A Convenient Lie

The “Dead Peasants” thing has a bearing on the economic mess. As I have argued, we need to bring back tariffs. But the bad name of Smoot-Hawley haunts the effort. A case can be made, however that Smoot-Hawley had the deleterious effects that it did, not because it protected domestic industry, but because it protected domestic industry at a time when America was running a massive trade surplus. We were prospering off of other countries’ unemployment, and Smoot-Hawley turned the knife. Still, the surviving myth is that protecting industry is bad, not that protecting a trade surplus is bad. And no matter how much evidence is adduced to demonstrate that the trade surplus is what matters, that China’s yuan policy is really a form of Smoot-Hawley, the free-traders will continue to use Smoot-Hawley as a conversation ender at every turn.

The poster child for such indifference to truth is Charles W. Wilson, who asserted his belief that General Motors was so tied to American prosperity that “what was good for the country was good for GM, and vice versa.” The potential ambiguity of such a remark was known as long ago as Plato. In Euthyphro, he asked: "Is the pious loved by the gods because it is pious, or is it pious because it is loved by the gods?" Is something good for GM because it is good for America, or is it good for America because it is good for GM? Wilson’s point, I think, is that there was no causation involved, just a community of interests. To suggest causation, to allege that Wilson intended to imply causation, is at best to err, and, to do so with animus is to lie. And yet, the implication that he saw GM as the source of all good things persists, because the lie is too useful to pass up.

I have written to Mike Myers, the lawyer who says that “Dead Peasants” referred to dead employees to tell him that the term actually referred to former ones who were still alive. So he now has reason to know that his explanation of how “Dead Peasants” insurance got its name is false. Will he change his story? Will he express at least some personal ownership of his inference, as opposed to his current flat statement of fact? I doubt it. The lie is too valuable, and, it has become sufficiently entrenched that he can pretend not to be responsible for its perpetuation even as he perpetuates it. Of course, I could be wrong. I could get an email from him any day thanking me for correcting his misapprehension, or he could amend his website to tell the story about how the media found the expression “dead peasants” in a memo and appropriated it to name the product, all on its own. One never knows. But one can guess.

In the scheme of things, Myers's inaccuracy isn’t that big a deal. Like the difference between calling it “janitor insurance,” as was done, and calling it “dead janitor” insurance, which was not. Indeed, I suspect the term “dead janitor insurance” was a corruption of “janitor insurance” in a sense “licensed” by the industry’s allegedly calling the product “dead peasants” insurance. (The little lie has babies.) But without the “dead peasant” or “dead janitor” label, outraged bloggers could not get all huffy about how “even the name” makes them cringe. Sort of like Obama’s death panels. Even the name makes me angry. (What, you say there are no death panels? Prove it, Commie bastard!)

A lot of comments on the aforementioned blogs are themselves mini-rants about how bad corporate America is. Care to lay odds that any of these posters will offer a heartfelt “oops” when they are told that companies who bought janitor COLI plans only made money while the employees lived? These are people who would happily admit that they know absolutely nothing about how COLI plans work – that the term “experience rating” is gibberish to them – but they will remain certain that the employers got rich when employees died, because, well, that’s what corporations do, isn’t it?

My claim that the COLI companies made money off living employees and not dead ones will be dismissed, coming as it does from someone who does not share the ranters' clear perception of corporate evil, someone who, therefore, must be lying. It’s a form of denial, really. They have a certain amount of emotional momentum, and no amount of truth is going to change that, not when there is a “bigger truth” (corporations suck) to support the rage, and the object of the game is not to know the truth but to pretend to have a reason to vent the rage.

And yet everyone in this drama would swear on a stack of Bibles that they are themselves not liars, and that they don’t like liars, like, for example, those big corporations and their apologists who say that COLI plan purchasers only made money while employees lived.

