The Republican leaders have the upper hand in the debt ceiling negotiation.  From the Machiavellian perspective, this is totally expected.  The negotiation is a classic game of chicken in which a crazy player has an advantage.

Several of the most recent Nobel prizes in Economics have gone to people who worked in a discipline called Game Theory, the study of strategic decision making.  One of the great discoveries in Game Theory is that in some games, a player can give himself an advantage if he loses some control.  The classic advantage is the game of chicken, beloved of boys who have just earned their drivers permit.  In this game, two boys (girls seem to lack interest in this game) race toward each other in their cars.  To play the game correctly, both players should accelerate to top speed so that if they collide, they will be at least seriously injured. 

Each boy can choose from two strategies, tough-guy or chicken. To win the game of chicken, one player must swerve while the other player does not.  The player who swerves last is the winner, the tough guy.  The player who swerves first is the loser, the chicken.  If both boys swerve, they both are chicken, the game is a draw, and the members of the press, assembled at the road-side, jeer, and write unkind reviews of the contest.

The interesting insight from Game Theory is that a player that can credibly demonstrate that he lacks control and hence cannot swerve will win the game.  For example, one driver might ostentatiously throw his steering wheel out the window.  Onlookers may think that he is insane, but the demonstration forces the other driver to rethink his strategic choices.  The sane player can dismiss the possibility that the crazy player will choose the chicken strategy.  Having seen the crazy player’s steering wheel fly out the window, the sane player knows that he can no longer win the game or even play to a draw.  He must concede.  The sane player must be the chicken.  Of course, the same logic holds of one player can credibly demonstrate that he delusional enough to believe that nothing bad can happen even if there is a collision.  In a game of chicken, the crazy player has the advantage.

That is the situation with the debt ceiling negotiation. The Republican leadership can credibly claim that most of its members are crazy enough to believe that if the U.S. defaults, nothing very bad will happen.  Their claim is credible because the current composition of the House Republicans is the result of a long selection process that has weeded out its sane, moderate, conservative members.  This fact forces Democratic leaders to rethink their position.  They cannot win or even play the negotiation to a draw.  They must concede.

Game Theory models are never perfect; there are always minor complications.  For example, the game of chicken is not usually played with passengers in the car.  In the budget negotiation, unfortunately, we are all passengers.  However, that consideration does not seem to concern either party.  A more serious complication is that while a boy’s game of chicken simply ends when one boy swerves, the budget game can go on.  There are two consequences.

First, this is probably not a good time to balance the budget.  The country is just emerging from the worst recession since the Great Depression.  The damage was severe and correspondingly the recovery is slow. The received economic wisdom is that this is still a time for deficit spending and stimulus.  Balancing the budget now will probably choke off the recovery.  In light of the current debt problems in Europe and even with regional government debt in China, a balanced budget in the U.S. will probably increase the value of the dollar.  A strong dollar will raise the price of U.S. exports and exacerbate America’s trade deficit and increase unemployment.  Since these things will happen on Obama’s watch, he is likely to get the blame.  The Republicans need not worry about this side effect, but the Democrats must worry.

Second, this negotiation may establish a pattern.  If the President makes concessions on the debt ceiling negotiation, the Republican leadership will be emboldened to continue bullying him.

What should Obama do?  Some commentators, even one particularly intelligent one, argue that if Obama does not show that he is a tough guy and draw a line in the sand, he his presidency will suffer.   However, if he plays tough in this negotiation, he will cause a collision which will do irreparable harm to the nation and to his presidency.  I believe that he should bow to the inevitable logic of this game, but work to change the circumstances so that it does not recur.  

One of the President’s strengths is the he is capable of strategic reasoning.  Having found that the Republican Party can win this game of debt ceiling chicken, President Obama is not likely to allow them to play it again.  He will, most likely, hold out for a deal that either increases the debt ceiling automatically or makes cuts that are so deep that the ceiling will never again be an issue.

By holding out for a comprehensive solution, Obama can turn the public perception in his favor.  He can become the deficit hawk.  Once he has disposed of the deficit ceiling issue, the Republican’s can no longer bully him. He can then draw his line in the sand and use his veto power to enforce it.  However, for this round, the Republican leadership has already won.

For an improved version of these short essays, follow me at http://blog.genegessert.com/.  For Machiavellian comments on current events see my Facebook page.

True Believers

June 19, 2011

Commentators tend to describe political confrontations (e.g. the upcoming fight in Congress over raising the debt ceiling) as negotiations among rational institutions (e.g., the Republican and Democratic Parties).  The implication is that the parties will reach a rational agreement and in particular will not do something that his mutually self destructive.  By this simplistic reasoning, Republicans and Democrats will reach a debt ceiling deal before the impasse causes real problems.  Unfortunately, the lack of a deal and the specter of an American government that is irrational and self-destructive are already causing problems and are likely to cause more.

