Sunday, February 22, 2009


Part II: Stimulus Packages

Previously: Part I: Capital, Saving, and Our Economic Crisis

The Nature of Stimulus Packages

As was shown in Part I of this article, economic recovery requires greater saving and the accumulation of fresh capital, to make up for the losses caused by credit expansion and the malinvestment and overconsumption that follow from it. Yet the imposition of “stimulus packages” results in the further loss of capital. The Keynesians not only do not know this, but would not care even if they did know it.

Because of their ignorance of the role of capital in the economic system and resulting inability to see even the clearest evidence that suggests it, the Keynesians can conceive of no cause of a recession or depression but an insufficiency of consumption and no remedy but an increase in consumption. This is the basis of their calls for “stimulus packages” of one kind or another.

They assume that the economic system always has enough capital, indeed, that it is in danger of having too much capital, and that the problem is simply to get it to use the capital that it has. The way that this is done, they believe, is to get people to consume. Additional consumption will be the “stimulus” to new and additional production. When people consume, the products of past production are taken off the shelves and disappear from the stores. These products, the Keynesians believe, now require replacement. Hence, the shops will order replacement supplies and the manufacturers will turn to producing them, and thus the economic system will be operating again and recovery will be achieved, provided the “stimulus” is large enough.

The essential meaning of a “stimulus package” is the government’s financing of consumption, indeed, practically any consumption, by anyone, for almost any purpose, in the conviction that this will cause an increase in employment and production as the means of replacing what is consumed. Despite talk of avoiding wasteful spending and being “careful with the taxpayers’ money,” the truth is that from the point of view of the advocates of economic stimulus, the bigger and more wasteful the project, the better.

This was made brilliantly clear many years ago by Henry Hazlitt, who chose the example of government spending for a bridge. It is one thing, Hazlitt showed, if the government builds a bridge because its construction is necessary to facilitate the flow of traffic. It is a very different matter, he pointed out, if the government builds the bridge for the purpose of promoting employment. In the first case, the government wants the best bridge for the lowest possible cost, which implies the employment of as few workers as possible, both in the construction of the bridge and in the production of any of the materials that go into it.

In the second case, that of stimulating employment, the government wants a bridge that requires as many workers as possible, for their employment is its actual purpose. The greater the number of workers employed, of course, the greater must be the cost of the bridge.

Indeed, no one could be more clear or explicit concerning the nature of government “fiscal policy” and its “stimuli” than Keynes himself, who declared (on p. 129 of his General Theory) that “Pyramid building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better.”

Acts of sheer destruction, such as wars and natural disasters, appear as beneficial to Keynes and his followers for the same reason that the “stimulus” of government-financed consumption appears beneficial. This is because they too create a need for replacement and thus allegedly result in an increase in employment and production. So widespread is this view that one can very often hear people openly express favorable opinions about the alleged economic benefits of such things as earthquakes, hurricanes, and even wars.

Stimulus Packages Mean More Loss of Capital

Despite the fact that what the economic system needs for recovery is saving and the accumulation of new capital, to replace as far as possible the capital that has been lost, the effect of stimulus packages is further to reduce the supply of capital, and thus to worsen the recession or depression.

The reason that stimulus packages cause a further loss of capital is that their starting point is the consumption of previously produced wealth. That wealth is part of the capital of the business firms that own it. The stimulus programs offer money in exchange for this wealth and capital. But the money they offer does not come from the production of any comparable wealth by the government or those to whom it gives money—wealth which has had to be produced and sold and thus put into the economic system prior to the withdrawal that now takes place. The starting point for the government and its dependents is an act of consumption, which means a using up, a loss of previously existing wealth in the form of capital.

The supporters of stimulus packages look to the fresh production that is required to replace the wealth that has been consumed. It will require the performance of additional labor. They are delighted to the extent that this fresh production and additional employment materialize. They believe that at that point their mission has been accomplished. They have succeeded in generating new and additional economic activity, new and additional employment. The only shortcoming of such a policy, they believe, is that it may not be applied on a sufficiently large scale.

Unfortunately, there is something they have overlooked. And that is the fact that any fresh production and employment that results is incapable by itself of replacing the capital that was consumed in starting the process. The reason for this is that all production, including any new and additional production called into being by stimulus packages, itself entails consumption. And this consumption tends at the very least to approximate the fresh production and, indeed, is capable of equaling or even exceeding it.

Thus, for example, we start with the purchase and consumption of a new television set by someone who has not previously produced and sold anything of equivalent monetary value that provided the funds for his now buying the television set. He has simply received the money from the government. In this case, what we have is one television set withdrawn from the capital of the economic system and placed in the hands of a non-producing consumer.

We can assume, for the sake of argument, that the retailer of the television set will order a replacement set from the wholesaler, and that the wholesaler in turn will order a replacement set from the manufacturer. We can assume further that the manufacturer will now produce a new television set to replace the one that he sells to the wholesaler from his inventory.

The production of the replacement television set entails a using up of materials and components and part of the useful life of the plant and equipment required. Aspects of such using up of capital goods also take place on the part of the retailer and wholesaler and in the transportation of the television set.

Very importantly, any new and additional workers who may be employed—precisely the goal of the whole operation—in producing a new television set or in moving a television set through the channels of distribution must be paid wages, which they in turn will consume. The goods these workers receive when they spend their wages represents a further depletion of inventories, on the part of all the retailers with whom they deal. In addition, the various business firms involved have additional profits, or at least diminished losses, as the result of the various additional purchases. This enables their owners to consume more and probably results in the payment of additional taxes, which the government consumes.

Even whatever depreciation allowances are earned along the way in the various stages of replacing the television set are likely to be consumed. This is because in the context of a recession or depression investors are afraid of losses if they invest in private businesses and thus prefer to invest in short-term treasury securities, such as treasury bills, which they consider to be far safer. But when depreciation allowances are used to purchase treasury securities, they end up financing consumption rather than capital replacement. This is because the Treasury uses the proceeds from the sale of its securities to finance nothing but consumption, either that of the government itself or that of the private individuals to whom the government gives money.

The point here is that any replacement of a good consumed by a non-producer itself entails very substantial additional consumption of inventories and the useful life of plant and equipment of business firms. The same is obviously true of the replacement of goods that have simply been destroyed, whether by war or by an act of nature.

No matter how long the process of spending and respending of the funds introduced into the economic system by a stimulus package might continue—no matter how many instances of replacement production there might be following the purchase and consumption of our hypothetical television set or of any other such good—the initial loss of capital need never be made up.

This is because each act of replacement production is accompanied by corresponding additional consumption. Thus the initial act of consumption—or destruction—of wealth and capital may be followed by 10 or 100 acts of subsequent production, each carried on in order to replace the goods used up before it. But if each of these subsequent acts of production is accompanied by fresh consumption that is equivalent to it, the net effect is still one act of consumption. As a result, the supply of capital is reduced. For what is always present is X instances of production respectively following X+1 instances of consumption.

Now countries have suffered enormous losses of capital and yet still managed to recover and go on to new heights of wealth and prosperity. Germany and Japan in the decades following World War II are perhaps the most outstanding examples of this.

