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About the Guest:
Richard W. Rahn is a senior fellow of the Cato Institute and the Chairman of the Institute for Global Economic Growth. He is also a weekly economic columnist for The Washington Times, and serves on the editorial board of the Cayman Financial Review.

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, today we are in the Bahamas with Richard Rahn. We interviewed him last year, as well. We had a great interview with him then and we had a lot of comments at that time. Richard Rahn is a man who has been highly motivated by the political changes in the country all through his life. After the Carter years, he went to work for Reagan, and then after that, for the first George Bush. What do you think he brings to the table this year?

David: He regularly comments for the Cato Institute, and you will find his columns, with some frequency, in The Wall Street Journal. We want to have a D.C. perspective, if you will, on some of the things that are changing, policy-related, that do have a direct impact into the financial markets. We can have our opinions, but to be quite honest with you, Durango is a long way from the Beltway.

Kevin: David, we went to New York to do the video a couple of years ago, and then we went on to Washington, D.C., and it was like going into a bubble, like a completely different world. You couldn’t feel the economic downturn. Actually, you couldn’t feel any kind of consistent consciousness.

David: Yes, Kevin, that was a few years ago, and the point was, we saw a transformation taking place. The power center had been New York City, and we saw the baton being passed, if you will, to D.C., passed, or taken, as it were. Washington D.C. now is in a very strong position to control outcomes within the capitalist system. There are challenges to the capitalist system, and we will have to see if that system, in fact, survives the pressures. We believe it will.

Kevin, the challenge to capitalism is now that the state is challenging the corporate structure which has become dominant over the last 30-40 years, with finance becoming more and more important as we go.

With finance being a part of that, we want to look at how individuals are navigating this. Last year, in our conversation with you, Richard, we talked about FATCA, legislation that has already been passed, and will be implemented in 2013.

Kevin: Of course, you are talking about the Foreign Accounts Tax Compliance Act.

David: Exactly. This is what is ultimately limiting in terms of an American’s ability to have assets anywhere else in the world, and it is strange because, while it is not important to most people, it is strange to be told, “You have to keep your money inside these walls.” When you are handcuffed, you realize that you are restricted. Without the handcuffs, there was no issue.

Kevin: David, it used to be when we talked about government regulation here in America, we were actually talking about government regulation here in America, but what is happening with FATCA is America going outside and regulating everything outside of its borders, as well.

David: Foreign banks and financial institutions having to comply with U.S. legislation, and being held liable if they don’t. Kevin, it’s not so much the issue of people having an account overseas, but it is that they can’t have an account overseas, and that is the real issue. You are free to live your life as you choose, as an American. Land of the free and home of the brave? “No, not outside our borders,” is the edict coming through FATCA.

Richard Rahn, this is the second year we have had the opportunity to sit down and visit with you. The Bahamas is a good place to reflect back on the U.S., and from an outside perspective, be thinking about, not only domestic policy, but foreign policy. Something that we covered last year in our conversation was FATCA. The legislation is pending, so to say, and won’t be an issue until 2013, but are things getting better, or worse? Are they revising it in our favor? What do you see happening with FATCA and legislation like that?

Richard Rahn: Of course, the legislation was passed, and what they are working on is the implementing rules, and Treasury has a huge amount of discretion on how the Foreign Accounts Transactions Compliance Act, FATCA, is actually implemented. The problem is, they keep trying to make it broader and broader, and bring in more and more financial institutions, and not just banks, but any foreign financial institution.

They also get hobbled with huge definitional problems. Last week I was talking to one of the attorneys involved and he said it is now up to about 350 pages, and his judgment was that it is getting worse, and he is one of the people who has day-to-day involvement with it. The administration keeps saying that they are trying to make it easier to comply with, but of course, these things get bigger and bigger, and when you have regulations that go on hundreds of pages, nobody understands what it is.

We have seen things like this happen in the past. Finally, they just often almost die of their own weight. The whole notion is stupid to begin with. It is destructive, because it drives capital out of the United States. We would be appalled if foreign countries tried to do things like that to us, and it makes it almost impossible for Americans abroad to get bank accounts.

Foreign banks and other institutions are, increasingly, just not going to accept any U.S. clients, or even invest in the U.S., and this could cause us as much of 1 trillion dollars in lost foreign investment. Of course, that means a huge reduction in the number of jobs created in the United States, the kind of capital we need for R&D and for economic growth. It is Washington insanity at its worst.

David: Would a change in elections this next year, from one party to the next, improve anything? Or is the die cast?

