Ideal Taxes Association

Paul Craig Roberts, head of policy at the Department of Treasury under Reagan, predicted an upcoming dollar crash in an August 16 commentary (The Ecstacy of Empire). He began: "The United States is running out of time to get its budget and trade deficits under control." He goes on to describe the upcoming dollar crash if this is not done:

Part of Roberts' solution is to bring U.S. troops home now. The other part is to switch our tax system to a value-added tax which has two tax rates, depending upon where the value is added. If the value is added abroad, the rate is higher. He wrote:...

In his August 3 commentary about the latest GDP figures in the Washington Times (Evidence and Denial) Richard W. Rahn was quite accurate about the economic dreamworld that the Democrats are living in. He writes:

But he misses the fact that the Republican establishment is living in a dreamworld also If he were to look closely at the second quarter numbers, he would have discovered that the rising trade deficits caused GDP to fall. Obama’s failure to deal the trade deficits is sinking his presidency....

On Feb. 13, 2009, Congress passed the $787 billion American Recovery and Reinvestment Act of 2009 (ARRA), commonly referred to as Pres. Obama’s economic stimulus plan. As of May, 2010, about 62% has been paid out. According to Prof. Romer, the Chairman of the Council of Economic Advisers, the act has saved or created 2.5 million to 3.5 million jobs. If the purpose of the act was to save some jobs, it may have succeeded. Indeed, analysis of the expenditures suggests that the act was poorly conceived. If its object was to create jobs and promote a recovery, it was a complete failure. The employment data of the Bureau of Labor Statistics as the following table shows does not evidence any net job creation. The number employed fell by 3.0 millions from March 2009 to December, 2009 and increased just over 1.1 million by the end of March, 2010 for a net job loss of 1.9 million jobs.

In the Wall Street Journal 7-19-10, Alan S. Blinder, a professor of economics and public affairs at Princeton University writes in an opinion piece entitled “Obama’s Fiscal Priorities Are Right”, writes: that the “deficit hawks” believe the federal budget deficit is already too large and that the first stimulus failed. He disagrees. He writes, “The hawks have even dug in their heels against extending unemployment insurance benefits at a time when the unemployment rate is 9.5%, or helping states and localities avoid laying off teachers in September. That’s pretty anti-Keynesian thinking.” The first part is not even true; the Republican leadership wants Congress to specify the source of the funds. Why not the Tarp program or the economic stimulus bill? They are loaded with billions of unspent funds. Why are the Democrats against specifying the source of the funds? And while it may not be popular in the polls to say so, many economists believe, that many, not all, receiving unemployment compensation are really not making a serious effort to find work. And these economists could be Keynesians and they include Prof. Blinder. Prof. Blinder’s answer later in his piece is that “the right level of unemployment insurance means balancing these costs and benefits—a tricky calculation.”

As for school districts that the economic stimulus plan is supporting, not a single new job has been created supporting them. Yes, Prof. Blinder, we believe the economic stimulus bill has been a failure. We believe the money should have been used to stimulate private investment in new factories and equipment. New factories create sustained employment and have a real multiplier effect. ...

For reasons that we have mentioned many times in this space, we believe the Obama administration’s policies to recover from this depression (technically, a recession) have been practically worthless, notwithstanding their enormous cost. The administration’s economists, who should know better, have endorsed the economic stimulus plan notwithstanding the fact that it throws money at a variety of programs that provide no sustainable stimulus to the private sector. Oh, the rebates, the klunkers’ program, subsidies for energy spending give temporary stimuli but nothing sustainable. To achieve sustainable economic growth, investment in manufacturing and industry is required. Stimuli to alternative sources of energy, principally wind, solar, and biochemical will not produce sustainable growth until we begin to run out of petroleum and natural gas which is likely to be delayed three to six decades.

All the while, there were cost-free and revenue-producing measures that could have been taken to stimulate private investment. In a posting on this site on June 28, 2010 entitled “ Bush and Obama's Economic Stimulus Attempts”, we criticized the administration’s policies as well as Republican proposals and promised to put forth our own proposals for a speedy recovery. Our first proposal is to end our foreign trade deficits which have caused the closing of thousands of American factories and the loss of millions of good-paying industrial jobs. We need to stop the outsourcing of the production of goods that Americans consume and produce the products of American ingenuity here. ...