What enabled them to recover was not further acts of consumption, not “stimulus packages” of any kind, but increases in production in excess—substantially in excess—of increases in consumption. That is to say, it was a process of saving and capital accumulation that made their recovery possible. On average, people in those countries, in those years, saved and reinvested a major portion of their income, often in excess of 25 percent.

It is possible, but highly unlikely, that the replacement production induced by an initial consumption/destruction of wealth might itself entail some such new saving. If round after round of replacement production were in fact accompanied by some such saving, then, eventually, the original loss of capital would be made good. But that would be the case only if such saving was not offset by fresh acts of “stimulus” or other policies that waste or destroy capital.

However, as I say, such an outcome is highly unlikely. If for no other reason, this is because, as I have already pointed out, the stimulus packages take place in an environment in which investors fear to invest in private firms. As a result, they use not only whatever new and additional savings they might make, for the purpose of buying “safe” treasury securities but also even funds they earn that are required for the replacement of capital goods. In this way, savings are diverted into consumption rather than capital accumulation.

(It is ironic that while, if it did manage to occur and was not diverted into consumption, such saving might mitigate the effects of a stimulus package, it is attacked as undermining the process of recovery. Thus, for example, Paul Krugman, the 2008 Nobel Prize winner in economics, writes: “Meanwhile, it’s clear that when it comes to economic stimulus, public spending provides much more bang for the buck than tax cuts…because a large fraction of any tax cut will simply be saved.” New York Times, January 26, 2009, p. A23.)

In addition to the diversion into consumption of such new savings as might occur subsequent to a “stimulus,” there is the fact that the source of any such saving, namely, the net product produced, is likely to be greatly diminished. The net product is the excess of the product produced over the capital goods used up in order to produce it. It is what is available for consumption or saving out of current wage, profit, and interest income.

The net product is diminished to the extent that production is made to take place in accordance with methods requiring the employment of unnecessary capital goods per unit of output. Environmental and consumer product safety legislation provide numerous instances of this kind.

For example, requiring gas stations, dry-cleaning establishments, and many other types of businesses to substantially increase their capital investments merely in order to placate the largely groundless fears of the environmental movement. Similarly, requiring safety features in automobiles, dishwashers, display cases, ice machines, stepladders, and countless other goods—features that the market does not judge to be worth their cost—adds to the cost of the materials and components that enter into the production of products without increasing the perceived value of the products. In both instances, the result is a larger consumption of capital goods but no increase in production, and thus a reduction in the size of the net product produced and thus in the ability to engage in saving out of current income.

As indicated in Part I of this article, the effect of capital decumulation, whether caused by stimulus packages or anything else, is a reduction in the ability of the economic system to produce, to employ labor, and to provide credit, for each of these things depends on capital. The reduced ability to produce and employ labor may not be apparent in the midst of mass unemployment. But it will become apparent if and when economic recovery begins. At that point, the economic system will be less capable than it otherwise would have been, because of the reduction in its supply of capital. Real wages and the general standard of living will be lower than they otherwise would have been. And all along, the ability to grant credit will be less than it otherwise would have been.

Stimulus Packages Are a Drain on the Rest of the Economic System

Even though stimulus packages may be able to generate additional economic activity, they cannot achieve any kind of meaningful economic recovery. Their actual effect is the creation of a system of public welfare in the guise of work. That is in the nature of employing people not for the sake of the products they produce but having them produce products for the sake of being able to employ them.

But stimulus packages are much more costly than simple welfare. On top of the welfare dole that allows unemployed workers to live, stimulus packages add the cost of the materials and equipment that the workers use in producing their pretended products.

The work created by stimulus packages is a make-believe work that is carried on at the expense of the rest of the economic system. It draws products and services produced in the rest of the economic system and returns to the rest of the economic system little or nothing in the way of goods or services that would constitute value for value or payment of any kind. In other words, stimulus packages and the needless work they create cause the great majority of other people to be poorer. I’ve already shown how they cause them to have less capital. Shortly, I will show how they also cause them to consume less. (For elaboration on this point, please see the forthcoming republication of my article “Who Pays for `Full Employment’?”)

Rising Prices in the Midst of Mass Unemployment

If economic recovery is to be achieved, the first thing that must be done is to stop “stimulus packages” and undo as far as possible any that are already in progress. This is because their effect is to worsen the problem of loss of capital that is the underlying cause of the economic crisis in the first place.

Unfortunately, they are not likely to be stopped. If they are implemented, especially on the scale already approved by Congress, the effect will be a decumulation of capital up to the point where scarcities of capital goods, including inventories of consumers’ goods in the possession of business firms, start to drive up prices.

Higher prices of consumers’ goods will result not only from scarcities of consumers’ goods (which, of course, are capital goods so long as they are in the hands of business firms), but also from scarcities of capital goods further back in the process of production. Thus a scarcity of steel sheet will not only raise the price of steel sheet, but will carry forward to the price of automobiles via the higher cost of producing automobiles that results from a rise in the price of steel sheet. Likewise, a scarcity of iron ore will carry forward to the price of steel sheet, which, again, will carry forward to the price of automobiles. And, of course, the pattern will be the same throughout the economic system, in such further cases as oil and oil products, cotton and cotton products, wheat and wheat products, and so on.

A rise in the prices of consumers’ goods is capable of stopping further capital decumulation stemming from the stimulus packages. When the point is reached that additional funds spent on consumers’ goods serve merely to raise their prices, then no additional quantities of them are sold. The same quantities are sold at higher prices. This ends the decumulation of inventories. From this point on, the buyers who obtain their funds from the government consume at the expense of people who have earned their incomes but now get less for them.

Once inventories become scarce in relation to the spending for goods, all of the funds that the government has been pouring into the economic system become capable of launching a major increase in prices. This rise in prices can take place even in the midst of mass unemployment. This is because the abundance of unemployed workers does nothing to mitigate the scarcity of capital goods that has occurred as the result of the attempts to stimulate employment.

Even though rising prices can deprive stimulus packages of the ability to cause further capital decumulation, the inflation of the money supply by the government results in continuing capital decumulation. In large part, this occurs as the result of the fact that the additional spending resulting from a larger money supply raises business sales revenues immediately while it raises business costs only with a time lag. So long as this goes on, profits are artificially increased.

Despite the fact that most or all of the additional profits may be required simply in order to replace assets at higher prices, the additional profits are taxed as though they were genuine gains. This impairs the ability of firms to replace their assets. The destructive consequences of this phenomenon can be seen in the transformation of what was once America’s industrial heartland into the “rustbelt.”

At the same time, throughout the economic system, starting long before today’s stimulus packages and continuing on alongside them, regular, almost year-in, year-out government budget deficits do their work of destruction. They cause a continuing diversion into consumption not only of a considerable part of whatever savings might be made out of income but also of the replacement allowances for the using up of plant and equipment and all other fixed assets. Generations of government budget deficits have sucked up trillions of dollars of what would have been capital funds and have gone a long way toward turning America into an industrial wasteland.

The blind rush into massive “stimulus packages” is the culmination of generations of economic ignorance transmitted from professor to student in the guise of advanced, revolutionary thinking—the “Keynesian revolution.” The accelerating destruction of our economic system that we are now experiencing is the product of a prior destruction of economic thought. Our entire intellectual establishment has been the victim—the willing victim—of a massive intellectual con job that goes under the name “Keynesianism.” And we are now paying the price.

