Christopher A. Preble
Earlier this week, Harvard economist Robert Barro and Veronique de Rugy of the Mercatus Center published a short paper assessing the economic effects of defense spending. Their findings are consistent with those of other studies, including one that Cato published last year by Benjamin Zycher. To wit, from Barro and de Rugy’s abstract:
While the impact of across-the-board federal defense spending cuts on national security may be up for debate, claims of these cuts’ dire impact on the economy and jobs are grossly overblown…
[A] dollar increase in federal defense spending results in a less-than-a-dollar increase in GDP when the spending increase is deficit-financed…
[O]ver five years each $1 in federal defense-spending cuts will increase private spending by roughly $1.30
The Barro-de Rugy paper should be of particular interest to Republican politicians and those who advise them. 2012 GOP presidential candidate Mitt Romney and his fellow Republicans attracted considerable scorn (including from yours truly) during a campaign in which they railed against government spending, but also wailed against military spending cuts. His critique was not primarily, or even chiefly, about the potential impact of sequestration on national security; rather, echoing the hardly objective estimates flogged by the Aerospace Industries Association and the National Association of Manufacturers, Romney asserted that cuts in military spending would result in the loss of hundreds of thousands of jobs.
Romney, of all people, should have known better. Government spending extracts resources from the private sector, in the form of taxes and/or debt, and the net effect of this spending is negative over the medium to long term. Barro and de Rugy show that the gains, to the extent that there are any, are particularly short-lived. The reverse is also true: Cuts in spending might result in brief declines in GDP, but Barry and de Rugy conclude that “the adverse effects … will be minor even in the short run.” “In the longer run,” they continue:
when reduced public debt and taxes … are factored in, real GDP should be higher than otherwise. This conclusion is consistent with findings that a smaller share of government consumption in GDP tends to enhance long-term economic growth.
There may be grounds for objecting to defense cuts based on reasoned arguments that these spending reductions would impair national security. But Keynesian arguments that a smaller defense budget will retard economic growth are not convincing.
I would like to believe that such findings would be sufficiently compelling to warn Republicans away from their embrace of military spending as a jobs program once and for all. But, as Tad DeHaven has observed here and here, such situational Keynesianism is a seemingly permanent feature of the nation’s political landscape.
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Beltway politicians like to pretend that smaller spending increases amount to spending “cuts.” As Dan Mitchell has pointed out numerous times (see here for one example), that’s baseline budgeting baloney. Now that the 2011 Budget Control Act’s spending caps are in place, politicians are making an even more ridiculous claim: the so-called “cuts” have already occurred.
The caps apply to spending over ten fiscal years – the last year being 2021. We are obviously not in the year 2021, so it’s impossible for the so-called “cuts” to have already been implemented. Yet here are two examples from a recent Politico article where politicians suggest that to be the case:
“There are people that think we need to cut more,” House Armed Services Committee Chairman Buck McKeon (R-Calif.) acknowledged in an interview. McKeon said he’s been pushing back against budget hawks in the GOP conference by pointing to the nearly $600 billion in spending cuts that the Pentagon has already absorbed in recent years — and that’s before sequestration would even begin.
“I think there’s spending that can be taken out of all departments,” said freshman Rep. Ted Yoho (R-Fla.). “And I’ve talked to people from the Pentagon. There’s just areas that, yeah, we can pull back a little more, even though they did their $470 billion already. They said it hurt, but we possibly could.”
I’ll cut Rep. Yoho a little slack because the article indicates that he’s open to cutting defense. Rep. McKeon, on the other hand, deserves no such leniency. (Why McKeon said $600 billion and Yoho $470 billion I have no idea.)
The following chart illustrates why it is ridiculous to act as if smaller future increases in projected spending amount to realized spending cuts. The chart shows the Congressional Budget Office’s August 2001 baseline estimate of defense spending from 2002 to 2011 versus the actual outlays:
The combined difference turned out to be $1.8 trillion.
But, you might respond, those estimates were published a month before the attack on September 11th, 2001, so of course they turned out to be way off!
And that’s my point. With the exception of Keynesian economists, no one can predict the future. All it will take is another major terrorist attack or another war and it’s adios spending caps. I would argue that such unfortunate scenarios are a distinct possibility given the Beltway crowd’s love for empire, but I’ll leave that topic to Cato’s foreign policy experts.