There is growing concern in this country about the outsourcing of manufacturing production and its effect on American jobs. In our book, Trading Away Our Future (Ideal Taxes Assn., 2008), we blamed foolish U.S. government policies recommended by foolish free trade academics for permitting the trade deficits that have led to our industrial decline and permitted our former enemies Germany and Japan, and our current enemy China to grow their industry dramatically at the expense of the American worker. In the July 5, 2010 issue of Business Week, Andy Grove, a founder of Intel and its former CEO makes the spectacular prediction that the outsourcing of production of technologically advanced products by our product innovators is an act of economic suicide. He writes,

The great Silicon Valley innovation machine hasn’t been creating many jobs of late -- unless you are counting Asia, where American technology companies have been adding jobs like mad for years. …Today, manufacturing employment in the U.S. computer industry is about 166,000 -- lower than it was before the first personal computer, the MITS Altair 2800, was assembled in 1975. Meanwhile, a very effective computer-manufacturing industry has emerged in Asia, employing about 1.5 million workers -- factory employees, engineers and managers. … Some 250,000 Foxconn employees in southern China produce Apple’s products. Apple, meanwhile, has about 25,000 employees in the U.S. -- that means for every Apple worker in the U.S. there are 10 people in China working on iMacs, iPods and iPhones. The same roughly 10-to-1 relationship holds for Dell, disk-drive maker Seagate Technology, and other U.S. tech companies.

American economists viewed this development with benign neglect. Groves cites the following quote by Princeton professor and former member of the Council of Economic Advisers under Clinton and member of the Board of Governors of the Federal Reserve System under Greenspan: “The TV manufacturing industry really started here, and at one point employed many workers. But as TV sets became ‘just a commodity,’ their production moved offshore to locations with much lower wages. And nowadays the number of television sets manufactured in the U.S. is zero. A failure? No, a success.” (Italics mine.)...

Now gather round all you Democrats and all you Republicans, and all you left and right leaning independents and all you tea party people and we’ll tell you how to quickly turn this recession into sustainable prosperity, with real jobs, millions of them. We know most of you who haven’t read our book, Trading Away Our Future (Ideal Taxes, 2008) are in a state of disbelief. How could we, three relatively unknown Ph.D.s, know what we must do when the former Chancellor of Harvard University, economist Larry Summers, and his protégé, former head of the Federal Reserve Bank of New York, Secretary of the Treasury, Timothy Geithner, and, Cristina Romer, Chairman of the President’s Council of Economic Advisers, approved the 2009 Recovery Act that budgeted the costly $787 billion economic stimulus program which created not a single net new sustainable job to date? The answer my friends is not blowing in the wind, nor even on Facebook. The answer is because the economic elite to which they belong are Keynesian and we aren’t. And they are ideologues on "free trade" and we are not.

They believe that increased government spending regardless of what it is spent on will stimulate the economy and promote a recovery. We maintain that an increase in deficit spending will provide only a temporary stimulus which will disappear as soon as the money runs out. Lord Keynes would turn over in his urn to observe what is being done in his name.

It isn’t that the Obama economic stimulus program doesn’t create or save some jobs, especially for teachers and other government employees, ninety-nine percent of whom voted for Obama, surely a coincidence. It just has no sustainable stimulating effect, i.e., it has no multiplier. It raises GDP temporarily and the stimulus disappears as soon as the money appropriated is exhausted. Plus, they are “free trade” ideologues. We know of no economic theory that holds that free trade is beneficial to both trading partners even when it is one-sided. Free trade does work in the 50 states where the U.S. Constitution forbids the states from imposing barriers to trade and the free movement among the states of workers and capital. Free trade works only when the trading partners are subject to those conditions, which means nowhere except in the U.S. ...

In a June 22 Seeking Alpha commentary (The Fed, the Yuan and the Failure of Diplomacy), Peter Morici accurately discussed U.S. economic history, pointing out the ineffectiveness of the Federal Reserve in recent years:

He is thinking through the problem in the same way that we have been. As usual, he is way ahead of most of the economic profession, which is still living in a dreamworld in which unilateral free trade is a good policy.

But my father, son and I are actually still a bit ahead of Morici here. We are advocates of the economic philosophy called "monetarism." The founder of monetarism, Milton Friedman, was my father's dissertation advisor at the University of Chicago.

Congress is starting to lose its enthusiasm for failing stimulus plans. Washington Post staff writer Lisa Montgomery reports (Election-year deficit fears stall Obama stimulus plan) that the Senate just recessed after only passing a quarter of President Obama's latest $266 billion stimulus plan:...

Fred Bergsten of the Peterson Institute for International Economics, a thinktank with close ties to the Obama administration, wrote a commentary for the Financial Times (New imbalances will threaten global recovery) which foresaw continuing world economic stagnation unless the US taxpayer bails out the world with increased deficit spending. Here is his reasoning:

"Interesting article... Is Manufacturing Going the Way of Agriculture? Manufacturing output may not actually be dropping in the USA even as employment in manufacturing is. How accurate do you think their #s are?"

My response: The authors are quite right that manufacturing employment has dropped more than manufacturing output. One explanation (presented as the only explanation in the article) would be that this is because productivity is increasing. Hence, manufacturing employment is going the way of agriculture employment. Few people work on farms anymore, but the U.S. still grows a lot of food because many of the farms that remain are extremely efficient and highly mechanized.

