cites the incredible example of Ireland, which reserves 10% of the seats in its senate to be elected by alumni of its top universities, which sounds like a pretty bad idea in the U.S. 
            6. Embrace national (or supranational) regulators whose goal is to reduce local regulations, a la the Great Reversal.
            7. Vigorously use earmarks: “The practical way to cement a spending cut deal would be to hand out a few dozen well-targeted earmarks to the most pro-spending members of Congress in exchange for a pro-spending-cut vote. (Even if the earmarks add up, they won’t add up to much; at their peak, earmarks were no more than 1% of total U.S. federal spending)”

            For more and more detail, check out the book!

            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 passionate about restraining government or its debt? How about any holders of U.S. bonds? Or perhaps lawyers ready to restructure our government?

            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 Many Want Your Job

              The Gist: Who benefits – and who suffers – from immigration to the U.S.

              A review of We Wanted Workers by George Borjas.

              Cui bono? Who benefits? This useful Latin question was the ancient Roman equivalent of “Follow the money!”

              George Borjas asks the question about immigration to the United States. Himself an immigrant, Borjas now researches and teaches immigration economics at Harvard. In We Wanted Workers, Borjas reveals who benefits – and who suffers – from immigration to the United States.

              Imagine that you are hiring. It doesn’t really matter what for – maid or mathematician, farmhand or pharmacist. Now consider two scenarios: in the first, you have 2 similarly-qualified candidates apply; in the second, you have 25 similarly-qualified candidates apply. Which scenario would you prefer? In which scenario would you be more likely to end up paying your hire less?

              Rose

              Figure 1. Like, what if the Bachelor could choose between only two romantic interests? How could he possibly find true love for the few months after his season ends?  

               

              Generally, the more competition the better for the consumer – in this case, you, the person hiring. If you have lots and lots of people who want to work for you and they’re all similarly-qualified, you enjoy a buyer’s market, can freely choose whom you like, and can more or less dictate salary. You naturally benefit by not spending as much – and you can divert that extra money to alternative uses that benefit others, whether it’s hiring another person you might not have, passing along your savings to your own consumers, buying something, investing, or even just putting it in a bank to be lent out. You may also be able to increase your productivity by spending more of your time on what you do best and (cheaply) delegating the rest.

              But, if the roles are reversed, and you are one of the candidates for the job, you may suffer as the employer benefits. Every additional similarly-qualified applicant for the job you want makes you both less likely to be hired in the first place and more likely to command a lower salary if you are. “The most credible evidence—based solely on the data—suggests that a 10 percent increase in the size of a skill group probably reduces the wage of that group by at least 3 percent.” If the place where you live has lots of candidates for every job, then you still might enjoy the benefits of lower prices or cheaper loans – but neither of those benefits will matter if you can’t secure an income. 

              There is the basic economic dilemma of immigration: employers benefit from cheaper and more plentiful labor, consumers benefit from lower prices, immigrants benefit from higher wages than from where they came, but similarly-qualified natives suffer from lower wages and fewer opportunities to be employed. To the degree that economists acknowledge that it’s a trade-off at all, most believe immigration is net-positive, growing the economy and making it more efficient. These economists argue that the immigrants make a country richer by saving natives money and allowing natives to become more productive with their time, by being additional consumers for goods and services often provided by natives, and by being additional sources of innovation, including starting businesses that hire natives.

              Beach

              Figure 2. Things get more complicated for natives if employers redirect their savings from hiring immigrants toward taking foreign tropical vacations clad in swimsuits made in China.

               

              Borjas concedes benefits of immigration but invites us to take a closer look at three aspects: 

               

              1. What we’ve already seen: the economic benefits of immigration fall unevenly on the population, with natives of similar skills suffering the most.
              2. The missing part of the equation: What we save in labor costs we may lose in an increased tax burden to pay for a larger welfare state supporting both natives and immigrants.
              3. What’s not in the formula at all: Immigrants are more than robots we program to do a job – they impact our culture in meaningful ways.

               

              Let’s explore those in detail.

              Borjas argues that “immigrant participation in the workforce redistributes wealth from those who compete with immigrants to those who use immigrants.” During the 2016 presidential campaign, Ted Cruz ran a clever television ad that featured men and women in business attire running across the border as the candidate bellowed that if lawyers and bankers and journalists were immigrating in mass to the United States, there would be instant political momentum for change. The reality instead is that America’s lowest-skilled natives suffer in political obscurity. Borjas relates a story of a federal immigration raid of a chicken-processing plant that resulted in 75% of its workforce disappearing. To survive, the company raised wages by a dollar an hour and wound up aggressively recruiting local US citizens – the biggest beneficiaries were low-skilled African Americans. Borjas concludes: “It is not that immigrants do jobs that natives don’t want to do. It is instead that immigrants do jobs that natives don’t want to do at the going wage.”

              George Shaw

              Figure 3. There’s an old story that I first heard referencing George Bernard Shaw. Seated next to a beautiful young woman, he asked if she would sleep with him for $1,000,000. She giggled and said she would. He then asked if she would do it for $5. “Why, what kind of woman do you think I am?” she indignantly replied. “We’ve already established that,” Shaw observed. “Now we’re just haggling over price.”

               

              The broader problem with low-skilled immigration is that it increases your tax burden: low-skilled American citizens face fewer and worse economic opportunities and the government responds with welfare programs that sustain joblessness. Yet it doesn’t end there: the government also subsidizes low-skilled immigrant households. With our debt, why should Americans continuously mass import a fiscal burden? It wasn’t always so. Borjas relates that, among the flinty Puritans, “as early as 1645, the Massachusetts Bay Colony began to prohibit the entry of paupers. In 1691, the Province of New York required a new entrant to ‘give sufficient surety that he shall not be a burden.’” In the 19th century, as the United States began experiencing new waves of immigration, the government legally prohibited immigrants who might become a public charge – and deported those who wound up receiving government benefits within a few years of their arrival. And this was a time when government benefits were rather few!

              John smith

              Figure 4. Virginia explorer, admiral, governor, mustache model John Smith decreed that “he that will not work shall not eat (except by sickness he be disabled). For the labors of thirty or forty honest and industrious men shall not be consumed to maintain a hundred and fifty idle loiterers.”

               

              Today we should know the high cost of good intentions: in the 1960s we simultaneously opened the doors to mass immigration and dramatically extended the infrastructure of entitlements. But as Milton Friedman insisted, “it is one thing to have free immigration to jobs. It’s another thing to have free immigration to welfare.” Without welfare, if there are no jobs, immigrants leave – to Friedman, this was a functioning free labor market that benefits everyone. Instead, Borjas’ research concludes: “Despite the many restrictions on welfare use by immigrants, the evidence indicates that immigrant households are far more likely to receive [government] assistance than are native households.” This becomes all the more clear when we consider a special feature of America: non-citizens’ children born in the United States are automatically citizens – and therefore entitled to all the benefits and harms of the welfare state. Borjas finds that “46 percent of immigrant households received some type of public assistance.” Again, with our debt, why should Americans continuously mass import a fiscal burden?

              Accountant

              Figure 5. Imagine your accountant – appropriately donning a green eye-shade – promises to save you money on most goods and services you consume. Sounds great! The only catch is you have to cosign all of his loans. Don’t worry! He has half your credit score but, with your help, he’s hopeful about bringing it up. 

               

              After extensive analysis, Borjas concludes that immigration has increased American GDP by a couple trillion dollars – but that “immigrants themselves get paid about 98% of this increase” and that, when you factor in government subsidies of immigrant households, immigration may be a “net economic wash.” And yet that’s not a necessary vice of immigration, only of our particular policies:

              “If the typical immigrant was a high-skill person, outperforming others in the labor market, that immigrant would surely be defraying the cost of welfare programs [by contributing more than she took]. But if the typical immigrant was a low-skill person, performing worse than other workers, that immigrant would likely receive a net subsidy. Put bluntly, low-skill immigration is likely to be a drain on native taxpayers, while high-skill immigration is likely to be a boon.” 

