Breaking down Peter Schiff’s defense of the 1%

October 29, 2011

Peter Schiff – In Defense of the 1%

Peter Schiff recently visited OWS, in an effort to “understand what was motivating these protesters and try to educate them about what caused the financial crisis.” Schiff is an Austrian brand economist who strongly believes the roots of the crisis are found in big govt. But his argument tends to fall apart at the seams, when placed under close scrutiny.

(The protesters) might shout, “the banks have taken over the regulatory agencies, so we need more regulations!” Obviously, this is paradoxical. If they’re blaming government for causing this problem, why would they suggest more government as the solution?

This deductive logic seems to make perfect sense on the surface, but pragmatically it is useless. The German govt was taken over by Nazis. This doesn’t make govt, in and of itself, wrong or ineffective or inevitably susceptible to corruption to the point of being inappropriate for society. The solution post-WW2 wasn’t to create a Germany without a govt. The solution was to replace the Nazi regime with a new govt. Similarly in today’s world, it is indeed true that poor regulations delivered us to this economic debacle. But that doesn’t mean we dismantle or just give up on them. Instead, we replace them with new regulations, ones designed to prevent the general types of malfeasance that caused the crisis.

The vast majority of protesters I met did believe in capitalism – they’re just tired of being screwed over by crony capitalism. Noted school-choice activist Michael Strong calls it “crapitalism,” and that’s what it is. It’s a rotten deal for everyone, and they know it.

On this point, I think we all can (and should) agree.

The problem is that many of these people are under the mistaken impression that Wall Street banks are to blame for this state of affairs. That’s like blaming the dogs for getting into the trashcan. Sure, it’s bad behavior, but the ultimate responsibility lies with the authority figures – in this case, Washington.

This analogy is clever, but it is false and misleading. First, Wall Street is operated by humans, not dogs. We can and should hold them accountable for their bad behavior. Second, Schiff assigns “ultimate responsibility with the authority figures”. Schiff intends to make the point that govt itself is the problem. However, the analogy actually implies that govt needs to restrain misbehaving Wall Street types, lest they run wild due to their inherent impulsive reckless greed. The dog analogy suggests the owner should leash his dog to prevent it from tearing into the trash. Extending it this way, it suggest that Wall Street as well must be “leashed” — by proper regulations decreed by the authority figures. However, Schiff derided regulations in the previous paragraph. So his message here is a bit muddled and inconsistent.

And while wealthy New Yorkers have historically made their living providing essential financial services to the global economy, Washington has always made its living one way: at our expense.

I think it would be hard to convince most people that $600 trillion in credit-default swaps and interest-rate swaps and other financial derivatives currently hanging over the global economy are the bi-product of “essential services”. Meanwhile, govt provides services like school systems, paved roads, police and fire, which most people consider worthwhile. Schiff’s characterizations here are unreasonable and ignorant representations of reality.

I have trouble sympathizing with people calling themselves the “99%”, implying they stand in opposition to wealth no matter how it’s earned.

This is a manipulative and incorrect and flat out ridiculous implication of the “99%” and what they stand for. The 99% are not opposed to wealth. Totally absurd rhetoric from Schiff here.

I own a brokerage firm, but I didn’t receive any bailout money. In fact, I have to work twice as hard to compete with bigger financial firms that are propped up by the US government. The least I deserve is the ability to keep what I earn.

No bailout money? Good. You have to work twice as hard as govt-backed firms? This is bad. It’s part of the problem, and we should work together to fix it. The least you deserve? You don’t “deserve” anything, Peter Schiff. No one does. Remove “deserve” from all your arguments, because it’s entirely too subjective a term for rational debate.

The other tool the government didn’t have to use against us back then was the Federal Reserve. Even if we drastically reduce taxes, the Fed might decide to do what it has been doing: printing money to finance government profligacy. This acts as a secret tax on everyone with a bank account, and is critical in transferring wealth from hardworking Americans to politically connected elites.