There is one thing that gives me pause about these figures, however, and that is that the manufacturing output and the productivity figures both are probably distorted by increased outsourcing of component production...

The headline in the WSJ (4-28-10) reads, “Crisis Spreads in Europe, Debt Downgrades in Portugal, Greece Sow Fear of Contagion.” The same article recites “The yield on Germany’s 10-year bond fell to 2.99%.” The following day, the headline read “Contagion Fear Hits Spain.” What is Germany doing right that Greece, Portugal, and Spain are doing wrong? For one thing, and we believe the main thing, Germany exports more than it imports while the others import more than they export. So Germany accumulates euros and foreign exchange while the others run out of euros and foreign exchange. Since their debts are payable in euros, they become unable to service their debts. As the following table shows, Greece, Portugal, and Spain display trade deficits in 2008 and 2009, the first a more or less normal year of growth, the latter a recession year.

The solution the article talks about is a loan of €45 billion from the EU and the IMF, a condition of which would be for Greece to tighten its belt and balance its budget averting its need to borrow. But a balanced budget is no guarantee that exports will rise and imports will fall. The U.S. enjoyed a balanced budget in 2000. Nevertheless, the trade deficits exploded....

The Democrats and Republicans in Washington are getting together this week on new financial regulations. But they are ignoring the cause of the last financial crisis and of the next. Meanwhile, writing in The Pilot, a local Soutnern paper, Tom Goergen nails it:...

The bipartisan U.S. Deficit Commission meets for the first time today (April 27). In December it will report its recommendations to Congress. The commission is expected to recommend some combination of tax increases and spending cuts to rein in our huge government budget deficits.

But there is another deficit problem that should be addressed at the same time. Our foreign debt has been skyrocketing. On July 13, 2009, we wrote a commentary (America Sliding Into a Pit of Foreign Debt) for the American Thinker about it. We wrote:

Eventually, when payments to foreigners get too high, a currency crash becomes inevitable. We also wrote about this back in July:...

The President’s motives in offering a financial reform bill to regulate Wall Street and the banks has all the appearances of a Mein Kampf strategy for national socialism. Like burning down the Reichstag and blaming it on your political foes. Pretend that the banks and investment houses caused this recession when everyone in Washington knows it was the housing bubble that created the financial crisis, a bubble one of whose authors was Barney Frank who reported out the House version of this bill. Taking advantage of the negative public reaction to bailouts, which actually turned out to be pretty inexpensive, the reform bill speaks of avoiding the need for bailouts in the future. Why? TARP’s toxic assets were rendered harmless at very low cost. Why not plan on repeating it during the next recession? Say, sixty years from now.

You won’t need any new taxes, no phony fund to slice up companies too big to fail. Why break them up? Make them a loan and get back your principal with interest! That is what happened during this recession. The loans, negatively referred to as bailouts, stabilized the banking system at amazingly low cost to the taxpayers. In the future it will be at a very high cost represented by the taxes to create a fund that will have as little reality as the social security fund. The taxes will all be used as the social security fund is used, to finance government borrowing. ...

A bi-partisan Congress and successive Democratic and Republican administrations caused this depression. What else should one call an economic situation in which nearly 10 percent of the work force is unemployed and an additional 8.5 percent have given up looking for jobs. The administration would like you to believe that it was caused by the big investment houses on Wall Street and by the banks. The banks caved in under government threats and blackmail by ACORN and other self-appointed community groups and made the rotten loans whose defaults were responsible for this depression. Wall Street, seeing there were profits to be made, volunteered to raise the capital to convert the trillions of dollars of foolish mortgages into foolish investment vehicles. It turned out to be very profitable in the short-run but catastrophic in the long-run. But the bubble had been set in motion by Congress, not Wall Street and not the banks.

It all began innocently enough with the passage of the Community Reinvestment Act of 1977 which required the banks to end their alleged discrimination against the poor, mostly black, residents in poor, so-called, red-lined neighborhoods. It was leftist propaganda that accused the banks of deliberately discriminating against blacks and the line was bought hook, line, and sinker by Sen. Proxmire, the bill’s sponsor, President Carter, and a know-nothing Congress. Banks, including black owned banks, as is to be expected, made fewer mortgages in economically deteriorating neighborhoods. But the act ignored reality and required banks to make loans in such areas and if they failed to do so, they would suffer penalties. ...