              Unfortunately for the American taxpayer, the typical immigrant today – and for more than the last three decades – has been low-skilled. In 1960, before our present immigration laws, immigrants to the United States had similar education to natives and earned 11% less than the average native upon entry. By 1990 and continuing through today, immigrants are 3.5x more likely than natives to lack a high school degree or equivalent and earn 28% less than the average native upon entry – a reflection of their lack of skills. Worse, this wave is not the result of thoughtful policy but our inability to control our border. Because we tacitly favor immigrants in walking distance, we get more Mexicans (who tend to be low-skilled and earn on average 50% less than the average native upon entry) and fewer Germans (who tend to be high-skilled and earn 70% more).

              commencment

              Figure 6. Concentrating on national origin can be a blunt instrument for understanding the data: Borjas says Mexico has plenty of college graduates – they just stay home because they earn double what someone without their degree can and wouldn’t make much more in the US of A. Low-skilled Mexicans come to the United States because the trip is relatively easy and they’re rewarded with better pay supplemented by government assistance. Compare this to the people who can’t walk here: “The average person in India has less than six years of schooling, but over 70 percent of Indian immigrants in the United States have a college or graduate degree.” Altogether, “The rule of thumb for immigrant selection is straightforward: the United States attracts high-skill workers from countries with egalitarian income distributions (those countries where high-skill workers do not do so well), and low-skill workers from countries with a lot of income inequality (those countries where low-skill workers do very poorly).”

               

              Borjas advises: “If our goal is indeed to make natives as rich as possible, the accumulated knowledge from economic research tells us exactly how to get there: we should admit only high skilled immigrants.” They are more likely to contribute more than they take and more likely to innovate and start businesses that improve our lives. If making natives rich is too crass and we desire to be humanitarian, why do we privilege our relatively wealthy neighbors (who break our laws) rather than find the globe’s most needy

              And yet, as Pat Buchanan asked, “Is our country nothing more than an economy?” Borjas’ title “We Wanted Workers” references the idea that we simply desire jobs done but don’t think about what else the job-takers bring along with them. How does our country change when 40+ million foreign-born constitute more than 13% of the population – more than triple the proportion of 1970? How do our politics change when there are more foreign-born residents of California than people in Tennessee and Utah combined – and yet everyone gets counted by the census for divvying up power and money? 

              For Borjas, the question is: how do we make it in the interest of immigrants to assimilate and adopt the best American culture has to offer? He cites Samuel Huntington who feared that modern Latin American immigration presents a threefold assimilation challenge: the numbers are high, continuously growing, and concentrated in a few states. Borjas compares this to the early twentieth century, when we also had high levels of immigration – no single national origin dominated and then the government dramatically restricted the total inflow: now Mexicans alone account for over 30% of our immigrants, they tend to cluster in less diverse communities than that previous generation, modern technology enables easy keeping in touch with home, and there is no political consensus on what to do about immigration.

              Whatever the reason, by at least one measure, we’re failing to integrate: Fairly consistently, about 30% of new immigrants speak English fluently. About 42% of those who arrived in the 1970s spoke English fluently by the end of their first decade in the country – a 12% gain. We might hope for more and yet we got less: Among those who arrived in the 1990s, only 33% spoke English fluently after a decade. What’s the point if you can get by without it? 

              Douglas Murray wrote a book about Europe’s far more challenging position of integrating significant Muslim immigration: “The world is coming into Europe at precisely the moment that Europe has lost sight of what it is. And while the movement of millions of people from other cultures into a strong and assertive culture might have worked, the movement of millions of people into a guilty, jaded and dying culture cannot.”  We may have all come from somewhere else somewhere in our family tree, but what we forged was something special: Has America “lost faith in its beliefs, traditions and legitimacy” as well? Will America still be worth coming to if we lose them?

              Borjas ultimately concludes that our path forward must start with controlling our borders and getting intentional about who we let in. “The fact that we have already had a major amnesty [in 1986] and that it did not work is partly the reason why the debate over ‘comprehensive immigration reform’ is so contentious.” He suspects that the only way to do that is “seriously penalizing lawbreaking employers” but is willing to offer a compromise: give employers the ability to rent guest workers and set the price appropriate to their total social cost. Otherwise, we have to decide what we really want out of immigration: who we want to benefit, who we are willing to let suffer. And that’s what makes immigration so hard. But maybe we could start with reforming welfare!

              We wanted workers

              Figure 7. Click to acquire We Wanted Workers by George Borjas (9/10), a nuanced, technocratic take on immigration that digs into the nuts and bolts of data to find winners and losers.

              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 immigration politics or policy? How about any American taxpayers who might want to know where their money is going? Or perhaps any American workers facing competition?

              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!

                Two More Votes

                The Gist: How the awesome Margaret Thatcher lost power.

                The third of a three-part review of Charles Moore’s three volume biography of Margaret Thatcher, ending with Herself Alone.

                Click here to read part one: My Heroine, and here to read part two: Win Big or Go Home.

                 

                Margaret Thatcher was ultimately betrayed by the senior members of the party she had led to three consecutive electoral victories while remaking Britain according to its manifestos. After more than 15 years of her leading the party, 10 years leading the nation, they were restless, ambitious, and soon conspiratorial. Her biographer Charles Moore reveals how the misdeed was done.

                Batman

                Figure 1. You either die a hero or you live long enough to see yourself become a villain

                 

                The opportunity arose because, though Thatcher was popular with the party’s grassroots voters, she had lost touch with the backbenches who formed her voting constituency – in Britain, the Prime Minister is similar to the Speaker of the House, who is elected by legislators, not average citizens. Thatcher had become and remained leader of the Conservative Party by employing skilled politicians who knew how to count, calm, and charm the votes she needed. As time went on and Thatcher went from political success to policy success again and again, she became less attentive to showing love to the backbenches, believing she had so obviously demonstrated why she was worthy. Tragically, Thatcher had lost her warning system to a pair of Irish Republican Army assassinations, first of Airey Neave, who had so brilliantly managed her first campaign, later of Ian Gow, who very capably managed the back bench mood through sustained drinking sessions. She never found another able ambassador or spy.

                 

                In addition to general feelings of being left out, backbenchers were specifically aggravated by a new tax – taxes being the most reliable source of conservative angst. Thatcher had long been frustrated with increasingly leftist local government: her father had been ousted from Grantham’s city council, her very first bill in Parliament had been to open up local council meetings to the press, and her stint as Education Minister was partly undone by local governments. As Prime Minister, Thatcher decided to do something about the source of local government funding: property taxation. Within local government, Moore notes that “those who made the greatest use of local government services – social services, for instance – were the least likely to pay for them.” Thatcher was more pithy: “The people who benefit don’t pay. The people who pay don’t benefit.” With only about 25% of people paying property taxes, 75% of voters were perfectly happy to increase their burden and enjoy the benefits of other people’s money. Besides, she was deeply offended by the notion that property was taxed at all:  “Any property tax is essentially a tax on improving one’s own home,” she lamented.

                Torture

                Figure 2. Extensive testing has demonstrated that conservatives prefer practically any pain to new or increased taxes: the medieval rack, root canals, telemarketing pitches, tangled Christmas lights with that one broken bulb you need to find, wet socks, inconsistent wifi, grandchildren who never call

                 

                All of which, you might expect, would sound pretty reasonable for conservatives to embrace. But local governments still required some source of funding and so Thatcher, striving for the efficiency of what you vote for you pay for, proposed replacing the property tax with something new: a “community charge” paid by everyone, though perhaps not everyone would pay the exact same. This nod to progressive taxation proved hopelessly complicated to implement while the attempt to match revenue to spending meant that the average charge was much higher than expected, such that 90% of households saw their local tax bills rise by around 50%. Leftists rioted while conservatives loudly complained to their increasingly anxious members of Parliament. Disaster was predicted in upcoming local elections and the Conservative Party tried a desperate campaign of declaring “Conservative Councils Cost You Less” (because they spend less). Expected to lose 600 seats, they only lost 172 – which was great versus expectations, but not that good, and the bitterness over the whole affair lingered among the backbenches. 