The rational-institutions model covers up an important complication.  Institutions do not negotiate; only the people who lead those institutions negotiate.  A negotiation cannot produce an agreement that is good for the institutions, unless that agreement is also good for the leaders.   

As a description of the Republican and Democratic Parties, the rational-institutions model is particularly misleading because the American political process increasingly selects politicians that are not rational people, but are true believers.  The selection process is particularly acute in primary elections where voter turnout is thin and dominated by the ideologically committed.  To win in such an election a politician must be seen as an absolutely reliable advocate for whatever issues dominate the ideology.  Ideological voters seek, not representatives who are smarter and wiser than themselves, but uncompromising zealots.

The political parties cannot act rationally unless their leaders are rational.  Unfortunately, it is unlikely that an institution made up of zealots will select rational leaders.  The leaders of both political parties (particularly the Republican Party) are not fully rational.  They are not seeking the interests of their Party or even their own selfish interests.  They are instead people who are animated by their faith in an ideal.

Niccolò Machiavelli’s friend Francesco Guicciardini put the issue nicely in the following quote.

“The pious say that faith can do great things, and as the gospel tells us, even move mountains.  The reason is that faith breeds obstinacy. To have faith means simply to believe firmly – to deem almost a certainty – things that are not reasonable; or, if they are reasonable, to believe them more firmly than reason warrants.  A man of faith is stubborn in his beliefs; he goes his way, undaunted and resolute, distaining hardships and danger, ready to suffer any extremity.”
Francesco Guicciardini, Maxims and Reflections (Ricordi), Pennsylvania Paperbacks edition 1972, p 39

On the rational-institutions view, Republicans and Democrats should nearly always reach a mutually beneficial compromise, and it should be very unlikely that they stubbornly set themselves on a course of action that is destructive to both parties.  However, the abysmal approval ratings that American voters give the U.S. Congress suggest otherwise.  

On the rational-institutions view, Republicans and Democrats will reach a compromise on a bill to extend the debt ceiling.  They will not be so obstinate that they will extend negotiations so long that the uncertainty spooks the market and they will not attach to the bill austerity measures that are so severe that they choke off the economic recovery.   Unfortunately, given the high numbers of true believers, obstinacy is exactly the outcome that we can expect.

U.S. banks believe that the actions of the Congress have already been self destructive.  Because of the protracted negotiations over the debt ceiling, the banks are curtailing their use of U.S. Treasury bond.  Banks use Treasury bonds as collateral for financial transactions because the bonds carry an excellent credit rating and they are so plentiful that they are easy to sell and thus make attractive collateral. 

If banks believe that U.S. bonds are becoming unattractive as collateral, it is a safe bet that demand for U.S. government bonds will decrease and that interest rates will have to rise to spur demand.   This will, of course, increase the cost of financing the debt and do measurable harm not only to both political parties, but to the U.S. economy.

Politicians and the media are all abuzz about the U.S. debt “crisis.”  That debt is roughly equal to the nation’s annual GDP.  So what? 

The annual GDP (Gross Domestic Product) is (roughly speaking) all the money that residents of the U.S. make (and either spend or save) in a year.  It is analogous a family’s annual income.   A family with an annual income of 50,000 per year and a $110,000 mortgage for its house is in much worse shape.  Yet, by conventional wisdom, assuming that the house is worth the investment, the family has made a sound economic decision. 

Is America’s national debt really a crisis?

Niccolò Machiavelli’s friend Francesco Guicciardini would answer as follows.

 “Wise economy consists not so much in avoiding spending – for that is often necessary – as in knowing how to spend well; that is to spend a grosso, and get twenty-four quattrini’s worth.”   [One grosso is twelve quattrini].

Francesco Guicciardini, Maxims and Reflections (Ricordi), Pennsylvania Paperbacks edition 1972, p 56.

By Guicciardini’s criterion America’s debt is worrying only because so little of it is a good investment.  Roughly 20% of government spending ($687,105,000,000) goes to the military.  That is 6 times the amount of the next most well defended nation, the Peoples Republic of China.    Defense spending is essentially a subsidy for business. It produces profit for defense related industries and contractors, but produces no value for the country.  Sadly, cuts in defense spending are off the table.

The only government spending of which Guicciardini would approve are projects that improve the nation’s infrastructure, its resources, or its people.  These would be programs for roads, communications, conservation, education, and health care.  These, however, are exactly the programs that both sides (and especially the Republican’s) propose to cut.