Inflation is not a “secret tax”. Calling it such is just a manipulative technique to get people to think of it as some underhanded govt conspiracy to take your money. Nor is it “critical in transferring wealth from hardworking Americans to politically connected elites.” Inflation in and of itself negatively affects creditors — i.e. people with lots of money (i.e. the rich “politically connected elites”). On the flip side, inflation positively affects debtors — i.e. people struggling to make ends meet (i.e the bulk of “hardworking Americans”).

One common refrain I heard at the protests was that our problems result from the rich not paying enough taxes. Most feel that economy was better when marginal tax rates were higher, and that lower rates are a cause of financial decline. Forget about the faulty logic of this assumption, it ignores two key points. First, while it’s true that marginal tax rates were much higher after World War II, the tax code also used to contain many allowances and exceptions, such that very few people actually paid the nominal rate. Second, prior to 1913, the rich paid no income taxes at all; yet, lower- and middle-class living standards rose much faster in the 19th century than in the 20th!

A few misleading statements here. First, the tax code still contains many allowances and exceptions, even as the nominal rates have fallen significantly in the last 30 years. Due to these allowances and exceptions, many huge corporations pay 0% in taxes, and the top 400 earners in America pay an effective rate of 17%. I pay about 28% (and I’m nowhere near the incomes of the top 400). Second, Schiff has absolutely zero evidence to support his claim that “living standards rose much faster in the 19th century than in the 20th”. It’s a baseless statement, without context. Which standards, exactly? At the start of the 19th century, America was a mostly agrarian society with some industry. At the end, we were pretty much the same. At the end of the 20th century, however, we had cars, planes, cell phones, laptop computers, internet, and then some. All of these devices drastically improved the living standards of nearly every American. And they’re all 20th century inventions. So what, exactly, is Schiff talking about? Let’s just write this off as pointless nonsense. And even if he did have some obscure statistic, it’s an ideological leap to think that tax rates had anything to do with it.

Overall, I think there was a real lack of understanding of basic economic principles among the Occupiers. Protesters thought that the rich owed a duty to share their wealth with society. However, they failed to see that in true capitalism, the rich can only acquire their wealth by serving others. No one succeeds in a vacuum. Of course, the idea that Occupy Wall Street protesters have a right to share directly in the private profits earned by others is immoral.

True, no one succeeds in a vacuum. And the “others” that Schiff mentions, acquire the wealth that they eventually transfer to the rich, by serving the rich. We are all in service to each other. That’s a basic principle of an economy. Perhaps Schiff understands this, but he puts greater moral emphasis on the flow of “service” from the rich to the “others”, and on the flow of wealth from the “others” to the rich. This is merely his subjective ideological opinion. He has a right to that opinion, but it doesn’t make it an economic or moral principle (no matter how many times he states it so matter-of-factly using terms like “of course”). The basic economic principle that allows the wealthy to become wealthy is that they charge more for their services than what they’re worth, while the “others” are paid less for their services than what they’re worth. This is economic fact. Does it “deserve” to be this way? No (as I said before, nothing’s “deserved”). But it is this way, and economic advancement works well with this type of asymmetry (i.e. “incentives”). Most people are OK with that — so long as it doesn’t feel like the elites are squeezing the life out of the working class (which, for many people today, it does).

Consider the late Steve Jobs…

I’ll just stop right there. I think it’s fair to say, nobody at OWS has a problem with Steve Jobs. Steve Jobs created his wealth by creating wealth for others. Every reasonably minded person in the world should have no problem with someone getting rich this way. Steve Jobs did not work on Wall Street. It’s not “Occupy Cupertino”. Wall Street created its wealth by peddling financial derivatives that turned the investment world into a casino — one where the odds are heavily tilted in Wall Street’s favor. No iPhones were built thanks to a derivative. The only things derivatives produce are fees for Wall Street banks and big paydays for hedge funds who gamble right.

I’m calling for these protesters to educate themselves on the causes of the current financial decline and not to waste their time attacking the wrong target. They have every right to be angry, but also an obligation to be part of the solution. Yes, I am the 1% – but I’ve earned every penny. Instead of trying to take my wealth away, I hope they learn from my example.