Richard: It could improve things. I think there is some increased pressure for repeal. Particularly, Americans abroad have been very vocal on it. I would expect a Republican Treasury to be less intrusive and try to be more reasonable in the regulations than the current Treasury.

One problem we have with the current Treasury is that there is virtually nobody there who has actually ever been in the private sector, and they have very little understanding of the cost of regulations, how these things are implemented. It also has a disproportionate burden on smaller financial institutions than the bigger ones, because of the cost of regulation, to some extent a fixed cost. You have to set up your compliance procedures, all the software, and it is very costly to train your people, but if you are a very large institution you can amortize this over many more clients.

Regulation, and actually regulation in general, not just this act, has driven much of the consolidation. People say they are concerned about these very big financial institutions, when it is regulation itself that does that, particularly as we see in the United States, because small banks cannot afford the burden of regulation. They are forced to combine just because of the increasing cost of compliance.

David: The size and scale of the too-big-to-fails is impressive, going back to 2007, Bank of America, Wells Fargo, J.P. Morgan. The argument as we came into the crisis in 2008 was that these were system-critical institutions and they literally were too big to fail. The irony is that by the end of 2011 those institutions grew, at a minimum, 24% in terms of assets, and in the case of Wells Fargo, 142%. They were too big to fail.

What are they now? You are right, this is a certain form of insanity. It has driven consolidation. It is not exactly what we would view as free market capitalism. What might you describe as the kind of market we have today, if not free market capitalism?

Richard: In some ways, it is almost fascism in that we have state control of privately owned institutions and the managers of these institutions have less and less discretion, and people in government have more and more control over them, in how they operate, and this, of course, undermines the whole free market system.

We know from past experience that other countries around the world for the last 150 years, when this stuff has been tried, it has always ended up in failure, and will in the United States unless it is all reversed. The Dodd-Frank bill – impossible. Sarbanes-Oxley still hasn’t been repealed, and that has caused much of the dry-up in IPOs in the U.S. Now, people who want to do initial public offerings go elsewhere in the world.

David: Is it fair to say that the ’20s were a period in time where power was consolidated in New York, and in the ’30s we saw migration of that power? The power center became Washington, D.C. We have seen the same sort of parallel where you could say the last 15-20 years it has been about New York and banking and finance, and that is, in fact, what we are seeing – a swing back toward governmental control and a focus on the power structures in D.C. If there is a similarity, is there anything we can learn from the 1930s and 1940s in terms of how we claw ourselves out of that and move back toward free markets?

Richard: We have a long history of what doesn’t work. With the big regulations in the early 1930s, the tax policy, the spending policy, and the monetary policy at the time, kept us in a depressed economic state for more than a decade. It is interesting to note that we had a very sharp recession in 1907, which is as sharp a drop as we had after the 1929-1930 crash, but in 1907 government didn’t interfere, and within 18 months the economy came roaring back and made up for lost ground, because a capitalistic system has these automatic correctives within it. It is painful for those number of months when you go through what they used to call panics, now we call them recessions. But with government coming in and trying to mitigate it, it usually makes things worse.

Look at the housing market. We have had depressed housing for four years, the situation is not getting better, we are still having all these foreclosures, and the basic problem is that government did not allow housing prices to drop right off to get to their new equilibrium point. If you are trying to prevent house prices from falling, then you never get to the equilibrium point and you keep getting people in houses they can’t afford, and then if you have an artificially low-rate mortgage, then when the mortgage interest payments start to go back up, the person is back in the soup again.

Washington tries to insulate people from reality, and of course, it only delays reality and makes it much worse when it finally comes around.

David: It has been suggested that the budget was really not politicized until after World War II. With the advent of greater voting rights, which we are all in favor of, came the consequence of politicians being much more concerned about where and how the money was spent, which constituency groups received it, and the budget was, in the context of universal suffrage, completely politicized.

Richard: Actually, I’m not in favor of expanded voting rights. Our founding fathers understood a fundamental truth. They were against democracy. That is why they formed a constitutional republic. They couldn’t figure any other way to do the transitions except for democracy. Democracy was a tool for the federal republic. They deliberately limited the voting franchise to property-owning males. There is something to be said for, and this will sound, in this day, totally politically incorrect, I understand, having people who really have a stake in the system.

You have probably all seen the late night comedians when they do these interviews with people on the street, and a high percentage of the people have no idea who the Vice President of the United States is, or they have no idea of the three branches of government.

David: This Vice President they might not know because I don’t think he has made a public appearance 3½ years.

Richard: Well, they try to keep him locked up, but at any rate, the problem is, we have large numbers of people who just have no idea. It is not a matter of being left or right, they just are totally ignorant when they walk into the voting booth.

