Friday, November 20, 2009

Why our Economy is toast... Obama is ignorant of economics

From the Wall Street Journal Opinion page:
One of the strongest factors promoting recovery from our 10 post-World War II recessions was an unshakable conviction that, regardless of the immediate trouble, the American economy is fundamentally strong. Based on this underlying confidence, recessions and recoveries roughly conformed to the principle of the bigger the bust, the bigger the boom, and vice versa.

Thus real growth in the four quarters following postwar recessions averaged 6.6% and 4.3% over the following five years. As the chief economist for Barclays, Dean Maki, said in this newspaper on Aug. 19, "You can't find a single deep recession that has been followed by a moderate recovery."

That may no longer hold. Since the current recession has lasted a record seven quarters—and has been marked by a near-record average GDP decline of 1.8% per quarter—we should be witnessing the start of a powerful and sustained recovery. Yet forecasts of a 2% recovery in growth are only one-fourth as strong as postwar experience suggests. Meanwhile, unemployment sits at a generational high of 10.2%.

Why all the pessimism? The source appears to be a growing fear that the federal government is retreating from the free-market economic principles of the last half-century, and in particular the strong growth policies that began under Ronald Reagan. A review of the economic policies instituted by President Barack Obama and the Democratic-controlled Congress lends credibility to this concern.

Exhibit A is the economic stimulus package signed into law by President Barack Obama in February. Even among previous stimulus efforts, the 2009 stimulus stands out for its ineffective targeting and sheer size. With interest, it is $1.1 trillion, double the size of Roosevelt's New Deal spending as a percentage of GDP.

Virtually none of the stimulus spending was directed towards encouraging broad-based private investment, and thus failed to encourage true economic growth.
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Exhibit B is tax policy going forward. It is a near certainty that Democratic-controlled Congress will allow most of the tax cuts of 2001-2003 to expire on Dec. 31, 2010. Marginal income tax rates, capital gains rates, dividend rates and death-tax rates will increase—significantly. Hardest hit by these increases will be small businesses that file under the individual income tax code as sub-chapter S corporations, partnerships and proprietorships. Yet these are the very people whose investment and hiring decisions either drive or starve recoveries.

Exhibit C is the administration's intervention in the GM and Chrysler reorganizations. Upsetting decades of accepted bankruptcy law, the administration leveraged TARP funds to place unsecured and lower priority creditors like the United Auto Workers union in front of secured and higher priority creditors. This intervention has arguably had the effect of stifling investment as wary investors watched political considerations trump the rule of law.

As Warren Buffett said at the time, "We don't want to say to somebody who lends and gets a secured position that the secured position doesn't mean anything." Gary Parr, deputy chair of the mergers and acquisitions firm Lazard Freres & Co., stated the problem more directly. "I can't imagine the markets will function properly if you are always wondering if the government is going to step in and change the game," he was quoted in The Atlantic Online in September.

Health care, the administration's signature issue, is Exhibit D. Disregarding its impact on quality and access, its plan will surely cost well over $1 trillion over the next decade. The House-passed version includes an 8% "pay or play" payroll tax and a half-trillion dollar surtax on incomes over $500,000, much of which will strike small business. Both taxes will tend to depress investment and the creation of new jobs.

And looming down the road is the proposed cap-and-tax legislation, which will cost taxpayers $800 billion.

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If one substitutes the Blue Chip Economic Forecast's interest-rate forecast for that of the administration, deficits will increase by an additional $1.2 trillion over the administration's projected deficits. If the next decade's interest rates climb to match those of the 1980s, then the deficit would increase another $5.3 trillion. If higher interest rates then slow economic growth, the impact on the deficit would be much worse.

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Given the magnitude of federal borrowing, there is good reason to expect higher interest rates and strong inflationary pressures in the future.

It is hardly surprising that many investors are reaching the conclusion that this administration and Congress favor policies that virtually guarantee the economy will not return to the climate of low interest rates, benign inflation and strong growth that we knew from 1982-2007. These investors understand a simple truth that current Washington policy makers fail to grasp: When you repeal the Reagan economic program, you repeal its results.


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