It’s impossible for them all to “learn from his example”, because it is impossible for them all to become wealthy like Schiff. As I mentioned before, it’s a basic economic fact that in order for one to acquire monetary wealth, symmetric economic forces must deprive wealth from someone else. We can’t all be CEO’s for brokerage firms. Somebody’s got to take out Schiff’s garbage and make sure the dogs don’t tear into it. And those people will most likely be paid less than their service is worth, such that Schiff can become rich.


17 Responses to “Breaking down Peter Schiff’s defense of the 1%”

  1. >> The least I deserve is the ability to keep what I earn.<<

    When some little kids get their hands on something, they say "it's mine", and want to keep it. Peter Schiff is still like that. He doesn't realize that the societal system around his business, also needs to be paid for. The big problem, that he's too infantile to discuss, is HOW HIGH taxes should be. What common services do we need, for our society to function optimally? And how should they be paid for? Today, it's become possible to charge tolls electronically and very cheaply. What will we gain and lose if we go back to a modernized version of the medieval system of having "robber barons" who OWN the roads, and who can charge you for using them? In that case, should anyone limit their freedom to charge whatever they want?

  2. Nas Says:

    You make some good points, Rob.
    But I do take issue with this:
    “The basic economic principle that allows the wealthy to become wealthy is that they charge more for their services than what they’re worth, while the “others” are paid less for their services than what they’re worth.”
    What do you have to support this claim? I would claim that the foundation of an economy is voluntary transactions where both parties are better off before the transaction occurred. Suppose I sell you a loaf of bread at a certain price. Presumably, I’d prefer to have that price more than the loaf of bread, and you would prefer to have the loaf of bread more than the price I charged. And if I happen to be the best breadmaker in the world, then I can become wealthy trading bread for..well, bread. This doesn’t account for all financial transactions, but I would claim this type is much more common than the type you described.

    • To be honest, I also take issue with my own point here. I haven’t really thought it through entirely. And even if it were generally true, it’s a very broad and abstract and useless point that doesn’t take into account utility or preference or anything like that. I derived it from the idea that a firm must pay its employees less than their worth in order to turn a profit (assuming their “worth” is equivalent to the firm’s revenue). I leapt and extended this idea to the general economy, probably inappropriately.

      • Nas Says:

        Very interesting way of looking at it. I hadn’t thought of it that way before.
        I always assumed my value to an employer is exactly the salary I’ve been able to attain. If I am worth more, the only way to prove that is to leave and make more elsewhere. In an efficient economy without surplus demand or supply for labor (yes, I know this is deeply hypothetical), employers have an incentive to pay workers at or close to the value they provide, or they risk high turnover and the resulting training/hiring costs associated with that. This is one of many fatal errors IBM made when expanding my former group to India.
        My analysis also assumes away any friction in moving jobs, but we all know that there is quite a bit of friction, especially when it may require relocation. So I would say in general, people make just about what they are worth, but what they are worth is a function of their willingness/ability to find other work and the supply and demand in the marketplace for their skills at any given time. Assuming that all or most computer skills are being automated or being attained by a greater number of people around the world at any given time, it’s possible that our (or at least my) worth is decreasing by the minute, unless I continue to learn more things.

      • Very good reply, Rob.

        Value varies with time and place, and sits in the brain of the person who’s doing the valuation. And sometimes it sits in the tummy: The food scraps that we throw into the bin here, are valuable enough that some people would offer themselves into lifelong slavery for them.

        If my employer doesn’t get more for the fruits of my labour, than what he pays me, he’s not getting a return on his investment in plant & machinery & his own time, and ought to terminate my employment. Unless he simply likes (values?) my company and my great conversation, and keeps paying me for that 🙂

  3. Nas Says:

    Also, this:
    “From Schiff: I have trouble sympathizing with people calling themselves the “99%”, implying they stand in opposition to wealth no matter how it’s earned.”
    From Rob: “This is a manipulative and incorrect and flat out ridiculous implication of the “99%” and what they stand for. The 99% are not opposed to wealth. Totally absurd rhetoric from Schiff here.”
    I have to agree with Schiff here. The “99%” is a rather poor and divisive label because it characterizes the 1% as all evil and the 99% as all good. The 1% contains Steve Jobs, Bill Gates, and many other people who have nothing to do directly with Wall Street. In fact, I don’t have the link handy but financial services employees don’t even make up 50% of the top 1%. To segregate based on income percentile is a rather crude mechanism. This came into relief when Michael Moore was asked by interviewer Piers Morgan this week to confirm that he was among the top 1% of earners last year. As expected, he hemmed and hawed and wouldn’t own up to it. In fact, he absolutely _is_ among the top 1% but he is not one of “them.” It’s a poor label, but it’s certainly catchy and I could see why it has great populist appeal. Good branding.