Nobel Prize-winning economist Prof. Paul Krugman, in a series of recent op-eds, has decried China’s policy of keeping its currency, the renminbi or yuan, undervalued to maintain and grow its chronic trade surpluses with the U.S. and other nations. An increase in the value of the rrenminbi relative to the dollar would make Chinese goods more expensive to Americans and U.S. goods less expensive to the Chinese which economists believe would stimulate demand for U.S. made goods and reduce demand for Chinese made goods. The trouble with this view is that the Chinese government denies consumers the foreign exchange required to import U.S. goods and services. In 2008, our trade deficit with China reached $268 billion, representing a loss of about 2.7 million US industrial jobs over the course of the last two decades. In 1989, our trade deficit with China amounted to $6.2 billion, or about 1/40th of the 2008 deficit. In 2008, our trade deficit with the rest of the world totaled over $800 billion, roughly equal to Pres. Obama’s economic stimulus plan to exit the recession. Balancing the trade deficit at the 2008 level of imports would create 8 million U.S. jobs.

In his most recent op-ed which appeared on the internet, March 14, Prof. Krugman called for a 25% percent increase in the value of the yuan relative to the US dollar, implying that such a revaluation of the renminbi would bring our trade with China into reasonable balance. A hundred and thirty US legislators of both parties have called for the U.S. to put pressure on China to revalue her currency. We do not believe that fluctuating exchange rates would be successful in reducing the trade imbalance. We believe there are many ways for mercantilist nations to restrict imports and subsidize exports in spite of a revaluation of currencies. ...

On March 1, 2010, Ambassador Ron Kirk, United States Trade Representative, disclosed “The President's 2010 Trade Policy Agenda”, a suicide pill for the U.S. economy. For three decades, every administration had more or less the same agenda and ideology: Ignore the trade deficits and just accept them as the inevitable result of competitive forces, which they are not. It follows that if China, Japan, Germany, and others want to exchange their valuable goods for mere greenbacks, why should we complain? We can print more.

It is hard to believe that that was and continues to be the attitude of the vast majority of economists. They’ve been brain-washed into believing that market forces must inevitably restore a balance of trade. Economic theory does not support that view. It applies only under certain conditions as we pointed out in our book, Trading Away Our Future (Ideal Taxes Assn, Jan., 2008). China, like Japan before it, was and continues to deliberately pursue the mercantilist policy of promoting a surplus of exports over imports by erecting all sorts of barriers to imports while subsidizing exports, keeping its currency artificially undervalued to make its imports expensive and its exports cheap, by buying U.S. financial assets to keep U.S.interest rates low to American consumers, to discourage savings and encourage consumption. Not until recently did an eminent economist like Prof. Paul Krugman condemn China’s mercantilist practices and suggest U.S. counteraction.

The slow-acting suicide pill suddenly accelerated in the mid-1990s. The result was the loss of millions of U.S. industrial jobs. How many? To balance trade at the level of imports in 2008, we would have to create eight million industrial jobs. The defenders of U.S. trade policy point to our achievement of full employment in 2007, neglecting to mention that the competition of factory workers who lost their well-paying jobs lowered the earnings of all workers. As a result, wages have stagnated over the past three decades, fewer workers enjoy middle class incomes, income distribution has worsened, and the U.S. is on the verge of becoming a second-rate industrial power if it has not already achieved that distinction. ...

Many commentators believe that dysfunctional Greece is the cause of Greece’s pending bankruptcy and many believe that dysfunctional USA is the cause of the USA’s pending bankruptcy. Time has run out for Greece and is running out for the USA. But the U.S. is more fortunate than Greece; its bonds are payable in U.S. dollars, issued as needed by its central bank, the Federal Reserve System. Poor Greece, its debt is payable in euros which are printed by the European central bank whose policies require Germany’s approval. And Germany does not approve profligacy.

The cause of Greece’s problems is alleged to be financial profligacy but its immediate cause is really its chronic trade deficit with Germany and the European community which causes it to run out of euros. The cause of the USA’s problem is alleged to be financial profligacy but its immediate cause is its chronic trade deficits with China, Japan, Germany, and OPEC which flood the world with dollars which the world hoards as reserves or sends to the U.S. in return for U.S. Treasury bonds and other U.S. financial assets. Unfortunately, this is not sustainable. . . .

A February 22 interview with the Arizona Republic editorial staff (Sen. John McCain: I was misled on bailout) shows that Senator McCain still doesn’t understand that his economic advisors' lack of common sense cost him the presidential election. They made four huge mistakes.

The American people have enough common sense to recognize a give-away to Wall Street lobbyists. Yet McCain voted for TARP, suggesting that his anti-lobbyist rhetoric was phony. Dick Morris and Eileen McGann noted at the time that McCain's TARP position may have cost him the presidency.

But McCain still doesn't understand his mistake. In his interview with the Arizona Republic editorial staff, he claimed that Paulson and Bernanke misled him about how the TARP money would be spent. But he again defended his vote, citing his economic advisors:...