Social Security and Medicare do not really figure into the question of the quality of the government’s spending as an investment.  These programs are basically mandatory, non-profit financial services that the government provides for its citizens.  If they were privatized, they could not be more efficient.  Privatization would replace the government’s single, integrated system with many private systems, which would produce diseconomies of scale.  Furthermore, each private provider would have to generate a profit for shareholders and pay high salaries to its executives. 

The idea that private industry could, in spite of these added expenses, provide the same service at the same cost to the citizens is fanciful.  That would be possible only if the privatized firms were miraculously efficient.  My experience is that private bureaucracies are not more efficient than public bureaucracies, they are just more expensive. The recent financial meltdown and great recession underscore the additional point that private firms are also more risky.   All that privatization will do with certainty is to create another subsidy for the financial services industry. 

A true believer in the divinity of the Free Market might argue that the government, as well as a private business can go broke.  That is true but if the provider of your private retirement plan goes bankrupt, the courts will decide who and how much creditors are paid.  You will be powerless.  If the government becomes insolvent, at least you will get a vote in how the problem is resolved.

To be sure, the Social Security and Medicare programs are becoming insolvent, because people are living much longer beyond retirement.  There are fewer person years of employment that can be taxed to pay for more person years of retirement and health care.  This imbalance means that to maintain the current quality of service, we will have to increase payroll taxes, increase the retirement age, or both.  

The imbalance is a problem for politicians, not for the country.  Politicians want to increase services without raising taxes.  When costs are rising faster than revenues, each side wants to serve its constituency, at the expense of the constituency of the other party.   

Furthermore, in America every political issue sooner or later has something to do with race.  The Republican Party depends on lower-middle-class, white, southern, voters; many of whom feel that their taxes are subsidizing lazy, morally degenerate Blacks and Hispanics.  The Democratic Party depends on Blacks and Hispanic voters; many of whom feel that their labor is subsidizing lazy, morally degenerate old white people who control the economy.  Republicans and Democrats pander to their supporter’s prejudices.  Republicans want to exploit the Social Security/Medicare funding imbalance to create an artificial crisis, in the heat of which they will be able to dismantle these “subsidy” programs.  The Democrats want to exploit the “crisis” to provide political cover for the necessity of raising payroll taxes or increasing the retirement age.

Underfunding Social Security and Medicare and the resulting political squabbles are a problem, but not a financial crisis.  Farsighted leaders would have addressed the funding imbalance years ago (when it was a minor problem) by small, incremental adjustments that pegged the retirement age to life expectancy.  However, foresight is not a virtue of the democratic process.  A democracy can deal with problems only when they have become serious and well known.  The challenge now is not to overreact.

Last week’s blog made the case for Machiavellian investing, outlined its skeptical investing assumptions, and drew the following important generalization.  Corporate management can do great harm, but little good.  When companies succeed, it is not due to dynamic leadership, but to external factors, such as political, and technical trends.  Here is a brief description of the most important trends that I believe will operate over the next several years.

Virtual slave labor

The world population is critically high and growing rapidly in the developing world (especially in India, Southeast Asia, China, North Africa, and the Middle East).   Employment will increase (perhaps dramatically in absolute numbers), but it will not keep pace with exponential population growth. Consequently, labor (skilled and unskilled) is cheap and getting cheaper.

In an area of over population and no employment laws, people must work at wages that are just above subsistence.  They are slightly less well off than slaves, because their employers are not required to feed them through slow periods in the business cycle.  If we over dramatize to have a concrete picture in our mind, we can think of this as virtual slave labor. 

The developed world will benefit.  Instead of importing the slaves (as America did before the Civil War) the developed world can leave the slaves in place and import the goods (both material and information products).  We in the developed world will benefit from cheap products, but we will also see higher unemployment and downward pressure on wages.

Political instability

Virtual slave labor will not be content labor.  The developing world, especially where populations are young, will likely see severe labor and political unrest for two reasons. First, as employment and consumption increase, food, energy, and basic material cost will skyrocket. This will hit the poor hardest.  At the same time, the infrastructure in the developing world will break down under the strain of the environmental effects of growth and the increased demand for infrastructure (such as, road, rail, sewer, and water).  Second, development will be inequitable.  Wealth will stay in families or benefit only the technical elite.  The lower class will sink into meager and arduous poverty. 

Asian nations will have prosperous economies that will function like the southern states in America before the Civil War.  Asia will be the major supplier of items produced by virtual slave labor.  These items will not be products of labor intensive agriculture, such as cotton, but mass produced industrial goods.  The profits will accumulate in the pockets of the ruling elites, but this will not bring political stability unless these national economies can achieve something approaching full employment. 

The Muslim Middle East will have a population that is so large, young, and unemployed that it will probably become chronically unstable.  Africa will likely stay mired in corruption.  Eastern Europe and South America will be better off but will not be as prosperous as either the old western economies or the new virtual slave labor economies.