I say, willing victims of an intellectual con job. What other description can there be of those who were ready to hail as a genius the man who wrote, “Pyramid building, earthquakes, even wars may serve to increase wealth….”

Only a brave few—most notably Ludwig von Mises and Henry Hazlitt— stood apart from this madness, and for doing so, they were made intellectual pariahs. But the time is coming when it will be clear to all who think that it is they who have had the last word.

*Copyright © 2009, by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. He is also a Senior Fellow at the Goldwater Institute. His web site is and his blog is A pdf replica of his book can be downloaded to the reader’s hard drive simply by clicking on the book’s title Capitalism: A Treatise on Economics and then saving the file when it appears on the screen. The book provides an in-depth, comprehensive treatment of the material discussed in this and subsequent articles in this series and of practically all related aspects of economics.

Saturday, February 21, 2009


This two-part article is the second in a series of articles that seeks to provide the intelligent layman with sufficient knowledge of sound economic theory to enable him to understand what must be done to overcome the present financial crisis and return to the path of economic progress and prosperity. The first article in the series was “Falling Prices Are Not Deflation but the Antidote to Deflation.”

Part I: Capital, Saving, and Our Economic Crisis

Imagine an individual who is lethargic and lacks the energy to function at his normal level because of too little sleep. There are drugs that can make him feel fully refreshed, even after a night without any sleep whatever, and apparently capable of functioning the next day with full efficiency.

Nevertheless taking such drugs is definitely not a good idea. This is because the individual’s underlying problem of insufficient sleep is not only not addressed by his being stimulated but is actually worsened. For the stimulus further depletes his body’s already diminished energy reserves and takes him down the path of utter exhaustion.

This description applies to the current slowdown in our economic system and to the efforts to overcome it through the use of “fiscal policy” and its “stimulus packages.” The meaning of these terms is more government spending and lower taxes specifically designed to promote consumption. This includes giving income-tax refunds to people who paid no income tax and who, because of their low incomes, can presumably be most counted on to rush out and consume more as soon as additional funds are put in their hands.

The main difference between such economic “stimulants” and pharmaceutical stimulants is that the economic stimulants will not succeed even in temporarily restoring the economic system to anything approaching its normal level of activity.

An economic system entering into a major recession or depression is in a situation very similar to that of our imaginary, sleep-deprived individual. All that one need do is substitute for the loss of the sleep required for the body’s proper functioning the loss of something required for the proper functioning of the economic system.


In the case of the economic system, that something is capital. The economic system is not functioning properly because it has lost capital. Capital is the accumulated wealth that is owned by business enterprises or individuals and that is used for the purpose of earning profit or interest.

Capital embraces all of the farms, factories, mines, machinery and all other equipment, means of transportation and communication, warehouses, shops, office buildings, rental housing, and inventories of materials, components, supplies, semi-manufactures, and finished goods that are owned by business firms.

Capital also embraces the money that is owned by business firms, though money is in a special category. In addition, it embraces funds that have been lent to consumers at interest, for the purpose of buying consumers’ goods such as houses, automobiles, appliances, and anything else that is too expensive to be paid for out of the income earned in one pay period and for which the purchaser himself does not have sufficient savings.

The amount of capital in an economic system determines its ability to produce goods and services and to employ labor, and also to purchase consumers’ goods on credit. The greater the capital, the greater the ability to do all of these things; the less the capital, the less the ability to do any of these things.


Capital is accumulated on a foundation of saving. Saving is the act of abstaining from consuming funds that have been earned in the sale of goods or services.

Saving does not mean not spending. It does not mean hoarding. It means not spending for purposes of consumption. Abstaining from spending for consumption makes possible equivalent spending for production. Whoever saves is in a position to that extent to buy capital goods and pay wages to workers, to lend funds for the purchase of expensive consumers’ goods, or to lend funds to others who will use them for any of these purposes.

It is necessary to stress these facts because of the prevailing state of utter ignorance on the subject. Such ignorance is typified by a casual statement made in a recent New York Times news article. The statement was offered in the conviction that its truth was so well established as to be non-controversial. It claimed that “A dollar saved does not circulate through the economy and higher savings rates translate into fewer sales and lower revenue for struggling businesses.” (Jack Healy, “Consumers Are Saving More and Spending Less,” February 3, 2009, p. B3.)

The writer of the article apparently believes that houses and other expensive consumers’ goods are purchased out of the earnings of a single week or month, which is the normal range of time between paychecks. If that were the case, no savings would be necessary in order to purchase them. In fact, of course, the purchase of a house typically requires a sum equal to the purchaser’s entire income of three years or more; that of an automobile, the income of several months; and that of countless other goods, too large a fraction of the income of just one pay period to be affordable out of such limited funds.

In all such cases, a process of saving is essential for the purchase of consumers’ goods. The savings accumulated may be those of the purchaser himself, or they may be borrowed, or be partly the purchaser’s own and partly borrowed. But, in every case, savings are essential for the purchase of expensive consumers’ goods.

The Times reporter, and all of his colleagues, and the professors who supposedly educated him and his colleagues, all of whom spout such nonsense about saving, also do not know other, even more important facts abut saving. They do not know that saving is the precondition of retailers being able to buy goods from wholesalers, of wholesalers being able to buy goods from manufacturers, of manufacturers, and all other producers, being able to buy goods from their suppliers, and so on and on. It is also the precondition of sellers at any and all stages being able to pay wages.

Such expenditures must generally be made and paid for prior to the purchaser’s receipt of money from the sale of his own goods that will ultimately result. For example, automobile and steel companies cannot pay their workers and suppliers out of the receipts from the sale of the automobiles that will eventually come in as the result of using the labor and capital goods purchased. And even in the cases in which the payments to suppliers are made out of receipts from the sale of the resulting goods, the seller must abstain from consuming those funds, i.e., he must save them and use them to pay for the capital goods and labor he previously purchased.

In contrast, the Keynesian reporters and professors believe that sellers do nothing but consume or hoard cash. They are too dull to realize that if that were really the case, there would be no demand for anything but consumers’ goods. This becomes clear simply by following the pattern of the Keynesian textbooks in allegedly describing the process of spending.

Thus a consumer buys, say, $100 dollars worth of shirts in a department store; the owner of the department store, following his Keynesian “marginal propensity to consume” of .75, then buys $75 worth of food in a restaurant, and allegedly hoards the other $25 of his income; the owner of the restaurant then buys $56.25 (.75 x $75) worth of books, while allegedly hoarding the remaining $18.75 of his income; and so on and on. Now, unknown to the Keynesians, if such a sequence of spending actually took place, all that would exist is a sum of consumption expenditures and nothing else.

The fact is that most spending in the economic system rests on a foundation of saving. The seller of the shirts will likely save and productively expend $95 or more in buying replacement shirts and in paying his employees and making other purchases necessary for the conduct of his business, and perhaps only $5 on consumption. And so it will be for those who sell to him, or to the suppliers of his suppliers, or to the suppliers of those suppliers, and so on.

