The
U.S. government's response to the situation -- and also that of other
governments, because they all play monkey-see-monkey-do -- is looking more
and more like that of the Great Depression.
It
didn't start out that way. We started with the fallout of a huge housing
bubble, not a global tariff war. At first, the U.S. government seemed to be
fairly committed to not raising taxes in the face of recession. The lefty Obama
even talked about a tax cut in the election (promptly forgotten as usual).
But,
over time, things have been getting more and more Depression-like.
I've
said before that a government's primary avenues of action are spending,
taxing and regulating. Plus, messing with the currency.
Spending
is clearly UP, although not so at the state and local
levels. This is not such a bad thing, especially the welfare-type stuff, but
if it is pursued excessively it can create large deficits, which lead to ...
Taxes
going UP. The fear of budget deficits, always and everywhere,
is what led mostly conservative leaders to enact ridiculous tax hikes around
the world, notably a huge leap in the top income tax rate to 63% from 25% in
1932. Herbert Hoover also tried to institute a national sales tax, but this
was blocked in favor of a grab-bag of excise taxes. Taxes look like they're
headed higher today. Unfortunately, with the combination of the cancellation
of the Bush tax cuts, plus state and local income taxes, a lot of people face
near-50% marginal tax rates today anyway, and that doesn't count payroll
taxes (which didn't exist in 1932). So, Herbert Hoover's sales tax (today's
VAT) is making a reappearance, and right on time too.
I
don't think politicians today care too much about deficits. Republicans and
Democrats together have embraced Dick Cheney's "deficits don't
matter" idea. Cheney was probably first exposed to this idea in December
1974, as part of his discussion with Art Laffer about enacting a major tax cut
to deal with the economic problems of the time. The idea was to counter the
knee-jerk conservative notion that the recession-caused deficits needed to be
countered with tax hikes. The benefits of the tax cut were worth the risk of
a larger deficit, and in the long run, the improved economy would result in
more government revenue, not less. That was the idea. Politicians today have
taken it to mean it's OK to blow a lot of taxpayer dough on whatever your pet
project happens to be (war in Iraq, "stimulus" spending etc.).
However,
even Democratic politicians are getting the idea that maybe their ambitious
spending schemes and attendant mega-deficits (mostly foreign financed) aren't
working out so well. The bond market is clearly choking on the new issuance.
Does that mean that -- just maybe -- their strategy of vomiting money all
over the landscape (and into bankers' pockets) needs reconsideration? Of
course not. Politicians are never wrong. It means that taxes have to go up!
Currency
is being DEVALUED. Most countries in the world devalued
their currencies in 1931, and the laggards (U.S. and France notably) caught
up in 1933 and 1936. Governments always reach to currency devaluation in hard
times. Today is no different. And, they always pay the price. "You can't
devalue yourself to prosperity," it is said. How could any country
possibly become wealthy just by fooling with the value of their currency? If
there was even one example of success, everyone would emulate it. However, it
is possible to devalue yourself to a short-term improvement in economic
statistics.
Governments
in the 1930s had at least a little discipline. They contented themselves with
a one-time devaluation, which wasn't really all that effective. Today's
economists have built their careers on the idea that the devaluation was
ineffective because it wasn't nearly big enough -- not because it is
inherently ineffective. It looks like Ben Bernanke wants to run a little
experiment in that regard.
I've
said before that this sort of thing is entirely contrary to the principles of
economic success, which we know as the Magic
Formula:
Low
Taxes
Stable Money
November 10, 2008: "Austerity"
November 2, 2008: "Stimulus"
September 21, 2008: The "Lowering
Interest Rates" Boondoggle
September 14, 2008: Depression Economics
December 10, 2006: The Magic Formula
In the
early 1930s, economists pointed to the example of the 1920 recession as a
situation where the economy quickly righted itself, apparently with no
government involvement. See, we can just do nothing and it fixes itself! Even
today, some conservative-leaning economists are again pointing to the 1920
example.
But,
if you look a little closer, the 1920 situation was not just about
"doing nothing." It was actually an example of a government
lowering taxes and making money more stable.
After
World War I (ending in 1918), the economy was going to go through a period of
adjustment in any case, as war-related demand disappeared and soldiers were
demobilized ("fired"). In addition, at the end of the war, the top
U.S. income tax rate was a whopping 77%!