Europe and North America will become the major consumers of Asian products and major exporters of integrated value added products.  Trade will flow between Asia and the West.

Because they are the beneficiaries of stable political systems and have advanced infrastructures, European and North American economies will likely continue to enjoy political stability.  However, they will probably be stressed by a decline in the standard of living. 

Deregulation

Deregulation will continue to increase in most national economies.  This trend has two causes: (1) the collapse of the Soviet Union as a political force and of Marxism as an intellectual force, (2) big-money politics in the first world. 

The demise of the Soviet Union led to an economic power grab that saw the rise of gangster capitalism in the former communist countries.  In Russia and the old East Block, the largest industries are now in the hands of former communist apparatchiks. 

We have big-money politics in the first world because we have rapidly increasing costs for political campaigns and increasing wealth concentration.  This means that the people who control big money control the U.S. government. These are not the big stockholders, but the people who manage those corporations. In America, both political parties have to beg for handouts from the same few hands. The people handing out the money want deregulation and are likely to continue to get it regardless of which party is in power.  For example, no new regulations were enacted after the Gulf Oil Spill.  Reforms that followed the 2007 financial crisis were superficial and even those reforms are under attack by the new Republican-controlled House.

Hijacking of the Fortune 500

Senior management is running America’s biggest corporations not for the long-term benefit of their shareholders, but for the short-term benefit of themselves. Hijacked corporations include not just those whose management has actually run their companies into the ground, but include most of our large cap companies, which are no longer globally competitive.  High labor costs are partly to blame, for the sorry state of America’s airlines, auto manufacturers, steel producers, and textile companies.  However, all these industries have failed to meet high labor cost with automation, and have failed to make even specialty products that consumers (even U.S. consumers) want to buy.  In addition, U.S. manufacturers are less competitive than some of their European counterparts who have to cope with stronger unions and more socialistic employment laws.

Fraud-plagued U.S. economy

The U.S. economy is plagued by deception and dishonesty at every level. Events leading up to the recent financial crisis illustrate the problem.

The Federal Reserve propped up the U.S. economy during most of the Administration of George W. Bush by keeping interest rates artificially low.  Low interest rates stimulated the housing market and encouraged consumer debt.  Conmen in the real estate and banks began to sell ignorant, envy-driven consumers mortgages that they could not afford.  Banks sold large numbers of bad mortgages to the financial services industry, who created dodgy bonds, collateralized debt obligations (CDOs). 

Regulators did not curb these practices because of the antigovernment stance of the Republican Party.  Republicans have consistently promoted deregulation, opposed new regulations, and underfunded the enforcement of existing regulations.

Standard and Poor’s and other rating agencies, had a massive conflict of interests between honest ratings and high fee income. They chose the fee income and gave even the CDOs backed by many bad mortgages high ratings. 

Finally, financial institutions inflated their fee income by creating structured investment vehicles (SIVs) to buy the CDOs. To finance their purchases, the SIVs borrowed at cheap, short-term rates in the money market and thus pocketed the difference between their borrowing cost and the high yielding CDOs. 

Unfortunately, the SIVs left the institutions vulnerable to a liquidity crisis, but that was a threat to the share holders, not to management, who had already pocketed huge bonuses from stock options that were ultimately based on stock prices that could last only until the inevitable collapse.

The government bailout and stimulus package may have prevented the economy from going into shock, but the prognosis remains bleak.  The mortgage crisis is far from a one-time aberration.  On the contrary, it is typical and the congress has done nothing to curb deceptive financial practices.  Consequently, the U.S. economy is likely to continue to encounter frequent scandals, suffer market crashes, and recessions.

The U.S will also suffer from economic retardation that is the result of inefficient markets.  Each time that Wall Street whips up greed-fueled investment craze, savings flow into bad investments.  During the S & L crisis the bad investments were phony land deals.  In the dot-com crash, they were foolish business ventures like “dog-food.com”.  In the recent crash, they were bad mortgages, CDOs, and SIVs. When these bad investments bust the investment capital becomes, not productive capital or infrastructure, but non-productive junk or toxic assets that are sold at fire sale prices.  Meanwhile, valuable investment opportunities go unfunded.  The only people who profit from these bogus investments are the promoters. 

The hijacking of the Fortune 500 and the fraud plagued economy not only underline the imperative of skeptical investing, but they suggest the need for a a strategy that is actively defensive.

Currency devaluation

High trade and budget deficits are continually undermining the value of the U.S. currency.  Europe runs high budget deficits, but not high trade deficits.  The U.S. has a high trade (current accounts) deficit in part because it is a consumer driven economy and in part because it is now a massive oil importer.