Any business income statement can provide a simple confirmation of such facts. The ratio of costs to sales revenues that can be derived from it, is an indicator of the ratio of the use of savings to make expenditures for labor and capital goods relative to sales revenues. For the costs it shows are a reflection of expenditures for labor and capital goods made in the past. The saving and productive expenditure out of current sales revenues will show up as costs in the future. The higher is the ratio of costs to sales, the higher is the degree of saving and productive expenditure relative to sales revenues. A firm with costs of $95 and sales revenues of $100 is a firm that can be understood as saving and productively expending $95 out of its $100 of sales revenues. This relationship applies throughout the economic system.

Hoarding Versus Saving

To the extent that “hoarding” or, more accurately, an increase in the demand for money for cash holding takes place, it is not because people have decided to save. What is actually going on is that business firms and investors have decided that they need to change the composition of their already accumulated savings in favor of holding more cash and less of other assets.

For example, an individual may decide that instead of being 90 percent invested in stocks and other securities and having only 10 percent of his savings in cash in his checking account, he needs to increase his cash holding to 20 or 25 percent of his savings.

Similarly, a corporation may decide that it needs to increase its cash holding relative to its other assets in order to be better able to meet its bills coming due. Indeed, this is happening right now as more and more firms find that they can no longer count on being able to borrow money for such purposes.

Furthermore, the increases in cash holdings that take place in such circumstances are not only not an addition to savings but occur in the midst of a sharp decline in the overall amount of accumulated savings. For example, the increases in cash holdings that are taking place today are in response to a major plunge in the real estate and stock markets, of numerous and sizable corporate bankruptcies, and of huge losses on the part of banks and other financial institutions.

All of this represents a reduction in asset values, i.e., in the value of accumulated savings. People are turning to cash in order to avoid further such losses of their accumulated savings. Of course, widespread attempts to convert assets other than cash into cash, entail further declines in the value of accumulated savings, since the unloading of those assets reduces their value.

Accumulated savings in the economic system have fallen by several trillion dollars, and nothing could be more incredible than that, in the midst of this, many people, including the great majority of professional economists, fear saving and think that it is necessary to stimulate consumption at the expense of saving. Such is the complete and utter lack of economic understanding that prevails.

One might expect that a group of people such as most of today’s economists, who pride themselves on their empiricism, would once and a while look at the actual facts of the world in which they live, and, in the midst of the loss of trillions of dollars of accumulated savings, begin to suspect that there might actually be a need to replace savings that have been lost rather than do everything possible to prevent their replacement.

Depressions and Credit Expansion

The loss of accumulated savings is at the core of the problem of economic depressions. Recessions and depressions and the losses that accompany them are the result of the attempt to create capital on a foundation of credit expansion rather than saving. Credit expansion is the lending out of new and additional money that is created out of thin air by the banking system, which acts with the encouragement and support of the government. The money so created and lent has the appearance of being new and additional capital, but it is not.

The fact of its appearing to be new and additional capital creates an exaggerated, false understanding of the amount of capital that is available to support economic activity. Like an individual who believes he has grown rich in the course of a financial bubble, and who is led to adopt a level of living that is beyond his actual means, business firms are led to undertake ventures that are beyond their actual means.

For an individual consumer, the purchase of an expensive home or automobile in the delusion that he is rich later on turns out to be a major loss in the light of the fact that he cannot actually afford these things and would have been better off had he not bought them. In the same way, business construction projects, stepped up store openings, acquisitions of other firms, and the like, carried out in the delusion of a sudden abundance of available capital, turn out to be sources of major losses when the delusion of additional capital evaporates.

Credit expansion also fosters an artificial reduction in the demand for money for cash holding, which sets the stage for a later rise in the demand for money for cash holding, such as was described a few paragraphs ago. The reduction in the demand for money for cash holding occurs because so long as credit expansion continues, it is possible for business firms to borrow easily and profitably and thus to come to believe that they can substitute their ability to borrow for the holding of actual cash. The rising sales revenues created by the expenditure of the new and additional money that is lent out also encourages the holding of additional inventories as a substitute for the holding of cash, in the conviction that the inventories can be liquidated easily and profitably.

Recessions and depressions are the result of the loss of capital in the malinvestments and overconsumption that credit expansion causes. The losses are then compounded by the rise in the demand for money for cash holding that subsequently follows. They can be further compounded by reductions in the quantity of money as well, such as would occur if the losses suffered by banks resulted in losses to the banks’ checking depositors. (Checking deposits are part of the money supply, indeed, the far greater part. In such cases, they would lose the status of money and assume that of a security in default, which would render them useless for making purchases or paying bills.)

The Housing Bubble

Our housing bubble is an excellent illustration of the malinvestment and overconsumption caused by credit expansion. Perhaps as much as $2 trillion or more of capital has been lost in the construction and financing of houses for people who, it turned out, could not afford to pay for them. The housing bubble was financed by the creation of $1.5 trillion of new and additional money in the form of checking deposits created for the benefit of home buyers.

The creation of these deposits rested on the readiness of the Federal Reserve System to create whatever new and additional supporting funds were required in the form of bank reserves. In the three years 2001-2004, the Federal Reserve created enough such funds to drive the interest rate paid on them, i.e., the Federal Funds Rate, below 2 percent. And from July of 2003 to June of 2004, it created enough such funds to hold this rate down to just 1 percent. The end result was a substantial reduction in mortgage interest rates and thus in monthly mortgage payments, which served greatly to increase the demand for houses.

Government also greatly contributed specifically to loans being made to homebuyers who were not credit worthy. It did this through its various loan-guarantee programs, carried out by Fannie Mae, Freddie Mac, and the Department of Housing and Urban Development; and by means even of outright extortion, though the Community Reinvestment Act, which required banks to make sufficient such loans as would satisfy local “community groups.”

In physical terms, the result of credit expansion was the passage of literally millions of houses that represented capital to the firms that built them, and to the banks and others that financed them, into the hands of consumers who not only had not contributed anything remotely comparable to the wealth and capital of the economic system but also had no realistic prospect of ever being able to do so. The further result has been that many of the builders of these houses are now ruined as are many of the banks and other investors that financed the construction and sale of those houses. And because so many lenders have lost so much, the business firms that depend on them for loans can no longer obtain those loans, and so they must close their doors and fire their workers.

The growing problem of unemployment that we are experiencing and the accompanying reduction in consumer spending on the part both of the unemployed and of those who fear becoming unemployed is the result of this loss of capital, not of any sudden, capricious refusal of consumers to spend or of banks to lend. Indeed, the kind of consumer spending that so many people want to revive and encourage, by means of “stimulus packages,” played a major role in the loss of capital that has taken place and now results in unemployment and impoverishment.

During the housing boom, millions of owners of existing houses thought that they were growing rich as the result of the rise in the prices of their homes and that they could actually live to a substantial degree off the accompanying increase in the equity in their homes. They borrowed against the increased equity and spent the proceeds. This consumption was at the expense of capital investment in the economic system, which was rendered correspondingly poorer by it. And when housing prices collapsed, and fell below the enlarged mortgage debts that had been taken on, the effect was to add to the losses suffered by lenders. This was the case to the extent such equity-consuming homeowners then walked away from their homes, leaving their creditors to lose by the decline in the price of their homes.