                And yet if the backbenches had started to feel a lack of love, the front bench of senior leaders had always felt disagreeable, excluded, and badgered. Startlingly, Thatcher never really recruited into her leadership a core of true believers. From the very beginning, of her 24 member leadership team, only 4 had actually voted for her. Thatcher chose her team of rivals to achieve political balance and give her internal critics shared responsibility. Despite not watching any television herself, she cared far more about how well someone presented on the BBC than if they were completely committed to her agenda.

                bob the builder

                Figure 3. Bob the Builder would probably have been the perfect Thatcher Cabinet member. Can we fix it? Yes, we can!

                 

                This arrangement inevitably sparked tension – but for most of her tenure, Thatcher was enormously aided by Willie Whitelaw, a politician far more moderate than she who had been Ted Heath’s preferred successor. Whitelaw could have made no end of trouble for her but instead chose to be her faithful deputy: “Never interested in policy, he knew that his power lay in his capacity to understand what she wanted and what others wanted, and reconciling the two.” When Whitelaw retired, she lost the bridge that her wet, moderate Cabinet members used to justify their presence.

                At the same time, Thatcher was also paranoid that if she cultivated potential heirs, her personal leadership would be more vulnerable – if she was the primary hero of the grassroots, then her rivals would hesitate. Toward the end, the Conservative Party tried to introduce a slogan “The Right Team for Britain’s Future” at a conference to direct attention away from her – but when she appeared, to the dismay of the “right team,” the conference went wild, chanting “Ten More Years!” But the backbenches, not the grassroots, were the key battlefield – and there was always danger that her Cabinet contained some of her most vehement opposition. 

                Because the Cabinet was filled with her internal political opponents, she excluded them from real power.  She privately claimed “I’d be able to run this Government much better if I didn’t have ministers, only permanent secretaries,” i.e. the deep state who was legally obligated to follow her directions. The two most powerful people in her government were her national security advisor Charles Powell and communications director Berard Ingham – both very capable civil servants who would have thrived without comment in the United States, but in the British system elected politicians are constitutionally responsible for running all aspects of government. Being Foreign Secretary is one of the most prestigious jobs in the United Kingdom – but Thatcher tried to neuter the role so she could run her own foreign policy. Worse for her domestic political future, Powell was so dominant that he overloaded her schedule with fascinating foreign intrigues: plotting grand strategy with historians, having heart to hearts with dissidents, reviewing the skullduggery of the intelligence services. Ingham daily briefed her on the moods of the nation and theoretically had a mandate closer to protecting her power – but he was statutorily prohibited from helping her in an internal party squabble. All together, among the people she most trusted, her politicians most in touch with the backbenches had been assassinated, her deputy who had smoothed over riffs with her leadership had retired, and the men through whom she ran her government were not looking out for her survival.

                If genuine disagreements over ideas weren’t sufficient reason to be unhappy, Thatcher had an incredibly harsh management style. She was very considerate of her personal staff – and, as the world’s most powerful woman, still insisted on making breakfast for her husband every morning – but she constantly berated, bullied, and browbeat the big egos who were the most senior elected politicians in her party. For many years this produced the remarkable results we’ve already discussed – but perhaps it worked too well: as “Thatcher had achieved many of her successes by going against the grain of most of her senior ministers, she came to believe in her own invincibility.” Moore concludes: “This was not good for her character. She talked even more; she listened less. She lost some of her ability to catch the political wind and some of the caution which, until the late years, had strongly balanced her crusading zeal. Combat became not so much a useful weapon in her armoury as her default mode.”

                squash

                Figure 4. A popular satire of the time depicted the following scene: “Mrs Thatcher was asked by a waiter serving the Cabinet what meat she wanted. She answered, ‘A raw steak, please.’ Then the waiter asked, ‘And the vegetables?’ Mrs Thatcher replied, ‘Oh, they’ll have the same as me.’”

                 

                Eventually, the slights built up to an unbearable burden, especially for Geoffrey Howe, her longest serving Cabinet minister. Thatcher treated him mercilessly for his temperamental lack of stridency but he had actually been a powerful advocate of her economic policies as Chancellor of the Exchequer. Moved over to the foreign ministry, where he was annoyed to be constantly upstaged by Powell, Howe pursued his greatest passion: the United Kingdom joining the European Community. In this, Howe was supported not only by the British civil service, but by many Conservative backbenchers: somewhat strangely in retrospect, the Conservatives had always had the most pro-European platforms in British politics. Howe romanticized that a united Europe, at peace at last, could be an economic powerhouse freed of the complications of each country’s individual trade barriers and regulations.

                Thatcher was deeply skeptical, fearing that integration would mean not more freedom but more regulation – and, worse, regulation imposed by an organization in which the British voter would only have a minority, perhaps super-minority, say. The perk of wiping out unhelpful European laws had to be balanced against the fear of losing British national sovereignty, especially the loss of determining the right monetary and immigration policies. Thatcher was horrified when Jacques Delors, president of the European Commission, claimed that by 1998, 80% of “economic legislation, and perhaps even our fiscal and social legislation as well, will be of [European] Community origin.”  She conceded that Britain was part of Europe culturally, but that Europe was not defined by its bureaucracy – and indeed, “Had it not been for [the] willingness to fight and die” of British troops “Europe would have been united long before … but not in liberty, not in justice.” Thatcher proclaimed “We have not successfully rolled back the frontiers of the state in Britain only to see them re-imposed at a European level, with a European super-state exercising a new dominance from Brussels.”

                jack daniels

                Figure 5. “Charles Powell recalled that, when, at European summits, she began to tire, he would bring her a surreptitious whisky and soda: ‘sure enough, it revived her spirits wonderfully.’ When Helmut Kohl got wind of this he said to Powell: ‘I wish you would stop doing that, you’re just making her more difficult.’ ‘To be honest, Mr Chancellor,’ Powell replied, ‘that’s the whole point.’”

                 

                Howe thought she was paranoid but also believed the rational way to head off her fears was to fully embrace Europe and lead from the inside. Determined as ever, Howe recruited the other most senior Cabinet minister, Nigel Lawson, his replacement as Chancellor, into a conspiracy. Lawson was actually skeptical of European integration himself but he had begun to lose faith in monetarism and was especially attracted to something called the exchange rate mechanism (ERM). The ERM attempted to stabilize European currencies’ values in relation to each other in order to ease cross-national transactions. For Europeans, this was the first step to union. For Lawson, this was an opportunity to outsource the fight against inflation to the German central bank, which had long had an international reputation for being hypersensitive to it. Together, Howe and Lawson repeatedly attempted to confront Thatcher, ultimately issuing an ultimatum that they would simultaneously resign – a public relations disaster – if she did not join the ERM. Thatcher was appalled: she retained her faith in monetarism and her skepticism about Europe. But faced with the threat, Thatcher sidestepped it: she publicly announced that the UK would join the ERM if the European community met certain preconditions respecting economic freedom and once Britain had sufficiently brought down its own inflation. That stance seemed pretty reasonable to the public and so the pair balked at resigning, prompting Thatcher to lord over them at the next Cabinet meeting: “No resignations yet, I see!”