Not enough is riding on the rehabilitation of dead peasants insurance for anyone to care whether it was a good thing or a bad thing for employees. It’s been assigned to the “bad for” bin, and there it will stay. But Smoot-Hawley is another matter. We desperately need to end our addiction to foreign goods. We cannot run an economy if our only comparative advantage is in capital-intensive goods. I believe tariffs are coming, and I think the harbingers will be increasingly public questioning of Smoot-Hawley’s role in its time. Two rhetorical titans - “Protectionism caused the Depression” and “China is stealing our jobs” are going to duke it out. Just letting Smoot-Hawley into the ring is progress. Whether it can punch its way out of its historical prison remains to be seen. Our fondness for convenient lies argues against it. But stay tuned.

Dead Peasants Insurance – Fifteen Minutes that Came and Went

So there I was watching CSI: Miami, when one of the characters said that the life insurance policy his corporation owned on another character’s life was “Dead Peasants Insurance,” a term I had never heard before. I had, indeed, heard – and used – the term “dead peasants” in connection with corporate-owned life insurance, but I had never heard this particular usage. Whereby, as they say, hangs a tale.

I used to work for a company that sold life insurance to corporations. One of our main products was what we called “Broad-based Corporate-Owned Life Insurance (COLI).” Less charitable observers called it “janitor insurance,” because the policies in question covered the lives of all employees from the CEO on down the payroll to, for example, the janitor. (It’s no accident, I suppose, that the deceased in last night’s CSI: Miami episode was, in fact, a janitor.)

Broad-based COLI programs were first and foremost tax-avoidance schemes. Life insurance proceeds are exempt from tax, but the tax advantage of broad-based COLI program did not arise from the tax-free windfall on an employee’s death. Rather, the advantage arose because the company could borrow the money to pay the premiums, deduct the interest it paid on the loans, and then receive a death benefit that effectively refunded the interest without tax. This particular gambit had always been permitted by the tax law, and was to some extent regulated and limited by then-existing law. But whether or not the tax benefits were valid, broad-based COLI worked best if the employees lived a long time. The death of an employee terminated his policy, leaving the employer with one less source of tax advantage. It was, therefore, in the interest of the employer that the employees live, not that they die.

There was no windfall when an insured employee died. A provision of the COLI plan allowed the insurer to raise future premiums to recoup any mortality losses, so the employer didn't get to keep any money it made by reason of early deaths. In case of catastrophic loss, the recoupment mechanism would fail, and the employer would receive a net gain on the insurance. But the loss of that many lives would almost certainly cost the company more money than the insurance could cover, so that was hardly the object of the game. The insurance element of the plan was not a profit engine, and, pace Michael Moore et al., the employer had no reason at all to seek or wish for the early deaths of its employees.

The tax advantages accruing on account of an individual remaining insured explains why employers continued to carry insurance on former employees long after they could claim any insurable interest in their lives. It is these former employees that we, at our company only, and for internal purposes only, referred to as “dead peasants,” an allusion to Gogol’s Dead Souls, in which the main character seeks to buy the registered ownership of dead serfs from feudal owners so that he could secure a loan against their future outputs, something he could do because banks used outdated census rolls to underwrite such loans. Our clients were securing loans on life insurance on “employees” who no longer were employees, so the analogy to peasants who were, in a sense, no longer peasants seemed apt. It never occurred to us that the term “dead peasants” would be applied to dead employees, in part because we already had a different use for the term, and in part because, as described above, the plans we were selling were designed to work best if the “peasants” lived.

But the football of life takes some odd bounces. In 1999, the Tax Court labeled the broad-based COLI program at Winn-Dixie Stores – a program that we sold – as a sham and denied Winn-Dixie the deductions it had claimed on the ground that the program had no business purpose, in part because it was never expected to show a pre-tax profit. Buried in the record of the case was this memo that I wrote. Mike Myers, a lawyer who has made Broad-based COLI his meal ticket, links to the memo in his blog, adding that “the ‘dead peasants’ referenced in the memo were deceased Winn-Dixie employees whose deaths resulted in policy benefits to the company.” On this score, he’s just plain wrong. As I said, “dead peasants” was short-hand for former employees. But reporters – he cites a couple – seemed to have reached the conclusion Myers offers, and that, as they say, was that.