As a result not only the government, but also business and consumers live on borrowed money.  This situation is analogous to removing parts of a building’s foundations and selling them.  We are creating a catastrophe scenario. The U.S. is still the single biggest political, economic, and military power.  We have the world’s largest building.  Consequently, we can borrow and undermine our foundations longer than can anyone else.  However, the longer we do it the greater the risk of a larger currency collapse. 

Fortunately, there are two potent, mitigating factors.

First, devaluation of the U.S. dollar will tend to reduce the real U.S. debt and thus tend to eliminate the causes of devaluation. This is possible because of the unique role of the dollar as the world settlement currency.  Most U.S. debt is denominated in its own currency.  Were it denominated in Euros, real American debt would skyrocket.

Second, dollar devaluation will make U.S. manufactured goods artificially cheep outside the U.S. and will stimulate U.S. exports. 

Because of these mitigating factors, it is in no one’s interest to prop up the U.S. currency and we can expect it to continue to decline.

Free knowledge capital

Knowledge once discovered is free.  Asia will exploit free knowledge capital to develop their economies rapidly.  Therefore, developing economies will compete not just in labor-intensive products, but also in knowledge-intensive products and service.  This will reduce the profitability of U.S. firms that provide consulting services and large-scale, stand-alone, high-tech manufacturing. In these businesses developing economies will be able to leverage free knowledge capital and enjoy a decisive advantage in cheap (virtual slave) labor.

Third world infrastructure problem

Asia, especially India and China, will need to build up their infrastructure in order to get their virtual slave labor products to market.  However, they will not be able to build their infrastructure as did the U.S. with energy from cheap oil.  The U.S. may enjoy a lead in the quality of its transportation, communications, and financial infrastructure for decades.  This lead will provide an advantage to U.S. manufacturers of products that require deep layers of subcontractors an efficient infrastructure to integrate the supply chain.  

Developed economies will specialize in integrated businesses that can thrive where there is a reliable and high speed infrastructure in place.  Developing economies will specialize in isolated businesses that do not depend on the infrastructure and can leverage virtual slave labor.

High velocity trade

Asia and second tier developing economies (such as Eastern Europe and South America) will need to import food, raw materials, and specialty equipment. By specialty equipment, I mean classes of equipment that are necessary for manufacturing and communications, but that developing economies cannot manufacture efficiently.  For example, India may build a highly competitive semiconductor fabricating plant, but it will be most cost effective to buy testing equipment from a supplier in the U.S. or in Europe.  Thus food, raw materials, and specialty equipment, will flow into developing economies, where virtual slave labor will turn them into inexpensive products.

At the same time, in order to maintain an acceptable standard of living, developed economies will have to import the cheap products produced by virtual slave labor.

Expensive energy

Several factors point to much higher energy costs. First, there is substantial risk that the Saudi government has over produced their oil fields, and that Saudi wells are pumping a large fraction of water.  This suggests that the fields are nearing their peak output.  Matthew R. Simmons book, Twilight in the Desert makes a persuasive case for this scenario.

Second, American foreign policy has created a power imbalance in the Middle East by critically weakening Iraq and thereby strengthening Iran.  This will destabilize U.S. allied regimes throughout the region and Saudi in particular. The Saudi government and its oil infrastructure are no longer reliable.

To compound the problem, all regional oil facilities rely heavily on pipelines, which are long, vulnerable, and enticing targets for terrorists.  By a similar logic oil exports from the region depend on ships, which are already targeted by pirates and may also be targets for terrorists.

Iraq may at any time fall into civil war and if it does Iran may make a grab for the Basra oil field.  While American troops are in Iraq, Iran will not be able to move west to seize Basra or to make an alliance with the Shiite government in Syria to attack Israel.  However, once the U.S. pulls out its troops matters may take a dramatic turn for the worse.

Finally, as Asia builds out its infrastructure and its productive capital, it will dramatically increase the demand for oil.

All these factors imply that not only will oil consuming economies have to pay high prices for oil but will have to pay a premium for reliable supplies.

Because of the threat of partisan political deadlock, Credit rating firm Standard and Poor’s (S & P) downgraded its “outlook on the long-term rating of the U.S. sovereign to negative from stable”.  Press reports showed consistent right-wing bias, demonstrating again that the idea of the liberal media is a myth.

The Republican Party is promulgating the idea that there is a deficit crisis that demands immediate action, a deficit of mass destruction. While the S & P rating concerned the long-term, and focused on political issues, press reports on the S &P rating change tended to reinforce the crisis atmosphere and hence support the Republicans.  Here are some representative headlines and summary quotes.

From WESTINGHOUSE CBS :

“S&P lowers U.S. debt rating to ‘negative’”

Apr 18, 2011 … Growing budget deficit puts U.S. on easy footing as credit rating agency drops long-term outlook.