                EDM

                Figure 6. As you’d expect, the extremely exciting topic of ERM is often confused with the very similar EDM

                 

                And yet, for the first time, the Iron Lady was seen to bend and the wets sensed weakness. Because Thatcher had no domestic policy equivalent of Powell, she did not have as fine a grasp of its technicalities and, amazingly, Lawson managed to use his power to tie the pound to the Deutschmark without publicly announcing nor privately revealing the shift from monetarism. When Lawson quietly resigned, he was replaced by John Major, an expert in-fighter who demonstrated his power by marshalling the building political pressure to compel Thatcher to concede to the ERM without the preconditions she had previously insisted upon. The European bureaucracy celebrated this unconditional victory with Delors projecting that there would soon be a United States of Europe. Thatcher was outraged and gave her renowned reply: “No. No. No.” 

                the more you know

                Figure 7. … the faster you’ll go!

                 

                For Geoffrey Howe, this was the last straw. “For him, ERM entry was the first move towards the destination, whereas Mrs Thatcher hoped it would be the way of preventing the full journey.” Already demoted from his beloved position as Foreign Secretary whose luxurious housing he could no longer use, Howe publicly resigned, giving a damning speech before a Parliament that had just introduced television cameras, increasing its notoriety. “The time has come for others to consider their own response to the tragic conflict of loyalties, with which I myself have wrestled for perhaps too long,” he declared. But the most important aspect of the speech was its timing: Howe delivered his searing critique just before the one time a year that the leader of the Conservative Party is subject to a challenge.

                Within a day, Michael Heseltine, who himself had dramatically resigned from Thatcher’s Cabinet a few years prior and had been agitating against her since, announced his challenge. Thatcher was terribly ill-prepared. Her replacement for her assassinated managers was wholly inadequate: Peter Morrison had at one time been closely in touch with the back benches but had spiraled into alcoholism and was loyal to the point of severe over-optimism. Morrison thoughtlessly announced a campaign leadership team without consulting any of its members, prompting them to be irritated and less than enthusiastic about securing votes. Dividing members into descriptions of “Sound,” “Dodgy,” and “Untouchable,” Morrison was so off-base that he had Howe as “Sound” right up until the latter’s blistering resignation speech. Earlier, Thatcher had inexplicably given the job of chief whip, a position described as the Prime Minister’s Praetorian Guard, to a romantic Europhile close to Geoffrey Howe, inexperienced in whipping votes, and who did not even support her. Her previous whip, upon hearing the news, commented “That’s crazy. That’s the end of Margaret.”

                Thatcher was arrogant. She had won three elections! She was extremely popular with the grassroots! She had decisively beaten a wet stalking horse in a previous challenge! And so she repeated Ted Heath’s mistake that had allowed her to rise in the first place: she did not ask for votes herself. Even more bizarrely, and again a reflection of Powell’s power, Thatcher was out of the country for the election. Her record did count for something: she won the ballot by 204 to 152. But according to the complicated rules, her victory did not constitute a big enough margin to win outright: she needed just two more votes. 

                Now blood was in the water. Thatcher disastrously decided to consult her Cabinet which, though technically her leadership team, probably had the most to gain from her departure: it was full of ambitious, belittled men who had had a hard ceiling on their ambition for 15 years. The most committed ideologue on her campaign team sensed danger and suggested Thatcher see them all at once and force them to commit to her publicly in the face of peer pressure. Instead, Thatcher listened to an old party hand brought into manage the crisis – but who secretly thought it was in the best interest of the party for her to gracefully leave. Thatcher saw her Cabinet one by one. Predictably, almost every one told her to resign.

                And yet while a number of backbenchers were annoyed that she had not cultivated them nor asked for their votes, there were plenty of true believers who were appalled by the unfolding coup. She was the greatest leader the Conservatives had had in a generation – and she had, after all, won the first ballot! They tried to break in to see her but by the time they did, Thatcher had concluded that she could not go on with the majority of her Cabinet opposing her. Thatcher realized she had mismanaged the parliamentary party and decided to concede to try to choose her successor. And yet, because she hadn’t elevated enough true believers, the only viable option was the chameleon John Major. Thatcher would later describe the experience as “treachery – with a smile on its face.” 

                In retrospect, we can easily see Thatcher’s crucial management mistakes – but let’s not forget that she is the longest serving Prime Minister since the 1800s and that her style produced big results. On the issues that she cared most about, Thatcher has been almost entirely vindicated. The biggest exception may be the community charge that had prompted backbench angst – it was quickly repealed – but so was the ERM which Major had staked his political reputation on. “The British economy, no longer fettered by an artificial exchange rate for sterling, recovered quickly. But the economic reputation and political standing of the Major government did not recover.” Major would lose in a landslide to Tony Blair, a politician akin to Bill Clinton who had refashioned the old socialist Labour Party beholden to unions into a suave, moderate coalition embracive of Thatcher’s success with markets. Thatcher would half-complain, half-brag in retirement: “The trouble is that we converted our opponents.” In this, she was wryly commenting on the ongoing conflict in the Conservative Party about her legacy. Upon her death, David Cameron, a moderate successor as Prime Minister, quietly lamented her argumentativeness but kindly conceded that “many of those arguments are no longer arguments at all” – Thatcher had transformed British politics from a consensus of socialist sclerosis to a cross-partisan embrace of market economics. 

                The major remaining argument is the one that finally took her down: Britain’s role in Europe. With Brexit, British voters appear to have expressed their verdict – but we shall see if the United Kingdom follows the path suggested by Thatcher: model itself after its old colony of Singapore and strive always for ordered liberty. Here’s Moore with the last word:

                If there was one uniting force in everything Mrs Thatcher did, it was her love for her country. All great political leaders have this in some form. Often, perhaps always, it is based on a heightened picture of the nation which they lead – a picture, of course, which puts them in the foreground and makes them embodiments of the nations they lead… What Mrs Thatcher loved in her country – its liberty, its lawfulness, its enterprise, its readiness to fight, its civilizing, English-speaking mission – was not always visible in the place she actually governed, nor was her love always requited. But great loves such as hers go beyond reason, which is why they stir others, as leaders must if they are to achieve anything out of the ordinary.

                Thatcher 3

                Figure 8. Click to buy Charles Moore’s three volume biography of Margaret Thatcher: Not for Turning (10/10); Everything She Wants (8/10); and Herself Alone (9/10). The first volume is the best. Once Thatcher becomes Prime Minister, Moore chooses to address her life by topic rather than chronology, which is probably best for understanding can be a bit jumpy. Charles Moore took over two decades and conducted hundreds of interviews to get this final product: altogether, the biography can be forgivably over-comprehensive, is sympathetic but frank, and hopefully leaves you inspired by her example.

                Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend:  Think – do you know any conservatives who might learn from one of the most successful conviction politicians of all time? How about any ambitious women? Or someone who appreciates modern history?

                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!

                  Win Big Or Go Home

                  The Gist: How the awesome Margaret Thatcher wielded power.

                  The second of a three-part review of Charles Moore’s three volume biography of Margaret Thatcher, the middle book being Everything She Wants.

                  Click here to read part one: My Heroine, and here to read part three: Two More Votes.

                   

                  Margaret Thatcher was a winner. She won three elections in a row for the Conservatives – her second victory not only made her “the first leader of any party” in the twentieth century “to serve a full term and then increase her majority” but that increase “was the greatest [for any government] in parliamentary history.” Her third victory marked her as the most winning British politician of the modern era – so much that her preferred memoir title was “Undefeated.” But Thatcher did more than gain and keep power: she used it. The secrets to her success were her convictions, her character, and her courage.

                  DJ Khaled

                  Figure 1. All she did was win. 