An interesting aside: the “section on dead peasants” mentioned in the memo would have addressed a quirk in the tax law that made certain limitations applicable to a policy if the insured “is” an employee. Since a former employee was no longer an employee, the limits arguably did not apply to a former employee, i.e., someone who no longer is an employee. It was soon after our investigation of this subject that President Clinton held forth on the meaning of the word “is” in connection with Ms. Lewinsky. Needless to say, we enjoyed that bit of tap-dancing immensely.

I left the COLI business before the Winn-Dixie case was decided, and I never saw another reference to dead peasants until last night. I now find, on further Googling, that Michael Moore used the term in his farce “Capitalism: a Love Story.” He presents a family outraged by the notion that their loved one had been insured and that the company got paid the amount of the policy when he died. No mention is made of the fact that the company didn’t get to keep the money but had to give the cash back to the insurance company as an adjusted future premium on existing policies. That would’ve spoiled the mood, I suppose. Indeed, one of the reasons the tax case was so weak was that, at least to the satisfaction of the IRS and the courts, the “insurance” wasn’t really insurance. The plan failed its purpose precisely because its purpose was not to profit on the deaths of employees. But the fact remains that profiting from lives, not deaths, is what the plan was about.

So, if the subject of dead peasant insurance comes up at a cocktail party, you tell 'em that you know the guy credited with providing the sobriquet, however unintentionally. It's not Susan Boyle type fame, but it's a start.

Technorati Tags: Dead Peasants,COLI,Janitor Insurance,Michael Moore

Whither Chimerica?

I’m trying to figure out what becomes of Niall Ferguson’s Chimerica. The US and China are locked in a tight embrace. But, as described below, I think the Chinese are better positioned to break away and leave us hurting.

My analysis depends on a certain view of the creation of money. Unfortunately, I don’t know anything “official” about how money is created. I only know what I think about how money is created. So, it only seems fair that I say how I think things work.

In the days of the gold standard, a guy with a gold bar went to the Treasury and said “Here’s some gold; give me some money.” The Treasury gave the guy some money and put the gold in its vault. The guy then put the money in the bank, and the bank lent it out to borrowers.

The money the bank had to lend was “backed by gold.” But there is only so much gold, and a growing economy needs more capital than the gold supply can support at a fixed price. Of course, there is no a priori reason why gold should be the only thing backing currency. German money after Weimar was backed by land. Saudi money is effectively backed by oil (and dollars). And if tangible assets can back money, why not intangibles like an ongoing business? Or an idea and a business plan? When I get money, I don’t care what specific thing of value stands behind it. So long as the money will buy something of value, the money is, well, money.

A well-known Soviet-era joke explained Soviet economics as follows: “We pretend to work, and they pretend to pay us.” Soviet Russians had lots of rubles, but they couldn’t buy anything with them; there was nothing to buy. So, were the rubles really money? Robert Frost wrote that home is where, when you have to go there, they have to take you in. Money, I think, is what, if you have to spend it, they will recognize as payment. All the Soviet Union had, once the price of oil fell, was the ability to force people to pretend to work. Not much value there.

Guys like Ron Paul criticize our financial system by claiming that so-called “fiat money” is worthless because it isn’t backed by anything tangible. They are right that it isn’t backed by anything tangible. But they are wrong to think it matters. What matters is whether anyone who receives a dollar believes that America has something worth a dollar available for sale. The problem with fiat money is not that it isn’t actually backed by real value, but that there is no way to be sure that it is so backed, so the temptation to issue it without any backing is politically overwhelming.

That temptation is exacerbated if a major recipient of your currency actually doesn’t care whether it will buy anything. That, I think, is how China views the dollar, and why the Chinese are not about to revalue their currency or sell dollars any time soon. (But may eventually do both.) And it is why we are not hesitating to print dollars unbacked by assets and products, dollars that others may soon reject.

