Wednesday, November 26, 2008

Robert Mundell’s New Wisdom

New economic stats on consumer spending and business durable goods investment show an economy that’s sinking fast across-the-board. Wall Street economist John Ryding expects a 4 percent drop in fourth quarter real GDP.

Of course, the Fed is pouring in new cash hand-over-fist. And plunging retail gas prices to about $1.85 per gallon nationally amounts to a huge consumer tax cut of perhaps $320 billion, according to Mark Perry of the University of Michigan. So we’ve moved from tight money and an energy tax hike a year ago, to easy money and an energy tax cut today. The former mix has generated a nasty credit crunch and a recession. But the new monetary/energy mix will generate recovery next year. I hope.

At a wonderful dinner last night I had a chance to talk to Nobel Prize winning economist Robert Mundell about all things economic. What is to be done? I asked him.

Mundell, you may remember, was a leading supply-sider in the Reagan revolution. He argued for low marginal tax rates to spur the economy and a stable dollar to eliminate inflation. Bob Mundell also is the father of the euro. He is plainly an incredibly brilliant and distinguished

The dinner was put together by the indefatigable hard-money analyst Judy Shelton, a pretty smart gal herself. Our spouses were there along with some friends.

So here’s Mundell’s latest take on a pro-recovery, fiscal-monetary, growth mix. First, he’d like to see a complete corporate tax holiday for one year. He then favors corporate tax reform that would drop the current top rate from 35 percent to 15 or 20 percent. He believes this would generate badly needed business investment and job-creation to fight recession.

Incidentally, in today’s durable-goods business-investment report for October, capital-goods shipments are falling at a 12 percent annual rate versus their third-quarter average. Orders are down 35 percent. (By the way, that third-quarter average was a negative number.)

So Mundell is clearly on to something. Business needs help. Without healthy business, there will be no significant new job creation or consumer spending power.

On money, Mundell had two interesting thoughts: First, the U.S. dollar and the Chinese yuan should basically be re-linked at roughly today’s exchange rate (about 6.8 yuan to the dollar). There should be no more Chinese currency appreciation. Incidentally, Mundell thinks the Chinese economy is actually in some trouble. And he’d know. Mundell travels to China about once every other month as a key advisor to the Bank of China.

Also on the currency front, Mundell would prefer a floor under the euro at roughly $1.25. That’s about where it is today. It’s also roughly the same as the original $1.18 euro initial public offering in 2000. So Mundell is pressing for dollar stability relative to Europe and China. And he believes
that would be consistent with domestic price stability here at home.

Unfortunately, Fed head Ben Bernanke simply doesn’t think in these global currency terms. Mundell has no real problem with the Fed’s huge balance-sheet expansion to push new cash into the credit-crunched recessionary economy. He believes there is a huge demand for dollars at
home and overseas, and that the Fed should be accommodating this.

But Mundell frets that Bernanke is too much of a Phillips-curve unemployment-rate targeter, and that he doesn’t understand the powerful influence of a sound currency policy.

Putting it all together, Mundell’s anti-recession program is a reduction of the high marginal tax rate on business to reignite growth along with a stable dollar to contain inflation.

We also got around to talking about Paul Volcker, who is a friend of Mundell’s. He’s also my former boss from 1975, back when I was a young staffer at the New York Fed and Paul Volcker was the bank’s new president. Volcker, of course, has been counseling Barack Obama during the financial crunch. And today, the president-elect appointed Volcker, the former Fed chair, to be the head of a new White House advisory board on the economy. This advisory board takes a page from Ronald Reagan, who set up PEPAB, the President’s Economic Policy Advisory Board, back in 1981. Members of that group included Milton Friedman, Art Laffer, Alan Greenspan, Arthur Burns, Herb Stein, and others. George Schultz was the first chairman. This group helped sustain Reagan’s supply-side policies during some difficult times in 1981-82.