                   

                  Charles Moore, the author of a three volume biography we review here, relates that “she carried in her head a picture of her country derived from its past greatness and energetically projected on to its future. It was more restorationist than revolutionary, though the restoration would sometimes require revolutionary methods.” Whether Thatcher was a traditionalist or a radical remains a subject of debate, especially in her own party. “To her, the habits of ancient institutions were not mere outward show. She believed they represented something deep and proud in the history of her country.” Thatcher loved a Latin motto translated as “To stand on the ancient ways, To see which is the right and good way, And in that way to walk.” But at the same time, “She had the radical’s total lack of embarrassment about arguing from first principles. Above all, she had the radical’s permanent angry impatience for change.”

                  That impatience fueled a legendary work ethic, in which she consumed and sharply commented upon reams of paper at all hours. “Mrs Thatcher’s chief method of exerting her will over the machine was not institutional but personal. She used every remark, every memo, every meeting as an opportunity to challenge existing habits, criticize any sign of ignorance, confusion or waste and preach incessantly the main aims of her administration.” The effect was galvanizing: When one of her junior ministers was dashing through the House of Commons, someone cried out “Slow down, slow down! Rome wasn’t built in a day.” “Well,” he replied, “Margaret Thatcher wasn’t the foreman on the job.”

                  Kremlin

                  Figure 2. Thatcher was simply always working: turning down a coveted opportunity for a backstage tour of the Kremlin in favor of studying her briefing books, she complained “Do you think I’ve come here as a tourist?” 

                   

                  Thatcher’s first challenge was beating double-digit inflation – and I will try my best to render monetary policy as straightforward as possible but, if your eyes glaze over, you can skip ahead to fighting unions and Communists (sometimes one and the same). A major reason why the post-war consensus was subject to successful assault was that the Keynesian economists entrusted to run things were thoroughly bewildered by the simultaneous presence of both high unemployment and high inflation: according to Keynes, the two should be balanced against each other, each requiring opposite responses. Thatcher’s prescription was the tough medicine of monetarism, a theory popularized by Milton Friedman and simultaneously being put into place by Paul Volcker in the United States. Monetarism rejected central bank tinkering in response to different economic conditions – Friedman feared there were excessive, destabilizing lags between a problem like unemployment arising; central bankers discovering and interpreting the problem through statistic collection; and central bankers finally conjuring and applying unpredictable, bespoke, and heavy-handed responses. Instead, the central bank should apply predetermined rules controlling the supply of money to preserve price stability and give businesses the opportunity to confidently plan for the future. 

                  The problem is that this takes time to work, sometimes more time than democratic leaders have before their next election. To confidently save, invest, or contract with their apparently decreasingly valuable currency, people have to truly believe that the government will not suddenly print and cheaply lend truckloads more. Thus, the immediate impact of Thatcher’s policies was to multiply unemployment without decreasing inflation. Ted Heath, the Conservative leader she ousted, pounced, publicly suggesting her failure, and demanding for a return to the post-war consensus. In response, Thatcher demonstrated her resolution, famously declaring before a roaring Conservative crowd, “You turn [back] if you want to. The lady’s not for turning.” She insisted that consensus was “the process of abandoning all beliefs, principles, values and policies in search of something in which no one believes, but to which no one objects.”  Thatcher’s vigilance would eventually be vindicated as inflation and unemployment both dropped over her tenure – but it did not happen before her first re-election. Until then she was barely able to keep in line her own party, filled with skeptical wets ready to return to consensus at any hint of failure. Thatcher herself was committed to monetarism but was always nervous about raising interest rates. She worried that “preventing people from borrowing was a sure way to crush the aspirations which she wished, for reasons of belief and of party politics, to foster” and “she hated the idea that young people on or approaching the housing ladder should be penalized by a Tory government.” But Thatcher kept administering the medicine to cure the bigger danger of inflation. When the election did come in 1982, her posters proclaimed “no Labour government had ever brought down the level of unemployment.” And Labour helped her enormously by publishing a far-left platform called “the longest suicide note in history.” But none of that might have saved her if it were not for the Argentine invasion of the Falkland Islands.

                  Right turn only

                  Figure 3. A sign worth hanging in political offices, judicial chambers, central bank lobbies. 

                   

                  The Falklands are an archipelago a little smaller than Connecticut about 300 miles from Argentina and 8,000 miles from Britain, then with a population of about 1,800. Though the islands had been continuously occupied by British settlers for over a century and claimed for much longer, Spain and its local successor Argentina also had an uneven presence on the islands until the 1830s. By the 1980s, the British, to the degree that anyone thought of the Falklands at all, considered them a nuisance: their maintenance cost money, they had practically no strategic value anymore, and the Argentines complained across Latin America about continued British colonialism. Indeed, the civil service had long been trying to figure out a diplomatic way to give them up. Calculating that the British wouldn’t bother defending a nuisance and hoping to patriotically distract their population from economic woes, the Argentine junta invaded the islands in 1982.

                  They terribly misjudged Margaret Thatcher. Thatcher immediately understood she must retake the islands. If she were to allow British territory to be seized, she would be advertising that more significant territories like Hong Kong and Gibraltar were doormats to willing aggressors. To concede the Falklands diplomatically was one thing, but to surrender the islands would be a blight on British national prestige, confirming the descent of the Empire into a second-rate nation. But there was an additional element: the islands were filled with people who had been British citizens for generations and wished to remain so within their homes. An inexact analogy might be if a Philippine dictatorship invaded the Northern Marianas, which you might be indifferent to until realizing that the Northern Marianas are part of the United States and filled with proud Americans. 

                  And yet even if the moral answer was clear, outside military experts considered the retaking a significant logistical challenge. Thatcher had been trying to cut government spending across the board and the ministry of Defense had easily found economies in the insignificant South Atlantic. The British Navy needed three weeks to sail from the UK to the Falklands and had to rely on what they brought with them, as opposed to the Argentines who were fighting just off their coast. Undeterred, Thatcher took the advice of her husband Denis, a veteran of World War II: “Get the Chiefs, give them clear objectives and then get out of the way.” This she did, and the British military proved up to the job.  In the subsequent election, a heckler shouted at future Labour leader Neil Kinnock that Thatcher had “guts.” Kinnock replied that it was “a pity that people had to leave theirs on the ground [in the Falklands] in order to prove it.” Labour, as we have relayed, badly lost.

                  Darth Vader

                  Figure 4. Argentina may have taken a lot of Germans after World War II but they failed to learn that the Empire strikes back.

                   

                  The Falklands would not be her only test of courage. In 1984, the Irish Republican Army bombed the hotel hosting the Conservative Party conference, killing five and injuring dozens. The IRA miscalculated where Thatcher was staying but if she had even been in a different part of her own room, she probably would have been badly injured. Immediately, she insisted the convention go on: “We must show that terrorism cannot defeat democracy.” This was not the first nor the last time she would be affected by IRA terrorism: her brilliant campaign manager Airey Neave had already been killed in a car bomb, her very capable backbench manager Ian Gow would die of the same fate. In church after the convention, she reflected “This is the day I was not meant to see. And Then I remembered my friends who cannot see it. I have never known such a blend of gratitude and sorrow.” Denis subsequently gave her a watch with the inscription, “Every minute is precious.”

                  The bombing occurred amidst an entirely different confrontation for which Thatcher had long been preparing. The British coal-miners’ union had been a dominant force in British politics for years, all the more so since the oil embargo, because they provided, through a nationalized industry, Britain’s heat. The coal-miners were considered one part of an unstoppable insatiable union triumvirate that also included railroad men and dock workers: combined, they could and did halt the British economy at their pleasure. When Ted Heath had been Prime Minister, he had talked a good game but ultimately conceded to their demands, helping bring down his own government. Thatcher was determined to be different. She made some initial concessions while laying the legal groundwork for breaking a strike and ordering a surplus of coal to be stored and warehoused to withstand it.

