A financial writer recently mused over the complexities of Jerome Powell’s job as Chairman of the Federal Reserve. He focused on the problem of interest rates. Lower them too rapidly and inflation may recur or worsen. Keep them high for too long and consumers will be priced out of the loan market and even worse the cost of federal borrowing will be so high that essential services will be threatened by the high cost of debt.
This fiscal conundrum fixed my attention on the problem. To begin with, I don’t understand the economy very well – if at all. According to the greatest economic thinker since Adam Smith (Frederich Hayek) this deficiency places me in the company of the rest of humanity. Hayek argued that the economy was too complex for any individual or group of like-minded observers to comprehend its intricacies. He further argued that it was best, whenever possible, to leave it alone. Humans, of course, are inveterate tinkerers and manipulators who cannot avoid providing essential services (free stuff) any more than a five-year-old can resist a marshmallow.
The amount of essential services provided by the federal government for much of its history was limited. National defense was the biggest item and this amount, save during the Civil War, was not large. It was confined to the expansion into the territories, overseeing the perceived welfare of the settlers and the often hostile relationships with the Indians, and the occasional limited war. Attempts to finance greater federal funding by the establishment of a federal income tax were thwarted by the Supreme Court which held such a levy to be unconstitutional.
Finally, during the apogee of the Progressive Era Congress passed and the states ratified the 16th amendment to the US Constitution which legalized a federal income tax. In only 30 words the 16th Amendment changed forever the basic nature of American life. In the same year, 1913, congress created the Federal Reserve System. Congress established three key objectives for monetary policy in the Federal Reserve Act: maximizing employment, stabilizing prices, and moderating long-term interest rates. As if this alteration in the function of the central government weren’t enough, six years later the 18th Amendment (Prohibition) was enacted establishing forever the integration of high-powered organized crime into the fabric of American intercourse. The constitution can be bent downwards as well as up.
I’ll ignore crime for the rest of this piece and concentrate on the economic and political effects of the transformation of the economic power of the central government. Had the public been aware of what would follow from the imposition of a tax on income I doubt they would have ratified the 16th Amendment, but they did and it’s here to stay.
At first federal spending did not grow very rapidly. But starting in the 21st century it began an explosive increase that if unchecked will ruin the fiscal health of the nation. The magnitude of the problem is easily discernible from the two graphs below.
As is easily apparent from the first graph, nondefense spending is the biggest item, by far. It is under this category that “essential services” reside. What are these essential services? The modern welfare state includes them all. Medicare, Social Security, Medicaid, Food Assistance, regulation of almost every feature of the national activity. The financial effects of this dinosaur go well beyond the deficits it creates, They are as ubiquitous as nitrogen. No politician has the fortitude, or folly given the addiction of the voters for “essential services” to reform them; they will run until stopped by exhaustion or collapse.
I mentioned “ruin” above. It has become popular to quote Adam Smith’s remark that “There is a great deal of ruin in a nation” made in late 1777 after he received news of General Burgoyne’s defeat at Saratoga. The welfare state by itself may take a while to ruin the country though destruction is its inevitable destination if left unattended. But it’s not the only threat to American predominance.
The Fed with its tripartite missions repeatedly gets things wrong, as Hayek predicted any such entity would. Its members are not stupid or malign, they are human and subjected to the fog of the economy. They will always be in the dark. Do not expect AI to come to their rescue. The economy cannot be roughly managed.
But the welfare state is not the only obstacle to the continued national state of well-being. Since the end of World War II, the USA has been the world’s dominant power. We have projected our power with effect if not always wisdom. It was our gigantic military establishment combined with our huge economy that allowed this force deployment. But as our debts rose, as did our commitments, our economy as a proportion of that of the world has shrunk to about 25%. We have manipulated the world’s fiscal system to attempt to impact international disputes such that the confidence in the US as a prudent “banker’ has faded – witness the development of the BRICS economies. More than one observer has pointed out that we can no longer run a 20th-century foreign policy with a 21st-century economy. The US economy may remain for some time the world’s largest, but its days of 20th-century dominance are gone.
The simplicity with which our government and press confront complex issues is telling. The war in Ukraine is a blazing example of oversimplification. If you would understand how the US arrived at its current policy in which it finances and oversees a war in which others die without an obvious end in sight listen to Christopher Caldwell’s exegesis about the conflict. Russia and American Foreign Policy Today (Oct 4, 2022)
Finally, there’s a relationship between immigration policy and essential services. As we are finding to our great cost, a country cannot simultaneously have both a country without borders and a large welfare state. Especially when the country starts such a policy with a Himilayan debt that is expanding like the girth of a python that has swallowed a pig.
I am neither knowledgeable nor facile enough to suggest a remedy for our economic and governmental malaise. But I do understand that diagnosis must precede treatment. Our government, media, and electorate seem still in the barber-surgeon era. Decline is a combination of both circumstance and choice. How essential are “essential services”? We may soon find out.
