What Would Andrew Jackson Do?: Public Choice, Public Finance and the Federal Reserve

John J. Louis

What Would Andrew Jackson Do?:
Public Choice, Public Finance and the Federal Reserve

The Huffington Post reports, Trust in Government? Poll finds Nearly 80% of Americans Don't, and the Chicago Booth/Kellogg Finacial Trust Index shows fewer than 1 in 4 americans trust the financial system. American's have been wary of banks since the founding. We have been especially suspicious of big banks, and at times downright hostile to central banks. Occupy Wall Street demonstrators show little has changed. 

In 1832, Andrew Jackson's famous bank veto officially ended the Second Bank of the United States. Jackson admitted, "A bank of the United States is in many respects convenient for the Government and useful to the people," yet he understood the concomitant dangers.  Jackson proclaimed"The many millions.. bestow[ed] on the stockholders of the existing bank must come directly or indirectly out of the earnings of the American people." Jackson understood that national credit could be used to underwrite favored lenders at taxpayer expense.


 Enriching the few at the expense of the many, Jackson believed the bank dangerous to individual liberty. Deeming the Second Bank of the U.S. an anathema, Jackson declared it contrary to the principles of the Constitution, and vetoed its charter. A national bank would not return as an institutional feature of the American state until the founding of Federal Reserve in 1913. 

The debt in our public economy, and the debt in our private economy is ballooning.  Risky private debts in the form of sub-prime mortgages were transformed by clever business school grads into 'risk-free' collateralize debt obligations that drove the housing bubble and led to the financial crisis. The failure of private banks to regulate risk spawned a government bailout of the financial sector. Private debt became public debt as the taxpayers footed the bill. Four years later the banks are better off, but many Americans aren't. 

The age of Andrew Jackson is a bygone era. Jackson speaking in 1832 could rightly declare, "The public debt... has been nearly paid off, and our revenue [taxes] will soon be reduced." Today the U.S. national debt stands at over $15,000,000, or just over 100% of GDP. Since the Reagan Administration the debt has continued to pile on: 

[I apologize for the partisan map (it sounds like Lary Bartels)]

 Bush II and Obama borrowed even faster. But neither president nor party are to blame. The symbiotic, perhaps parasitic, relationship between the financial industry and the government is the culprit. And although few of them predicted it, many economists can now say why the crisis was inevitable. And now some are warning of a Financial Crisis 2.0. The banks are undoubtedly to blame. But so too are the politics that made the solution inevitable. Both Democrats and Republicans voted for the bailout to save the country and prevent the second great depression. The solution was prefabricated, and advocated by Treasury Secretary Henry Paulson the former C.E.O. of Goldman Sachs.   

In his recent book A Capitalism for the People: Recapturing Americas Lost Prosperity University of Chicago Business School professor Luigi Zingales gives his account of the financial meltdown and its consequences in Washington. Professor Zingales, an Italian immigrant, fears that America has forgotten free-market principles. He claims government has become friendly to business, but not necessarily effective at creating markets.

Zingales draws a distinction between pro-market and pro-business policies. Governments protect businesses by setting up barriers to entry, providing tax incentives and subsidies.  Governments protect free markets by creating an equal playing field. In other words, setting fair and equal rules of the game. 

When governments protect markets capitalism functions. Following WWII in the greatest era of prosperity in American history, the federal government largely worked to protect markets. The federal government heavily regulated some industries, but the use of tax incentives to particular industries was far less frequent. But Zingales argues, "With the Reagan revolution in the 1980s, business stopped being a bad word" and the government started working to protect business. The Business Friendly atmosphere in Washington continued under Clinton. Public-private partnerships flourished, and lobbying exploded. Luigi argues that when governments protect business rather than markets capitalism becomes crony capitalism, and fears the consequences for American prosperity and democracy. 

The financial crisis was a market driven reaction to poor risk management practices by some of America's largest corporations. The result was bad for business. The catastrophe, was that those businesses were banks, and that America more so than ever depended on credit markets for the functioning of the economy. The average household debt is just over $600,000. If the banks had to absorb the losses from their poor asset purchases credit would dry up, paralyzing the economy and exacerbating the recession.

Prices on these asset backed securities should have signaled to investors their risk. When something seems to good to be true it usually is. Only the banks had another form of risk insurance: the federal reserve. The official bailout is over, The Troubled Asset Relief Program (TARP) long since enacted. Yet, the federal reserve and the Treasury continue to reward bad business practices. 

