Posted by
Mr. D. on Friday, November 21, 2008 2:56:50 PM
Economic “bubbles” occur when the cost of money is too low for too long. The present economic and financial crisis developed when the “Housing Bubble” burst. Sub-prime lending, created to spread home ownership among low income groups and facilitated by low interest rates, spread throughout the mortgage industry because of political pressure to lower mortgage underwriting standards. The Housing Bubble was artificially created by government manipulation of the market.
When the bubble bursts, money is destroyed. Money is created all the time. When a bank makes a loan, it doesn’t gather up the cash and stack it in the corner of the vault with the borrowers name on it. The bank simply makes an entry in the account of the borrower increasing the balance by the amount of the loan, thus “creating” money. When an economic bubble bursts, the reverse occurs and “money” is destroyed as if it were burned on a bonfire.
The sudden and sharp decline in the supply of money is seen as “deflation” in the economy. Because there is less money relative to the supply of goods and services, the value of the dollar increases and prices fall. To compensate for the loss of value, banks have to raise cash to preserve their reserves and borrowers have to pay down debt. The stock market bubble of 1929 was the result of low margin requirement that allowed investors to buy stock with too much borrowed money. When this bubble burst, the FED did not react and increase the money supply and the Roosevelt Administration increased taxes, constricting the money supply. By 1933 the money in circulation in the United States had decreased by 33%! All subsequent actions by government to end the depression failed because they were all efforts to stimulate demand. Since nothing can be consumed until something is produced, this is like trying to push a string. The government managed to turn a 3 year deflationary recession into a ten year depression that would have persisted even longer were it not for World War II.
To counter deflation or the fear of deflation, the typical FED and Treasury action since World War II has been to increase the supply of money. Normally, these are modest changes in the money supply that have little or no percieved impact on the average person. However, the enormity of the amounts involved in the current crisis has required the FED and Treasury to figuratively dump shrink wrapped pallets of $1,000 bills from the holds of C-5As in a, so far vain attempt, to increase the money supply sufficiently to encourage lending. A period of economic stagnation and falling prices prevails as deflation continues and the money supply is replenished. With the injection of trillions of dollars, perhaps tens of trillions of dollars, the economy will show signs of recovery during a brief period when the appropriate balance between the money supply and production is acheived. Unfortunately, by the time this apparant recovery occurs too much money will already be in the system.
Instead of recovery, the economy will go throuh a period of inflation and stagnation. It is impossible to accurately fine tune the money supply of a $15 trillion economy that has a currency based on nothing more than faith. In other words, the government cannot possibly know how much money to inject into the economy is enough and since the effects of injecting money into the economy lag many months behind, it is certain that the money supply will be increased far beyond that necessary to recover from deflationary stagnation. Like a drunk driver overcorrecting and bouncing off of one curb and then the other, the government will tighten credit and shrink the money supply to counter inflation as in the late 1970’s. Eventually, and only through trial and error, the appropriate balance between the cost of money, the money supply and the requirements of a growing economy will be found. How long this will take and how much pain and suffering must be endured during that time is unknowable.
Under the current monetary system and economic circumstances, the question is how can the fuel the economy needs to expand most efficiently, effectively and most rapidly be supplied? The course being followed by the government pumps money into failing companies and institutions “too big to fail” or too important to “national security” and proposes to grant more federal money to individuals, in one fashion or another, so they can “stay in their homes.” While it may be reasonable to view banks as public utilities most able to keep the lifeblood of the economy flowing by efficiently facilitating lending, the same cannot be said for private companies whose business models have failed and can produce no plausible scenario resulting in profitability. Neither does the “rescue” of individuals who cannot afford their mortgage payments. These schemes do not create wealth or value. They can only create a more disastrous outcome by increasing the value that will be destroyed when the inevitable bankruptcies occur.