It was interesting, with the recent State of the Union address, I commented in my weekly column, there is a group that measures at what level each State of the Union address is addressed to. This one was at an 8th grade reading level, and that is the lowest since the 1930s. We can see this dumbing down of government all the time. As they dumb things down, we tend to get worse and worse policies because people don’t understand the consequences.

An issue which has concerned me is this attack by the Treasury on foreign banks who happen to have U.S. clients. Politicians in Washington, people like Carl Levin and other demagogues, start shouting about people evading their taxes. Well, there are a few people who do that, but the tax loss is miniscule compared to the cost to the economy of all the capital it has driven out, and also the reductions in liberty.

This hypocrisy, this American financial Imperialism which we would never tolerate from any other country, is extremely destructive. It comes because the politicians can pander to people who do not understand the consequences of virtually anything, just huge government spending, as if it comes from the Tooth Fairy. We have half of the adult population that no longer pays income taxes. So they of course say, “Let’s tax the rich. I’m not paying anything, let’s get this other guy to do it, and I’ll get the benefits.” As Margaret Thatcher used to say, “You eventually run out of other people’s money to spend.” And that’s the point where we are.

The Swedes, when they were confronted with this problem 15 years ago, really reversed course, and they have a very flat tax system now. Their tax rates are fairly high, but the Swedes are well educated, and the common person there now understands that if they demand more benefits, they are going to be paying for it, it’s not going to be the person down the block, and that is healthy for a democracy. People have to understand that they can’t shift the burden to, as the former chairman of the Senate Finance Committee, Russell Long, used to say, “the fellow behind the tree.”

David: That’s interesting, because while their tax rate is incredibly high, everyone gets to participate, and that is maybe the difference, because your concern, if we can put it in those words, over what was intended to be a constitutional republic, and has become a democracy, or some form of mob rule, is that you really have people voting their self-interest. With no skin in the game, nothing to lose, everything to gain, it is pretty predictable the course that human nature will take.

Richard: Yes. Virtually all democracies have failed because of this. There was a great line from Thomas Jefferson. He said, “When the people realize they can vote themselves benefits, all is lost.”

David: It seems like we should have learned from history in that regard, and I realize this comes back to the issue of having way too many people who just don’t get it. They haven’t gotten the education they needed. They don’t have the perspective necessary to give a real input at the polls. What we look forward to in 2013, 2014, 2015, 2016, is either a new administration or the same administration.

What is your advice in terms of the average citizen who does care? What should they be doing? There is room to be a critic and I would not say an armchair critic, “Oh, this is just a problem with a world that’s going to hell in a handbasket.” But there are a lot of people out there who want to know, “How can we make a difference? We love this country. It’s a great opportunity to live here. A privilege.”

Richard: Getting involved, educating oneself, and then also making efforts to educate others. Those of us at the Cato Institute and other think tanks – that is one thing that we try to do. I spend a great deal of time writing, lecturing, doing radio and TV, and hopefully bringing some increased level of understanding of how these things operate.

We do have a lot of young people, Ron Paul supporters, and others, and it is very interesting to see how many people who don’t have any immediate self-interest, but do understand the longer-term self-interest, are beginning to catch on here that we cannot continue this course because it is in the process of ruining the country, and it will if we don’t make the changes. One can be an optimist and say, well, “Canada and Sweden reversed course.” Greece didn’t. A number of other countries haven’t. Argentina, as an example, keeps smashing into the wall.

David: Is it fair to extrapolate from those examples, and say that if we don’t reverse course, then the outcome is fairly predictable?

Richard: Yes. Let’s take Argentina. 100 years ago it had the 4th highest per capita income in the world.

David: Not third, but fourth?

Richard: It could be the third, but I think it was the fourth, as well as they could measure back then, but it had an extremely high standard of living. Now it is something like 78th.

David: Wow.

Richard: We see other countries which have gone steadily downhill. Sweden is very interesting. Where it had grown rapidly from 1870 to 1970, and had reached the top 3 or 4 levels of per capita income, and then because they allowed their welfare state to grow, they nationalized a number of industries, economic growth plummeted, unemployment went up, debt rose, and the Swedes saw they were on a disastrous course. By 1995, the parties of the left and right came together and said, “This isn’t working.”

We all think of Sweden as this big socialist welfare state, but actually they have a voucher system now for schools. Every parent is given a voucher so they can pick their own public or private school, so there is competition in education. They have gone to the Chilean model for pensions, which is a defined contribution like a 401k, rather than a defined benefit. Thirty countries have adopted that. So we do have examples from around the world where countries have reversed course before they went over the cliff.