    • Whether or not the 99% label is divisive (which it probably is), it is inappropriate for either side to take the label and draw absurd characterizations from it, like that the 99% are “opposed to wealth”, or that the 1% are “all evil”. The problem being highlighted by the 99% label is the wealth disparity between the 99% and the 1%. This disparity is a real economic problem, regardless of who is in the 1% or how they got there.

      • Nas Says:

        Now we’re onto something. In my view, extreme income disparity and wealth disparity are problematic, but there a few ways to approach this that result in very different policy outcomes. For instance, how does an investment banker command a salary that is 100X the median salary in this country when their social output is far less than that (my evidence of their output is from what I’ve seen of my ibanker friends, so purely anecdotal)? Let me try 3 formulations:
        1) Maybe their activities are under-regulated, so they can defraud their counterparties at every turn and are able to earn huge salaries as a result. The recent subprime crisis suggests this is at least part of the problem. If that is the case, then we need to create some better regulations.
        2) Another possibility is that they successfully lobbied for a regulatory environment that keeps barriers to entry very high, and thus concentrates profits among very few players when in fact the market would naturally spread more reasonable profits among more players. This is the classic rent extraction scenario, and occurs in practically all large industries, with some extracting more successfully than others. The government-sponsored oligopoly of the Big 3 ratings agencies is part of this formulation of the problem.
        3) Yet another view is that in a just society no one should make 100X-1000X the median or own 100X-1000X wealth than the median. The simple policy response here is to more aggressively tax those who end up with the unacceptably high incomes or wealth levels, regardless of how they got there.

        I personally think 1 and 2 are real and should be targeted, as I assume you do too. But 3 is easiest to understand, and gets a lot of airplay in the media. It is also the simplest policy to institute (soak the rich!), but I think if you do this you are targeting a symptom and not the fraudulent activities or regulations that caused it. A 3% increase in the top marginal rates won’t destroy innovation in this country, but it also won’t fix the underlying causes of the recent recession, fix unemployment by any appreciable amount, or fix our long-term balance sheet. It would be at best a short-term palliative to get through some tough times.

  4. Nas Says:

    You make the claim that the Steve Jobses of the world obtained wealth by creating products that made other people better off. This is absolutely true. But this success is not independent of the people on Wall Street that you claim are only responsible for creating a casino.
    Apple would be nothing without a robust financial community to provide start-up funding and to buy and sell shares of their stock, thereby reducing their cost of capital. In a modern economy, even the “doers” like Jobs need help and support from the financial firms (and even from filthy rich individuals) in order to be as successful as possible in the marketplace.
    You also imply that derivatives have no positive social value. Your local banks that allowed their subprime home loans to be packaged up into CDOs actually benefited from the ability to do so. In a non-recession economy, this type of activity allows them to free up more capital for loans to local businesses, instead of keeping it tied up in 30-year loans on their books. One coudl argue that it makes more sense for the larger institutions to hold these types of loans than your local bank. Of course, the subprime crisis was fraught with corruption and deceit, and I can’t defend any of that, but it is somewhat naive to say that derivatives have no value except to generate fees for banks.

    • I never said that Apple’s success was independent of Wall Street, nor did I say Wall Street is only responsible for creating a casino. You’re making a straw man of my argument. As for derivatives, I’d argue that most of them (CDS, interest-rate swaps) are mechanisms that allow banks to circumvent regulations, and in the process create a complex web of global banking inter-dependency that results in one gigantic “too big too fail”. I believe the social cost of such a system far outweighs its benefit, but that’s just my opinion. Perhaps if it didn’t end up with Wall Street swimming in wealth and a guaranteed govt backstop, while the rest of the global economy suffers with high unemployment, I’d think differently.