                  From 1984 into 1985, the Marxist union leader Arthur Scargill, determined to bring down Thatcher in the same manner as Heath, led two-thirds of Britain’s coal-miners out on strike in the largest labor action in decades. But his very extremity hurt his cause: having lost national ballots of workers in the past, Scargill refused to hold one, rendering the strike technically illegal. Previous governments had made martyrs out of illegally striking union leaders by arresting them; Thatcher instead used a new legal regime to take their money. Scargill then accepted funds from Libya and the Soviet Union, radioactive actions that highlighted how out of touch he was, while Thatcher had already won over many union members through her patriotic leadership. Above all, Scargill alienated the wets who wanted to compromise by refusing “to budge from his position that no pit should ever be closed for economic reasons, but only if its seams were exhausted (or unsafe).” Thatcher reframed the old battle: this was not a fight between her and Scargill, but an attempt by Scargill to coerce the British people. After a long year, the strike ended without a deal. Thatcher’s failure to flinch paved the way for labor reforms across society, even of the lawyers’ guild, that rejected extortion in favor of economics.

                  Baseball

                  Figure 5. Scargill was used to waiting for the perfect pitch but this time struck out. 

                   

                  Of course, one of the reasons why Thatcher had to deal so directly with the coal-miners was because the industry, along with telecommunications, oil, automobiles, steel, airlines, and too many others were all owned by the government. In fact, when Thatcher had taken over in 1979, “a seventh of the British workforce was employed by nationalized industries.” She was determined to restore market incentives to the British economy – and she started with what would become perhaps her most popular achievement: selling public housing to its current occupants. “By 1983, it would become commonplace for people, mainly from the upper working class, to declare ‘Maggie got me my house.” In real numbers, the share of British households in government housing would go from nearly a third to less than 10 percent. When she won again in 1982, her team put together “one of the most ambitious plans for legislation ever laid before a British Cabinet” – a series of specific dates for industries to be sold back into the private sector – and then they did it, netting the government billions of dollars, the economy a more efficient footing, and shareholders a fresh and growing stake in British prosperity. By the end of her tenure, Thatcher would deregulate financial markets making the City of London the financial capital of Europe and cut the tax burden. The only significant fiscal goal Thatcher fell short on – she herself acknowledged “I asked for too little, didn’t I?” – was in the overall spending of government, which increased every year but, significantly, decreased as a proportion of GDP. Ultimately, Thatcher’s most lasting domestic legacy was her dismantling of the post-war consensus and the prosperity that resulted.

                  What Thatcher was most proud of, however, was her role in winning the Cold War. The Iron Lady was an especially articulate anti-communist, and that ended up credentialing her, somewhat ironically, in cultivating the leaders of both superpowers: Ronald Reagan and Mikhail Gorbachev. Reagan, of course, is less of a surprise: he described her as his “soulmate” and they shared similar views on politics domestic (market-oriented) and foreign (anticommunist). They did differ over nuclear weapons – Reagan wanted their abolition, Thatcher insisted that mutually assured destruction was the best route to peace (in this, a retired Richard Nixon encouraged her.) She was annoyed over the American invasion of Grenada, a former British colony, but Reagan charmingly apologized: “If I were there, Margaret, I’d throw my hat in the door before I came in.” But when she needed help with the retaking Falklands, Reagan countered some of his team: “Give Maggie everything she needs to get on with it.” When America needed help punishing the Libyans, Thatcher insisted, despite some unpopular politics,  “We have to support the Americans on this. That’s what allies are for.” Reagan would write her after leaving office, “I feel that the Lord brought us together for a profound purpose and that I have been richly blessed for having known you. I am proud to call you one of my dearest friends, Margaret; proud to have shared many of life’s significant moments with you; and thankful that God brought you into my life.” When asked who should give his eulogy, Reagan insisted on Margaret. All of this intense personal diplomacy translated into genuine worldwide influence and betterment for the interests of both Britain and freedom for the 8 years they shared power. But in the end, her influence frayed: she would not enjoy remotely the same relationship with the “wobbly” George Bush, who concluded that a united Germany was the future of a continent where America did not have “exclusive friends.” Luckily, by then, the stage was already set for the Cold War to be won.

                  Unexpectedly, she enjoyed a better relationship with Gorbachev than Bush. Thatcher had always sung the virtues of freedom, challenging the world,  “what is there in the Soviet system to admire? Material prosperity? It does not produce it. Spiritual satisfaction? It denies it.” She warned “when the Soviet leaders jail a writer, or a priest, or a doctor or a worker, for the crime of speaking freely, it is not only for humanitarian reasons that we should be concerned. For these acts reveal a regime that is afraid of truth and liberty; it dare not allow its people to enjoy the freedom we take for granted, and a nation that denies those freedoms to its own people will have few scruples in denying them to others.” When she first met Gorbachev, she “deliberately and breathtakingly…set about serially cross-examining him about the inferiority of the Soviet centralised command system and the merits of free enterprise and competition.” Gorbachev proved an amused interlocutor and Thatcher recognized that he represented something different from anything the Soviet leadership had produced in the past: a genuine reformer. She, the ultimate anti-communist, publicly validated, especially to her dear friend Reagan who hadn’t yet met him, that Gorbachev was a man with whom the west could do business. Thatcher probably took her support for Gorbachev too far as she considered the balance of power at the end of the Cold War, but she deserves much credit for her searing moral clarity. In her own memoirs, she described a visit to Poland after the Iron Curtain fell:

                  She attended Mass at the Church of the Holy Cross in Warsaw. As the priest rose to deliver his sermon, she realized, though she did not speak Polish, ‘that I had become the focus of attention’. The priest, she paraphrased, was telling his congregation that ‘during the dark years of communism’ the Poles had been sustained by many voices from the outside world ‘offering hope of a different and better life’. But they had come ‘to identify with one voice in particular – my own’. They had not fully felt the change until that day ‘when they finally saw me in their own church’. Lines of children presented Lady Thatcher with bouquets of flowers while their parents stood and applauded. Her chief of staff, Julian Seymour, who was present that day, remembers this as ‘the most electrifying moment of my two decades-plus involvement with her’. In the last paragraph of her book, Lady Thatcher declares her wish that the congregation of the Church of the Holy Cross should be her ‘character witnesses’ on Judgment Day

                  Thatcher 2

                  Figure 6. Click to buy Charles Moore’s three volume biography of Margaret Thatcher: Not for Turning (10/10); Everything She Wants (8/10); and Herself Alone (9/10). The first volume is the best, and from which much of this specific email is derived. Once Thatcher becomes Prime Minister, Moore chooses to address her life by topic rather than chronology, which is probably the right decision for understanding but is a little jumpy. Altogether, the biography can be forgivably over-comprehensive, is sympathetic but frank, and hopefully leaves you inspired by her example.

                  Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend:  Think – do you know any conservatives who might learn from one of the most successful conviction politicians of all time? How about any ambitious women? Or someone who appreciates modern history?

                  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!

                    My Heroine

                    The Gist: How the awesome Margaret Thatcher rose to power.

                    The first of a three-part review of Charles Moore’s three volume biography of Margaret Thatcher, beginning with Not for Turning.

                    Click here to read part two: Win Big or Go Home, and here to read part three: Two More Votes.

                     

                    I want to tell you about a personal hero – or more precisely – personal heroine.

                    Needle

                    Figure 1. That final “e” is important

                     

                    Margaret Thatcher may be the modern world’s greatest national leader, the closest in my lifetime, perhaps even my father’s lifetime, to the awesome standard of James K. Polk. Nicknamed “The Iron Lady” by the Soviets for her hardline stance in helping win the Cold War, what makes her truly remarkable is her transformation of British politics from a consensus of socialist sclerosis to a cross-partisan embrace of market economics.

                    Iron

                    Figure 2. The iron that won the Cold War, produced by free markets, could easily and appropriately have appeared on the set of Star Wars.

