U.S. Treasury Secretary Hank Paulson’s announcement that he will devote $800 million of his Goldman Sachs fortune to charitable activities, primarily in the area of the environment, brought coos of approval from the business and establishment press. In reality, it raises serious questions about the market’s efficiency. Does a system in which wealth is achieved primarily through rent seeking, and then redistributed through charitable donations, bear any relationship to a free market?
Free market absolutists may object that Paulson’s wealth was acquired honestly, as were most of the other gigantic fortunes that have appeared in the last decade, and that through charitable donation Paulson is able to mitigate the malign effects of excessive wealth concentration, and return wealth to the community at large. However from a free market perspective there are severe objections to both the last decade’s creation of these huge wealth pools and their dissipation through charitable bequests.
First, the free market paradigm assumes that money is of constant value, and that all prices are set by willing buyers and willing sellers in the market. In the days of the Gold Standard that was more or less true, although variations in the rate of finding gold produced inflationary and deflationary periods. However, with the rapid increase in world population after 1900 a Gold Standard which depended on finding new sources of gold to keep up with world population and wealth increase rapidly became excessively deflationary. When world GDP was increasing at 3% per annum (say half each from population increase and productivity increase) and gold supplies were increasing by 1% per annum, overall price levels were forced to decline by 2% per annum, dangerously close to the level at which the monetary system ceased to work properly because holding cash became too attractive an investment alternative.
However since the world went off the Gold Standard we have had fiat money, in which central bankers create money more or less ad hoc, according to whichever monetary theory is currently fashionable. It’s possible to run the world’s financial system under fiat money, and it may even be necessary because of the world’s excessive population growth, but to do so and maintain the conditions under which classical economic laws remain valid you have to expand money supply at a modest even rate, announced in advance, as did the Paul Volcker Fed of 1979-87 or the pre-1999 Bundesbank.
Nothing in economic theory suggests that the price mechanism should work properly in allocating resources with a randomly fluctuating money supply. The introduction of a non-market driven money controller into the financial system invalidates the assumptions on which free-market economic theory is based. In 1929-32, as Milton Friedman and Anna Schwarz demonstrated in their “Monetary History of the United States” that non-market player, the Federal Reserve system, kept money too tight and precipitated a depression of a duration and severity that should under the classical theory have been impossible.
Since 1995, the Federal Reserve under Alan Greenspan and Ben Bernanke has been at fault in the other direction. It has increased M3 money supply by almost 10% per annum, far more quickly than the growth in nominal Gross Domestic Product (since March 2006, when the Fed stopped reporting M3, we can’t tell what it’s been doing, but market conditions suggest that the laxity has continued.) It is only to be expected that, like the Fed’s excessive tightness in 1930-32, its excessive laxity over a period of more than a decade had a major distorting effect on the world economy; we just need to look a little harder to find that effect.
One would normally expect that a period of excessive monetary laxity would produce a burst of inflation, as the quantity and value of money adjusted themselves. It did in the 1970s. However since 1995 the world has enjoyed a supply-side benefit from the Internet and modern telecommunications, which have made it for the first time economically feasible to subcontract the production of a vast proportion of goods and services to the low-wage-cost Third World economies of India and China. This supply side effect has counterbalanced the monetary laxity, preventing the increase in consumer prices that would normally have occurred several years ago.
The suppression of price inflation has been assisted by politically-driven revisions in price indices in the U.S. (in 1996) and Britain (in 2003) by which inflation reported to the public was kept considerably below its actual rate. In the long run, this deceptive practice will be corrected for by the market. However, combined with the Internet supply side effect, it has over the past decade allowed the Fed to allow the money supply to grow more than it should, producing low real interest rates but not the burst in reported inflation that would have brought the bubble to an end.
Because of the suppression of price inflation, lax monetary policy has continued for far longer than would normally have been possible, fully 12 years, a period of monetary ease and low real interest rates entirely without precedent. For more than a decade price signals have been distorted and resources have flowed in artificial directions. On the asset side, this has been reflected first in an enormous boom in speculative tech stocks, then in a house price run-up which is only beginning to reverse (and has not yet done so in Britain), more recently in a tsunami of low quality “junk” corporate and emerging market debt and now in an explosion of private equity funds and hedge funds, far beyond the level imaginable a decade ago.