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China doesn’t care what the dollar is worth because China is using the dollar to keep score in its newly competitive economic regime. China’s goal is to become self-sufficient in just about anything it could buy from the US. Buying stuff from us is the last thing on their minds, so what the dollars can actually buy is of no moment to them. They are happy to own zero-interest T-bills that produce a negative return if that will keep their factories humming.

China faces the daunting problem of booting up a capitalist society. Chinese entrepreneurs need customers above all, and the US has the most and best to offer. We provide a demand for quantity and quality, both essential to the long-term success of any enterprise. We are, in effect, the judges in their game of “So You Think You Can Run a Business.” We buy the outputs of their most effective companies, and that’s (a) how they know who those companies are, and (b) how their people and the rest of the world know that the yuan is “backed” by the productive capacity of a real economic engine.

The Chinese pay us for service as judges by selling us stuff at artificially low prices and lending the money back to us at artificially low interest rates. Such largesse is not, however, without consequences: we have lost jobs to cheap imports and borrowed too many cheap dollars at both the private and public levels. But that’s not China’s lookout. And, as described later on, cheap labor is cheap labor, whether or not it is even further subsidized by a cheap currency.

To understand China’s indifference to the value of the dollar, try this thought experiment. Suppose the Chinese government announced that Chinese exporters no longer needed actually to export their goods to America. Instead, Chinese companies can simply dump their outputs in the ocean and receive yuan equal in value at the official exchange rate to the dollars the company would have collected if the goods had been sold in America. (Think cash for clunkers.)

Why would this not work? Certainly, it would stimulate outputs, and thus jobs, and it would give Chinese workers and entrepreneurs money to spend. One reason it would not work is that there is no way to prove that Americans would have bought a merchant’s products at the price he says he could have sold them. As they say about upsets in the world of sports, that’s why they play the game. So, without regard to whether China actually needs to get dollars for the yuan it issues, the American consumer serves a valuable purpose just by buying one Chinese company’s outputs rather than anyone else’s. They play the game, and what we buy from them is their score. The winner has actually proven an ability to produce desirable goods at a good price, and that means that the yuan issued to it with respect to its sales are “backed” by productive capacity, whether or not they are also backed by the dollars the Chinese government gets for them.

Now let’s look at how important it is that the Chinese actually get those dollars, or, more realistically, whether those dollars hold their value or earn a positive investment return. Instead of the merchants destroying the goods in our experiment, suppose they have to make real sales, but that the Chinese government destroys the dollars it gets for the yuan it issues. (After all, lending to us at zero interest is as close to burning the money as the Chinese can realistically come.) The only real issue for the Chinese is whether the yuan issued on account of the goods sold to the US would be respected by those asked to accept it.

Those yuan are fiat money, but lots of countries issue fiat money. The yuan are nominally backed by the dollars received, but they are, I submit, also, increasingly (and more importantly) backed by the entrepreneurial infrastructure and labor of the Chinese people. Real factories will have produced real goods for this money, proving that the money can be spent on real products from real factories. So, what’s the difference to Chinese yuan-holders whether the dollars received for the exported goods are overvalued when received or become more so in the Chinese government’s hands? More and more, it is the Chinese economy, not the dollars, that make the yuan credible. Thanks to our willingness to buy good Chinese products, the Chinese workers do not have to pretend to work, and the Chinese government does not have to pretend to (provide the money) to pay them. No wonder the Chinese government has no interest in revaluing their currency: getting more dollars for less product might make economic sense, but it makes no political sense at all.

So we and the Chinese are for now co-dependent. We are addicted to their products, and they are addicted to our custom. Which of us, if either, will get over our addiction? China, I think. The very prosperity that China seeks to create must inevitably lead to consumption there. Even modest consumption would be significant. One little car in each of 1.2 billion garages, a chicken in every one of 1.2 billion pots, is a lot of consumption. When their own consumers are buying their own outputs, we won’t be so valued a customer, and the yuan will be allowed to appreciate against the dollar (again, “destroying” China’s dollar reserves, as in our experiment).