In the U.S., we are getting very, very close now, and we are down to talking about months, no longer years. Back in 1982 and 1983 I was on the Social Security Advisory Council, the Quadrennial Commission, that was employed by President Reagan. In those years we were dealing, particularly, with Medicare, and trying to make some changes. It was clear that we had roughly 20 years, maybe 30 years, before we hit the wall with Medicare. This was almost 30 years ago, and we have now hit the wall, because we didn’t do the changes that each of the quadrennial commissions recommended, the one I was on, and subsequent ones, and the politicians have ignored the reality, and now we have the mess.

David: Eyes wide shut, is basically the status quo in D.C.

Richard: Yes. It is amazing the denial that we still have. Paul Ryan, the Chairman of the House Budget Committee, extremely bright guy, a very good economist, full of integrity, came out with a budget that could work. All these people applauded him for his great courage, and it did pass the House, but it absolutely died in the Senate. The Senate Democrat leaders wouldn’t even bring it up for a vote, but they didn’t come up with an alternative. What Harry Reid did was just an abdication of a basic responsibility. He could have said, “Well, I disagree with Paul Ryan on this or that,” and have come up with an alternative, but the Senate did nothing. That’s not how the system is supposed to function.

David: If the system were to function in a healthy way, and we are talking about the structure of our government, it would still need good people. We’re in too deep, a generation or two needs to go by, and in the context of crisis, perhaps there are the right people who would be born out of that, or could we scratch around and find something other than a law professor at the University of Illinois? What kind of leadership would actually set us on a decent course, and perhaps reverse the Reid tendencies, if you will?

Richard: There are a lot of good people, actually, in Congress, particularly in the House. We have people like Paul Ryan, and a number of others, who are smart, trying to do the right thing. I am old enough to remember the Carter Administration, when we had double-digit inflation, a 21% prime rate. Then, fortunately, Ronald Reagan came along, and a number of good members with him, and we were able to reverse course.

We saw the same thing happen in Britain at the same time. Margaret Thatcher was elected the year beforehand, because Britain was going down the tube. I still remember when she was up for her first re-election. I think it was in 1983. I was in London, and I had gotten in a taxicab to go out to Heathrow to fly back to the U.S. I asked the taxicab driver his opinion of Mrs. Thatcher. He said, “Oh, I don’t like her. I come from a Labor family, always been Labor.” I said, “Well, you are voting against her then, aren’t you?” He said, “No, I’m voting for her.” I said, “I thought you just told me you didn’t like her.” He said, “I don’t, but Britain needs her.” I thought, that is the wisdom of the common man, but things have to get bad enough.

We saw that happen in the U.S. in 1980. The media tried to portray Ronald Reagan as some kind of madman who was going to start a nuclear war and do all kinds of things, and of course, it was nothing of the kind. But people woke up and saw that they couldn’t continue this.

I hope this happens again. You never know beforehand who will emerge, who is going to be a stand-up person. We have been lucky as a country, the right person at the right time. Britain has been particularly lucky. At the beginning of World War II, Winston Churchill had been out in disgrace, but people suddenly realized he had some of the qualities they needed, an incredible background, and the smarts, and he could do what needed to be done. And he did.

David: There is this perception, I think, amongst many U.S. investors, that the dollar is doomed, the Treasury market is doomed, the U.S. is doomed. The best thing that you can do is jump ship as fast as you can, relocate to Ecuador, Panama, South America, Ireland, Singapore – anywhere is better than the United States.

To be honest, I travel a lot out of the United States, and I come home, and every time I come home, other than the TSA, I still like coming home. It still represents a bastion of many, many things, I could make a

laundry list of the things that set it apart and make it better than wherever I’ve just come from, whether it is the Middle East, whether it is Asia, whether it is South America, or Central America. What is your response to the dollar is doomed, the Treasury is doomed, the U.S. is doomed, throw in the towel?

Richard: Well, if I thought all that, then I wouldn’t be doing what I do. Every week, I sit down and write a column, and I could find a little place to hide out in and do nothing, but I prefer to stay here and fight and try to change things. If I thought it was totally hopeless I wouldn’t bother.

David: Is it fair to say that, to the degree that one does throw in the towel, there is a certain degree of culpability for this “inevitable demise,” if one hasn’t done anything to stop, because then one bears some of the blame.

Richard: We, indeed, are masters of our destinies, collectively anyway. My family goes a long way back in the United States. We had ancestors that fought in the American Revolution and at that point they really risked everything. They were going to be dead if they didn’t win. Our struggles are much less severe.

