How Countries Get Out Of Crisis

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Published : September 01st, 2020
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Category : Editorials

Today, there is a lot of talk that the U.S. is entering a crisis phase. This is right in line — both in character and timing — with the thesis presented 23 years ago by William Strauss and Neil Howe in The Fourth Turning (1997). But, today we will talk about how countries get out of crisis, in the most successful fashion.

Today’s difficulties are not, for the most part, economic in character, in the first instance. It is true that there have been some worrying long-term trends, notably an increase in public and private indebtedness. But, in 2019, the general trend was toward a more business-friendly tax system (due to the 2017 Trump tax cuts), and a Federal Reserve that was at least making a moderate effort at returning to “normalcy.”

Then, stuff happened. As is often the case, these non-economic challenges soon resulted in an economic policy response that will probably prove to be not such a good idea. I say that the Magic Formula is: Low Taxes and Stable Money. The Stable Money side of things, which went pretty well during the “Yellen gold standard,” has been severely compromised, as giant deficits, and the need to fund them, have become the new normal. This has been leading to a move toward higher taxes, not so much at the Federal level where the expectation is that deficiencies will be relieved, one way or another, by the Federal Reserve; but definitely at the State level where new tax increases are on the agenda.

I think this will probably lead to its natural conclusion in disaster. At least, we might come close enough to disaster (as we did in 1979-1980) that we will make a major change of direction to avoid it. Then what?

Caesar Augustus (63 B.C. – 14 A.D.) found Rome in ruin and civil war, and remade in peace, prosperity and abundance. How did he do it?

There is a lot more to good economic policy than the Magic Formula. But, Low Taxes and Stable Money are so important that, if you get these wrong, you can get everything else right and it won’t matter very much. Also, if you get these right, then you can get a lot of other things wrong, but it will work out OK. There is more to it than that: if you get the Magic Formula right, then it becomes a lot easier to get other things right as well. If you get it wrong, then everything else becomes a lot more difficult, and often one bad policy after another is implemented in a bonfire of economic destruction.

In 1949, both Germany and Japan were in the throes of hyperinflation. The war was long over, and both governments were under foreign military occupation. But, in 1949, as China went communist (also in the midst of hyperinflation in China), U.S. policy shifted toward building up the economies of Germany and Japan in an effort to contain the communist menace. The Germans and Japanese also favored this plan, so there was a political consensus.

The hyperinflation resulted because both governments, destitute and in economic ruin, had been funding themselves by the printing press. The first step was to make deficit spending and debt issuance illegal. This relieved the pressure on the central banks to buy government bonds with freshly-printed money. (”Modern Monetary Theory” has been around a long time.) The ban on debt issuance persisted in Japan until 1965! The next step was to put the German mark and Japanese yen on a gold standard, within the context of the Bretton Woods global gold standard system instituted in 1944. The parity rates were 4.2 marks/dollar and 360 yen/dollar. Since the dollar was linked to gold at $35/oz. in the Bretton Woods system, this translated into 147 marks/oz. and 12,600 yen/oz.

Then, both Germany and Japan had big reductions in tax rates. With Low Taxes and Stable Money, Germany and Japan had the best economic performance among major countries in the 1950s and 1960s. Japan’s nominal GDP actually increased by 16x over those 20 years, without any change in the yen’s value. Incredible. (I wrote about Japan’s postwar economic policy in more detail in Gold: The Once and Future Money (2007), and Germany in The Magic Formula (2019)).

France’s First Republic was a wreckage that had collapsed into hyperinflation when Napoleon Bonaparte, a general in the French army, stepped in to restore order in 1799. Once again, the Republic had been reduced to printing money to pay the bills, the notorious assignats. (This was wonderfully described in Fiat Money Inflation in France (1896), by Andrew Dickson White.) Napoleon put the franc back on the gold standard in 1800 at a parity of 107.24 francs/oz. This lasted until 1914. Napoleon also eliminated debt finance (since nobody would buy the debt except the central bank), running his government on a cashflow basis only, and reduced taxes. France, which was floundering in the gutter in 1799, soon recovered and resumed its natural role as a major European power.