Keynesian Ignorance and Blindness

The immense majority of people, including, of course, most professional economists, are ignorant of the actual nature and cause of our financial crisis. This is because they are ignorant of the role of capital in the economic system. They are all Keynesians. (Even Milton Friedman, the alleged arch-defender of capitalism is reported to have said, “We are all Keynesians now.”)

But as von Mises so aptly put it, “The essence of Keynesianism is its complete failure to conceive the role that saving and capital accumulation play in the improvement of economic conditions.” (Planning for Freedom, 4th ed., p. 207. Italics in original.) In the eyes of Keynes and his countless followers, economic activity begins and ends with consumption.

So deeply do people hold the view that consumption is everything, that it blinds them to obvious facts. Thus, the present crisis has been well underway at least since the late spring of 2007, when the sudden collapse of two large Bear Stearns hedge funds occurred. This was followed by a continuing string of bankruptcies between June of 2007 and August of 2008 of significant-sized and fairly well-known firms, such as Aloha Airlines, Levitz Furniture, Wickes Furniture, Mervyns Department Stores, Linens N’ Things, IndyMac Bank, and Bear Stearns itself. The list includes an actual run on a major bank—Northern Rock in Great Britain—in September of 2007, probably the first such run since the 1930s.

Financial failures reached a crisis point in September of 2008, with the collapse of such major firms as American International Group (AIG), Lehman Brothers, and the Halifax Bank of Scotland. These were followed by the bankruptcy of Fannie Mae and Freddie Mac, the two giant government-sponsored mortgage lenders that had led the way in guaranteeing sub-prime mortgages to borrowers who could not repay them.

Yet as late as September of 2008, the unemployment rate in the United States was no more than 6.2 percent and at mid-month the Dow Jones Industrial Average was still well above 11,000.

All this confirms that the crisis did not originate in any sudden refusal of consumers to consume or in any surge in unemployment. To the extent that unemployment is growing and consumption is declining, they are both the consequence of the economy’s loss of capital. The loss of capital is what precipitated a reduction in the availability of credit and a widening wave of bankruptcies, which in turn has resulted in growing unemployment and a decline in the ability and willingness of people to consume. The collapse in home prices and the more recent collapse in the stock market have also contributed to the decline in consumption, and probably to an even greater extent, at least up to now. Both of these events are also an aspect of the loss of capital and accumulated savings.

What Economic Recovery Requires

What all of the preceding discussion implies is that economic recovery requires that the economic system rebuild its stock of capital and that to be able to do so, it needs to engage in greater saving relative to consumption. This is what will help to restore the supply of credit and thus help put an end to financial failures based on a lack of credit.

Recovery also requires the freedom of wage rates and prices to fall, so that the presently reduced supply of capital and credit becomes capable of supporting a larger volume of employment and production, as I explained in
“Falling Prices Are Not Deflation but the Antidote to Deflation,” which was my first article in this series. Recovery will be achieved by the combination of more saving, capital, and credit along with lower wage rates, costs, and prices.

In addition, recovery requires the rapid liquidation of unsound investments. If borrowers are unable to meet their contractual obligation to pay principal and interest, the assets involved need to be sold off and the proceeds turned over to the lenders as quickly as possible, in order to put an end to further losses and thus salvage as much capital from the debacle as possible.

In the present situation of widespread financial paralysis, firms and individuals can be driven into bankruptcy because they are unable to collect the sums due them from their debtors. Thus, for example, the failure of mortgage lenders would be alleviated, if not perhaps altogether avoided in some cases, if the mortgage borrowers who were in default on their properties lost their houses quickly, with the proceeds quickly being turned over to the lenders.

In that way, the lenders would at least have those funds available to meet their obligations and thus might avoid their own default; in either event, their creditors would be better off. In helping to restore the capital of lenders, or what will become the capital of the creditors of the lenders, quick foreclosures would serve to restore the ability to originate new loans.

Recovery requires the end of financial pretense. There are banks that do not want to see the liquidation of various types of assets that they own, notably, “collateralized debt obligations” (CDOs). These are securities issued against collections of other securities, which in turn were issued against collections of mortgages, an undetermined number of which are in default or likely to go into default. The presumably low prices that such securities would bring in the market would likely serve to reveal the presence of so little capital on the part of many banks that they would be plunged into immediate bankruptcy. To avoid that, the banks want to prevent the discovery of the actual value of those securities. At the same time, they want creditors to trust them. Yet before trust can be established, the actual, market value of the banks’ assets must be established, even if it serves to bankrupt many of them. The safety of their deposits can be secured without the banks’ present owners continuing in that role.

When these various requirements have been met and the process of financial contraction comes to an end, the profitability of business investment will be restored and recovery will be at hand.

Next: Part II: Stimulus Packages

*Copyright © 2009, by George Reisman. George Reisman, Ph.D. is the author of
Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. He is also a Senior Fellow at the Goldwater Institute. His web site is and his blog is A pdf replica of his book can be downloaded to the reader’s hard drive simply by clicking on the book’s title Capitalism: A Treatise on Economics and then saving the file when it appears on the screen. The book provides an in-depth, comprehensive treatment of the material discussed in this and subsequent articles in this series and of practically all related aspects of economics.

Saturday, February 07, 2009

New York Times Columnist Maureen Dowd Wants Soviet-Style Show Trials with Capitalist Defendants in Shackles

New York Times columnist Maureen Dowd has written a column (January 28, 2009) full of withering hatred and contempt for many of today’s most prominent businessmen, first and foremost the heads of the Wall Street Banks. She singles out Citigroup and Merrill Lynch in particular, denouncing the first for going ahead with taking delivery of a $50 million luxury jet at the very time the firm was losing billions, and the last CEO of the second, John Thain, for spending $1 million to redecorate his office, also in the midst of his firm’s suffering major losses.

Her column leaves the reader with a view of these people and, by implication, of practically the whole economic class to which they belong, i.e., virtually all businessmen and capitalists, as having a mentality that combines the worst features of Marie Antoinette and Nero. The former, of course, was Queen of France until 1793, when she was beheaded. She is famous for allegedly having said in response to being informed of the peasantry’s lack of bread, “Let them eat cake.” And Nero was the Roman emperor who is known for having fiddled while Rome burned, and who died in 68 AD, committing suicide when he learned that the Roman Senate had ordered that he be flogged to death.

Having led her readers to such an assessment of these people, she concludes her column with the declaration, “Bring on the shackles. Let the show trials begin.” If they do begin, Dowd will be there, perhaps with knitting needles, in the role of a modern-day Madame Defarge, the Dickens character who knitted while watching aristocrats being guillotined during the French Revolution.

The day after Dowd’s column appeared, a news story in The Times reported that, “Despite crippling losses, multibillion-dollar bailouts and the passing of some of the most prominent names in the business, employees at financial companies in New York, the now-diminished world capital of capital, collected an estimated $18.4 billion in bonuses for the year. That was the sixth-largest haul on record, according to a report released Wednesday by the New York State comptroller.”

The day after that, President Obama called the bonuses “shameful.”

The Fate of Capitalism

It is very easy to interpret the kind of facts that have been described, as an indictment of the capitalist system, which is exactly how they are being interpreted. Millions of people have lost their jobs; millions more fear that they will lose theirs. These millions cannot avoid the further fear that they and their families will be utterly impoverished. And they are being led to blame their losses on capitalism, in large part by being led to blame it on the persons of individual businessmen or capitalists whom they perceive as hateful.