Now, no one really knows what Paul Volcker really thinks about the myriad TARP financial-rescue packages being run by the Treasury, the Fed, and the FDIC. Nor do we know what Volcker thinks about the Fed’s ballooning balance sheet, or U.S. dollar policy for that matter. A lifelong Democrat, Volcker is properly credited with slaying inflation in the 1980s. But he is no supply-sider.

Presumably, however, the conservative-Keynesian Volcker, along with Tim Geithner, Larry Summers, and Christina Romer, will advise Obama not to hike taxes in the next two years.

But that’s a presumption. We don’t know who else will be on this Obama economic advisory board. Might they consider a stable dollar and a big corporate tax cut? Well, if Volcker listens to his friend Mundell, he’ll gain some important advice to be passed along to the new president-elect.

Thursday, November 13, 2008

Bush Shows Obama the Way

President George W. Bush came out fighting for free markets with a strong and stirring defense of American capitalism on the eve of the G-20 World Economic Conference. Stocks soared 550 points Thursday as Bush’s luncheon speech was played live on all the major cable networks. It was as though Mr. Bush was trying to leave an economic-primer to his successor-elect Barack Obama. Markets cheered because it’s the best thing they’ve heard in many weeks.

Here’s one of several great passages from Bush: “At its most basic level, capitalism offers people the freedom to choose where they work and what they do … the dignity that comes with profiting from their talent and hard work. … The free-market system also provides the incentives that lead to prosperity -- the incentive to work, to innovate, to save and invest wisely, and to create jobs for others.”

In other words, free-market capitalism is the best path to prosperity.

During a gloomy period of financial crisis, recession, big-government rescues, and ailing banks and industrial companies, Bush has provided a strong visionary dose of big-picture economic prosperity and optimism that can lead the U.S. and the rest of the world out of its economic doldrums.

Here’s another uplifting passage from Mr. Bush: “Free-market capitalism is far more than an economic theory. It is the engine of social mobility -- the highway to the American Dream. And it is what transformed America from a rugged frontier to the greatest economic power in history -- a nation that gave the world the steamboat and the airplane, the computer and the CAT scan, the Internet and the iPod.”

Capping all this off, Bush said, “The triumph of free-market capitalism has been proven across time, geography, culture, and faith. And it would be a terrible mistake to allow a few months of crisis to undermine 60 years of success.”

That reference to 60 years harkens back to the original post-WWII economic-rebuilding conference held in Bretton Woods, N.H., in July 1944. At that historic meeting, the U.S. and Britain led 170 delegates from around the world into a new era of free markets, free trade, and stable currencies. It was a conference of global coordination that broke down the isolationist and protectionist sentiments that upset the world order so badly during the prior 15 years.

Ultimately, the free-market system forged at Bretton Woods, which was in no small way predicated on economic prosperity, led to a triumph of Western values over Soviet state socialism. And it was President Reagan -- along with his friend, British Prime Minister Margaret Thatcher -- who applied the final blow to the now-defunct Soviet system with his rejuvenation of free-market capitalism.

So what George W. Bush seems to be saying is this: Do not discard that triumphal system just because we’ve had a rough year in the financial markets and the economy.

In a few weeks Barack Obama will inherit the mantle of the capitalist system. What will he do with this responsibility? That’s the question being asked everywhere.

Since the election, and up until President Bush’s important G-20 speech, stock markets sold off nearly 15 percent. Investors want to know if economic rewards will be encouraged or penalized. Will trade remain open and free? Will we maintain competitive businesses that can compete worldwide? Or will we resort to the protection of ailing or failed businesses?

Will the U.S. lurch toward the semi-socialism of Old Europe? Or will we stay with free-market capitalism? Will we expand the nanny-state economy? Or will we keep the door wide open to entrepreneurial spirit and gales of creative destruction?

Investors want to know which way President-elect Obama is going to go. Might he reach back to the Democratic pro-growth supply-side policies of John F. Kennedy’s tax cuts, free trade, and strong dollar? Will he opt for Bill Clinton’s free-trade and strong-dollar policies, or even his capital-gains tax cut? Or will he fall back to the hopeless government tinkering of Jimmy Carter or the welfare-statism of Lyndon Johnson?