Ralph E. Gomory is a former Senior Vice President for Science and Technology at IBM and the former President of the Alfred P. Sloan foundation. He is also the author of a mathematical theorem that bears his name.

The Keynesian multiplier posited that an increase (decrease) in investment (I) or in government purchases (G) will cause an increase (decrease) in national output equal to 1/(1-MPC) where MPC is the percent change in consumption that results from an increase in income. To illustrate, an increase in domestic investment of $10 billion will increase income directly by $10 billion. If the MPC is 80 percent, the recipients will spend $8 billion on increased consumption, the recipients of the $8 billion will increase their consumption by $6.4 billion, which in turn will increase consumption by $ 5.12, and so on. The increase in I plus the successive increases in consumption amount to $50 billion. We believe there is no multiplier effect from governmnent-financed temporary employment. Mulltiplier effects can be expected only when enduring jobs are created increasing expected lifetime income, a conclusion that follows from Prof. Milton Friedman's hypothesis that consumption depends on expected lifetime income. Jobs that are expected to be temporary do not have multiplier effects.

The Bush and Obama administrations spent several hundred billions in the TARP program to stabilize the banking system in the belief that the banks in turn would make loans to businesses. No demand for loans for investment in factories and equipment materialized and there was no increase in private investment and therefore no multiplier effects. Pres. Obama's so-called economic stimulus program spent a couple of hundred millions to stimulate public works which created no expected increase in lifetime income because of the temporary natrure of the jobs created and spent hundreds of billions more on programs that simply supported existing state government budgets. No job creation there! It subsidized some school construction but created few jobs. Unemployment continued to rise throughout Pres. Obama’s first year which accords with the permanent income hypothesis.

We have no quarrel with the idea of the multiplier when it is applied to increases in productive investment. Our quarrel is with those who believe the multiplier applies to purchase of financial assets of financial institutions, to support of state and local government budgets, to subsidies like “klunkers”, to buying mortgages, to nationalizing businesses and insurance companies, to the gifts made to households by the Bush and Obama administrations, or to payments of unemployment compensation, etc., etc. None of the legislation that the administration has been pushing – health care, capping carbon emissions, man-made global warming grants and subsidies -- create enduring jobs.

There would be a multiplier only if there were increased private investment in enduring productive facilities. Unfortunately, private investment in manufacturing and construction in the United States has been nil. Investment in renewable resources subsidized by government is offset by the inefficiency of such enterprises which for all practical purposed produce nothing of value. The electricity they produce if valued at the cost of electricity produced by fossil fuels, hydro-electric, and nuclear plants would result in a negative return on investment which means they are equivalent to digging trenches and then re-filling them. The higher prices of electricity reduce the income of households and raise the costs of producing goods. Lowering demand and leading to a negative multiplier.

Here are some of the things we have been recommending that do have multiplier effects:

The news during the week Friday, January 8 to Thursday, January 14, 2010, was dominated by two events indicating a worsening economic outlook. The first was the disappointing employment news released by the U.S. Bureau of Labor Statistics that showed that total nonfarm payroll employment declined by 85,000 workers between November and December, 2009 while economists were expecting a much smaller decline as though any decline is good. The decline was led by a loss of 57,000 construction jobs and 27,000 manufacturing jobs. The former is understandable; the latter is scandalous.

The second was the trade data released by the Department of Commerce that showed that U.S. exports rose in November to $138 billion, up 0.9 of one percent but imports rose faster, up 2.6 percent to $175 billion, the difference equivalent to a loss of about 370 thousand jobs. Manufacturing jobs have been declining precipitously since the explosion of the trade deficits since the late 90s. This is the sector whose growth is the key to ending the recession. Below we offer some suggestions that will create millions of jobs in a few years and won’t require “trillion economic stimuli” based on a disproved theory of a Keynesian multiplier.

There are a number of reasons why we are not getting much investment in American manufacturing. The major reason is that it is much cheaper to produce goods abroad and export them to the U.S. than produce them here. The Obama administration and preceding Republican and Democrat administrations let Japan and Germany since WWII and China and other Asian countries more recently to employ mercantilist policies such as import barriers and export subsidies and keep their currencies undervalued in order to keep their products less expensive and American products more expensive. American manufacturers have learned that it is foolish to invest in manufacturing facilities in the U.S. They joined the club, producing abroad and exporting to the U.S.

There is a simple solution, balanced trade. Under the rules of international trade, countries experiencing chronic trade deficits have a right to impose tariffs and restrict imports. My recommendation is that a uniform tariff of one-third or more be levied on imports from those countries and only those countries with which we have sizable chronic deficits. Some fear China will retaliate. As Prof. Paul Krugman wrote in a recent article, we have little to fear. Besides, retaliation would hurt China more than it would hurt us. They and we will talk the talk and walk the walk.