Chinese prosperity can cure China’s addiction to American customers. But what will we do when the Chinese don’t need us to buy from? One possibility is that like a bee, we will simply move on to the next flower. Other countries may want to emulate China’s entrepreneurial path, starting as China did with no indigenous consumer class. But the Chinese flower may be unique. The sheer number of people, the policy coherence, the level of education, the cultural work ethic may all have conspired to make China a once-in-a-century opportunity for economic symbiosis. There may well be a place that doesn’t care what the dollar is worth, but it probably won’t be able to absorb as many dollars as we have become accustomed to printing. (And we will still be attached to the oil teat, exacerbating the trade deficit. We desperately need an energy policy that provides certainty that home-grown energy will not be rendered uneconomic by global action.)

What makes our situation so troubling is that the villain in the piece is something most of us, including me, think of as usually benign: international trade. I like the idea of comparative advantage. When two economies have comparative advantages in mutually desirable goods, trade between them is good for both. But the law of comparative advantage ignores the effect of trade on displaced workers. Trade may be advantageous to the traders precisely because it displaces workers. Of course, the gains from trade can create capital that then reemploys the workers at higher wages. But that’s a contingent event: sometimes it happens, sometimes it doesn’t. And when one trading partner’s comparative advantage arises from its people’s willingness to live poorly (broadly defined to include preferring poverty to torture or death), the other partner’s workers are likely to be dragged down to that level if they hope to stay employed.

I’m not making a moralistic argument about how our trading partners treat their people. That argument is available, but there are counters to it that don’t need to be addressed if the argument isn’t made. Whatever one may think of slavery as a form of economic specialization, one ought not to volunteer for it lightly. A national trade policy that costs jobs here because labor of equivalent skill is cheaper elsewhere is a mistake: such practices create a race to the bottom; we get stuff cheaper, but we can afford less of it. And “trade” in which they send us stuff and we send them money is not “trade” at all.

To understand the ramifications of dealing with cheap labor sources one need only apply the classic comparative advantage paradigm. If England sells Portugal wool and Portugal sells England wine, there are fewer vineyards in England and fewer sheep farms in Portugal. Presumably, the people who would have produced English wine or Portuguese wool are busy making English wool or Portuguese wine. But if the Third World sells us all of the labor-intensive goods we need, we can only sell them capital-intensive ones. A country cannot sustain a workforce by selling only capital-intensive goods. Such a country becomes a land of rich entrepreneurs (and bankers) and underemployed proletarians. Sound like any place you know?

We have to stop living for deals. We need jobs not bargains. We need protectionism, not because it’s “good” or because free trade is “bad.” We need it because the Chinese – and everyone else with coolie like labor – should not be allowed to exploit a comparative advantage in labor per se. Any comparative advantage they can get from geography or innovation or education or organization is fine. But we ought not to compete on whose workers are willing to live worst.

I understand that if we impose tariffs or quotas on Chinese goods, we may have a trade war. But that assumes that we are not already in one and losing it. If our trade imbalance with China goes away because they don’t import from us, I believe that our domestic consumers will more than pick up the slack over time, and the stronger dollar will enable us to maintain low interest rates permanently. I know Smoot-Hawley is said (increasingly by people who don’t know anything about the matter) to have made the Depression worse, but that idea seems to have been largely discredited by a host of economists with the perspective that only time permits. China will not revalue the yuan voluntarily, and even if it does revalue it, other cheap-labor states will fill any void created unless we impose real quotas that enable well-run American companies to employ well-educated and well-paid workers. Otherwise, what good are cheap toys?

Decisions Only a Lawyer Could Love – Part I

Two recent court cases reminded me how differently from real people lawyers are taught to view the world. Both decisions support Mr. Bumble’s pronouncement that if the law is as described, “the law is a ass,” as both decisions produce bad results. But neither decision, I submit, is wrong.

