I don’t have to point out to anyone that the dialogue between the left and the right has pretty much completely broken down in this country, to the point where the two sides simply aren’t talking to one another. When they do talk, they talk past one another, not to one another. Each sides talk to the positions that they accuse the other side of having, which may or may not have anything to do with the positions actually held.

I don’t think this serves either side very well, because politically we have begun to find it acceptable to compromise our positions in order to prevent the “other” guys from getting into power. 

I’ve been scratching my head, trying to figure out why otherwise intelligent, rational people have such disparate ideas about how things should be run. The only thing that I can come up with is that liberals and conservatives must be operating under completely different underlying assumptions, and aren’t aware that the other side does not share those assumptions. Some things seem so obvious that they don’t seem worth mentioning, so when someone says something that is plainly contrary to a core assumption, our first reaction is to brand that person as an idiot.

This theory bears itself out in conversations with liberals, which I have a seemingly infinite supply of, living near Portland, Oregon. When I have stepped back from issues that we disagree vehemently on, and questioned the assumptions which lead to these disagreements, I have invariably found that the other side has a completely different set of assumptions. This has the potential to turn into a huge discussion, so I’m only going deal with one assumption here and save others for future installments.

The Myth of the Zero Sum Game.

One day a few years back, after martial arts practice, I was having a couple of beers with fellow martial artists. They were all considerably younger than I was and all liberal. I proposed the question; “Is the economy a zero sum game?”

The unanimous response was “Huh?”

Okay, if I earn a ton of money and get rich, does somebody else automatically get poorer as a result? 

There was some shuffling of feet and intent peering into half-empty beer glasses. Those who knew me knew that I had just laid a trap. They weren’t sure how, but they were loathe to step into it. One brightly androgynous young lady, confident in her idealism and confident that she had strength of numbers on her side, announced “Of course! How could it be any other way?”

And that, boys and girls, is a fundamental postulate, one that is taken as gospel by many on the left, and one that is considered patently absurd by the right. It is so fundamental that no one ever thinks to question it from either side.

The funny thing is that there is precedent for both sides being right.

Let’s consider basic economics. The foundation of economics is production. Workers produce goods, and then trade those goods for other goods or services. Note that I started with producers of goods, not providers of services. Service providers, although they play a valuable role, cannot exist without goods producers. Goods producers can do just fine without service providers.

The most fundamental good of all to produce is food. The producers of food must produce enough food so that the entire population – producer and providers and those who do neither – can eat. Failure to do so means people die. Let’s remember this, because we’re going to come back to it in a moment.

There are two types of goods that can be produced: Durable and perishable. Durable goods keep their value. They can be traded, hoarded, and traded again. When durable goods are consumed, the result of their consumption is other, hopefully more valuable, durable goods. Perishable goods have a shelf life, after which they are either consumed or have no value. Consumption of perishable goods yields nothing of value, or value that is transitory. Consume firewood, and the resulting heat is valuable, but doesn’t last. Consume gasoline, and the resulting motion has no lasting value. Consume food, and the result actually costs money to dispose of. Consume pig iron, and the result is probably a product which has value, hopefully more value than the original pig iron. Food is perishable, pig iron is durable.

 The wealth of any community large or small may be measured in terms of the amount of goods it is capable of producing. Now let’s back up 500 or 600 years and examine the sorts of economies extant up to that time. Before the industrial revolution, all production was done by muscle power. If a man or animal did not do some sort of work, nothing was produced.

Because of the phenomenal expenditure of muscle power necessary for any sorts of production, pre-industrial economies were dominated by food production. This is where the majority of the workforce was employed, and what consumed most of the productive capacity available. Artisans and skilled producers of durable goods were highly valued, and ensured they kept their value by associating in exclusive guilds which jealously hoarded the secrets of their production.

Think about this for a second: Most of the productivity of a community is going to disappear within one year, either consumed for sustenance or spoiled. 

How can anyone get rich in such an economy? The answer is easy: you steal it. You can either set yourself up as some sort of government, which has the right to help itself to the food production of all the populace, or you can go as far as claiming ownership of the very means of production – the people who do the producing. The guy actually doing the production has no chance to get rich, because he simply can’t produce enough by the sweat of his brow to accumulate enough to be able to pay someone else to do it. Those in the service industries do have a chance to get rich, if they can manage a way to market their services to enough producers to take advantage of economies of scale. Their success is closely tied to that of the producers, and in a horse-drawn economy, economies of scale are difficult to come by.   Those in political power have the best chance of getting rich, because they have no need to give any sort of value for that which they take, and can do so by fiat and force of arms. Often it’s politically safer if you’re in political power to go abroad and steal from someone else, so you don’t live in fear of your own people, and in fact you can buy their loyalty by paying them with plunder. 