                     

                    Charles Moore, a journalist during her heyday, tells her story over three volumes – and nearly three thousand pages – of an authorized biography that took over two decades and hundreds of interviews to complete. In our correspondence, we will discuss how she developed her views, how she dealt with her biggest challenges, and how she was finally betrayed.

                    Margaret adored her father, Alfred Roberts, a grocer active in the local politics of Grantham, an English town a hundred miles north of London then about 20,000 in population. Alfred had dropped out of school as a teenager to support his family but did not let a lack of formal education deter him from his interest in ideas: he was a voracious reader and active recruiter of interesting speakers for the local Rotary Club.  Most significantly, Alfred was a lay Methodist preacher who inspired within his daughter a “puritanical desire for self-improvement” that celebrated the classic Protestant work ethic (“There is no promise of ease for the faithful servant of the Cross”) as well as a stridency of purpose (“God wants no faint hearts for His ambassadors.”) 

                    The most telling anecdote of her childhood came when she petitioned her dad that she be allowed, like so many of her peers, to enjoy Sundays doing whatever she liked (or perhaps even wear a ribbon from time to time!). Alfred responded, “Margaret, never do things just because other people do them. Make up your own mind what you are going to do and persuade people to go your way.” Many would have bristled under this austere regime. Margaret thrived – and all the more so because Alfred gave her an opportunity rare among girls at the time: he encouraged her to regularly speak publicly, especially about their faith. His advice was simple and profound: “Have something to say. Say it as clearly as you can. That is the only secret of style.”

                    Batman

                    Figure 3. The best superheroes are advised by wise, older, British men named Alfred.

                     

                    Extraordinary work ethic and clarity of communication would be defining features of her life – and they would lead to her first big opportunity. When her high school principal told her she didn’t have what it took to go to Oxford, Margaret replied “You’re thwarting my ambition” and convinced someone at the boys’ school to help her get what she needed. She was one of the few women to study chemistry – and she would later prefer to be known as the first Prime Minister with a science degree rather than the popular reference that she was the first female premier. But what would help her become PM was her active leadership of the Oxford University Conservative Association, where she made crucial early connections.

                    One of those connections recommended her, at age 24, to a local conservative party for nomination to Parliament. The British system and culture of politics is quite different from the United States, partially because Members of Parliament are actually expected to run the government departments whereas members of Congress only vote. As a result, candidates for Parliament are not necessarily from the places they stand to represent – nor even ever intend to live there. Indeed, at this time, Margaret was accepted by the local party because they were the hopeless minority and wanted an attractive, young, Conservative fighter to try to make a dent. If she performed well, she could expect to try to represent somewhere else where she might actually have a chance of winning. She ran well twice in Dartford, and cut Labour’s significant majority, but she did not come close to winning. The experience was good – she even was a youth speaker at a rally for Winston Churchill – but the most significant outcome was that she met her beloved husband Denis. Amusingly, Denis had been invited to a party meeting to meet “a very pretty girl” and was surprised to find “Good God, it’s the candidate!” Smitten, he volunteered to drive her around (she couldn’t afford a car) and soon gave her the surname she’s famous for: Thatcher.

                    What is striking in retrospect is that Thatcher was not yet the maverick she would become. Yes, the core was there – “a romantic belief in the greatness, and a sad lament at the decline, of her country” but she had not yet defined the path forward. Thatcher was for the sound running of government and began saying what she often would: “The Government should do what any good housewife would do if money was short – look at their accounts and see what was wrong.” But what conservative wouldn’t agree? More interesting is her early complaint that “There is a whispering – in fact, a shouting campaign in operation – that if the Tories get back they will take off all the [price and regulatory] controls, but this is untrue. It was the Tories who introduced the finest food rationing system during the war.” This was meant mostly as a criticism of the then-Labour government’s rationing – but it hardly sounds conservative to say “We actually do rationing much better!” And yet that was the position of the Conservative Party at the time.

                    The decades of “post-war consensus” had their origins in the coalition government of World War II – Churchill was satisfied to run the war and leave the details of domestic politics to his Labour partner Clement Atlee. After the war, both Labour and Conservatives accepted the welfare state and Keynesian economics as settled: the government should aspire to maintain full employment through high spending financed by high taxes, general regulation, and the occasional state seizure of entire sectors. The only difference may have been that Labour wanted to nationalize new industries while Conservatives were satisfied with the industries already nationalized.

                    Churchill

                    Figure 4. Churchill once visited the men’s room at the House of Commons and, discovering Atlee at the urinal, proceeded to the opposite end. Atlee inquired, “Feeling standoffish today, Winston?” “That’s right,” Churchill replied, “Every time you see something big you want to nationalize it.”

                     

                    Thatcher would soon be dissatisfied with such an arrangement. After over a decade of politicking, Thatcher had sufficiently shown her talents to be circulated on the Conservative Party’s official approved list of candidates they’d like to see in Parliament. A local party with a comfortable conservative majority gave her the nomination, though perhaps because the sympathetic chairman “lost” two of her opponent’s votes. In 1959, at age 34, she was finally a member of Parliament. Because the Conservatives were in power, she was soon given a job in government. Because she was so new, it was very junior. Because she was a woman, it was in the machinery of the welfare state, which the leadership thought relatively unimportant. 

                    Thatcher initially wasn’t very happy with the assignment but the job “taught her how welfare worked, and did not work, and why government spent so much money.” And she started to make her mark. Moore observes that, “Combined with her lower-middle-class background, [being a woman] gave her a sense, which never left her, that she was living dangerously. To succeed, she knew she would have to do everything twice as well as the others, virtually all of whom were men. If she failed, no chums would save her.” When she objected to blindly signing off on paperwork, a civil servant objected “Bloody woman. Her job is to sign them, not read them.” Her boss would inquire, “She’s trouble. What can we do to keep her busy?” Eventually, as she rose to a point where she was considered for the Cabinet, the Conservative leader Ted Heath presciently lamented, “once she’s there we’ll never be able to get rid of her.”

                    The Conservatives would be thrown out in 1964 and then return in 1970, with Thatcher as Minister of Education. Her goal was to save meritocracy in schools. She failed. The problem was threefold. First, her own party was divided while Labour was united in opposition. She was a product of what were called “grammar schools,” an equivalent of America’s public magnet schools, where gifted children at the age of 11 were selected to pursue a separate, more academically-rigorous program. Moore notes their compelling features: “They represented excellence, they benefited from the exercise of parental choice, and they were the best ladder of advancement ever devised for bright children from poor backgrounds.” But less than 20% of children attended these selective schools – and those tied to the 80%, an overwhelming number for a democracy and necessarily including lots of frustrated Conservative Party members, did not like the diversion of scarce resources nor the feeling of being left behind. Her second problem was that control over schools was proudly decentralized and her role was essentially confined to sending a check. Moore relates that “In parliamentary answers to Education Questions throughout her time in office, Mrs Thatcher’s most common reply begins with the words: ‘I have no direct control…” But the third problem would become the most famous. The Conservatives were trying to cut spending across government and demanded that Thatcher produce cuts in her own department. Desiring to minimize any cuts to classroom education, she agreed to extend a previous Labour government decision to withdraw free milk from high schoolers to younger children. This caused an uproar that led to her first nickname: Margaret Thatcher, Milksnatcher. She retreated from the limelight, became abnormally accommodating to preserve her position, and quietly prepared to fight another day.

                    milk

                    Figure 5. The opposition milked the controversy dry.

                     

                    Over these years, in and out of government, Thatcher honed her views. Working on the nuts and bolts of the welfare state, she would conclude that “she wanted the state to mobilize to help the unfortunate, and always believed that there was no full private substitute for this, but she always feared two things – that the ‘shirkers’ would tend to benefit at the expense of the workers, and that the cost, if not carefully controlled, would produce national ruin.” She was sympathetic to one particular part of the post-war consensus articulated by Churchill’s adviser Lord Beveridge, who argued that “when someone did have to be given National Assistance, the ‘provision of an income should be associated with treatment designed to bring the interruption of earnings to an end as soon as possible’.” On the campaign trail, Thatcher would make one of her most famous observations, that socialism has “always succeeded in running out of other people’s money.”

