The Day FDR Tore Up The Constitution

With the Supreme Court nomination hearings for Elena Kagan last week, it's time once again to open up our "Pocket Constitutions."

Kagan has already faced questions on the constitutionality of "Don't Ask, Don't Tell" and the classic "Right to Bear Arms." But the major question that nominees always face during these events is whether the Constitution should be open to interpretation or if it is a literal document. And that got us thinking...

What if some of our current policies weren't so constitutional after all? After just a little research, we found that one of our most entrenched national institutions barely passed constitutional muster.

In part of FDR's New Deal, Social Security was dreamed up to protect people against financial devastation in their most dependent times. The concept of Social Security was straightforward; the constitutionality of it was not. In concept, the Social Security system would collect a special tax to fund a special account that provides financial support to the nation's elderly, disadvantaged and dispossessed.

But in constitutional terms, the Social Security program would collect taxes from the many to distribute funds to the few. Thus, the Social Security Act of 1935 was a truly groundbreaking piece of legislation...and maybe even unconstitutional.

Prior to the New Deal, legal precedent on the Supreme Court had established that any practice the Constitution did not explicitly permit was, by definition, unconstitutional.

Under the 10th Amendment, federal powers are restricted to what the Constitution says. Nevertheless, politicians and jurists throughout history have debated whether the letter or the spirit of the Constitution ought to be the deciding factor in any Supreme Court decision. Alexander Hamilton and James Madison debated this very idea in the early years of the republic. Hamilton argued the federal government could levy new taxes for the general welfare of the country in a broad sense. But Madison countered that the federal government could only levy new taxes specifically granted by the Constitution.

Central to the New Deal decision was whether or not the Social Security tax "provided for the general welfare" of the country. Creating a brand-new agency to collect and distribute a special tax was unheard of and there were no real precedents to fall back on.

Ultimately, the court settled this debate by declaring, "The powers of Congress to authorize expenditure of public moneys for public purposes is not limited by the direct grants of legislative power found in the Constitution."

This may have been the most expensive sentence ever issued by the Supreme Court. This one little phrase not only blessed the Social Security concept of taxation and redistribution, but it also created the first legal precedent for levying new taxes to fund specific programs.

The rest is history...and it's not a very pretty one. The Social Security system is functionally bankrupt...and growing more insolvent by the day. Far from spending "public moneys for public purposes," the Social Security system borrows foreign money for unsustainable entitlement benefits.

Today, roughly 18 million new or reissued Social Security cards are sent out each year. And more than $600 billion in payments are given to some 50.9 million beneficiaries of the Old-Age and Survivors Insurance and the Disabilities Trust Funds.

For years, we've heard that someday the Trust would begin to run deficits - handing out more payments than it receives through taxes. This date has always been in the distant future. But because of the economic meltdown of 2008-09, that day has unexpectedly arrived this year.

For the first time since Social Security was just a twinkle in FDR's eye, the Trust will lose money. The Congressional Budget Office predicts Social Security outlays to reach $708 billion in FY2010, up from $665 billion last year. Meanwhile, revenues are expected to fall flat near $670 billion.

Without significant changes to the system right now, this arguably unconstitutional program could disappear.

 