This sort of situation gives rise to heroes like Robin Hood, who robbed from the rich and gave to the poor. This was not deemed immoral, because in this sort of economy the rich probably got that way by robbing in one form or another from those who did the production. Good kings were those who laid the whip of taxation lightly, and who provided service for their income, in the form of protection and justice. 

Wealth is this system is based on the quantity of recent production – typically the production of the previous year, which will be worthless within a year. The amount of wealth in a community is therefore relatively fixed at any given period of time, and subject to consumption that usually equaled or exceeded the ability to produce. While not precisely a zero-sum game, this agrarian based economy is close enough to a zero-sum game that the principle effectively holds: If you’re rich, chances are you stole it from someone else. In this economy, money is the root of all evil; or rather, the love of money is the root of all evil. An entirely just system would punish the robbers by redistributing the wealth to ensure that the producers shared in the fruits of their labor. This way of thinking was deeply ingrained in the justice systems developed over the centuries, and Karl Marx attempted to adapt its dynamic to the industrial revolution.

Economics changed dramatically with the industrial revolution. The development of machinery which did not base its power on muscle power greatly magnified the productive capacity of the individual. For the first time in history, durable goods composed the greater part of the productive capacity of a population. As machinery became more sophisticated, and the productive power available became amplified, production of perishable goods became a relatively insignificant part of the economy. 

Now think about this: Most of the productivity of a single person may be hoarded by that person, and traded for the productivity of others. It never disappears, it never spoils. 

The efficiency that a single person can achieve, and that person’s ability to literally reach a global marketplace, means that the producer himself can now gather wealth and become rich. This is not simply because people have the power to produce more. Because a person can trade their surplus production for someone else’s surplus, Efficiencies of specialization are realized. The wealthy person does not need to steal from other people to get rich. His productivity is such that he is capable of living a very comfortable life purely on the basis of his own production. 

The truly wealthy in this economy are not robbers, they are people who have developed ways of producing something of value to the community on a vast scale, with the most efficiency. Because one person cannot do this alone, this person often employs other people to produce under his direction. The ability of a person to produce for his or her employer is rewarded by the employer. If the employee feels his compensation isn’t commensurate with his productivity, he’s free to shop his productive abilities to other employers who may value his abilities more.

In this economy, Robin Hood is not a hero, he has become an evil villain. In this economy, wealthy people are enjoying the fruits of their own productivity, and doing so as much by trade as by production. To take from such a person is to steal the from the best of the people who Robin Hood formerly championed.

Because the economy is predominantly durable goods, production has lasting value. Consumption is relatively minor compared to production, so the total wealth of a community is constantly expanding. It is not a zero-sum game. If one person gets rich, he does so because he has mastered efficient, valuable production. He has not taken anything from other people. The liberal may argue that he has achieved his wealth from the production of other people who are in his employment. This is true, and those people were compensated accordingly, in a mutually agreed upon employment contract. The employer is obligated to compensate his employees commensurate with the value they provide for him, or they will defect to another employer who appreciates their value more.

And herein lies the fallacy of the liberal propensity to try to equalize the wealth disparity. The urge to be Robin Hood denies the fact that industrial capitalism has a perfect mechanism for rewarding those who contribute the most to society, and penalizing those who contribute least. The intelligent liberal should seek not to redistribute wealth by force of arms, but to work to level the field of opportunity for everyone to realize their full productive potential. This cannot be done when non-productivity is rewarded, and the most productive are punished.

There is much more to be said on this subject, and others have said it better than I can. Please read a critical excerpt from Ayn Rand’s Atlas Shrugged. Take the time to read the whole passage and understand it, for in today’s economy, money is the root of all good. To deny this is to invite certain catastrophe.

Barack Obama would have you believe that the Democrats have the solution for the economy, if only those rascally Republicans would stop getting into office and messing everything up.

Now just a cotton-pickin’ minute here! Let’s just review some basic economic facts before we start pointing fingers. I know a bunch of people voting today really don’t remember the 1970’s,   so hang on, kids, it’s time for a history and economics lesson.

In the last 40 years, we’ve had economic ups and downs. The seventies were marked by an astonishingly bad economy – bad enough that the present crisis looks like a spectacularly good day. The Democrats controlled congress, and President Nixon was a social liberal. Wage freezes were in effect (Can you imagine? The Federal Government making it against the law to give someone a raise?). Oil prices were causing lines at the gas pumps that were miles long at times. 