                    And, really, public speeches were Thatcher’s tool to clarify her own thinking – at the end of her career, she would reflect “I have never knowingly made an uncontroversial speech in my life.” She would agree to speak on a topic of interest sometime in advance – and then she would “absorb almost any amount of detail” she could about the subject. And yet “Strong though she was on the detail, most of the time she articulated a purpose beyond it.” Building on her father’s lessons, Thatcher would learn “‘Every speech should tell a story or a fable’ and that ‘A speech is to be heard,’ a living performance which the speaker must enact with hands, eyes and voice as well as verbal content.” Thatcher was better at selecting and editing collaborators than writing speeches herself – but she was at heart the political equivalent of a method actor who obsessed about the meaning and presentation of her words. 

                    In what may be described as her national party debut, Thatcher had been invited in 1968 to give a major speech outside the Conservative Party conference on the subject of women’s rights. She rejected that narrow subject – she was pleased by the opportunities offered a conservative woman but did not want to be confined. In another context, “in a sentence which summed up so much of her attitude to life, she declared, ‘Equity is a very much better principle than equality.’” She applied herself completely to the preparation of the speech, checking out over 30 books on conservative economics, philosophy, and history. She wound up presenting the moral case for markets: “The Good Samaritan had to have the money to help, otherwise he too would have had to pass by on the other side.” She would soon contrast this against the Labour position: “If you make it, I’ll take it”

                    Thatcher had come to the conclusion that “politics is a question of alternatives” but, remarkably, she was a subtle rebel. Throughout her entire legislative career, Thatcher only voted against her party leadership’s official preference once: to restore corporal punishment to criminals (a position, like her desire to restore the death penalty, supported by the grassroots but opposed by the elites). Thatcher signalled to the right-wing of the party that she was sympathetic through her speeches and private communications – but she was not one of its leaders, like Enoch Powell or Keith Joseph. Powell had dramatically gotten himself fired from Cabinet for giving a vivid speech about the need to rethink immigration and continued to throw verbal bombs from the back benches. Joseph remained in prominent party leadership but also had set up a think tank to critically reconsider Conservative Party modern orthodoxy.

                    In 1975, Ted Heath had been leader of the Conservatives for about a decade. He had lost an election in 1965, miraculously won another in 1970 in defiance of polls and expectations, then lost another in 1974 when he didn’t have a good answer to the heckler who cried “What can you do if you win that you can’t do now?” Heath was the epitome of the post-war consensus, even believing that the only way to deal with persistent industrial problems may be a grand coalition government with Labour. Moore observes that

                    “Government spending had risen from a 44 per cent share of Gross Domestic Product in 1964 to 50 per cent in 1969. That drift, the Tories had argued, had to stop and be replaced by a downward pressure and by a political direction which would be maintained. The Conservatives who won in 1970 were committed to a smaller state, and a freer economy, and to the urgency of these matters. They failed, and their failure created the conditions for Margaret Thatcher to become their leader.

                    But that outcome was not at all obvious. Thatcher, a footsoldier, was going to be campaign manager for the real star: Keith Joseph. But Joseph hesitated, partly because challenging a sitting leader is risky and partly because of the reaction to his recent controversial speech about broken families in Britain’s lower classes. Thatcher then entered the race herself – but she was widely considered a stalking horse for Joseph. The tactic, well-recognized in British politics, was that her challenge would show the strength of Heath: if he won decisively, her career might be badly damaged but the real rightwing leadership could live to fight another day. If Heath won with only a small majority against such an insignificant candidate, then he could gracefully exit while the real leadership contest proceeded. Given Heath’s weakness, the joke was that the race was between a gelding and a filly. No one actually thought she could win.

                    Except, perhaps, her campaign manager, a brilliant Machiavellian named Airey Neave. Neave was a perfect example of the backbenches of the Conservative Party who had never gotten much love from Heath – and therefore knew exactly how to talk to many of his peers who shared the same disillusions. Neave kept Thatcher above the fray: he encouraged her to keep making smart speeches that demonstrated the courage of her convictions while arranging for her to spend time with key people. Meanwhile, Neave politicked: in a representative example, he flattered one disenchanted backbencher by saying “Margaret assumes you must have turned down a job offer from Ted.” “Why?” replied the backbencher. “Oh, because you so obviously should have one if you want it.” Even more effective than generating goodwill, however, Neave played on the hopes of all people skeptical of Heath for different reasons. Though he had a highly accurate list of where the votes were and he was aware that Thatcher was continuously gaining, Neave would tell people on the fence who really wanted someone else that she was short of what was needed to knock off Heath. When the vote happened, Thatcher beat Heath 130-119.

                    “The oldest, grandest, in many people’s eyes the stuffiest political party in the world had chosen a leader whose combination of class, inexperience and sex would previously have ruled her out. And it was not obvious that it had really meant to do so, or that it was confident of its choice.” But Thatcher knew what she was doing, insisting to the media on the very day of her election as leader: “You don’t exist as a party unless you have a clear philosophy and a clear message.” To the dismay of her competition, she quickly won over the party’s grassroots voters, declaring in a speech before their convention: “It is often said that politics is the art of the possible. The danger of such a phrase is that we may deem impossible things which would be possible, indeed desirable, if only we had more courage, more insight.” When Labour politicians were aghast at her expressing criticism of the UK while in the United States, she defiantly proclaimed: “It’s no part of my job to be a propagandist for a socialist society.” From then on, Moore notes “Mrs Thatcher could still be slowed down by appeals to the political danger of what she was trying to do, but nothing could stand in the way of the general direction of travel.”

                    British voters finally were offered a choice. Over three decades of the post-war consensus of socialist sclerosis culminated in the Winter of Discontent of 1978-1979. In just the last five years, the British pound had lost more than half of its value and inflation was still in the double digits. Labour was already embarrassed by having to apply for the largest loan in IMF history and now proposed to battle inflation by holding down public sector wages, including in many of the industries they had nationalized, hoping to inspire what remained of the private sector to do the same. But this angered the Labour Party’s extremely powerful union allies, who understood that if their wage increases did not match inflation, their purchasing power was being commensurately cut. Truckers, railroad workers, garbage men, manufacturers, and others went on strike, emboldened by the recent success of the almighty coal-miners, upon whom the nation depended, through a nationalized coal industry and amidst an international oil embargo, for heat. The post-war consensus had lost its shine. And the whole point of the Labour Party – created to give unions political power so as to achieve industrial harmony – seemed gone.

                    Thatcher supplied the alternative, best encapsulated in a political poster of the time said to depict some of the 1.5 million Britons out of work under the headline “Labour Isn’t Working.” In the 1979 election, the Conservative Party won a comfortable majority in Parliament, making Margaret Thatcher, as she preferred to be known, the very first Prime Minister with a science degree.

                    Thatcher 1

                    Figure 6. Click to buy Charles Moore’s three volume biography of Margaret Thatcher: Not for Turning (10/10); Everything She Wants (8/10); and Herself Alone (9/10). The first volume is the best, and from which much of this specific email is derived. Once Thatcher becomes Prime Minister, Moore chooses to address her life by topic rather than chronology, which is probably the right decision for understanding but is a little jumpy. Altogether, the biography can be forgivably over-comprehensive, is sympathetic but frank, and hopefully leaves you inspired by her example.

                    Thanks for reading!  If you enjoyed this review, please sign up for my email in the box below and forward it to a friend:  Think – do you know any conservatives who might learn from one of the most successful conviction politicians of all time? How about any ambitious women? Or someone who appreciates modern history?

                    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!