What is present and being inflamed is the psychology of an angry mob. Its sympathies are with innocent victims who have suffered a great wrong. It’s sure it knows who is responsible and how. The next step will be for someone to yell, “Get a rope!”

Already, businessmen and capitalists are starting to cower in fear. Corporations are racing to get rid of their private jets. Next it will be their private dining rooms and limousines. Private profit and personal luxury at any level are in danger before the onslaught of a collectivist mentality that holds that if many are suffering, all must suffer, and, further, that those who do not suffer are responsible for the suffering of those who do. Anyone whose head is above the crowd will risk being a target.

This is the time for everyone to recall whatever instances in his life that he remembers when angry mobs turned out to be wrong. Perhaps it’s only a scene from a movie or book, in which someone is able to present a few facts that the mob doesn’t know and that begin to place things in a different, calmer light. Let me be that someone now and begin with one very important and fundamental relevant fact.

Today’s Economic System Is A “Mixed Economy,” Not Laissez-Faire Capitalism

And that is that even if all of the facts as presented were absolutely true, it would not imply any reason whatever to condemn capitalism. Capitalism is a system in which absurd, self-destructive behavior severely punishes whoever is guilty of it. Such people suffer losses, go bankrupt, and lose their ability to have significant further economic influence. Their example then serves as a lesson to others to avoid such behavior.

However, we are very far from having capitalism today, certainly not capitalism in its logically consistent form of laissez-faire capitalism. What we have today is a “mixed economy,” that is, a severely hampered, distorted form of capitalism. In such a system, such behavior can continue, thanks to government subsidies, grants of monopoly privilege and suppression of competition, and now by means of government “bailouts.”

A mixed economy is an economy which remains capitalistic in its basic structure, but in which the government extensively intervenes with the initiation of physical force to compel actions that are against the interest of individuals and/or to prohibit actions that are in the interest of individuals. For example, today it compels people to pay an income tax, which is against their interest but which they pay in order to stay out of jail. It also prohibits them from engaging in various business mergers or paying wages below a certain amount, things which it would be to their interest to do but now do not, because they wish to avoid being fined or imprisoned. (In my recent article
“The Myth that Laissez Faire Is Responsible for Our Financial Crisis,” I present an extensive description of the extent of government intervention.)

A mixed economy lacks the fundamental moral-political principles that are needed to determine what is proper or improper for a government to do. Its only principle, if one can call it that, is that the government can do anything that enough people believe will accomplish what they think is “good,” according to an undefined standard. Our mixed economy rests on the effective discarding of the United States Constitution, which placed severe limits on government power and thus stood as a bulwark in defense of an economic system that was almost one of laissez-faire. The Constitutional protections were discarded by a process of pretending that the Constitution could somehow “grow” or “evolve,” which actually meant nothing other than choosing to ignore it.

In a mixed economy, every significant-sized business must fear what the government can do to it. It needs protection, in the form of political connections. It secures these through appointing former government officials to its board of directors, paying such officials lavish consulting fees, and giving lavish campaign contributions to candidates for public office. In these ways it buys the protection it needs.

But soon businesses learn that their protectors can also be used to gain lucrative government contracts, government subsidies, and monopolistic privileges ranging from tariffs and licensing laws to antitrust suits against competitors. Thus, it is not long before the upper echelons of large firms become populated not only with men who cower before the government but also with those who seek to manipulate the government to their advantage, which is where we are today.

Certainly not all big businessmen are this way, and probably only a few of those that are, are so through and through. For the most part, they still have real jobs to do in running their companies, and to the extent they simply do those jobs, they are productive. But probably most big businessmen are morally compromised if only because they must live in fear of the government and are helpless to do anything about it.

Responsibility for the Financial Crisis

There is a sense in which an important sub-group of businessmen does have genuine responsibility for the present economic crisis and for all previous crises of financial contraction and deflation. This is the sub-group of commercial bankers.

Ironically, the way in which they have been responsible is by means of doing something that almost everyone very much wants them to do, above all, the government, and even when the crisis comes, still wants them to do or to get back to doing as soon as possible. This something is the practice of credit expansion. Credit expansion is the lending out of new and additional money that is created out of thin air, with the encouragement and support of the government. Governments value and encourage credit expansion both in the mistaken belief that it is a source of prosperity and in the knowledge that it is a ready source of money to finance government spending.

Credit expansion is what creates a delusion of prosperity while it lasts and economic depression when it ends. It is all that needs to be stopped to end the boom-bust cycle. (In this brief article, I must ask the reader who wants to understand the process, and how to stop it, to be content merely with references to further reading, namely, Chapters XX and XXXI of Ludwig von Mises’s
Human Action and Chapters 12 and 19 of my own Capitalism: A Treatise on Economics. Concerning the role of credit expansion in our present crisis in particular, please see my articles “The Myth that Laissez Faire Is Responsible for Our Financial Crisis,” “Our Financial House of Cards and How to Start Replacing It With Solid Gold,” and “The Housing Bubble and the Credit Crunch.”)

I want now to deal with the subjects of bonuses and corporate jets.


Granting bonuses to employees and buying jet planes are perfectly legitimate for private business firms. In today’s context, this means firms that have not received government bailout money.

Giving bonuses and buying jet planes are purely business decisions. It’s only a question of whether the bonuses motivate the employees who receive them to bring in profits to the firm that are greater than the bonuses paid, or not. If the answer is yes, then it makes sense to pay the bonuses.

To the chief executive of a privately owned, non-taxpayer supported Wall Street firm, the payment of bonuses even in a year of calamitous losses may appear as still making economic sense, at least if the firm expects to stay in business. This is because the bonuses are not paid to people who have incurred the firm’s losses. Those losses are in the assets the firm owns. They are not in its day-to-day trading operations, which may continue to be profitable.

The situation is analogous to that of a retail chain which has had massive losses because of such things as fire or hurricane damage to its warehouses, but whose stores are still making money. The Wall Street firm is still executing customers’ orders in buying and selling securities, it is still trading in currencies and in the futures markets, and still arranging mergers and acquisitions, and divestitures and breakups. All of these aspects of its business may well still be profitable.

The brokers and traders, the mortgage and acquisition specialists et al., and their various assistants and supporting staffs, have contributed very substantially to these operating profits. The same is true of many of the economic and financial researchers and analysts that the firm employs in connection with its still profitable operations. Money is set aside out of the year-end totals to pay bonuses to the members of such groups, based on their respective individual profitability. The bonuses are accumulated employee compensation, similar in nature to the commissions paid to retail sales clerks. If the firm expects to be in business in the following year, and wants to retain the services of these employees, who, despite the firm’s massive losses in its accumulated assets, have performed well, it probably needs to pay them their bonuses.

John Thain, the then president of Merrill Lynch tried to explain this fact to an interviewer, when he said, “If you don’t pay your best people, you will destroy your franchise” and they’ll go elsewhere, he said.