Enter Jimmy Carter, and things got worse. A lot worse. Carter raised taxes and increased social security benefits. The Dow lost 25% of its value in the first two years of his presidency, and we were introduced to a term called stagflation – double digit interest rates, coupled with double-digit inflation. Economists assured us this was impossible, except it was happening! The media coined a new term, called the misery index, which coupled the unemployment rate to the inflation rate.

Carter did one thing of particular note during his presidency. In 1977 he signed into law the Community Reinvestment Act. This gave incentives to banks to help low-income borrowers get a home. Not a bad idea. Remember this, we’re going to come back to it.

Because of the dismal economy at home and a general indecisiveness abroad (remember the Iranian hostage crisis?), Carter lost his job to Reagan after one term. Reagan proceeded to slash corporate taxes, capital gains taxes, and the marginal tax rate. Nay sayers scoffed at “Reaganomics”, and “Trickle-down economics.” They still do, in spite of the overwhelmingly positive results.

You see, Reagan was a visionary who implicitly understood that the way to build the country’s wealth was to let the people who were wealthy create more wealth! Wealthy people don’t store their wealth in a shoe or under the mattress, they invest it! They use it to buy things. They use it to employ people! In short, they put their money to work making more money! If you don’t believe this would have a positive effect on the economy and put the nation back to work, then just answer one question: When was the last time you drew a paycheck from a poor person?

The economy started grinding ahead under Reagan. It was a slow recovery, but it was sustainable. By the end of Reagan’s first term, the Dow had more than doubled its value. There was a huge hiccup in October of 1987, which was not so much a case of weakness of the economy, except a literal financial fumble. New computerized trading systems had no safeguards, and a sudden sharp sell off created a computer-driven panic that crashed the market 20% in a single day. Stop orders were tripping, causing computerized sell orders, which drove the market down and caused more stop orders to trigger. The wheels fell off, and no one could do anything, because they couldn’t get in front of the computers. The panic was short-lived, and by the end of the month, the market had resumed it’s steady climb upward, albeit from a more subdued starting point. 

The Bush administration was unremarkable. The Iraq invasion of Kuwait caused the market to react negatively, but as Bush got control of the situation, the market recoverd quite nicely. 

All the while, under the hood of the economy where no one could see, some things were happening.

• First, Reaganomics were still at work. The money that companies saved under the Reagan tax cuts was going to work. Infrastructure was being laid, buildings and factories were being built. The machines that would make the machines which would make the goods of the nineties were being designed and built. All of this took money – money made available by Reagan leaving it in the hands of the very people who knew how best to use it.
• Second, we had won the Cold War. Reagan, Thatcher and John Paul II had rocked the Communist monolith and discovered it was a house of cards. The vast sums of money that was essentially flushed down the economic toilet to maintain military parity with the Communist block were cut back to a trickle, and the resulting proceeds became available for reinvestment into growing the economy. Call it a Peace Dividend.
• Third, a strange new technology called the microprocessor was about to revolutionize the economy of the USA. This technology would become a gigantic force multiplier for the US worker, and to feed the huge demand for it, whole new industries were laying down foundations. This technology would create a huge vacuum full of unexplored opportunity in just about any field of endeavor you could imagine.

When Bill Clinton took office, these three things were set to explode and carry the economy forward on a literal tidal wave of prosperity. And Clinton, in his usual style, surfed this tidal wave of prosperity and claimed credit for every bit of it, even though he had nothing to do with it (of course he did have the creator of the internet as his vice president. . .).

During the economic boom of the Nineties, set off by a triple fuse that Reagan had lit ten years earlier, Clinton could pretty much do what he wanted and could do no wrong economically. One thing he did do was to revamp the regulations regarding the Community Reinvestment Act (remember that?). Under new regulations, banks faced stifling penalties if they did not expand their role in lending money to borrowers with low down or no down payments. Banks were basically forced to issue $1 trillion in new “subprime” loans to people that they would not have loaned to in a free market, because these people were credit risks. Failure to do so would be noted when the banking regulators reviewed applications to branch and grow.

During March 1995 congressional hearings William A. Niskanen, chair of the Cato Institute, criticized the proposals for political favoritism in allocating credit and micromanagement by regulators, and that there was no assurance that banks would not be expected to operate at a loss. He predicted they would be very costly to the economy and banking system, and that the primary long term effect would be to contract the banking system. He recommended Congress repeal the Act.

The banks swallowed this poison pill and smiled, because what the hell, the economy was doing great, so the risk was theoretically still manageable, right?

This created subprime mortgage securities. Bear Stearns was the first to do it. Mortgage underwriter Fannie Mae added fuel to the fire, and subprime mortgages started to grow. 

Okay, here’s where it starts getting a little tricky, so stay with me here. More money made available for loans to buy homes increases competition for those homes. House prices rise. Market speculators see this and start buying homes as short term investments, further fueling the pressure for prices to rise. 