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Washington Post columnist Courtland Milloy:
When Charles “Chuck” Hicks does the Martin Luther King Jr. Day peace and freedom walks Saturday, he’ll also be taking a step for what the National Rifle Association has dubbed “National Rifle Appreciation Day.” That’s because Hicks is the son of Robert Hicks, a prominent leader of the legendary Deacons for Defense and Justice — an organization of black men in Louisiana who used shotguns and rifles to repel attacks by white vigilantes during the 1960s.
“The Klan would drive through our neighborhood shooting at us, shooting into our homes,” recalled Hicks, 66, who grew up in Bogalusa, La., and has been a civil rights activist in the District for more than 35 years. “The black men in the community wouldn’t stand for it. You shoot at us, we shoot back at you. I’m convinced that without our guns, my family and many other black people would not be alive today.”
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Robert Poole is one of the founders of the Reason Foundation (which publishes Reason Magazine), and served as its president and CEO from 1978 to 2000. He is currently director of transportation policy at the Reason Foundation and frequently writes about issues related to privatization.
In this video from a Libertarian International conference in 1984, Poole speaks about the moral frameworks surrounding national defense and foreign policy. He also goes into the means of national defense, including a lengthy discussion on nuclear armaments and nuclear shield programs.
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By Christopher Preble
The rumors that President Obama will nominate Chuck Hagel to be the next Secretary of Defense should be welcomed by anyone frustrated by years of war and foreign meddling, and out-of-control spending at the Pentagon. Which is to say, nearly everyone. I hope the reports are true.
The biggest boosters of the Iraq war, the Afghan war, the Libyan war, and possible war with Syria and Iran, are apoplectic. And they should be. Hagel, a decorated Vietnam war veteran, understands war, and doesn’t take it lightly.
Although the president will obviously make the decisions, I expect that Hagel will generally advise against sending U.S. troops on quixotic nation-building missions. We might even see a resurrection of another Republican SecDef’s criteria for restraining Washington’s interventionist tendencies. At a minimum, Hagel will reflect Colin Powell’s view that “American GIs [are] not toy soldiers to be moved around on some sort of global game board.”
Hagel’s speech earlier this week to the Atlantic Council encapsulated many of the views that he has articulated throughout his career: he favors active engagement with the outside world, wants America’s allies to contribute more to global security and to cooperate with the United States in addressing common challenges, and is a consistent advocate for free trade.
I don’t put much stock in the neoconservative echo chamber’s claim that Hagel will have a tough time being confirmed. As David Boaz pointed out in 2010, Hagel’s other views should put him squarely in the conservative Republican camp. Aside from the small (and shrinking) Interventionist Caucus in the Senate, on what grounds would other Republicans oppose his nomination? Because he learned the error of his ways in initially supporting the Iraq war, and many of them never did? If more Republicans had come to their senses sooner, they would likely be the majority party in the Senate, and Hagel could just as easily have been nominated by a Republican president.
I had the pleasure of introducing then-Senator Hagel at a Cato event on Capitol Hill in 2007. We welcomed him to Cato to talk about his book in 2008. He is a serious and thoughtful individual who has served this country well, and will do so again. I sincerely hope that President Obama chooses him to be the next Secretary of Defense.
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By Christopher Preble
The defense contractors and their allies and advocates in Washington have been beating the drum against sequestration for over a year. They’ve commissioned studies purporting to show that sequestration will throw hundreds of thousands of people out of work. They’ve embarked on a “stop sequestration” road show, and boosted spending on advertising and gimmicks, including the Countdown to Sequestration clock.
And they’ve held press conferences, including one today at the National Press Club that I attended.
The contractors’ full-court press isn’t working. Polls show that the American people are more interested in cutting defense spending than domestic spending to reduce the deficit. (See, for example, The Economist/YouGov poll, .pdf, Q15) And they, and especially Republicans and independents, are opposed to paying higher taxes to fund a bloated Pentagon (.pdf, Q56).