Ms. Dowd apparently does not know the difference between an operating profit and a balance-sheet loss. She apparently does not know the difference between the due of a successful salesman in a retail-store and the due of someone whose actions have served to burn down the store’s warehouse. But she does know how to be furious. She responded to this explanation by exclaiming:

Hello? They destroyed the franchise. Let’s call their bluff. Let’s see what a great job market it is for the geniuses of capitalism who lost $15 billion in three months and helped usher in socialism.
Despite her ignorance and her collectivism-inspired refusal to draw distinctions between individuals and their respective individual performances and responsibilities, Ms. Dowd does have something of a point. Namely, if because of the bankruptcy and closing of many Wall Street firms, there should be a glut of brokers and traders et al., then the remaining Wall Street firms would be in a position to reduce their compensation. But that would be something they would typically announce before the fact, not after the fact of an agreed-upon compensation having been earned.


My discussion of bonuses was in the context of the operations of a privately owned business firm, not one that has to be financially supported by the government and is operated with funds provided by taxpayers. In awarding bonuses after Merrill Lynch’s receipt of government bailout money, which started in September of 2008, Mr. Thain did not realize that he was no longer in charge of a private firm. He did not realize what difference this made to the fundamental character of his firm. Neither did very many other people at the time. But more on this later.

Corporate Jets

I turn now to the subject of corporate jets.

If a corporation can afford to buy a jet and having it will enable extremely high-paid executives to avoid wasting time waiting at airports and be able to be more efficient in working in the time spent in flight, then over time its purchase may actually save more money than it costs. If so, then it will be a good business decision to buy the plane.

It may even be a good business decision to buy it, if the executives who fly in it simply prefer it because it’s more comfortable and enjoyable. In such a case, even if the plane saves nothing in costs or not enough to justify its purchase, it can still make good economic sense for the firm to buy the plane. This will be the case if it is in a position to reduce the compensation paid to the executives in question by as much or more than the amount that it must expend for their personal benefit.

Thus, for example, if the plane falls short of covering its cost through increased productivity on the part of the executives by, say, $1 million per year, the firm will have the benefit of more satisfied executives at absolutely no net cost to itself, if it gets the executives to accept $1million less per year in monetary compensation. In that way, it is the executives who effectively bear the cost of the plane that is otherwise uncovered. And the firm will have whatever indirect monetary gains that may result from better satisfied executives.

Indeed, to the extent that the executives are willing to forgo an amount of compensation that is greater than what is required to cover any otherwise uncovered cost of the plane, the firm has a clear saving in monetary terms. Thus, if the executives can be paid $2 million less per year, while the otherwise uncovered part of the cost of the plane is still $1 million, the firm has a monetary saving of $1 million per year by buying the plane. (Today’s tax laws work in this direction. The replacement of $1 million in monetary compensation with $1 million in indirect compensation, serves to reduce the executives’ after-tax monetary compensation by perhaps as little as $500 thousand, while saving the corporation the full $1 million.)

Situations such as this actually occur all the time, throughout business. Again and again, firms provide fringe benefits that are of value to their employees but which do not cover their cost through increased productivity. They are motivated to provide them by being able to save more in what they would otherwise have to pay the employees in take-home wages than the cost of the fringe benefits.

For example, imagine the situation of employees having to choose between two employers. One of them provides air conditioning. The other does not. In the heat of summer, it is a comparative pleasure to work for the one, and extremely uncomfortable to work for the other. If the employees can earn $1,000 per week by working for the employer who provides air conditioning, and they value that air conditioning sufficiently, then in order to be induced to work for the second employer, they might require a wage of $1,100 per week. If that second employer can provide air conditioning at a cost to himself of, say, $10 per worker per week, then he will save $90 per worker per week if he provides it. Because in that case, he can obtain his workers for a take-home wage of $1,000 plus an air-conditioning cost of $10, instead of for a take-home wage of $1,100 plus no cost on account of air conditioning. Obviously, such conditions compel the employer to provide air conditioning. It is his recognition of such conditions that led the first employer to provide air conditioning to begin with, i.e., simply because employees value having it far more than the reduction in their take-home wages that is needed to pay for it.

This discussion has application to the $1 million office remodeling that so offended Ms. Dowd. Please keep in mind that the remodeling was commissioned in late 2007, when the executive in question started his position. At that time, Merrill Lynch had not yet received any government money and was thus still a fully privately owned company. The executive in question, John Thain, was a man in charge of the use of hundreds of billions of dollars of capital. And, therefore, if he was indeed the right man for the job, which is certainly what was hoped, was easily entitled to compensation at least as far into double-digit millions as that paid to Hollywood movie stars and leading athletes.

With this many millions in compensation, the value to him of $1 million more or less, may not have been terribly great. (Hollywood stars have weddings that cost more.) It may well have been far below the value he attached to spending his hours of working time in an office that was made to personally please him in every possible respect, and which he may have expected to occupy for many years. In such a case, instead of his firm paying him however many millions it otherwise would have paid him, it could pay him a million dollars less, or even more than a million dollars less. In that case, it was he who bore the cost of the office, out of compensation to which, in the judgment of the parties concerned, he was entitled.

Alternatively, it’s entirely reasonable that providing such an office and the optimum working environment that it provided, could be expected to improve his efficiency with respect to deciding the pattern of investment of his firm’s hundreds of billions of dollars of assets. It would not have taken a great deal of such improvement with respect to the use of sums so vast to be able to earn an additional billion or more of profit for his firm. Understanding this, the firm may well have given him his office in the belief that doing so would add vastly more to its profits than the cost of the remodeling.

When Ms. Dowd discussed this million-dollar office remodeling, her reaction was one of incredulity, outrage, and utter contempt. Here’s what she said (referring to an interviewer of the executive):

Bartiromo pressed: What was wrong with the office of his predecessor, Stanley O’Neal?

‘Well — his office was very different — than — the — the general décor of — Merrill’s offices,’ Thain replied. ‘It really would have been — very difficult — for — me to use it in the form that it was in.’
Dowd then asked in a triumph akin to that of crushing a cockroach:

Did it have a desk and a phone?
I can’t help wondering, if when Dowd may need a surgical operation someday, she will be satisfied if her surgeon has a table and a knife.


Government bailouts put everything in a different light. They give everyone in the country the right to second guess every decision of the firms that have received the bailouts, on the grounds that the money used by those firms is theirs, the taxpayers.

Understandably, the taxpayers become furious about things like bonuses, corporate jets, and expensive office remodelings. They see themselves simply as being made to pay for these things. This is because, unlike the shareholders of a private company, the taxpayers will never have any possible financial benefit even if the expenditures might actually be perfectly reasonable and well made if they took place in the context of a privately owned company. And unlike the shareholders of a private company, they were never given a choice about whether or not they wanted their funds to be turned over to this or that company. Their funds were simply seized in order that others might have the means with which to pay bonuses and financially profit from and/or personally enjoy such things as corporate jets and expensive offices.

Bailouts represent a collision between two incompatible modes of operation—between what Mises calls “profit management” and “bureaucratic management.” That is, they represent a collision between operation according to the principle of striving to make profits and avoid losses, which characterizes private business, and operation according to the dictates of rules and regulations, which characterizes government.

The companies bailed out expected to go on operating as private businesses, but with government money. That’s how the bailouts were advertised. But that is impossible.