      • Nas Says:

        Sorry, I wasn’t trying to make a straw man of your argument. But you did indeed differentiat between people like Jobs and those on Wall Street, implying that one provides utility for the world and the other just extracts wealth through derivatives. I was trying to show that the one depends on the other, thus lessening Wall Streets “evil” quotient. But I think I understand where you’re coming from, and you probably understand my point as well.
        What you say about derivatives is interesting. I’d like to learn more to confirm whether “most of them are mechanisms that allow banks to circumvent regulations.”

  5. Lots of good comments, Nas. Thanks!

    “So I would say in general, people make just about what they are worth, but what they are worth is a function of their willingness/ability to find other work and the supply and demand in the marketplace for their skills at any given time.”

    Our respective views here depend on our definitions of “worth”. You are defining worth in terms of marketplace competition. I’m defining worth as the value of your output. Your definition is more practical and useful. Mine is quite macro, almost philosophical. But then again, how do you value “output”? If you produced for me a bottle of water at this moment, I’d pay about a dollar for it. If, however, I had just dragged myself across miles of desert, I might give you everything I had for that water. Does that make your production “worth” my life’s savings? No. So while I’ve defined “profit” as your “worth” minus “what you’re actually paid”, you could also define it as “utility” minus “cost”. But anyway, in short, it all depends on definitions.

    As for your income disparity formulations:
    1) Agreed.
    2) Agreed.
    And I’d add that as more wealth gets concentrated in fewer hands, the more capable those few hands become at accomplishing both #1 and #2. It’s a self-reinforcing cycle. Wealth disparity is not a moral or “just” problem. It is a practical problem.
    3) I agree, a simplistic analysis and response like this only addresses the symptom, not the problem. However, rolling back the Bush tax cuts would go a long way to helping the govt maintain a healthy balance sheet (certainly that isn’t a problem now, as the more we go into debt, the more the market seems willing to buy it, but we can’t assume it’ll be this way forever). Rolling them back also includes a 5% increase on capital gains, and a 24.5% increase on dividends (not at all trivial increases).

  6. Nas Says:

    Good analysis on “worth.” I am most comfortable with my definition because it is practical and tangible. The philosophical approach that you described is still interesting.

    “And I’d add that as more wealth gets concentrated in fewer hands, the more capable those few hands become at accomplishing both #1 and #2. It’s a self-reinforcing cycle. Wealth disparity is not a moral or “just” problem. It is a practical problem.”

    I’m not fully convinced it’s much of a practical problem, but I can see why you might. In my view, #1 and #2 will always happen, regardless of wealth disparity. Economic regulations are very often (not always) bought and designed by special interests, and sold to the public under false pretenses of social good. And special interests will always be able to amass larger sums than “the people” when it comes to lobbying and campaigning, regardless of individual income disparity.
    In the few cases where the regulations are written by well-intentioned technocrats and central planners, they suffer from Hayek’s knowledge problem, in which the economy is so complex that the macroeconomic effects of central planning can neither be predicted reliably nor measured after the fact. There certainly are laser-targeted reforms where the benefits seem to outweigh the downsides and unknown consequences, but they are few and far between. The public instead tends to clamor for large, sweeping reforms, without much understanding of the feedback effects or unintended consequences. Due to my beliefs above (and they really are just that), I tend to trust de-regulatory efforts over active intervention. The less the government is involved in the marketplace, the less it can introduce inefficiencies and the less it can re-direct rents to its favored constituencies.

    As for taxes, are you familiar with Kotlikoff’s Purple Plan? My econ professor friend pointed me to it, and it appears to make a lot of sense. Kotlikoff is also well-respected among both the left and the right for his policy chops (he served in Reagan’s Council of Economic Advisers).
    As you have stated, we need revenue from taxes to support the primary functions of government, the social safety net, etc. And if we accept that if you tax a certain activity, you will get less of it, then it’s preferable to tax consumption rather than income, savings and investment. The Purple Plan replaces the individual income tax, corporate income tax, death tax, and capital gains tax with a progressive sales tax and a progressive inheritance tax. He also reforms FICA to make it progressive (it’s quite regressive today). He recently wrote a short policy brochure on the regressive nature of the corporate income tax, and highlighted some points of the Purple Plan here. I think you’ll enjoy this if you’re not familiar. Let me know what you think:

    • Jørgen Klaveness Says:

      Thanks for posting this. I find myself agreeing with almost everytning. There’s one point, though, wheres I’d like to extend the horizon a little. It’s where you say

      (1) that “In my view, #1 and #2 will always happen, regardless of wealth disparity”, and

      (2) that “The public instead tends to clamor for large, sweeping reforms, without much understanding of the feedback effects or unintended consequences.”