From GENERAL ELECTRIC NBC’s Today Show:

“The situation in this country with entitlements is a big issue”

From DISNEY ABC:

“S&P Cuts Long-Term Outlook for US Debt to Negative” 

From NEWS CORPORATION LTD (a foreign company) Fox:

“’Negative’ Outlook for U.S. Debt Sends Jolt Through Capitol Hill Debate on Debt Ceiling”

All of these headlines are misleading because they imply that the problem is urgent and economic, and concerns rating of U.S. debt.  In fact, S & P’s report actually said that the crisis was long-term, political in nature, and concerns its rating of the country (the “U.S. sovereign”), not specific debt instruments. 

The key points in the S & P report are as follows.

  • In the short term, the report says that the U.S has a “high-income, highly diversified, and flexible economy” that is “backed by a strong track record of prudent and credible monetary policy…”
  • After the worst recession, bailouts and stimulus measures created a budget problem. “In 2003-2008, the U.S.’s general (total) government deficit fluctuated between 2% and 5% of GDP. Already noticeably larger than that of most ‘AAA’ rated sovereigns, it ballooned to more than 11% in 2009 and has yet to recover.”
  • In the long term, S & P warns there is a risk that political factionalism may hinder the country’s ability to address the budget problem in a timely manner. 
  • “The outlook reflects our view of the increased risk that the political negotiations over when and how to address both the medium- and long-term fiscal challenges will persist until at least after national elections in 2012.
  • “Standard & Poor’s takes no position on the mix of spending and revenue measures the Congress and the Administration might conclude are appropriate. But for any plan to be credible, we believe that it would need to secure support from a cross-section of leaders in both political parties”.

In short the problem is not financial but political and it stems from Republican intransigence.

Based on the actual text of the report, the above headlines should have said something like “S & P condemns political deadlock.”  Instead, the headlines supported the Republican Party line about a debt crisis.  We should not be surprised that the media conglomerates show the same bias in their reporting that they show in their campaign contributions.  However conservative talk show hosts tell us the press has a liberal bias.  This is, of course, transparently silly. Media giants are not somehow the only corporations that are unable to make their employees do as they are told.  Furthermore, most employees do not need to be told what to do.  Media corporations hire editors who share their own conservative bias and who are anxious to please.

The current state of the media illustrates the wisdom of two tenants of the Machiavellian perspective. 

First, we view politics, not in terms of ideological conflicts or policy differences, but in terms of organizations and interests, conflicts and collaborations.  In this case, there are two clusters of organizations.  On the one hand there are organizations (such as international corporations and trade groups) that cluster around the Republican Party and that represent the interests of the oligarchy.  On the other hand, there are organizations (such as professional societies and associations) that cluster around the Democratic Party and that represent the interests of the productive professional class.  

The Republicans and Democrats have a deep conflict of interests about who will control the U.S. government and in whose interests (or against whose interests) that government will exert its coercive power.

Second, we believe that ideology and policy follows interests.  All of the above organizations have not only lobbyists but public relations firms whose job it is to manage the 24 hour news cycle. To understand what is happening, you must view a “news” story not primarily as information, but as a tactic.  

The Republican tactic is to create an artificial crisis (like the weapons of mass destruction tactic that launched the war in Iraq) and to use the crisis atmosphere to justify radical changes in the American political system.  The goal is to make the government serve the interests of the oligarchy and keep the government from “wasting” money on programs (such as medical care, consumer protections, and environmental regulation) that promote the interests of the professional class.  For this reason the Republican budget proposals favor high military expenditure, which is good for big business, but otherwise oppose government spending.  It advocates additional tax cuts, not just to line the pockets of the oligarchy, but to starve government agencies that regulate and therefore curtail corporate political power.

From the Machiavellian perspective, the likelihood of a budget deal is vanishingly small, because it is not in the interests of the Republican Party.  Delaying a budget deal will undermine confidence in the U.S. political system and that will create real problems in the country’s ability to refinance its debt. It will transform the political problem into a real economic problem. That would be bad news for the country, but good news for the Republican Party.  The Republicans can be sure that, owing to the conservative media bias, a real economic crisis will undermine the Obama administration.  Furthermore, a real refinancing problem will add to the deficit of mass destruction hysteria and make it easier to sell a radical solution.   

The Republicans may be correct that lower taxes, less government regulation, less social welfare for the middle class, but high defense spending is the optimal government policy.  They may even be correct that the country should be run by and for the few individuals that control giant corporations (the oligarchy).  However, that is not the decision that is being presented to the citizens.  In fact, given the ownership of the media and the degree of media manipulation, the whole premise of an informed electorate has been seriously compromised and for that the right wing press has much to answer.