The public isn’t falling for the lobby’s scare campaign for a few reasons. First, U.S. military spending remains near an all-time high in real, inflation-adjusted dollars. Second, sequestration would reduce the budget to 2007 levels, and reductions along those lines are consistent with other post-war drawdowns. Third, while Americans overwhelmingly support the troops, they appreciate that not every dollar spent on the military is spent wisely.
The United States will retain a state-of-the-art military even if total Pentagon spending declines by 10 to 15 percent. Such reductions might actually induce policymakers to be more responsible when it comes to military intervention abroad. The leading opponents of sequestration are big fans of open-ended, nation-building missions, but they are a small and shrinking minority. Most Americas have learned the painful lessons from the wars in Iraq and Afghanistan, and they are determined to avoid those sorts of expensive and counterproductive wars in the future.
A smaller U.S. military that costs less money cannot be expected to be everywhere all the time. U.S. troops should not be the first responders to every 911 call. Other countries will have to step forward to take responsibility for their own defense, and contribute their fair share to address common security challenges.
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In August 2011, President Obama signed the Budget Control Act of 2011 (or BCA), which is the law that created the so-called “fiscal cliff” that, if Washington D.C. politicians such as President Obama are to be believed, threatens potential disaster for the U.S. economy.
The BCA combines income tax rate hikes on all Americans and government spending cuts that, unless the federal government acts otherwise, will go into effect in 2013. In that year, the fiscal cliff will lead to an estimated additional $536 billion in tax collections and $500 billion in federal government spending cuts.
Since half of the spending cuts associated with the fiscal cliff would affect the nation’s defense programs, those particular cuts have been a source of concern. What effect might these cuts have on the nation’s security?
The Mercatus Center’s Veronique de Rugy has charted out how the BCA’s mandated spending cuts will affect overall defense spending for the next ten years:
As the chart shows, defense spending has almost doubled in the past decade in current dollar terms and will continue to grow in spite of automatic cuts set by the BCA. Clarifying these figures reveals that sequester cuts do not warrant the fears of policymakers who warn about “savage cuts” to the defense budget.
That reality perhaps explains the unusual reaction of the Fortune 500 company Honeywell executive Mike Madsen to the prospect of defense spending cuts for his company:
While most large U.S. defense contractors have warned a $500 billion cut in military spending over the next 10 years could be disastrous, Honeywell International today bucked the trend and announced it would welcome the reductions.
During a meeting with investors Mike Madsen, president of Honeywell’s defense and space unit said that the company recognizes that a majority of the budget cuts that make up the so-called “fiscal cliff” will happen.
“We’re not really fighting these; they need to occur,” he said.
If only other recipients of the federal government’s largesse would take such a mature view….
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By Christopher Preble
It is no surprise that the defense contractors want to protect their profits by getting taxpayers to pony up more money. Now they have secured the support of Crossroads GPS in a commercial against Senate candidate and former Virginia governor Tim Kaine. The Crossroads ad follows similar ones from Kaine’s challenger, George Allen, and the National Republican Senatorial Committee. All three ads claim that spending cuts under sequestration will result in devastating job losses to the defense industry and Virginia; the Crossroads ad claims 520,000 jobs will be lost. But these estimates are wildly inflated and represent the short-term interests of the defense industry, not the American taxpayer.
In actuality, the cuts, if they occur, will be evenly divided between the Pentagon and the rest of the discretionary budget. They are a very modest share of total federal spending over the next decade, and the assertion that the cuts will lead to massive job losses have been thoroughly refuted here, here, and here. Indeed, there is good reason to believe that such cuts will have beneficial effects over the medium- to long-term, if the savings are returned to taxpayers, and not merely plowed into other federal spending.
All of these pro-GOP ads get the lost jobs number from a study commissioned by the Aerospace Industries Association and authored by George Mason economist Stephen Fuller. Last Friday, the Cato Institute hosted a forum—which included Fuller—that considered the effects of military spending cuts on employment and the economy. We discussed the positive impact that cuts in Pentagon spending can have in the wider economy, and even in a state like Virginia that is more dependent than other states on federal spending. The Wall Street Journal’s Steve Moore argued we should just let sequestration happen (I agree). As the Washington Post reported, Economist Benjamin Zycher summed up the hypocrisy of conservatives claiming the defense budget produces jobs:
“Conservatives .?.?. are highly dubious about the purported [gross domestic product] and employment benefits of federal domestic spending, as illustrated by the meager effects of the Obama stimulus fiasco,” he said. “There’s no particular reason to believe that defense spending is different.”