The first case involves JFS, a Jewish private school in London. Under British law, religious schools receive state support, and they may give admissions preferences consistent with their religious orientation (as determined by a religious authority). They must not, however, discriminate on the basis of ethnicity. This puts Jewish schools in an odd position, because one of the tenets of orthodox Jewish belief is that a child is Jewish if, and only if, his or her mother is Jewish, by birth or orthodox conversion.

JFS gives an admission preference to “Jews” of all level of observance. The school’s admission policy is intended not only to enable the observant to remain so but to enable the uninitiated to become observant. This policy may be perfectly laudable, but it is not consistent with the purpose of the English law, which is to allow parents to send their kids to schools that teach the parents’ religion. One can easily imagine non-observant Jewish parents sending their child to a Jewish school not to get a religious indoctrination but in spite of it. Such children would be given preference at JFS, contrary to the purpose of the state support. The school’s admission policy is thus inconsistent with the law, and, according the the English Court of Appeal, a mid-level appellate court, its implementation violates that law.

The JFS case involved a boy whose mother was converted by a non-orthodox method and was denied admission by the school on this ground under the schools’ policy of giving preference to “Jews” as defined by the Orthodox rules. The court held that a school may not use the matrilineal test because that is an ethnicity test, not a religious one.

The case has raised a big stink for a couple of reasons. First, if one doesn’t look too closely, the court appears to be deciding who is a “Jew.” But it is not. The court doesn’t care who is a Jew. The court is saying that a school for “Jews” is a tribal, discriminatory place, whereas a school for the children of people who practice orthodox Judaism is not.

Second, inside the Jewish beltway as it were, the ongoing battle of orthodox and non-orthodox rabbis over the nature of conversion is being played out. If the boy’s mother’s non-orthodox conversion had been accepted by the school, the whole thing would never have come up. Of course, the legality or not of the admissions policy would remain the same, but there’d be no plaintiff to make a fuss. The political furor over the case is stoked by this internal battle, but it seems to me wholly irrelevant to the legal case.

To the lay press, the case seems to be about the state meddling in the internal affairs of a religious denomination, deciding to whom a Jewish school may give preferences. But to a lawyer, the case is about whether there can be a “Jewish” school at all, as opposed to a “Judaist” one, a straightforward question of statutory law. The matter is clouded by what many see as a bad result – an orthodox Jewish school not being able to restrict admission to people who can be orthodox Jews – but that result is bad only if you think such a school is worth having, and if you think the state should pay to subsidize it. These are interesting policy questions. But they have no bearing at all on the correctness of the court’s decision.

And Another Thing (about driving in Europe).

Lane discipline. What’s so hard about driving on the right unless passing? Why can’t/won’t Americans do it? It’s the law here. It’s the proper etiquette here. But good manners are simply un-American.

The autostrade in Italy have a speed limit of 130 kph (about 78 mph), except when it rains, when it’s 110. (What’s up with that? Two speed limits, like two flush buttons. Those furriners can handle some complex stuff, by golly!) They enforce the speed limits – laxly, it appears - with roadside cameras rather than patrol cars. And lots of people speed. It’s not at all uncommon to see someone zoom by in the left lane going 100 miles an hour. But on a perfectly maintained (or maintenance-free rubberized asphalt) road, with no morons on cell phones clogging up the left lane, there seems to be no problem.

I think there’s something to be said for the American disdain for rules. Rules are how the undeserving rich stay rich and the undeserving bosses stay bosses. But no one ever accused the French or Italians of being a particularly ruly bunch, at least not recently. The Germans and Brits, yes. But not the French and Italians. Yet they seem to have figured out that driving on the right is a good idea. It lets them go faster. They break the rules by speeding, and they observe lane discipline so that they can speed. They observe a rule so that they can break a rule. Chew on that one for a bit.

[2023 Update. I drove in France this year. The French now have tons of cameras and much more diligent enforcement of them. My four tickets attest. The cars are equipped with warning buzzers, but unless one is fluent in French Buzzer, one learns too late what they are trying to say...]