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I think we can safely
call the current situation an economic crisis. How do you deal with an
economic crisis? The solution is to:
Identify the Problem
Then
Solve the Damn Problem
How could it be any other
way?
In any economic crisis,
there is some entity, typically the government, upon which falls the
responsibility of resolving the crisis to the best of its ability. Typically
they fail miserably. One of the most common modes of failure in this regard
is the failure to identify the problem. This was very much the case during
the Asian Crisis of 1997-1998 for example, which was very obviously a
currency crisis. Nevertheless, a myriad of "solutions" were applied
as if the problem arose from some other source, such as excessive government
spending, "crony capitalism," or some other imagined beast. (In
Indonesia in 1998, the IMF crisis-resolution program included revising
subsidies on fishmeal.) Very little was done in resolving the currency
issues, because very few people identified the currency issue as the problem.
This was also the case in Japan in 1990-2002, which was also a currency
issue. It seems the vast majority of commentators still haven't figured that
out, although it was as obvious as getting hit in the head with a stick.
Their economic understanding didn't include getting hit in the head with a
stick, so when they were duly hit, confusion resulted.
So what else is new.
Remember the magic formula? It said that Low
Taxes and Stable Money were the keys to
economic success. With that in mind, we can put crisis-generating problems
into three categories:
High or Rising Taxes
Unstable Money
Other Problems
You'll notice I'm making
this very simple so that even a government bureaucrat can understand it.
Maybe I need a purple dinosaur?
The solution to these
problems is:
High or Rising Taxes:
Lower Taxes
Unstable Money: Stable
Money
Other Problems: Other Solutions
Yes, it really is that
simple.
A corollary of this is
that if you try to solve a tax problem with a monetary solution, or an other problem with a tax solution, the results will
tend to be disappointing.
Let's look at what forms
these problems typically take today:
High or Rising Taxes: This was a biggie in the
Great Depression, especially in the US, Britain and Germany. After signing
the Smoot-Hawley Tariff, which imposed a 60% tariff on just about anything of
importance, Herbert Hoover raised the top income tax rate in the US from 24%
to 65%. Britain and Germany did pretty much the same. This was so disastrous
that practically nobody would do something like this today. In recent times,
gradualism has been the rule regarding tax hikes. Taxes are raised bit by bit
over several years. Japan has been up to this recently, especially regarding
payroll-type taxes. This gradualism produces a stagnant or deteriorating
economy, but it usually avoids a sudden "crisis" like the Great
Depression. Another thing that sometimes happens is that governments may
impose a tax hike in response to a crisis caused by some other factor. The
Asian governments raised taxes during 1997-1998 due to the bizarre notion
that the crisis was caused by government deficits, although the governments
had all been running surpluses for years and had low debt/GDP. Today, the US
has a trend toward higher taxes, namely the Democratic opposition to making
the Bush 2003 tax cuts "permanent." Japan has a rising tax trend.
Developed Europe and most of the EMs have a trend toward lower taxes. This is
not the cause of the current crisis.
The solution to a problem
of High or Rising Taxes is to undo the tax hikes. I mean -- duh. If the Great
Depression was instigated by the Smoot-Hawley Tariff or the Hoover tax hikes
(and similar policies among governments worldwide), then a proper solution
would have been to immediately abolish the tariff and the tax hike. You just
say: " Whoops, that was a mistake, let's fix it right away." This
never happens. Apparently, the ego of the national leader takes precedence
over all economic considerations, even though that leader will soon face
mandatory retirement in any case. Even the incoming governments, who came to
power by criticizing the policies of the previous tax-hiking leader, seem
incapable of simply reversing the obviously wrong policies. Well, people are
stupid, and people in government are even stupider than average. If I could
elect a box of rocks, I would. At least they wouldn't hike taxes. The Asian
governments in 1998-1999 actually reversed some of the tax hikes that the IMF
pressured them to impose in 1997-1998. That's one reason the Asian economies
are rock-'em-sock-'em
today. For the kind of chronic underperformance caused by high (but not
dramatically rising) tax rates, the flat-tax policies of Eastern Europe have
been proven to be a wonderful solution. There are other solutions as well.
Unstable Money: This is certainly the
case today, as we see currencies all around the world lose value. The dollar
is at the head of this parade, as the kamikaze Ben Bernanke (can you be a
kamikaze helicopter pilot?) cuts rates further as the dollar sinks to
unprecedented lows vs. gold. Pressure is on other central banks to follow
suit, both to counter an economic slowdown and prevent currencies from rising
too much against the dolllar, introducting
competetive currency issues. The Bank of Canada
just cut rates, the BoE has been doing so as well, the BoJ
is still maintaining super-low rates, and the ECB is under pressure to get
with the program. Policy is inflationary worldwide. I continue to maintain
that this inflation will have the greatest long-term consequences. However, thus far, the
inflationary effect has been mostly perceived as beneficial. The inflation
has translated into higher food and energy costs, which are affecting
consumer budgets. and spending patterns. However, inflation also helps
counter financial issues, as debts are easier to repay in a cheaper currency.