I wish that organizations like Crossroads GPS were as committed to saving the taxpayers money as they are to electing Republicans. I’d also like it if they relied on objective facts, not statistics designed to protect the narrow interests of an industry that relies overwhelmingly on taxpayer dollars. We wouldn’t expect Republicans to accept the teachers unions’ claims about job losses from cuts in the Department of Education. Why, then, do they promote these phony numbers by the defense contractors?
On Thursday, Dan Mitchell and I will be discussing this issue—the effects of sequestration—on Capitol Hill. It is not too late to register, but space is limited, so act now.
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By Justin Logan
Smaller countries free ride on larger countries’ security guarantees because it is the rational thing to do. Almost two years ago, Schmitt authored a very similar piece in the Wall Street Journal. If he was concerned then, or is concerned now, with the inadequate spending of our allies, the best way to change that is to revoke our commitment to defend them. As I wrote in response to Schmitt’s Wall Street Journal article:
In their 1966 article “Economic Theory of Alliances,” Mancur Olson Jr. and Richard Zeckhauser solved this puzzle. Olson and Zeckhauser explained the disproportionate contributions of NATO members with a model that showed that in the provision of collective goods (like security) in organizations (like the NATO alliance), the larger nations will tend to bear a “disproportionately large share of the common burden.” Due in part to these dynamics, Kenneth Waltz concluded by 1979 that “in fact if not in form, NATO consists of guarantees given by the United States to its European allies and to Canada.” As Waltz pointed out, France’s withdrawal in 1966 from NATO’s integrated military command failed to “noticeably change the bipolar balance” between NATO and the Soviet-sponsored WTO.
The implication of the Olson-Zeckhauser model, which has held up remarkably well over time, is that the only way to force Europe to spend more would be to make clear that the United States views European security as a private, not a collective, good, and that consequently its provision was rightly Europe’s responsibility. Given U.S. policymakers’ extreme reticence to adopt this conclusion, likely because a more independent Europe would be more independent, we should expect European defense spending to stay low and U.S. defense intellectuals to keep complaining about European free-riding, all to no avail. (I have previously written about this subject here and here.)
If we maintain a commitment to defend our European wards, they’ll keep free riding and Uncle Sucker will keep paying. Think tankers writing earnest op-eds and policymakers giving stern speeches isn’t going to change this dynamic.
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In Defense of Bank Runs
By Detlev Schlichter May 22nd, 2012
One with a populist view might ask:
Is it really true that we have too-much state involvement in finance? Do we really have some form of monetary central planning? Does this view not completely underestimate the power of the big private banks?
When one looks at the gigantic positions these private banks have on their balance sheets (and the even bigger positions they have ‘off balance sheet’), and when one looks at the outsized bonuses the bankers pay themselves, and when one furthermore considers that most money-creation is done by the private banks, then it appears as if ‘central planning’ or ‘the power of the bureaucracy’ appear inaccurate descriptions of the present system.
After all, J.P. Morgan just admitted to losing $2 billion and counting on complicated derivative positions. How can that be the fault of central bankers or imaginary monetary ‘central planners’? Isn’t this the opposite of central planning? Is this not capitalism running amok?
Maybe we need more regulation and more control by the state authorities. Is the main threat to our economic well-being really a too-powerful central bank? Isn’t it really a private banking system that is run for the benefit of the bankers rather than the ‘real’ economy and that may collapse as a result of uncontrolled speculation? Our system doesn’t look like grey and boring Soviet-style central planning at all but more like flamboyant capitalism spinning out of control.
And by going back to a gold standard would we not restrict the power of the central bank to save us from the mistakes of the bankers? Bringing back gold and restricting the maneuvering space of central bankers will make things worse.
The way I described the populist view here contains observations and conclusions. I believe the conclusions to be largely incorrect. They may appear intuitively sensible but they do not stand up to closer scrutiny. However, there is no denying that many of the observations that form the basis of this popular view are evidently correct.