Should the tariff be applied to oil companies who sell to the U.S.? Yes, to those which have large chronic trade deficits with us and belong to the illegal oligopoly called OPEC.

There are many other actions we could take. Millions of jobs could be created quickly at no cost to the US taxpayer or even increase government revenues as the tariff revenues would.

Drill, drill, drill! Permit drilling for oil on public lands and off shore in the Atlantic and Pacific and in the Arctic (as Russia is doing). This would diminish the demand for foreign fuel and lower world prices even if we continue to import crude oil. Likewise, we should be encouraging the use of natural gas, which is abundant, as an automotive fuel. Huge amounts are available and a pipeline from Alaska is being built from Prudhoe to Alberta and Saskatchewan by Alaska, Canada, and Exxon-Mobile. Under pressure from leftist environmentalists, the U.S. administration and Congress has ignored the job-creating potential of prospecting, producing, and distributing additional supplies of oil and gas. Hundreds of good-paying jobs are being forfeited on the altar of environmentalism. (I am tempted to use the word “treasonous” to describe some of the policies of environmental activists. Recent evidence suggests that the hypothesis that global warming is man-made may have been a hoax perpetrated by leftist academics. A large number of distinguished physicists believe that changes in the sun’s geomagnetic emissions are the principal cause of climate warming and cooling, not carbon emissions. Carbon emissions are unable to explain the earth’s recent cooling that lasted more than a decade and continues to this day.)

Abolish the Corporate income tax to stimulate manufacturing investment in the U.S. A distinguished American economist has shown that corporations that sell in the U.S. are able to shift the burden of the tax to consumers whereas they cannot do so in international markets. This puts the American corporation at a great disadvantage. Whereas foreign nations are permitted to rebate value-added taxes under WTO rules, income taxes may not be rebated. We should replace the corporate income tax with a value-added tax that can be rebated to our exporters and imposed on all our imports.

There is a lot we can do, but unfortunately we have elected one government after another that talks the talk but doesn’t act.

The Treasury Department announced on December 24, 2009 that it removed the $400 billion financial cap on the money it will provide to keep Fannie Mae and Freddie Mac afloat. According to the Associated Press, taxpayers have shelled out $111 billion to the pair, and a senior Treasury official said losses are not expected to exceed the government's estimate this summer of $170 billion over 10 years. Nevertheless, it appears that the Treasury did not believe its own forecast that $400 billion would be enough. The date chosen to remove the financial cap -- Christmas Eve -- was no accident. Not only was it buried by the passage the same day of the Senate's health care biil but it obviated the need for Congressional approval. "Treasury officials said they decided to lift the caps to eliminate any uncertainty among investors about the government's commitments. But the timing of the announcement on a traditionally slow news day raised eyebrows." The two Government Sponsored Enterprises (GSEs) constitute the secondary for mortgages. The financial commitment provides a limitless supply of money to the two government run entities for four to five more years.

Housing Predictor forecasts that this bail-out will cost trillions and take a number of years to unwind the real estate crisis as more homeowners lose homes to foreclosure. The surge of foreclosures in the New Year is forecast to top previous records. The Treasury and the Fed are on a mortgage buying binge of securities, and the Federal Reserve Board of New York made an emergency loan to the companies.

If you are about to buy a house because of this forecast, then you are a sucker. Here's a quote from the story:

As you can see, house prices are nowhere close to their normal levels. (.) A little review of how we got here could help.

From 1951 through 1997, whenever a homeowner sold his or her primary residence to buy another residence, the capital gains tax was deferred (i.e., rolled-over) until the new home was sold. Homeowners would typically build up their equity in one home, sell that home, and then use their savings to make a downpayment on a larger home. During that period, there were large changes in interest rates, yet home prices were quite stable as shown in the graph below:

Interest rates probably caused some of the price appreciation after 1997. Governments around the world have been building up their dollar reserves since 1996, sending their countries’ savings to the United States. The increase of foreign savings flowing into the United States caused real-long term interest rates to fall precipitously from 4.5% in 1996 to 1.3% in 2005 (see Chapter 2 of our book). The fall in interest rates tends to push up house prices, both because it reduces mortgage interest rates and also because it reduces the returns to competing investments.

But it took Congress to get the house price bubble started. In 1997, at the urging of President Clinton, they eliminated the capital gain tax paid by most homeowners. This action told speculators that the capital gain that they would earn if they bought a house with plans to sell it would probably be higher, since it would be tax free.

Under the new provision, almost anyone who had lived in a house for 2 years of the past 5 years could sell the house free from capital gains tax. The new policy encouraged people to gamble on real estate. If they saw that houses were going up in price, they would buy in hopes of getting a tax-free capital gain.