Also,
the newly-created Federal Reserve was being pressured by the U.S. Treasury to
undertake a new project. The federal government had added a lot of new debt
during the war, and wanted to keep its interest payments on the debt low. So,
it instructed the Fed to engage in open-market operations to keep a lid on
interest rates. (I don't know if this was done on the short end or through
buying long-dated debt. Probably both.) This caused the dollar's value to sag
compared to its promised gold parity. The Fed eventually said: "Sorry,
we're not playing this game anymore." It then contracted the monetary
base to bring up the value of the dollar to its gold parity at $20.67/oz.,
roughly its value since 1789.
(You'll
remember that the same thing happened after World War II as well, until the
Fed refused in the Accord of 1951.)
The
monetary base fell from a peak of $7.330 billion in October 1920 to a low of
$6.085 billion in January 1922. A decline of 17%!
This
was, of course, a monetary deflation, but it was only to correct the
relatively small inflation that took place during the war and soon
afterwards. The dollar was only returned to its long-term value at $20.67/oz.
So,
although there were certainly short-term "deflationary" effects, it
was more in the nature of a "disinflation." Certainly, the Fed was
abiding by the principle of Stable Money.
President
Woodrow Wilson cut the top tax rate to 73% in 1919. In the 1920 election --
the depths of the 1920 recession -- Warren Harding promised a "return to
normalcy" regarding the tax system. Since the top income tax was 7%
before the war started, this could be interpreted as a whopping big tax cut.
Of course he was elected.
Thus,
although it was still just the election, in 1920 people heard the Fed
promising to abide by the gold standard, and Harding promising a huge tax
cut.
Nonfarm
unemployment reached 20% in 1921, but it was back under 5% in 1922. Harding
managed a reduction in the top tax rate to 57% in 1921, and an elimination of
an excess-profits tax. In 1923 and 1924, more tax cuts reduced the top tax
rate to 46%, and in 1925 it was cut to 25%. The economy began to roar.
Think
about what might have happened in 1920 if:
a) The
Fed was encouraged to "lower interest rates" and devalue the
currency even further, resulting in a break of the dollar's gold link and
inflation;
b) The
government, worried about its dwindling popularity, showered money on all its
political supporters, calling this "stimulus." Big deficits result;
c) High
income tax rates from the war weren't lowered, and in the recession, a new
VAT was introduced.
What
would the 1920s have looked like then?
Maybe
some enterprising PhD student will study the 1920 recession in more detail.
* * *
A VAT
tax in the US?
Certain
Republican types have argued for years that the best tax system would be a
national sales tax. No income, corporate, capital gains, payroll, inheritance
etc. etc. taxes, just one simple tax on sales. It's an idea with merit,
although I personally prefer a bit of "progressivity" in tax
systems, more like the Kemp-style flat tax.
This
is completely different.
This
is a brand new VAT (like a sales tax) on
top of our existing tax system, which is none too generous as it
is. Yowza! That could be truly disastrous -- not only because of the economic
implications of the tax itself, but also because tax hikes tend to depress
demand for currency, which typically translates into downward pressure on currencies.
So, we'd have a)
downward pressure on the dollar, and b)
pressure on Ben Bernanke to do something about the economy that's crapped-out
by the new VAT tax, and you know what that means for Mr. One Trick, right?
More downward pressure on the currency!
The
Washington Post reports:
http://www.washingtonpost.com/wp-dyn/content/article/2009/05/26/AR2009052602909_pf.html
With
budget deficits soaring and President Obama pushing a trillion-dollar-plus
expansion of health coverage, some Washington policymakers are taking a fresh
look at a money-making idea long considered politically taboo: a national
sales tax.
Common
around the world, including in Europe, such a tax -- called a value-added
tax, or VAT -- has not been seriously considered in the United States. But
advocates say few other options can generate the kind of money the nation
will need to avert fiscal calamity.
At a
White House conference earlier this year on the government's budget problems,
a roomful of tax experts pleaded with Treasury Secretary Timothy F. Geithner
to consider a VAT. A recent flurry of books and papers on the subject is
attracting genuine, if furtive, interest in Congress. And last month, after
wrestling with the White House over the massive deficits projected under
Obama's policies, the chairman of the Senate Budget Committee declared that a
VAT should be part of the debate.
"There
is a growing awareness of the need for fundamental tax reform," Sen.