I’m keeping an open mind on Mr. Obama during this post-election honeymoon period. After all, he stole the tax-cut issue from Sen. McCain during the election. And surely he knows the conservative red states that joined his campaign for change didn’t vote for a leftward lurch to socialism lite.

Mr. Obama has a huge opportunity and an outsized responsibility to mend and revive the economy. It may be too much to ask, but perhaps he will give President Bush’s marvelous speech a close read. There is much wisdom there. And there is no iron-clad reason why a Democrat can’t adopt the economic-growth model that has worked so well and so long for this country.

Paulson's Rescue Plan Adjustments

Remember that huge congressional swing-out two months ago over the Treasury's request for $700 billion to purchase at auction a bunch of toxic assets that no one wanted to buy? And remember John McCain's curious behavior, temporarily shutting down his campaign in order to fly to Washington and save the nation from financial collapse? (Some say that
episode sunk Big Mac's campaign.)

Well today, Treasury man Paulson announced that there probably won't be any toxic asset purchases after all. Instead, he intends to forge ahead with more capital purchases to strengthen bank balance sheets and also, by the way, non-banks, which lend roughly 40 percent of total consumer credit. Think AMEX, GE Capital, maybe GMAC, and others.

Actually, Paulson has a good idea for a private capital injection into banks (and maybe non-bank lenders) that would then be matched by taxpayer capital. This was a good idea proposed a while back by Harvard economist and former Bush advisor Greg Mankiw. The more private capital the less the government-takeover threat and the healthier the banks will be.

But there's more from Paulson today. He talked at some length about Treasury assistance for securitized credit-card student-loan and auto-loan assets, and he said the Fed is designing a lending facility to meet liquidity needs for asset-backed securities and their sponsors. This securitized-loan business is a whole new avenue of rescue operations. And it surely opens the
door to a lot of non-banks that are going to play in the Treasury's sandbox.

Mr. Paulson also said the Treasury is looking at FDIC chair Sheila Bair's multi-billion dollar loan-guarantee program for foreclosure mitigation. This really means Uncle Sam will wind up eating some significant losses while the interest and principal on shaky mortgage loans
are written down.

Stocks were off big today — before, during, and after Paulson — closing down over 400. Tough to pin it on the Treasury man, however, since the plunge started in the early-morning well before he spoke.

Some folks think the stock market is stalking Obama, whose defining moment may be a GM bailout. Plus, investors are waiting for a new Treasury appointee who will shed light on Obama's tax and trade threats for 2009 as well as his UAW rescue mission that is so strongly favored by Speaker Pelosi and Senate Majority Leader Harry Reid. Policies protecting
ailing industries would certainly set a France-like tone for the new administration.

Here's a stat from my friend, blogger Mark Perry: Total compensation per hour for the big-three carmakers is $73.20. That’s a 52 percent differential from Toyota's (Detroit South) $48 compensation (wages +health and retirement benefits). In fact, the oversized UAW-driven pay package for Detroit is 132 percent higher than that of the entire
manufacturing sector of the U.S., which comes in at $31.59.

I don’t care how much money Congress throws at GM. With that kind of oversized comp-package they are not going to be competitive. It’s throwing bad money after a bad cause. What a way to start the new Obama era.

I would still argue that rescuing banks and consumer credit companies removes systemic risk from our lending system. But the only thing systemic about the GM bailout is the hegemony of the UAW. Or maybe I should be more cynical: Republican socialism followed by more Democratic socialism.

Monday, November 3, 2008

Is Obama Swiping the Tax Cut Issue?

Voters seem to think he’s the Ronald Reagan tax-cutter of the 2008 election.