Last week, in response to Paul Ryan’s Republican plan, President Obama presented his own budget blueprint.  From a Machiavellian perspective, the dynamics of the opposing power blocks are more enlightening than the two plans.   Most interesting of all, the associated Republican propaganda has created a political Frankenstein.

There is an important underlying issue that comes in two parts.  First, between 1972 and 2001, real wages for the top 1% of Americans (a key constituency of the Republican Party) jump by 100 percent.  However, gains for Americans at the 50th percentile were meager, roughly 7%.  (I am relying on numbers from Janet L. Yellen, President and CEO, Federal Reserve Bank of San Francisco November 6, 2006 ). 

Second, since the 1990s, productivity has increased at 3% per year.  If you put these two facts together, it is fair to conclude that the benefits of the productivity increase ended up in the pockets of the top 1%. 

There are several ramifications.

  • To protect its gains, the 1% pressured the Bush administration for tax cuts.  Granting those cuts created a revenue shortfall that resulted in a budget deficit. 
  • Most Americans, including the base constituencies of both political parties (neither of whom are part of the 1%), have suffered a loss of status.  In our materialistic, consumer society, this loss of status has translated into widespread envious dissatisfaction.
  • The 1% has been able to translate its economic resources into political power and become an emerging oligarchy.   The oligarchy has been increasingly able to operate America’s corporations and its government in their own short term best interests. This has escalated the feeling of discontent in to pervasive political dissatisfaction.  Most Americans feel that the country is headed in the wrong direction.

The Republican Party’s elite constituency is made up primarily of oligarchs; whereas, the party’s base is made up of traditional conservatives and the religious right, essentially old white people. 

The Democratic Party’s elite constituency is made up primarily of upper middle class professionals and liberal idealists; whereas, the party’s base is made up of Blacks and Hispanics.

Unsurprisingly the two parties’ budget proposals reflect the interests of the party elites.

  • Republicans propose to cut government services but keep the tax cuts for their elite.  Unfortunately this obliges them to cut some services for their base.  They mitigate this side effect by rhetoric and by making the most severe cuts fall on the young and people of color (i.e. the Democratic base).
  • Democrats have proposed to tax those who have a level of income that falls above that of their elite.  The added revenue allows the Democrats to propose less severe cuts in entitlement programs, which are political payoffs to their base constituents.

Democratic rhetoric has been muted, because they too rely on campaign contributions from the oligarchy.  To be sure, oligarchs prefer to fund the Republicans, but they do their best to co-opt influential Democrats, particularly those that cannot be defeated because they occupy safe seats.  Democrats have not been confrontational, but have relied on their standard liberal rhetoric, which is largely harmless, but sets a Machiavellian’s political realist teeth on edge.  According to the Democratic dream world vision all children want to learn, discipline is unnecessary, education is optional, criminals are easily reformed, everyone is entitled to entitlements, and in foreign affairs, all we need is to give peace a chance.  

However, since continuing tax cuts for the 1% is not in the interests of the base of its own party (much less that of the Democrats), Republican rhetoric has had to leap well beyond simple persuasion. 

The deficit presents an awkward fact. In reality the deficit is due to (A) the revenue shortfall created by the Bush tax cuts, and (B) one-time factors including the wars in Iraq and Afghanistan, and by the recession, which necessitated a bailout and a stimulus package.  The onetime factors are, of course, a direct result of mismanagement by the Bush administration.  To explain away this problem the Republican propaganda machine has floated the idea that the deficit is due to a pattern of over spending. 

Even with mismanagement America’s budget deficit is not out of line with that of our European allies.  However, to continue to push its agenda Republicans have portrayed it as a crisis and have whipped its media allies into frenzy about the “Deficit of Mass Destruction.” 

The Republican propaganda machine has constructed an alternative vision that is so divorced from reality as to be delusional.  The main tenants of this alternative reality include: the god-like wisdom of the free market, the virtue of personal responsibility, and the evils of government.  Unfortunately the recent mortgage crisis demonstrated a massive failure of the free market, and a corresponding failure of personal responsibility at all levels.  Worse still, corporate America had to be bailed out by emergency funding from the hated Federal Government.   In the face of this stubborn reality, the right wing vision is a sort of paranoid delusion in search of a host. 

The delusion has found many hosts among those who are victims of income inequality and the ensuing crisis of envy and political dissatisfaction.  The readymade paranoid fantasy has attracted to the Republican banner a entire cult of people who seem to have Schizotypal disorder.  This is an official personality warp that is characterized by odd beliefs (magical thinking), suspiciousness, obsessive elaborate and stereotyped thoughts, odd speech, and delusional ideas.  Think for example of talk show hosts such as Glen Beck. These people have organized themselves into a cult, the Tea Party, which has taken on a life of its own.  Unfortunately for the Republican hierarchy, as in the Frankenstein story, the thing has got a bit out of control.