Banks see this trend, and are under pressure to make a profit. They begin developing designer loan packages, with outrageous variable interest rate schemes. The idea is that the investor could get a low introductory rate which would eventually reset to a usuriously high rate. This didn’t concern the investor, because his plan was to sell into the hot market and catch a quick profit and flip the house before the interest rate reset. He’s like the family who always uses a credit card, and doesn’t worry about the interest rate, because he pays off at the end of the month – always.

The gun was cocked and aimed at the economy’s head. And it was Democrat legislation that cocked it.

George Bush took office at the beginnings of an economic decline. Clinton had steered the booming economy perilously close to the rocks, and handed the wheel to Bush just before it hit. The economic downturn actually had begun to be felt in October of 2000, a mere month before the election. Bush took immediate action to right the course and steer the economy back on track. He cut taxes, which quit putting a brake on the economy, and allowed the productivity that had begun to falter under Clinton to begin regaining speed

Then 9/11 happened. International terrorism struck right at the heart of our financial system. Fortunately, the terrorists didn’t understand that Wall Street is just a reflection of the economy. The real wealth is made in the factories, not on Wall Street. Under the Bush tax plan, the economy shrugged off the damage and surged forward once again.

Meanwhile house prices (yes, we’re revisiting the growth of the mortgage bubble) were accelerating. For the first time in history, house price appreciation was no longer tracking the Consumer Price Index, but was surging way ahead of it. Responsible politicians began to get alarmed. 

In 2003, the Bush administration recommended the housing finance industry be overhauled. But the democrats stopped it: “Supporters of the companies said efforts to regulate the lenders tightly under those agencies might diminish their ability to finance loans for lower-income families.”

 “The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.” – Barney Frank (D-MA)

 “…And in the process weakening the bargaining power of poorer families and their ability to get affordable housing, “–   Melvin Watt (D-NC)

In 2005, John McCain warned of mortgage collapse and he co-sponsored “The Housing Enterprise Regulatory Act Of 2005”. Democratic opposition ensured it never got out of committee. There might be thousands of reasons for this. But something smells bad: the top three recipients of campaign finance contributions from mortgage lenders Freddie Mac and Fannie Mae for the last 20 years? 

• Christopher Dodd, (D-CT), chairman of the Senate Finance Committee. 
• Barack Obama, (D-IL)
• John Kerry, (D-MA)

I don’t know, I’m just sayin’. . .

So in spite of the Bush administration and John McCain’s efforts to disarm the financial gun that was pointed at the economy’s head, the Democrats earned their money by keeping things as they were.

Then something else happened, something that neither Democrat or Republican had any control over. 

There are a billion Chinese in China. And a billion Indians in India. And all these people started exhibiting an unusual behavior. You see, they were working, too. A lot of their work was building things to sell to America to support its booming economy. And all these workers were making money, and then they were spending that money to buy . . . cars. 

And cars need gas. 

And gas needs oil.

Except that the oil producing cartels weren’t opening the spigots to meet demand. And oil prices went up. This is economics 101: Supply and demand. Even a Democrat can understand this. Oil is a fungible commodity: The consumer doesn’t really care about where it comes from, and the supplier doesn’t really care who buys it. Basically suppliers sell their oil into the world market, and consumers buy it off the world market. To try to regulate oil prices for domestic oil companies merely punishes them and prevents them from competing in the global market.

So gas prices started rising. And that affects everything. It takes oil to produce food. It takes oil to get the food to market. It takes oil to move goods from factory to consumer. All these things cost more, and the prices get passed on to the consumer, putting a brake on personal income just as bad if not worse than raising taxes.

Now, suddenly, the guys who never should have gotten a loan in the first place could no longer make payments and keep gas in their cars and buy food. Mortgage defaults began to rise. As foreclosures become more common, the housing industry faltered. House prices flattened out and began to fall in some places. The investors looking for a quick flip watched in horror as their equity evaporated, and their adjustable rate mortgages started to reset to fantastically higher rates – rates that couldn’t be sustained. The investors started lose money, and either dumped their houses for what they could salvage, or rode them down to foreclosure. 

Banks had been forced by regulatory requirements to give out risky loans by Democratic legislation, supported by Democratic stonewalling against reform. Those loans were now defaulting, and the banks were collecting collateral that was no longer worth the money which had been loaned.  The trigger had been pulled.

The free market had not failed, because it hadn’t been free.

To quote a Chicago pastor, “Them chickens have come home to roost!”

Failure of banks is not a good thing. It smacks too much of the Depression. But government money to bail them out, without reforming the very artificial condition that led to this mess is like fighting a fire with gasoline.