There is no logical conflict, however, between these observations and the critique of fiat money as a form of monetary central planning. In fact, all the symptoms that the populist view concerns itself with and that form the basis of the widespread public anger – the apparent detachment of global finance from the real economy, the outsized and uncontrollable derivatives market, the bonus culture and the instant claims of the private banks on unlimited bank reserves and unlimited bailouts – all have their origin in the decision to abandon the gold standard and replace it with unlimited fiat money under state control.
Once this connection has become clear, more of the system’s critics should see that the cure is not more power to the bureaucracy and more regulation and controls but simply a return to hard money and thus a return of a system that is controlled, not by bureaucrats and bankers, but by the consumers of financial services.
The power of the consumer
In capitalism, in a truly free market, the consumer decides what is being produced, how resources are allocated, and who makes profits and who doesn’t. By buying from some and not buying from others the consumer ultimately directs production, economic activity and the use of scarce resources.
Under capitalism the consumer decides how capital is deployed. Our problem is that today we have no capitalism in finance, and the reason for this is quite simply the abandonment of a gold standard and the establishment in its place of a system of unlimited fiat money and of central banking.
What is money?
Gold and silver have been used as money in the form of coins for 2,500 years. ‘Modern’ finance started with the rise of banking, roughly 300 years ago. Banks have never really confined themselves to just taking deposits and making loans but, pretty much from the start, have been in the business of creating money, a business that they invented.
Of course, money proper was still gold or silver, and those could not be created by banks, but banks issued what I will call money derivatives. Think banknotes or bank deposits. As these were not gold or silver they were not money proper but they were usually claims on gold or silver, and they began to circulate in the economy and were used by the public as if they were money proper.
And of course, if all money derivatives in circulation had been fully backed by gold or silver in the banks’ vaults (i.e. by gold and silver that is not presently in circulation) then the supply of what the public uses as money would not have expanded and the banks would not have become money producers.
But as we all know, banks quickly managed to issue money derivatives that were not backed by gold or silver, or at least not fully backed by gold or silver. To the extent that the public accepted uncovered money derivatives as money, the banks had indeed a license to print money, and this allowed the banks to extend more loans and make more profits.
But the operative words in the previous sentence are “to the extent that the public accepted”. The consumer of finance, in particular the depositor, decided to what extent bankers could become money producers. If depositors became uncomfortable with the practices of their banker, they no longer accepted his money derivatives but instead removed their deposits and placed it with somebody else, or simply held physical gold and silver again. The consumer had the power to pull the plug on the bankers.
In defense of bank runs
What was money and what was not money had, with the arrival of deposit banking and fractional-reserve banking, become a somewhat fluid concept. And it has remained such ever since. It has become subject to change.
There is, in the words of Keynesian Paul Krugman, a continuum. But under a gold standard, what was accepted as money was ultimately decided by the public. The license to print money could be revoked by the depositors at any time. That put the banker in a perilous position. Being a money creator was lucrative but it placed the banker at the mercy of a fickle public. There was always the risk of a panic and a bank run.
Now, who would be in favor of bank runs and panics? Are they not a sign of a potentially irrational and panic-prone public that fails to make wise decisions in its own best interest? — That is today the generally accepted view, I guess. But the prospect of bank runs is also without question a drastic form of consumer power, of capitalism’s essential checks and balances.
The risk of a bank run, of the public’s sudden loss of faith in the prudence, reliability and solvency of a banker, is a powerful check on the banker’s risk-taking and overall business strategy. Not surprisingly, prior to the arrival of lender-of-last resort central banks and unlimited fiat money, banking seemed to have attracted a very different type of individual than it does today. Bankers were conservative and extremely concerned with a public appearance of restraint, prudence and the utmost reliability. Because they had to be. No macho-talk about “global business opportunities’” of market share and high “return on equity”.
Power shifts from the depositor to the bureaucrat
Enter the central banks. This is what Milton Friedman and Anna Schwartz had to say in their seminal book A Monetary History of the United States about the founding of the Federal Reserve:
“The Federal Reserve System was created by men whose outlook on the goals of central banking was shaped by their experience of money panics during the national banking era. The basic monetary problem seemed to them to be banking crises produced by or resulting in an attempted shift by the public from deposits to currency (currency meant specie at the time, DS.)”
