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Saving the economy by wrecking it
By W. James Antle III
With stock prices sliding, Washington is abuzz with talk about how to fix the economy. Recent market volatility threatens the financial security of millions of Americans and there have been some $1.5 trillion in market losses already.
Unfortunately, this response does not include a lightening of the government burden on productive Americans while malinvestments throughout the U.S. economy are liquidated. Instead, the proposed solutions include destroying stock options, exploiting recent business scandals to impose new regulations, increased spending, expanding the money supply and, at least on the part of the Democrats, effectively raising taxes.
Every single one of these ideas is bad. Yet every single one of them is likely to come to pass, as there seems to be no movement in the direction of politically viable alternatives. Assuming that anything that would not damage the economy further is politically viable.
Some perspective is in order. While the stock market has recently been behaving erratically - and the general trend in recent months has been downward, with the S&P 500-stock index down more than more 40 percent from its March 2000 peak - the economy as measured by gross domestic product is growing. A drop in stock prices does not constitute an economic contraction. Given that corporate earnings have been down for the past five quarters, it is understandable that stock prices would go down.
This is little consolation to ordinary Americans watching their portfolios, and thus their retirements, vanish. The economist Frank Shostak recently wrote, "Contrary to popular understanding, the stock market does not have causative powers as far as economic activity is concerned." In fact, in the long run the causation typically runs in the opposite direction. However, Shostak continued with the observation that stock prices "reflect individuals' assessments about the facts of reality." (Emphasis his.) If all this talk about a crisis of economic confidence means anything, it should inform us that part of the reason the stock market is in decline is that many investors no longer feel these stocks are worth their previous prices.
This illustrates why a policy based on relying on increasing the money supply is so wrongheaded. According to the Federal Reserve Bank of St. Louis, the money supply as measured by MZM grew 10 percent from 1996 to 1998. It was during this time we witnessed the boom, finally braked when the Fed tightened in 1999. So why didn't Alan Greenspan and company simply continue lowering interest rates and watch MZM continue to grow at a 15 percent rate as it did the second half of 1998? Yet the damage was done by loose money, not by tight money. It was during the period of excessive monetary growth that consumer spending zoomed forward in spite of negative savings rates. Real investment was replaced with monetary growth, which was fueling credit allocation to companies whose stock prices soared even as they never turned a profit. Gene Callahan and Roger Garrison recently noted that the NASDAQ increased 80 percent in 1999 alone, as this monetary binge helped fuel the dot-com craze.
The problem is that this was not sustainable based on either savings or actual production. Dot-com companies with P/E ratios of zero were outrageously priced on the stock market. Many of these companies were bound to fail, and fail they did - they are still closing their doors today in some cases.
Since 1992, Japan has grappled with its economic woes using a policy mix that includes increased public spending, monetary growth and artificially low interest rates. This approach has failed miserably. Yet there remains a bipartisan chorus for more interest rate cuts here in the United States and MZM grew at a double-digit rate in 2001.
Won't increased spending help the economy? The problem is that the government cannot spend what it does not first take from the private sector in the form of taxes or borrowing (unless it inflates the money supply). This will simply reallocate wealth less efficiently. Incidentally, as Stephen Moore of the Club for Growth has noted, the federal budget has grown 20 percent in the last two years.
The myriad financial scandals rocking Wall Street have also led to an orgy of regulation and congressional preening that is not helping the market in the least. Sen. Paul Sarbanes' (D-MD) measure to unleash trial lawyers on CEOs across the country will not improve the business climate. In an effort to punish future Enrons and WorldComs, Congress and the federal regulatory apparatus are anticipating new policies without considering their unintended consequences. Some commentators, most notably Paul Craig Roberts, have argued that the unintended consequences of past regulations and reforms are an unexplored contributing factor in these outrages.
Most of this is bipartisan malfeasance. The only area where the Republicans are behaving noticeably better than the Democrats is on the matter of tax cuts. Many leading Democrats would like to reduce and delay the 2001 marginal income tax-rate cuts. Republicans in Congress and the Bush administration have so far resisted these efforts.
Liberals are falsely accusing President Bush of wrecking the economy by pushing for tax cuts. But the biggest problem with his tax cut is that it is too small compared to either the general economy or anticipated federal revenues and it will take too long to phase in. We will not see significant marginal rate relief until 2005 and the tax cut is not fully implemented until 2011 (after that, it will expire). Even when it is completely phased in, the bottom marginal tax rate will still be 10 percent and the top rate - where people are most responsive to being able to keep additional income at the margin - will still be 35 percent. The much larger and faster Reagan tax cut, which helped set off a fantastic economic boom, still was unable to prevent a recession in 1982 in part because it had not yet been fully phased in.
Rather than cancel the tax cut out of feigned concern for the deficit (nobody seems concerned about the impact of prescription drug benefits on the deficit), taxes should be cut faster and deeper. Government spending needs to be restrained and the bad investments made during the monetary binge need to be allowed to run their course. This activist agenda of taxing, spending, regulating and inflating will only continue the vicious cycle.
The best thing the government can do right now for the economy is exercise some restraint and not wreck it. Given the statist impulses of too many policymakers and the inherent bias of politicians to appear to be doing something for their constituents, this doesn't seem likely to happen. But a bull market for big government is bearish for Wall Street and Main Street alike.
James Antle III is a senior writer for Enter Stage Right.
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