Once government money enters the picture, the firms are effectively nationalized, even though the outward guise and appearance of private ownership may remain. This is because their operations are no longer based on profit-and-loss considerations but on satisfying the government and whatever sectors of public opinion are loud enough at the moment to influence the government’s decisions.

What precise actions the government will take are unclear at the moment and appear contradictory. For example, the front-page lead article of The New York Times of February 5, 2009 carries the headline “Executive Pay Limits Seek to Alter Corporate Culture,” followed by the subhead, “Obama Announces a $500,000 Cash Cap at Companies Getting Future Aid.”

Nevertheless, a careful reading of the article shows that $500,000 is a limit only on annual salary. Payment of stock options will still be possible, but they will not be able to be exercised until all of the company’s debt to the government is repaid. Even the limit on annual salary appears to be not very firm. In most cases, it can apparently be waived by means of a “nonbinding shareholder vote.”

The article declares,

Even the new rules allow companies some leeway. While giving shareholders a say in bonuses above the cap and restricting when stock incentives can be cashed in, the rules do not place limits on the size of such awards, which have become the biggest part of many compensation packages. In addition, the toughest new rules apply only to large companies seeking government assistance to survive…. And companies that seek aid but do not need exceptional government assistance can waive the $500,000 pay cap, as long as they submit their executive pay policies to a nonbinding shareholder vote.
Very significantly, the article notes that

The rules would not prohibit a lower-level executive, like a stock trader or investment banker, from continuing to receive tens of millions of dollars in pay. (My italics.)
If this last is true, then one must wonder exactly what the brouhaha about bonuses was all about in the first place. Because, with this last provision, they appear to be back in, almost in full force.

The current version of the proposed pay caps is clearly contradictory and bound to disappoint Wall Street’s critics. It reads like a compromise forged of a competition between whose lobbyists could get to which politicos with the largest bribes or greatest threats first. At this point, there is no telling what the final proposal will look like. The Times’s article notes that “Officials also emphasized that several of the proposals would not be made final until after public comments had been considered.”

What would be required to satisfy the rhetoric of Wall Street’s critics would be the total abolition of bonuses and a maximum limit on total executive compensation in the nationalized firms to $500,000 for any one individual. That, of course, would mean the destruction of the nationalized firms as viable institutions.

With such a level of compensation, further discussion of such things as corporate jets and expensive office remodelings would disappear, at least as far as the nationalized firms were concerned. This is because the low pay ceilings on executive salaries, and thus the kind of low quality executives likely to be attracted, would eliminate the context in which an economic calculation could justify the purchase of a jet or an expensive office remodeling.

Executives whose salaries are limited to $500,000 are not going to be able to afford to accept the kind of reduction in take-home wages that would be necessary to cover any significant part of the cost of providing a jet or an expensive office remodeling. Nor is any enhanced productivity of such executives likely to be great enough to justify the cost. The head of a government controlled firm may inherit a luxurious office but all that he can afford or that can be afforded on his behalf is not very much more than a desk and a phone—and volumes of rules and regulations that he can consult and scrupulously follow, in order to be able to prove that whatever losses may strike his firm were not his fault.

But the destruction of bailouts is not limited to the crippling of the firms that are bailed out. It also taints the operations of the firms that are operating without bailouts. As already pointed out, they too have given up their jets and are keeping their heads down, despite the fact that economic rationality implies that they should keep their jets. They have been cowed by a raging hostility toward capitalism and wealth.


I quote the words of a prominent New York Times reporter, who sees the facts of the situation, even describes some that I omitted, and yet approves of what has happened. He writes:

When you get right down to it, the purchase of a new plane or an office renovation is pretty meaningless for companies as large as Citigroup or Bank of America [Merrill Lynch is now part of Bank of America]. It’s not unheard of for executives to spend $1 million or more on remodeling when they get the corner office. It’s pocket change. And companies can usually make a halfway decent business case to justify a new airplane. (It goes longer distances than older planes, can take more executives to meetings, allows the top brass to be more efficient and productive, etc., etc.) The question of whether bailout money was used to pay for these perks — as alleged by The New York Post, which broke the Citi airplane story — is, at best, ambiguous. Indeed, breaking the airplane contract and sending the jet back to the manufacturer will probably
cost the bank more than keeping the plane. None of that matters. You could make the same argument about the auto executives who flew on corporate jets when they came to Washington to ask Congress for help: surely, it was a better use of their time to fly rather than drive from Detroit, as they did the second time around, after being spanked for taking the jets. That didn’t matter either. What matters is the symbolism. At a time when the country is in such trouble — and executives are asking for bailouts — anything that smacks of plutocracy is going to arouse justifiable populist anger. (Joe Nocera, “It’s Not the Bonus Money. It’s the Principle,” New York Times, January 31, 2009, p. B1. My italics.)
So here we have it. What the outrage is really all about is the hatred of great wealth and its possessors. The goal is to attack them in the name of an alleged duty of the individual to sacrifice his wealth, pleasure, and enjoyment, and ultimately his life, for the benefit of others less fortunate. Seen in this light, the furor raised about corporate jets, office remodelings, and the like is understandable. It is the kind of symbolism appropriate to a campaign on behalf of self-sacrifice and against the pursuit of happiness.

In sharpest contrast and opposition to the philosophy of self-sacrifice and to the role of government as the enforcer of sacrifice, stand these famous lines:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. — That to secure these rights, Governments are instituted among Men….
These words are from the Declaration of Independence, which is the founding document of the United States. Their meaning is that the United States was established for the purpose of securing the right of the individual to pursue his own happiness, which includes material prosperity. In the United States, the individual and his rights are supreme. Government exists only in a subordinate role, that of a servant dedicated to protecting and securing the individual and his rights from the aggression of common criminals at home and of despots abroad.

What symbolism would be appropriate to this conception of the relationship between the citizens and their government? How would it differ from the present such symbolism?

The present symbolism depicting the relationship between the government and the citizen is that the head of the government, the President of the United States, has at his disposal, with no objection from anyone, Air Force One, which is a Boeing 747 jet plane that costs hundreds of millions of dollars and, when configured for commercial operation, carries more than 450 passengers. At the same time, howls of anger and fury go up when one of the largest private corporations in the country dares to order a 12-seat jet plane for $50 million.

The acceptance of this relationship symbolizes the total reversal of the relationship between government and citizen that the founding of our country was intended to establish and maintain. The symbolism appropriate to that relationship would be that while private citizens are free to fly in 747s, or Lunar Landers for that matter, depending only on how successful is their individual pursuit of happiness, the President of the country, who is merely the chief night watchman of the nation, and is its servant, is consigned to a 12-seater jet.

Of course, this is not to begrudge the President of the United States the use of a 747 in today’s world, in which he may require such a plane merely in order to have necessary means of communication at his disposal. But it is to remind all those seeking to deify the government and raise it above the citizens, that they are encouraging a servant to forget his place and to become the master of those whom it is his duty to serve.

Copyright © 2009, by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. He is also a Senior Fellow at the Goldwater Institute. His web site is and his blog is A pdf replica of his book can be downloaded to the reader’s hard drive simply by clicking on the book’s title, above, and then saving the file when it appears on the screen. The book provides further, in-depth treatment of the substantive material discussed in this article and of practically all related aspects of economics.