This “attempted shift by the public” was none other than the sovereign consumer deciding that there were now too many money derivatives around and that he now preferred to hold money proper again, i.e. gold. It was apparently deemed okay for the consumer to shift from currency (gold) to deposits, thereby widening the definition of what was accepted as money and thus allowing the banks to create more of it.
But, so the founders of the Federal Reserve System decreed, it was not acceptable that the consumer would ever narrow the definition of money again and reduce the banks’ ability to place more money derivatives. The state thus entered the scene in order to protect the banks from changing preferences of the public, at least those changes in preferences that were bound to limit money creation and credit expansion.
You may say it was good of the Fed to reduce the risk of bank runs and make banking safe. That is the standard interpretation today. (By the way, the Fed has neither made the economy more stable nor banking safer, as George Selgin demonstrates nicely in this excellent presentation.) However, the good economist does not just look at the immediate and most obvious consequences of policy but also at the long run consequences.
There is no escaping the fact that the establishment of a central bank as a backstop for the banks’ production of money derivatives was the starting point of a process of disenfranchisement of the depositor as ultimate controller and arbiter of what is money, of how much there should be of it, and of what makes good and prudent banks. The power of the depositor — the consumer of banking — was weakened, and the power of the central banker, the bureaucrat, as ultimate judge of what is money and what is good banking was strengthened. The bond between banker and depositor was starting to be replaced with the bond between banker and central banker.
It is clear that the interests of banker and bureaucrat were closely aligned and both pointed toward ever more money production. The banker wanted to conduct the lucrative business of creating and placing money derivatives with the public without the risk of sudden changes in consumer preferences. The state officials wanted to encourage monetary expansion as this was deemed to be good for business and because the state itself was of course an important borrower. It is hardly surprising that with the advent of central banking and later unlimited fiat money, state borrowing began to expand.
The score at this point: Bankers/bureaucrats 1 – Consumers 0
There is no such thing as a free lunch. While that is a famous and very fitting quote of Milton Friedman’s (1912-2006), it is Ludwig von Mises (1881-1972) who the bankers and central bankers of the 1920s and 1930s should have listened to. The money-induced credit boom of the 1920s ended in the crash of 1929, and although the public had accepted more money derivatives during the boom as these now came with a government backstop from the young Federal Reserve (and this had made the extended boom possible in the first place), when the bust started the consumer definitely wanted to hold money proper again, and that was still gold.
Bank runs still ensued and now were much worse than they ever had been in the pre-Fed era, simply because the Fed had by now encouraged the issuance of vastly more money derivatives. Although the country was officially on a gold standard and the banks had promised their depositors repayment in gold as part of their strategy to place their money derivatives with the public, the state decreed that the banks would collectively default on this promise and that they could still continue as going concerns.
The state also decreed that money derivatives were now the new money proper and in order to leave the public no choice whatsoever – and no say in what was money or not -the state confiscated all previous money proper (that is gold) via executive order of the president in 1933. (In the United States of America private ownership of gold remained severely restricted until 1974.)
History is always written by its victors, and the victorious money statists, central bankers and Keynesian economists claim – to this day – that this was all for the better. It ended monetary contraction (true) and ended the Great Depression (not quite true but it probably provided a break). But – oh those long run consequences!
The money consumer had been disenfranchised. What bankers could do and not do, how much money there was in the economy and what interest rates were – none of this was any longer a give and take between profit-seeking bankers and their banking consumers, and thus identical in its dynamics to the relationship between any entrepreneur and his customer, but it was now the outcome of policy. In 1953 the Chamber of Commerce of the United States published a pamphlet entitled The Mystery of Money that roundly stated: “Money is what the government says it is.”
The bankers, by and large, embraced this change. It was better to be in bed with the state than the fickle public. The state had unlimited resources (almost) and could make laws. And most important, the state was interested in constant monetary expansion – a magnificently lucrative proposition for the bankers as money derivative producers.
The score: Bankers/bureaucrats 2 – Consumers 0…
Statistics: Posted by yoda — Tue May 22, 2012 6:58 pm
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