Kent Conrad (D-N.D.) said in an interview. "I think a VAT and a high-end
income tax have got to be on the table."
A VAT
is a tax on the transfer of goods and services that ultimately is borne by
the consumer. Highly visible, it would increase the cost of just about
everything, from a carton of eggs to a visit with a lawyer. It is also hugely
regressive, falling heavily on the poor. But VAT advocates say those
negatives could be offset by using the proceeds to pay for health care for
every American -- a tangible benefit that would be highly valuable to
low-income families.
Liberals
dispute that notion. "You could pay for it regressively and have people
at the bottom come out better off -- maybe. Or you could pay for it
progressively and they'd come out a lot better off," said Bob McIntyre,
director of the nonprofit Citizens for Tax Justice, which has a health
financing plan that targets corporations and the rich.
Hoo
boy, does that sound uber-horrible.
Federal
tax receipts haven't been doing too well:
Federal
tax revenue plunged $138 billion, or 34%, in April vs. a year ago — the
biggest April drop since 1981, a study released Tuesday by the American
Institute for Economic Research says.
When
the economy slumps, so does tax revenue, and this recession has been no
different, says Kerry Lynch, senior fellow at the AIER and author of the
study. "It illustrates how severe the recession has been."
For
example, 6 million people lost jobs in the 12 months ended in April —
and that means far fewer dollars from income taxes. Income tax revenue
dropped 44% from a year ago.
"These
are staggering numbers," Lynch says.
Big
revenue losses mean that the U.S. budget deficit may be larger than predicted
this year and in future years.
http://www.usatoday.com/money/perfi/taxes/2009-05-26-irs-tax-revenue-down_N.htm
Democrats
are still kicking around ideas of how to "fund" a National Health
Care System.
I say:
it's already funded!
The
best system, especially given our present situation, would probably be a
fully government-operated system, just like the existing Veteran's Affairs
hospital system. Instead of having to be a veteran to get in, you just need
to be a US citizen.
This
would require hospitals, of course. The U.S. already has plenty of hospitals,
including many private ones that are about ready to shut down. The government
could make bids for private hospitals below the cost of building a new
facility. There would probably be many thankful sellers.
Then,
you set a budget of perhaps 6% of GDP (possibly shared with states), to run
them. This would be a budget-driven system, not a "needs"
(wants/entitlements/profit) based one. The existing Medicare/Medicaid system
would be phased out. There wouldn't be any more Medicare entitlements fright
stories, because we would already know what the budget 10 years from now
would be. It would be 6% of GDP.
The US
government (all levels) is already spending about 7.5% of GDP on health care.
Or, to put it another way, the US government (all levels) is already spending
about 22% of all
health care spending in the world. That is plenty. So, this
would actually be less than the present level of spending, which of course
means no new taxes.
Like
maintaining roads and delivering postage, this is something that governments
are passably good at. Say what you want about the communist states like the
Soviet Union or Cuba -- they tended to have pretty good medical care.
Employers
would be ecstatic. They would be free of health care obligations for most of
their employees. Maybe the upper management would get some additional
private-sector benefits.
Even
doctors might like it. They would work 40 hour weeks and be free of malpractice
risks.
I
suppose some people wouldn't be too happy with the level of care that they
got at the Public Health hospitals. No problem. You can also go to a private
hospital, if you are willing to pay up for it. Which is just the same as
today's system, without the public hospitals.
This
would radically change the incentives from the profit-driven one of providing the least health care
for the most cost to a budget-driven one of providing the most health care for
the least cost.
* * *
Recent
Federal Reserve internal paper showing "need" for -5% interest
rate.
http://www.frbsf.org/publications/economics/letter/2009/el2009-17.html
* * *
I was
reading about a fellow who broke his arm recently. He had an ambulance trip
to the hospital and a half-day of care. It cost him over $100,000! For a broken arm? Even a
fancy lawyer bills at only $500 an hour. What should four hours and some
plaster cost? Don't you think that's a little ridiculous? I know many people
think that's ridiculous but
they keep paying anyway. Can you imagine a sorrier bunch of
serfs?
There's
a restaurant in town here that used to be a small hospital. On the wall they
have a copy of a bill from 1944. It's for a baby delivery, and includes a
full week in bed, which is how they did things in those days. The total cost
was $42. Even adjusting for inflation, that's about $600 in today's terms. Think about that.
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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