The assassination of Julius Caesar in 44 B.C. plunged Rome into political instability and civil war. As rival factions clashed, the coinage was debased (the old-fashioned means of financing the government by “printing money”) and higher taxes were imposed, eventually degenerating into arbitrary confiscations by the for-profit tax farmers and roving militaries. After Caesar Augustus defeated his rival Marc Antony at the Battle of Actium in 31 B.C., he set about fixing the economic ruin of Rome.

A monetary reform in 23 B.C. established the gold and silver values for the denarius that held, with only minor slippage, for nearly two centuries afterwards. No more funding the government by minting coins at higher and higher denominations; nor was there any market for government debt. Rome was run on a cashflow basis. A major tax reform was undertaken in which the centuries-old and corrupt practice of tax farming was eliminated, and a new system of very low taxes was introduced. (As part of the implementation of this new tax system, a census of the Empire was undertaken, which is why Joseph and Mary had to travel to Bethlehem to be registered).

Augustus’ new system was Federal in nature. Rome would provide military protection and domestic order for the entire Empire. This was funded by a handful of minimal taxes: a sales tax of 1%, a 5% tax on inheritances, a 4% tax on slaves, and a 5% tax on imports. To keep Rome’s expenses low, Augustus cut the size of the military in half. Everything else was left to local governments within the Empire, where local taxes were introduced to fund local services. Rome itself remained tax-free. The result of this successful implementation of the Magic Formula was nearly two centuries of economic prosperity in Rome. Augustus is still considered today perhaps the finest leader in all of Western history. The month of August was named in his honor.

Let’s consider how this might apply to the United States, perhaps 5-10 years from now. Just as the wars and disorder during the 1780s led to the hyperinflation of the Continental dollar, so too we might by that time be disgusted with fiat money, printing-press finance, and its smarty-pants advocates.

The first step could be a ban on deficit finance and debt issuance, which would eliminate the pressure on the Federal Reserve (or whatever monetary arrangements are present) to help finance the government by means of the printing press. (This was also the pattern, more recently, at the Fed/Treasury Accord of 1951.) The U.S. Federal government would have to get by on current cashflow only.

This would be challenging, but since things would probably be in a state of disarray by that point — like France in 1799 and Rome in 31 B.C. — this could be accomplished with a wholesale reorganization of the Federal government’s priorities. I suggest that the easiest and best path would be for the Federal government to return to its Enumerated Powers under the Constitution — basically, a common military defense, foreign policy, domestic justice (a properly-operating justice system) and tranquility (suppression of domestic unrest). Everything else would simply be cancelled with immediate effect, returning all such responsibilities to the State level. This would allow a huge reduction in expenditure. It would return things to the way they were in 1925; and even, in large part, to the way things were in 1960, before the explosion of Federal social programs in the 1960s.

Just as Augustus did with Rome, nearly all domestic policy would be a matter for State and local governments as per the Tenth Amendment, to tax and spend as they see fit, according to their own Constitutions, legislatures, and electorates. This would allow a minimal Federal tax system. I suggest eliminating all existing Federal taxation in favor of a simple, low, uniform tax, such as a 10% (or lower) national retail sales tax or VAT, and no other taxes on payrolls, income, or capital. (Income taxes, and all other “discriminatory” or non-uniform Federal taxes, should be banned by Constitutional Amendment.)

I think it is safe to say that the most successful States under this program would be those that provided tranquility, justice and sound administration, with low taxes. That is already the pattern, as the productive classes flee Democrat-run states to the low-tax havens of Florida, Texas or Nevada.

You could write a big book about all the governments that were not successful in recovering from their Crisis phases. (Rome after 260 A.D., for example; or Spain after 1600.) The successful ones have certain things in common — basically, the Magic Formula. Unfortunately, knowing this today probably won’t change the general course of things. Winter must have its Season. But, it might make all the difference, a few years from now.

(This item originally appeared at Forbes.com on August 31, 2020.)

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Nathan Lewis was formerly the chief international economist of a firm that provided investment research for institutions. He now works for an asset management company based in New York. Lewis has written for the Financial Times, Asian Wall Street Journal, Japan Times, Pravda, and other publications. He has appeared on financial television in the United States, Japan, and the Middle East.
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