In a recent article QE or not QE?  the Economist helped explain, " In normal times central banks move short-term interest rates via “open-market operations”: by buying or selling securities, they supply or subtract reserves from the banking system." The majority of these purchases are treasury bonds at $831. 54 billion. Some are not. The financial statements of the New York Fed detail the purchases. "Government-sponsored enterprise debt securities, net" account for $50.14 billion. The Fed purchased $394.48 billion in "Federal agency and government-sponsored enterprise mortgage-backed securities, net."  Think Fannie May. 

The Fed defends its position. The New York Fed financial report explains, "the Bank also executed a limited number of TBA MBS coupon swap transactions, which involved a simultaneous sale of a TBA [To Be Announced]  MBS {Mortgage Backed Security] and purchase of another TBA MBS of a different coupon rate." A NY Fed Staff Report entitled Participation in TBA trading argued the practice, "significantly improves agency MBS liquidity, leading to lower borrowing costs for households." The financial report claimed, "the Bank’s participation... furthered the MBS purchase program goals of providing support to the mortgage and housing markets and of fostering improved conditions in financial markets more generally." 

Central bank financial wizardry attempts to keep the machine going. The FED's mission is to provide for "maximum employment" and "stable prices."  The constant growth model requires that the blue line (payroll growth) on the graph stays above the red line (inflation). Central banks use open market operations to keep the red line (inflation) down.

The Fed is trying to limit inflation. QE is also being used to artificially reduce loses from certain public and privately held assets in an attempt to expand credit. 

 In the veto message Jackson declared, "The powers privileges, and favors

bestowed upon [the Bank of the U.S], by increasing the value of the stock far above its par value, operated as a gratuity of many millions to the stockholders."  Andrew Jackson would have never allowed QE. He would not have allowed the federal reserve in the fist place. Jackson was a populist, and a capitalist. As a politician he championed egalitarianism and democracy. As a businessman he was a successful planter. lawyer, and Country Store Owner. But Jackson's egalitarianism was an egalitarianism without benefits, and his business a business without privileges. 

Economic distress has been a known precursor to political revolution. The English Civil War arose over financial disputes between the King and Parliament. Financial collapse played a factor in the success of the Bolshevik Revolution and the birth of the USSR. Hyper-inflation in the Weimar Republic helped precipitate the rise of Nazi Germany.

Both Republicans and Democrats react to the gloomy economic forecasts with intensified populist rhetoric. The Right trumpets a social populism of Christian values seeking to reclaim America's moral identity. The Left proclaims an economic populism of equal rights and free universal coverage for all. Obama is not Stalin. Romney is not Hitler. American's still believe in the liberal creed. But the populism of either party does little to address more serious problems. Zingales hopes for a "capitalism for the people" based on a populism of limited government and equal opportunity, but worries Washington has become Rome.

 Looking at the mainstream political candidates, its hard to find a resurgence of the American liberal tradition. The defining beliefs at the foundation of American exceptionalism have taken a backseat to the talking points of the day. Perhaps Zingales, should be encouraged by the success of Ron Paul in the 2012 Presidential Primary. Paul received support from fiscal conservatives and social liberals, who wanted the government to both stop handing out special privileges and cease legislating morality. The libertarian oriented candidate received significant support, especially among younger voters.  New Hampshire exit polls, according to Blogger Emily Ekins of reason.com, showed that "Ron Paul overwhelming won the youth vote."

But Paul is almost 80. By April of 2012 his campaign had raised $38 million dollars. Romney raised over $40 million in April alone. Populism will not sell itself. Crony capitalism easily morphs into fascism. Oligarchs and business elites reign. Redistribution and entitlements become socialism. Bureaucrats wield both economic and political power.  Each offers the road to serfdom. 

The fundamental question of politics is who rules? The Constitution established a government of the people. The Founders understood the fragility of individual liberty.  American's apt to ask, "whats in it for me?" Are likely to find the answer, "hard work and self-determination" less appealing than special privileges and guaranteed entitlements. We forget that whatever we take from the Government we take from the people. Democracy can all too easily destroy itself. When confronted with a populism that seems to sidestep the most serious issues facing American's today. We should remember as Andrew Jackson did that "eternal vigilance is the price of freedom."