Inflation also tends to introduce more consumption, as prices are effectively
lower. Inflation really starts to hurt when prices rise by huge amounts and
interest rates rise alongside. We're talking CPI and T-bond rates over 10%.
Nasty. We aren't there yet. So far, the inflation has mostly been perceived
as a good thing, as is typically the case in the early stages, and which is
why central banks are still inflation-friendly at this time.
The solution to unstable
money is stable money. This means a gold standard or, particularly for
smaller countries, perhaps a currency board linked to a more-stable major
currency. It may involve a correction of past monetary error, namely "reflation" (correction of deflation) or
"disinflation" (correction of inflation).
Other Problems: If the present situation
is not a High or Rising Taxes Problem or an Unstable Money Problem, then what
is it? Well, if you're 11 years old and have been reading the New York Times, you probably know that
the present crisis is one primarily of crappy debt, and debt-linked
derivatives. It is secondarily one of declining "consumer spending"
perhaps, plus declining market prices for houses and the like.
OK, let's think about
this. The biggest problem for the collapse in fixed-income values is capitalization
of banks. It is really not so good to have your financial system implode,
even though certain hair-shirt libertarians might think so. Banks have been
scrounging around for capital infusions, mostly from "sovereign wealth
funds," which is to say, foreign governments. At the same time, the Bushies have proposed a $150 billion "economic
stimulus plan." What if that $150 billion was used to recapitalize the
banking system, including the bustaroonie monoline insurers? (Actually, the monolines
should go under, with the government backing up guarantees of the
straight-bond components, mostly munis. The CDO
universe should head for the bottom of the ocean.) Now, I know that this kind
of partial government ownership of the financial system is not kosher according
to many people. It is definitely not an ideal solution. But this is not an
ideal situation. Many other governments have stepped in to
recapitalize/partially nationalize banking industries in crisis. It is common
in the EM world, and Japan did so recently. Britain is in the process of
doing so today with Northern Rock. For the most part, the governments are
pretty well behaved about it, and are eager to hand the financials back to
the private sector at the first opportunity. The process has gone pretty
well. In the scale of things, this is no big deal. Why is it OK for foreign governments to recapitalize banks,
but not the domestic
government?
In any case, this would seem a much more effective course of action than just
mailing checks to taxpayers.
As for the "consumer
spending" element (and the associated excessive "consumer
spending" on houses), it should be apparent by now that much spending
was fueled by the crappy lending which resulted in the crappy debt that is
now going kerblooey. Since this was an
unsustainable situation, nobody should attempt to sustain it. I have argued
that it is common for an economy to have ups and downs within the context of
overall positive progress, with the regular recessions of the 1950s and 1960s
one example. This has been one of the most extreme credit bubbles in US
history, which would be logically followed by one of the biggest credit busts
in all of US history. Nevertheless, after a half-dozen or so bad years, which
is not such a big deal compared to the multi-decade disasters of the Great
Depression or the 1970s Inflation, things would probably get back on track
pretty well if a) systemic collapse like mass banking failure were averted,
b) taxes were kept low, and c) money was kept stable. Most of the economy outside
the financial and housing-construction sphere is in pretty good shape. Many
EMs and also developed Europe is benefitting from lower taxes and greater
monetary stability. Things would muddle along, and turn up eventually. A few
tax cuts would help, over the longer term. However, tax cuts won't help much
(especially in the short term, which is a priority in a crisis, practically
by definition) if the problem is an Other Problem. Other Problems demand
Other Solutions.
So, that's my solution.
As you can see, if you get the Identify the Problem part right,
the solution part is usually rather straightforward.
Now, what is really going
to happen?
A) The pace of financial
deterioration will be too rapid for the government to react to effectively.
B) The present "lies,
spin, and market manipulation" approach will take precedence over
effective, fundamental solutions.
C) The government will
attempt to solve an Other Problems problem with a Monetary solution, namely currecy devaluation (via low policy rates). This is like
putting water on an electrical fire. Not so good. (This policy approach is a
result of the fantasy that the Tax Problem of the Great Depression could have
been solved by a Monetary Solution of currency devaluation, which should be
obviously wrong wrong wrong,
as our dear Ben Bernanke will presently demonstrate.)
D) The Other Problem
(financial system insolvency, among other things) will remain unsolved, while
an additional problem (monetary inflation, i.e., Monetary Instability) is
added.
E) Depressed tax revenues
due to recession, plus the prevalence of Stupid Spending ("tax
rebates," Iraq War) will put the kibosh on any tax cut proposals.
F) The ultimate result will
be disaster.
Surprised? This is just
business as usual, on this planet of economc
ignorance.
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United
States, Japan,
and the Middle East. About the Book: Gold:
The Once and Future Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is
available at bookstores nationwide, from all major online booksellers, and
direct from the publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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