All of the economic problems we suffer from and that government is unsuccessfully attempting to deal with were caused by government. And, all of the solutions to the economic problems we suffer spring from government. These “solutions” are nothing more than attempts to manipulate individual behavior and instill confidence in government when it is clear that government does not have nor deserve confidence. Government management of the economy is perhaps the last vestige of the notion that the same kind of central planning that won World War II could also provide unending prosperity. Even a cursory examination of history shows otherwise and should dispel that notion.
The objective facts show that government has an unrivaled and seemingly unlimited capacity to damage economies and almost no capacity to positively affect economies. Every economic action by government to manipulate markets, create “socially desirable” outcomes or produce “economic justice” has instead resulted in unintended consequences at least as bad and most often far worse than the circumstance they sought to address. Over time, government has even failed to perform thet basic and necessary function of maintaining a stable currency. Today, people have no faith in a government manipulating an economic system based on a medium of exchange supported by faith. In the past 13 months the value of the Dow Jones Industrial Average has declined by 50%. This is all the evidence necessary to show that faith in government and confidence in the government’s course simply does not exist.
There is a principle that everyone has faith and confidence in and that history shows is demonstrably true. That is that no one spends money more carefully than when they spend their own money. In this simple and self-evident principle lies economic recovery and lasting prosperity.
· The first thing that the government could do to halt economic decline is to stop proposing solutions or taking positions. With each and every pronouncement, the most immediate measure of economic confidence, the DOW, sharply falls. Confidence in markets would soar with the knowledge that there is no necessity of trying to factor in the consequences of many and varied government fixes in order to evaluate risk.
· To immediately reverse the decline of the most visible measure of future economic health, the government must eliminate the Capital Gains Tax. The market needs an infusion of capital and nothing would do more to encourage capital investment and lowering the threshold for acceptable risk than eliminating the tax on gains from investment. As it is, eliminating the Capital Gains Tax would be largely revenue neutral since there are no gains to tax.
· Eliminate corporate and small business taxes. These taxes are eventually paid by consumers and immediately distort business decisions and impair cash flow. Eliminating the tax would give businesses greater ability to manage their obligations and reduce the need for financing their operations during a period of credit tightening. It would also benefit consumers who could expect greater value for their dollar.
· Reduce income tax rates 25% across the board. Investment fuels innovation, innovation causes business formation, business formation creates jobs, jobs produce income and income permits consumption.
Tax cuts targeted at low income individuals, “paid for” by corresponding tax increases on higher income individuals, cannot stimulate the economy. Low income individuals will rationally spend their tax cut on the necessities of daily life. The transfer of a dollar from one taxpayer to another is, at best, the equivalent of taking a dollar out of the left pocket and putting it in the right pocket. Nothing is produced and no value is added in the process. Worse yet, the result of exactly how the person who earned the dollar would have used it if allowed to keep it cannot be calculated. If the person who earned the dollar spent it the same as the person who received it the net effect on the economy would be zero. If the individual who earned the dollar saved it, the bank holding the deposit could loan $10 to a borrower stimulating the economy more than if it were spent. If invested, the dollar it might contribute to the development of a breakthrough product and stimulate the economy much more. Only if the individual who earned the dollar lost his investment or burned the dollar could the transfer to someone else stimulate the economy more than it otherwise would if left in possession of the individual who earned it.
Government produces nothing and occupies itself by spending other people’s money. Yet, common sense and everyday experience confirms that no one spends someone else’s money as carefully as he spends his own. Leave the money in the hands of those who earned it and let them decide how to spend, save and invest it.
· Dramatically reduce unnecessary federal spending. Government gets money to spend from taxes, borrowing and printing. Taxes take money out of the economy at a time when it is desperately needed in the economy. Government borrowing competes with private borrowing at a time when credit is too constrained as it is. Printing money devalues the currency and amounts to a hidden tax. The only viable option, if the economy is to be revived, is reduction of government spending.
The only thing that prevents tax reductions is the political lust for the power to manipulate behavior, reward political allies and punish political opponents through the tax code. Changing this is the change we need.