Wouldn’t it be the height of irony if Barack Obama wins this election as the Ronald Reagan tax-cutter? His tax plans are severely flawed and his campaign narrative to support them is all wrong. And yet a recent Rasmussen poll shows that 31 percent of voters believe Obama is the real tax cutter, while only 11 percent choose McCain.

Believe it or not, Obama seems to have swiped the tax-cut issue from the Republican party. How can this be?

Well, for almost two years Obama has talked about cutting taxes for 95 percent of the people. McCain has no such record. And even though McCain has launched a strong Joe the Plumber investor-class tax-cutting surge in the last days of the campaign, it may not be enough to significantly impact Tuesday’s voting results.

This is bad news since Obama has some pretty strange views on taxes. Just look at his recent explanation for the decline in third-quarter GDP. He calls it “a direct result of the Bush administration’s trickle-down, Wall Street first, Main Street last policies that John McCain has embraced for the last eight years and plans to continue for the next four.”

Is Obama really blaming the Bush tax cuts for this recession?

After the bursting of the tech bubble and the 9/11 attacks, George Bush lowered tax rates across-the-board for individuals and investors. For five years the stock market rallied without interruption -- the longest bull market without a correction in post-WWII history -- while the economy expanded for six years, a bit longer than the average post-war recovery cycle.

And Obama wants folks to believe that tax cuts caused this downturn? Not the credit shock? Not the Obama-supported government mandate to sell unaffordable homes to low-income people and the pressure on Fannie and Freddie to securitize these loans? Not the oil shock?

No self-respecting Keynesian would buy into this. Yet Obama was at it again in Monday’s Wall Street Journal, saying, “It’s not change to come up with a tax plan that doesn’t give a penny of relief to more than 100 million middle-class Americans.”

Regrettably, not even John McCain has contradicted this. But the facts speak otherwise.

For example, the nonpartisan Tax Foundation says the Bush tax cuts -- which McCain would maintain -- provided substantially more relief than middle-class Clinton-era tax rates: A single earner making $30,000 will pay $2,756 under 2008 Bush tax law compared with $3,157.50 under Clinton tax law (in 1999). That’s a larger Bush tax cut by 8.7 percent. A married couple earning $50,000 will pay $4,012 under Bush compared with $5,085 under Clinton. That’s a bigger Bush tax cut by 21 percent.

So the facts of a middle-class tax cut are far different from what Obama claims. Obama also says his tax rates will be below those of Ronald Reagan. Wrong. Obama will raise the top rate to 39.6 percent, whereas Reagan left taxpayers with only two brackets of 15 and 28 percent.

Incidentally, the income cap for Social Security and Medicare taxes was about $42,000 when Reagan left office, compared with $104,000 today and the threat that Obama will raise that cap significantly.

It’s also worth noting that the Reagan tax-reform bill of 1986 mistakenly allowed the capital-gains tax rate to move up to 28 percent from 20 percent. Many believe this was a significant factor in the stock market crash of 1987.

Similarly, Obama intends to raise the cap-gains tax rate from 15 to at least 20 percent. It’s a risky move. Of course, Obama says only rich people will pay the higher cap-gains rate. But the reality is that a cap-gains tax hike will raise the after-tax cost of all capital, which will depress the future value of all equity assets.

McCain has recently proposed a reduction in the capital-gains tax rate from 15 to 7.5 percent. With 100 million-plus investors out there, and nearly two of every three votes in national elections being made by shareholders, this is right on target. Last Friday, McCain told me in an interview that a “low capital-gains tax is probably the greatest incentive for investment that we have in America today.

In the frenetic final hours of the campaign McCain is also talking up his corporate tax cut, which would be a tremendous boost to plunging stock prices since corporate profits are the mother’s milk of stocks. Indeed, McCain’s overall tax-cut plan is far more powerful than Obama’s when it comes to creating jobs and stimulating economic growth. But his marketing effort appears to be too little, too late.

These things do, however, have a way of balancing out: If Obama and the Democrats go on a tax-hiking spree to penalize successful earners and investors, they will pay for it dearly in 2010 and beyond.