      Number (1) makes me think of the inherited privileges, that played important parts in literally bankrupting France in the early 1700s, and in setting that country up for the revolution of 1789.

      Number (2) makes me think of the series of wars and revolutions that followed, and which eventually led to a new political-economic order where the old privileges had been either swept away or cut back to manageable size. It was a VERY messy process.

      Today, we’re again faced with a situation where a new form of “inherited privilege” (money) is giving some people so many advantages that it’s getting in the way of optimal resource utilization for society as a whole. This will be resolved in one of two ways. Either by a gradual adjustment through democratic means, or through another (possibly violent) upheaval.

      In my mind, this depends on where the conservative movement will allow itself to be bent – like the willow – or be like the oak, which remains proudly standing upright until it’s too late.


  7. Rob Says:

    “In my view, #1 and #2 will always happen, regardless of wealth disparity.”

    Yes, they’ll happen. But I contend that wealth disparity makes it worse. On a level playing field, where wealth is distributed evenly, the special interests must amass a lot of popular support before they become big enough to corrupt. In that case, they’re fighting for the interests of many people, which isn’t as bad as, say, 5 bank CEOs in a room, commanding vast wealth, essentially putting a gun to the regulators’ heads, saying “bail me out or else”.

    “I tend to trust de-regulatory efforts over active intervention.”

    That is to say, you trust the market over the technocrats. As a former Austrian thinker, I used to be right there with you. At some point I changed my mind. As I see it now, the market gets things just as wrong as a naive central planner. I think the recent turn of economic events, and the still-existing $600 trillion of derivatives hanging over the global economy like an anvil, are evidence of that. Only the unfettered financial wizardry of the smartest money men alive could have created a market worth 10x global GDP. Yes, it’s easy to describe the value of an individual derivative (they must be valuable to someone if we have $600 trillion of them). But this tangled mess of global inter-dependency has given private bankers around the world the keys to the castle. They have complete power over governments. If they fail, they threaten to bring down the entire global economy, as all these derivatives go bad. And so, they force govts to eat all their bad bets, which causes the kind of sovereign solvency problems we see throughout Europe and elsewhere.

    In short, I don’t trust a market commanded by extremely wealthy elites, any more than I trust technocrats or naive central planners. In my mind, they’re all one and the same. None of them can perfectly foresee the consequences of their actions – and the more power they command, the more amplified their errors become.

    This is why I consider the enormous wealth disparity between the 1% and the rest of the population to be a practical problem — one that will be solved voluntarily by those who control the wealth, or via a very messy revolution by those who don’t.


    Some scientific evidence around the clustering of wealth and power and the interconnectedness of the global economy that I’ve been pontificating about (thanks Ilana!).

  9. Oh, I forgot to comment on taxes..

    “And if we accept that if you tax a certain activity, you will get less of it, then it’s preferable to tax consumption rather than income, savings and investment.”

    I don’t necessarily agree with the premise of “preference” here. This is conventional wisdom of many economic theories, but I lean toward a velocity-centric view of healthy economy. And velocity depends a lot on consumption. Plus a flat consumption tax disproportionately hurts the lower classes (tho this report proposes a progressive one, so I’ll take a read).

    But it’s all part of the same equation, I suppose. If you tax consumption you’ll simply get less income and savings, and vice versa. So I’m not sure showing preference to one side or the other makes a difference in the overall equation. It may make a difference, however, in the balance of wealth distribution.

    I agree that inheritance should be taxed heavily, to curtail dynasties and unearned privilege.

    I’ll read the report. Thanks for the link.

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