For example, in the budget compromise passed in the House last Friday, 59 Tea Party members voted against the party elite. The crisis nature of the budget debate, the threatened government shutdown, and the Republican defections are unsettling for the world financial system.  The political mess raises the specter that America may not be able to reach pragmatic policy decisions that are in its own interests.  Clearly, if we have a genuine debt crisis, we should be doing everything possible to down play it. 

The next political showdown will come near the May 16th deadline for raising the Federal debt-ceiling.  The Frankenstein faction again threatens to push the Republican Party into creating yet another crisis, but this time it may have dire consequences.  According to the Wall Street Journal, Rep. Michael Grimm is warning his Republican colleagues that “Wall Street understands that if we default on our obligations, our markets are going to crash,” By its inflexible stance the Tea Party cult has set up a dynamic of catastrophe.  The party’s Schizotypal rhetoric will repel independent voters.  As the Tea Party cult takes control, the Republican Party will expel its political realists. The repulsions and expulsions will make the Republican Party increasingly desperate and confrontational.  In the end, demographics are against a party of crazy old white people.  The Republican Party will implode and America will then have to rely on the Democratic Party for political realism and that too is a Machiavellian horror story.

Washington is gripped by a budget crisis so severe that lawmakers narrowly avoided a government shutdown.  At least that is the story.  We at the Machiavelli household are skeptical.  It is certainly true that the U.S. has a budget problem, but it is not a crisis.  The crisis talk is simply a pretext for self-serving emergency legislation.

We can gauge the severity of the budget problem by comparing our situation to that of other countries.   If we do that we find that, as a percentage of GDP, the U.S. debt is modest.  According to the CIA Fact Book (2010 numbers) Japan’s debt is 225% of GDP. Mighty Germany’s debt is 79% and the UK’s is at 76%.  The U.S. debt is a modest 59 % of GDP, just one percentage point above the world average. 

If the budget is a problem but not a genuine crisis, what is happening?   In politics, when things do not add up, one must suspect strategic mendacity.  I suspect that what we are seeing is a propaganda ploy that we might call the “artificial emergency”.

My best guess is that the phony budget crisis is analogous to the Reichstag fire in Berlin (27 February 1933).  This is the classic example of taking a simple problem and claiming that it is a crisis and then using the supposed crisis as a pretext for promoting a radical, self-serving response.  In 1933, Hitler claimed that the fire was the first move in a communist plot to take over the country.  He asked for and got a declaration of emergency, after which he made mass arrests of opposition leaders.  The Nazi party gained a clear majority in the Reichstag and then passed the Enabling Act, which allowed Hitler to govern by decree. 

The artificial-emergency ploy did not die with Hitler.  The supposed crisis (over weapons of mass destruction), which the Bush administration used to promote America’s entry into the Iraq war, and which the press bought hook line and sinker, provides a modern example.  

In response to the artificial budget emergency, Paul Ryan (R, Wisconsin) has prepared the Republican budget proposal (the GOP version of the Enabling Act).  His cuts kill healthcare reform, financial reform, and the federal support for home ownership, but propose no cuts in defense spending.  On the other hand, Ryan finds money in his budget to cut the corporate tax, the capital gains tax, and to make the Bush tax cuts permanent.  Ryan’s proposals are revolutionary, not on the level of the Enabling Act, but they are certainly radical and self-serving. 

Ryan’s proposals are also risky for the country, but not for the Republican Party. Reducing federal spending too soon could endanger America’s recovery from the worst recession since the Great Depression. 

However, the Republicans can afford to take that risk.  If big budget cuts kill the recovery, the party benefits because the administration in the White House, typically gets the blame for an economic down turn.  If the economy survives, the Republicans can take credit for saving the economy from Obama’s runaway spending.

In spite of the new blood in congress, this is just politics as usual.  A politician must as, Niccolò tells us, be a fox and know how “to circumvent the intellect of men by craft”.

“But it is necessary to know well how to disguise this characteristic, and to be a great pretender and dissembler; and men are so simple, and so subject to present necessities, that he who seeks to deceive will always find someone who will allow himself to be deceived.”

The Prince , Chapter 28

Nobel laureate economist Paul Krugman compares Ryan’s ideas to unicorn sightings.

However, true to Niccolò’s prediction, most pundits are saying that Ryan is a hero.  For example, Carla Feide of CBSMoneyWatch.com tells us that  Ruan “deserves credit for taking on the big ticket issues… Paul Ryan has grabbed the third rail.”  Whoopee.