How to Cure an Economic Depression

"As recently as two years ago, anyone predicting the current state of affairs (not only is unemployment disastrously high, but most forecasts say that it will stay very high for years) would have been dismissed as a crazy alarmist." That was Paul Krugman in today's newspaper. Thomas Friedman is fixing problems in the Middle East, so we'll have to make do with Krugman to entertain us on economic matters. It is amazing that anyone takes Krugman seriously. It is obvious now that he - and his fellow interventionists - had no idea what was going on two years ago. Now, at least he sees the drift of events more clearly; we are headed towards a Japan-style deflationary slump. "It's a good bet that by some measures we'll be seeing deflation by sometime next year," he writes. "Mr. Bernanke has thought long and hard about how to avoid a Japanese- style economic trap, and the Fed's researchers have been obsessed for years with the same question. But here we are, visibly sliding toward deflation..." So you see, dear reader, even a Nobel Prize-winning dog can learn a new trick. Now, he sees through a glass darkly... Soon, he will be face to face with deflation. Of course, the poor man still completely misunderstands what is really going on. But what do you expect? His career depends on not understanding it. Krugman would have to turn his back on his neo- Keynesian creed if he ever caught on to the plot. He would have to look for a new job if he were ever to tell his readers about it. Almost everyone wants the feds to "do something" to avoid the Japanese "trap." Imagine what would happen if The NY Times' leading economist were to say: "Forget it. The feds have already done too much. Following my advice, they were a major cause of the present crisis. Following my advice, they have made it worse. I was wrong. Now the best thing they can do is to withdraw as gracefully as possible." That's not what Times readers want to hear. It's not what anyone wants to hear, except us "crazy alarmists" here at The Daily Reckoning. We've been talking about the Japan trap for years. Economist Richard Koo calls it a "balance sheet recession." He's right about that. The private sector destroys excess capacity and excess debt. When it's over, the private sector balance sheet looks a lot better. Of course, it could happen faster. In Japan, it may still be going on. Why? Because the Japanese feds worked so hard to stop it. Monetary stimulus. Fiscal stimulus. Quantitative easing. They tried everything. And kept at it for nearly 20 years. But what they were really doing was preventing the one fix that really fixes. It is as if they were letting the air out of the market economy's tires...and then were amazed that it didn't roll. You know what cures a depression, dear reader? We'll tell you. A depression. A depression destroys excessive debt. Businesses with too much debt go broke. Bonds that can't be paid go into default. Households that have spent more than they could afford go broke. Problem solved. Debt disappears. Then, the economy can grow again. So what does Krugman suggest? You guessed it: stop the process of debt destruction at all costs! Do what the Japanese did, in other words, only do more of it. And more thoughts... What's really going on? No one knows. The world is much too complex a place to ever really know what is going on. At best, we can have a vague idea...and maybe see a couple broad trends developing. Our guess is that the broad trend developing leads towards more debt destruction...deflation...and a Japan-style on-again, off-again slump. US top stocks for 2011 still trade at 17-times earnings. Most likely, earnings are going down. P/E multiples are going down too. So, the Dow can be expected to shrink to half or less of today's level. It's harder to see the trend in the bond market. Bill Gross says the two-decade bull market in bonds is over. We're not so sure. The 10-year yield - at 3.05% - is just above the record low from November '09. The 30-year is at 4.04%. Both seem to be sinking toward record lows (meaning higher bond prices). Meanwhile, world trade appears to be slowing. The key shipping index has been down every day for a month. And the two biggest emerging markets both announced warning signs. China said yesterday that its property prices were declining. India said its rate of industrial production growth "sharply" declined to 11.5%. If this is so, expect higher bond prices...and perhaps lower gold prices...over the next few years. *** Does that mean you should sell your gold? Well, if we were speculators, we might consider selling. But here at The Daily Reckoning, we're not gamblers. We hold gold because it represents real wealth, not because we think it will go up in price. We don't really know what direction it is going. But that's why we hold it. We don't know what direction anything is going. The nice thing about gold is that it doesn't matter. Gold doesn't go anywhere. It just sits there. If you buy a bond, for example, you have to worry about the credit quality of the issuer. If things get bad enough, he won't be able to pay up. Your bond could be worthless. Same for 2011 top stocks. A stock is a share of a company. If the company goes out of business, your stock certificates (assuming you have them) are only good for decorations. Real estate is more reliable. But there are taxes and upkeep to pay. Gold is a better way to store wealth. You don't pay property taxes on it. And the roof never leaks. Besides, gold is especially valuable when other forms of money lose their appeal. The trend of debt destruction will probably not end soon. And the feds will probably sooner or later follow Paul Krugman's advice to "raise [the Fed's] long-term inflation target to help convince the private sector that borrowing is a good idea and hoarding cash is a mistake." In the meantime, gold may go down in dollar terms. Which will make a good time to buy it. *** "Boy, those days were very different. It was before the war." An uncle, 93, was reminiscing. "I was so lucky. I had just gotten out of Polytechnic in Baltimore...which was what you'd call a high school...but I think it was much better than high schools today. And I had a girlfriend at the time whose father had bought her a little roadster. We'd drive around town and have a great time. "I'd pull into a gas station. In those days, someone would come right out and start washing your windshield. "I'd say 'fill 'er up' like I was a big shot. Gasoline was only 15 cents a gallon. But I only had 30 cents. Of course, no one had any money. And everybody knew that no one had any money. So I would say 'fill 'er up' to impress my girlfriend, but then I'd put my arm out the window and hold two fingers down so he knew I really only wanted two gallons. "Ha ha...what a ball we had back then... And then I was lucky again. I got a job at the Bethlehem steel plant. I made $18 a week. That was a lot of money back then...I was on top of the world. "Then, of course, along came the war. And we all knew what we had to do. So, we all went down to the armory and signed up. "We'd had such good training in math and geometry at Poly that they put us in the artillery. And they sent me to officer training... "And then, they sent me to the Pacific. And I was lucky again. I guess I've always been lucky. If I weren't so lucky I probably wouldn't still be here. They sent me to one of the islands. I was leading a platoon. My mission was to clean the enemy out of valley. We went in...and didn't encounter any resistance. And then we realized that it was a trap. We were surrounded. And they were shooting at us from every side. We radioed for help but there wasn't any help around. "The men were looking at me... And I was just a young lieutenant... Good God, I thought we were all finished. "I didn't know what to do. We were stuck. And if we stayed there, we were all going to be killed. So, I ran up a white flag. And when they stopped shooting, I got up and took a couple of men with me...and we advanced to where most of the shooting was coming from. Of course, we thought we were going to be gunned down at any minute. But they allowed us to come up to them... "And I still didn't know exactly what I was doing...but it was too late to think...I went right up to the fellow who was in command and asked him to surrender! "And he did! Ha...ha...I couldn't believe it. "Boy, you can't imagine what that felt like... I was so lucky. He thought he was surrounded...and he was short of supplies."