Here is how Kenneth Harney (2008) described how the 1997 tax treatment encouraged speculation in a Washington Post article about Congress’s 2008 attempt to tighten its provisions:

The Housing Bubble that began in 1998 had other contributing factors, but Vernon L. Smith, a Nobel Prize winning economist largely due to his laboratory study of economic bubbles, held that it was primarily caused by the 1997 legislation. He pointed out that, at the time it was enacted, the 1997 legislation was quite popular among the industries that were most severely hurt when the bubble burst. He wrote, sarcastically:

Smith argued that, instead, Congress should have done exactly what we recommend in our book. Specifically:

During the asset bubble, homeowners depleted their savings, leaving them with less money for a future downpayment. Tyler Cowen (2008) described this psychology in a New York Times commentary:

In fact, people did more than stop adding to their personal savings. They began subtracting from their personal savings. As documented by Louise Story in the New York Times, bank advertising campaigns encouraged people to consider the rising value of their homes to be income, to be consumed in the present. They urged homeowners to take out second mortgages on their homes so that they could increase their current consumption and coined the new term “equity access” to replace “second mortgage.” Borrowing on home equity increased steadily.

You'd think that economists would understand what was happening at the time, but as recently as September 2005, Charles Himmelburg, a senior economist at the New York Federal Reserve, co-authored a NY Fed staff report and an NBER working paper which claimed that there was no housing bubble. You really have to read this one to believe it.

Just 9 months later, in June 2006, house prices peaked and the house price bubble began to burst. Now house prices will probably keep falling for awhile unless overall inflation forces prices upwards.

Howard

p.s. Follow the following link to see the original Shiller index starting with 1890 as it appeared in his 2005 book Irrational Exhuberance: http://graphics8.nytimes.com/images/2006/08/26/weekinreview/27leon_graph2.large.gif

On Friday [Jan. 16, 2009], the Wall Street Journal editorial staff analyzed President Bush's economic mistakes (The Bush Economy) while completely ignoring two of them: (1) tolerating the foreign savings inflows that caused the trade deficits and (2) causing the stock buybacks that slowed economic growth.

The Wall Street Journal begins by correctly pointing out that Bush inherited a recession when he took office in 2000:

Mr. Bush inherited a recession. The dot-com bubble had burst in 2000, and the economy was sinking even before the shock of 9/11, the corporate scandals and Sarbanes-Oxley....

He also inherited a growing trade deficit. During the late 1990s, when the bubble was occurring, foreigners were selling their currencies to buy dollars so that they could buy US stocks. As a result, they bid up the dollar and caused the US trade deficits to worsen, as shown in the graph below:

After 2002, the trade deficit would have fallen, but foreign central banks greatly increased their dollar reserve purchases so that they could keep the dollar high compared to their currencies. In the graph below, the US trade deficit (i.e., the current account deficit) is shown in red and the portion caused by foreign central banks is shown in green:

Bush and Greenspan did nothing to stop these increased foreign central bank dollar purchases. Greenspan could have easily counteracted them by buying the same amount of foreign currency reserves. Because he didn't do anything, net fixed investment in US manufacturing collapsed, as shown in the graph below, making American products less and less competitive in world markets:

The other effect of the foreign government reserve purchases was that they caused US long-term interest rates to fall, which contributed to the house price bubble. The Wall Street Journal blames these low interest rates on Greenspan's monetary policy. But Greenspan wasn't causing inflation.

His real mistake was that he, like the Wall Street Journal editorial staff, believed in the "free flow of capital ideology" which holds that the inflow of foreign capital is good for a country, even when it causes trade deficits. That's why neither he nor Bernanke nor the Bush administration did anything to counteract the inflow, even when it was deliberately being produced by foreign central banks, at the behest of their governments, in order to steal manufacturing market share from American producers.

The main central bank to follow this strategy was the People's Bank of China. The Bush administration never counteracted their successful attempts to manipulate their currency and ours in order to steal market share from American manufacturers.

The Bush administration's record is not entirely negative. They did do a good job with a tax cut in 2003 that helped the economy recover from a recession. The Wall Street Journal editorial notes:

This time the tax rate reductions were immediate, and they included cuts in capital gains and dividends designed to spur business incentives. As the tax cuts became law in late May 2003, the recovery began in earnest. Growth averaged nearly 4% over the next three years, the jobless rate fell from 6.3% in June 2003 to 4.4% in October 2006, and real wages began to grow despite rising food and energy prices. The 2003 tax cut was the high point of Bush economic policy.

Indeed, Bush's tax cuts provided the short-term stimulus which got the economy out of the recession. Unfortunately, the capital gains tax cut part of the stimulus severely hurt the economy in the long-term. Capital gains tax cuts increase tax revenue because investors take advantage of them to cash in and consume their capital.