Globalization and the greater ease of outsourcing have kept wages down at the bottom of the scale in the US and Europe (an effect which excessively lax immigration policy has compounded.) However at the top of the scale those able to benefit from IPOs, those with excessively large homes, the managers of hedge funds and private equity funds and above all the gatekeepers such as Goldman Sachs, who control access to the overwhelming flood of liquidity, have all benefited far more than they should have in a well functioning economic system. It is in this sense that they have received “rents.”
The U.S. and world economic system has been distorted in these people’s favor for more than a decade, to the excessive benefit of their net worth. They have enjoyed a bubbling bull market for twelve years, and the wealth of the world has been artificially redistributed into their pockets. They have come to expect such benefits; the Goldman Sachs participation in the Initial Public Offering for the Industrial and Commercial Bank of China, in which the firm and its partners, mostly the latter individually, made a $6 billion profit due entirely to its insider position in the world financial markets, might have landed them in jail for insider trading in a more stringent environment but in this market only further fattened their bonus pool.
If the diversion of wealth to the very rich was artificial, how about their charitable donations? It is amply clear that these do not restore the status quo. Paulson’s $800 million could buy approximately 80 million pizzas for the working stiffs of America who have lost out in the last decade. If Paulson simply bought everybody pizza, that would restore wealth to its proper free-market destination. However, he hasn’t done this. Indeed I know of no case in which a billionaire bought eleemosynary pizzas with his wealth; the billionaire ego gets in the way.
In Paulson’s case, he has donated first $100 million and now $800 million to the Bobolink Foundation, an environmental charity he founded, and has stated that he intends to devote himself to charitable work when he leaves the Treasury. If he intends to give away the assets of the Bobolink Foundation during his lifetime, this will at least avoid the problem of many past foundations, which after the founder died became vehicles for left wing activism of a kind their founder would have abhorred. One thinks of the Ford and Rockefeller Foundations, and also of the John D. Macarthur Foundation, in which $5 billion of good conservative money was devoted to leftist political causes that would have been anathema to its donor. The Bill and Melinda Gates Foundation will also suffer from this problem when its founders die, if only because of its size, particularly now that Warren Buffett’s billions have been added to it. However in this case both Gates and Buffett are center-left, so the ideological shift will be less extreme.
There should be no question that a billionaire can do what he likes with his money. If H.L Hunt had wanted to use his billions to proclaim that Communists were destroying America’s precious bodily fluids through water fluoridation, he should have been able to do so, rather than see his wishes thwarted by trustees. However it must be questionable whether a tax exemption should be given for this purpose, let alone egregious tax benefits such as tax deductibility of stock grants on which capital gains tax has not been paid. In this respect, even if Paulson were to redistribute his wealth in the form of free pizza, economic damage would be done because the taxes on his accumulation would be correspondingly lowered while those U.S. taxpayers not in the Foundation class continued to pay full whack. At the very least, the tax deduction for charitable donations should be capped at 10% of income, in order that the U.S. budget can get the full benefit of tax on the rest. As a U.S. taxpayer I am otherwise subsidizing Paulson’s interest in the environment, and I object to so doing.
The other problem with large charitable donations, if they are made out of money that should in a free market have gone elsewhere, is that they impose the donor’s political and social views on those resources. Objectively, it may be economically and morally optimal for Bill and Melinda Gates’s money to be used to provide old age pensions to Africa, in order that the incentives for reproduction on that continent can be reduced and its catastrophic population growth rate stemmed. However, Gates Foundation money will not be used in an economically optimal manner, it will instead be used to subsidize whichever fashionable aid or environmental nostrums capture the Gates imagination.
To the extent that Gates or Paulson made their money in a free non-rigged market, this is appropriate – the resources devoted to their fads would have been collected through a free market process. However, when they became rich partly or wholly through the rent-granting effect of lax monetary policy and a series of asset bubbles, the ideological and social priorities of fashionable Georgetown and the Upper East Side are being given yet more weight in the economy than they already have, weight which they in no way deserve.
Paulson can avoid this problem by cancelling his donation to the Bobolink Foundation and buying everybody pizza (without imposing the organic vegetarian variety on us.) Hey Hank, mine’s a pepperoni with extra anchovy!
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)