David: I think if the average citizen did say, “I have pledged my life, my fortune, my sacred honor,” and set aside party politics, not unlike the taxi driver in Britain who said, “I don’t like her, but the country needs her,” wouldn’t that be interesting? It’s a different perspective when you can look at your preferences and say, “My preferences don’t matter.”

Richard: I think it gets to a point, at least I hope so, and I use that taxicab illustration, when people say, “We cannot continue on this way,” and the pain gets increasingly great. We saw that in the late 1970s. What we used to call the misery index, the combination of inflation and unemployment got sky-high, and people were hurting day in and day out.

The fact is, people are not hurting as much now. Unemployment is high, but inflation hasn’t been, but this is all going to come, and people will find that they are not having improvement in their lives. Real per capita incomes have not risen in four years, and we have not had such a period in the United States since the end of World War II. At some point, people are going to say, “Enough is enough is enough,” and we are going to have to make the changes, even if they are painful.

David: The statistic that I have seen is that in the year of an election, if a political party has not coincidentally seen an increase in the national income of 3.2%, that party is out. It doesn’t matter what party it is, essentially, if people aren’t doing better, in a very short time frame, not doing better in the year that they get to vote and say, “I don’t like this,” then the party is done.

On the one hand, the statistics are implying that whoever takes the Republican nomination is a shoe-in by default. People aren’t happy. We are not seeing an increase in income. And the issue also is that unemployment remains stubbornly high. 7.4% is the statistic often used. If unemployment is above 7.4%, the incumbent is done – out. If it is below, then they are likely to remain. There is this opportunity on the part of the Republican Party. Is the RNC engaged with this? Is the RNC going to do anything other than stand by and watch the suicides between the contenders today? Will they do anything? Tell me there is a plan here.

Richard: Well, I don’t know. I used to be involved much more heavily in politics than I am now. I worked for both President Reagan, and the first President Bush, but since those days I decided just to work on policies rather than particular candidates. I have found that if you can convince people of the correctness of a policy, that the politicians will come along. Trying to convince the politician the correctness of the policy, if the constituent hasn’t been convinced, doesn’t do you a whole lot of good. I focus my time and energy working with think tanks and other groups who are trying to educate people in terms of the proper policy.

David: That says that grass roots efforts are far more important than the person in power, which speaks to the issue that no one should be throwing in the towel. Everyone should be deeply involved. Maybe it is extreme to say one is culpable if they have thrown in the towel, but the reality is, if it is not a leader, if it is us directing a leader, and then basically taking their finger to the wind and saying, “Oh the people really do care about that issue. That just means that we have to make our voice heard.

Richard: Most politicians, if they see that people really want less spending, or lower taxes, will go that way. There are a few who will go against their constituencies and do the wrong thing, and there are a few of them who will go against their constituencies to do the right thing, but they are a rare breed.

David: A rare breed, indeed.

Richard: Ronald Reagan, to me, thinking back on it, I always liked him, but I didn’t fully appreciate how good he was until years after. People used to say he repeated the same thing over and over and he was repetitive with it. But he had been a radio announcer selling some kind of product at one point in his life, and he said he had learned, “First you have to tell people what you’re going to tell them, then you have to tell them, then you have to tell them what you told them, and then you have to do it time and time again.” It was a never-ending educational job to get people to understand, and people got it. And he was able to get those two landslide wins, bringing along a good number of members of Congress to get the fundamental changes.

But also, he focused very much. One problem with Newt Gingrich, and I have known Newt for 30 years, is that he is not focused. Reagan had two basic goals: Rebuild the U.S. economy, and win the Cold War. Those were two big ideas, as Newt would say, but Reagan didn’t try to go on with 32 big ideas. That is one reason he succeeded, because people could understand it.

Another problem we have had with the huge growth of regulations, I read the other day we have more than 4,000 felonies in the United States, things you can do which are felonies. The average person can’t remember the Ten Commandments, let alone 4,000 things they could go to jail for. It is not only about keeping government small, but also keeping it simple, so people understand what the basic rules are. We don’t need that many rules. If we say no person has a right to interfere with anybody else’s person or property, or engage in misrepresentation, theft, or fraud, that pretty well covers everything you need to know.

David: That sounds like we should return to the Copybook Headings, if you remember that simple poem. Next year we look forward to an update, whether it is FATCA being implemented, or perhaps being repealed, and other developments inside D.C., and we look forward to your input.

Richard: Let’s hope it is very deep into the ground where it belongs. (laughter)

David: (laughter) Thank you.

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