Investors always face the choice of whether or not to keep their capital invested in order to earn the future income. When capital gains tax rates fall, as they did in 2003, investors are more likely to choose present consumption over future income. When they cash-in their wealth, aggregate demand temporarily increases while future income permanently decreases.

After 2003, Corporate managers, especially, cashed in their companies' wealth through stock buybacks. They would have their companies borrow at the cheap interest rates produced by the foreign savings inflow and use the borrowed money to buyback their own stock. They gave themselves stock options and then bid up their own companies stock price through stock buybacks. In this way they took advantage of Bush's 15% capital gains tax rate, as compared to the 35% tax rate they would have had to pay if they had received salary bonuses.

In all, from 2004 through 2007, America’s 500 largest corporations earned $2,505 billion while spending $1,578 billion on buybacks and $853 billion on dividends, leaving only $84 billion of their profits for reinvestment and corporate income taxes. The increase in stock buybacks began immediately after the 2003 capital gains tax cut, as shown below:

When the financial crisis hit in 2008, the very same corporations that were coming to the government for help had been depleting their corporate reserves through buybacks.

[Note: We recommend the rollover tax treatment for capital gains: High tax rate when capital consumed, but taxation deferred when capital rolled-over from one asset to another.]

At the end of their editorial, the Wall Street Journal blames the Bush administration for the fact that their February 2008 stimulus package and October 2008 TARP bill did not turn around the economy. They argue that if these stimulus packages had been different in their composition or if they had been timed differently, they would have worked.

But these stimulus packages completely failed to address the real cause of the current recession: The American consumer could not continue borrowing more and more money to pay for the trade deficits. As the economics analysis of the Levy Economics Institute of Bard College makes clear, no stimulus package will end this recession unless the trade deficits are also addressed.

In an May 15 commentary, we summarized Bush's economic mistakes with the following words:

There are four major Republican economic ideas. Two of them work and two of them don't. Unfortunately, President Bush chose the two that don't work, and that is the reason for the current U.S. economic stagnation. These two Republican economic ideas work:

The Republican Party has lost the Presidency, the House, and the Senate because of President Bush's economic mistakes. It is ill-served when the Wall Street Journal ignores those mistakes.

In his most recent column, Cal Thomas provides a sweeping summary of the financial difficulties faced by the American Republic. He argues that the projected 9.1 trillion next-decade budget deficit is actually overly optimistic, and that a more realistic figure would be 13 trillion. Thomas concludes with the warning that

If we don't [ask government to let us take care for ourselves and vote accordingly], the future belongs not to us but to China, Japan, Qatar, Venezuela and Saudi Arabia, among others -- all holders of our national debt.

Thomas' warnings concerning the improvidence of American government are well placed, but they are likely to go unheard. The last four decades have been decades of improvidence, a period in which government has heeded the calls of a narciscistic generation unwilling to plan and cooperate effectively for the future, whether personal or collective.

At the personal level many Americans have abandoned thrift and saving for improvident waste. Personal savings rates have recovered slightly over the last year, but this probably reflects the inability of the irresponsible to get additional credit more than a true change in national culture.

At the collective level the Federal government has run budget deficits through most of the last four decades. The current levels of deficit spending would be far more modest were it not for the massive interest payments that are already due, currently running about 400 billion per year. Democrats favor spending increases and Republicans favor tax cuts. Unless balanced by painful tax increases or spending decreases the result is quite the same in the end.

The Federal government under both Democratic and Republican administrations has also done little or nothing to stop three decades of massive trade deficits that have transformed the United States from a creditor to the worlds largest debtor. In the process, trade deficits (and the government policies that sustain them) have eviscerated American comparative advantage across a wide range of fields, diminishing the prospects that the U.S. will be able to successfully pay back decades of borrowing without suffering broad declines in living standards.

The illusion persists among those in the improvident generations that have wrought the current and coming crises that somehow they will escape. That this will all be passed on "to the kids."

Thomas remains in delusion. He writes "(the kids will be paying for this)." It is unquestionably the case that the kids will (and are) paying for this. But the assumption that only the kids will pay for this is an illusion of the first order. Perhaps Thomas plans to die soon. But it is us, and our parents as well as our children who will be and are paying for the improvidence of ourselves and our forebears. We have met the improvident and it is us.

It is also a delusion of the first order to claim that either the Republican or Democratic parties stand for fiscal responsibility or serious efforts to right our international balance of payments. Such efforts would smack too much of the self control, care for the future, and discipline that the improvident have ever lacked.

Thomas calls for mobilization:

It's our money, not theirs. They are now stealing it before we make it. Let's hear some outrage about this. Let's sustain it through the next three election cycles, beginning next month with the governors' races in New Jersey and Virginia.

Vote for a Democrat who supports substantial and specific spending cuts or a Republican who takes a stand for real and sizable tax increases if you can find one. They are rare in this improvident land.