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November 10, 2004
Money
As the whole world expected, the Fed raised its policy target rate by one-quarter of a percent to 2 percent. Since last June the fed funds rate has doubled from 1 percent to 2 percent. What is so interesting about this is that long term Treasury bond rates have actually fallen to around 4.25 percent from 4.75 percent. This is significant evidence that neither actual inflation nor expected future inflation is really a problem. The Fed was right to move today but not for the reasons given by a majority of demand-side economists. It's not about budget deficits, or trade deficits, or jobs growth, or what looks to be a strengthening economic recovery rate. The best reason for the Fed move is because short term interest rates have been rising -- the three-month Treasury bill had leap-frogged the old 1.75 percent Fed target rate and landed at nearly 2.10 percent. The Fed is right to follow market interest rates, especially its unregulated T-bill cousin. Would that the central market would decontrol its own overnight target rate; then market forces would run monetary policy rather than econometric models that abide by discredited trade-offs between inflation and unemployment. Also in the realm of market forces, the dollar lately has lost some additional value in terms of gold and foreign currencies. So there could be a small amount of excess money which needs to be absorbed by the government bank. When they raise their target to 2.25 percent next month it is quite possible that they will have removed the monetary excess. One important issue not mentioned in the Fed's policy statement was the dollar. Everybody on Wall Street is talking about the falling dollar. They are obsessing about it. And most blame the lower greenback exchange rate on America's widening trade gap. This is totally wrong. The main reason the dollar has slipped when measured against the euro is that European monetary policy and their creation of new euros is way too stingy; it is in fact still deflationary. The Fed, on the other hand, has moved from deflation to reflation in recent years, thereby creating plenty of new greenbacks. So euro scarcity value has raised its currency at the expense of the dollar. In essence, it's not so much that the Fed is too loose as it is that the euro central bank is too tight. Consequently, Eurozone economic growth has averaged a recessionary 1 percent in recent years, whereas the U.S. recovery rate has been 3.5 percent. America lowered tax-rates, but the Europeans refused to do so. Top heavy social spending and excessive regulating of business and labor markets also suppress Eurozone growth. In comparison with the U.S., not only does Europe not work, not produce, not invest, with terrible productivity, their monetary policy is scorched-earth deflationary. But, Fed officials should stop talking the dollar down. In recent weeks Janet Yellen, Ben Bernanke, and Robert McTeer (before he took the presidency of Texas A&M) suggested that the dollar should fall some more. This is dumb. It may be the biggest reason for the recent dollar decline. And we have learned that the falling dollar relative to the euro is tightly linked to a rising gold price. As for the trade deficit, the U.S. grows faster than its biggest customers. So we import more than we export. However, exports are rising at a 13 percent pace; a great sign of economic health. Imports are rising even more by 17 percent. We are selling goods and services to China at a 37 percent rate. But the volumes are too small to dent the trade gap. This will change over the next decade. Meanwhile, America's profitable investment margins attract foreign private capital inflows from all around the world. Lately foreign inflows have come in around $600 billion, about the same as our $570 billion current account deficit for goods and services. In other words, there is no financing problem at all and no reason to tie the dollar to the trade accounts. However, it would be foolish if the U.S. Fed started targeting the euro for its monetary policy. If the Europeans are stupid enough to crash their economy, that's their business. But whatever hedge fund traders may say, the U.S. must not make the same monetary mistake that would wreck our prosperous recovery. Domestic price stability should be the Fed's strategic goal. As long as they follow interest rates and commodity movements, as Greenspan seems to be doing, then the U.S. will continue along a path of non-inflationary economic growth.
Posted at 3:45 PM, November 10, 2004 | Trackback | Print | #
Tax-Reform Personnel
At Arthur Laffer's post-election conference in New York, a couple hundred supply-side optimists spontaneously decided to support Glenn Hubbard for the chairmanship of the Federal Reserve in the post-Greenspan period that begins in 2006. Bush administration insiders believe the choice will boil down to Hubbard or Martin Feldstein. Two smart guys with tremendous credentials. However, many recall Feldstein's mixed tenure as chairman of the Council of Economic Advisors under President Reagan. After writing many fine articles about the benefits of lower tax rates, and after pointing out flaws in the Social Security system and healthcare entitlements, Feldstein, upon taking office, started crusading for higher taxes in order to narrow the budget deficit. Feldstein worked with OMB director David Stockman, White House big Richard Darman, and New York banker Pete Peterson to press for a tax-hike "solution." It was virtually a fifth column in 1982. Reagan refused to budge on tax rates, though he did allow some tax-loophole closers in return for spending cuts that never materialized. In 1986, however, he signed tax-reform legislation that designated only two tax brackets, at 15 and 28 percent. (That's not a bad model for George W. Bush's second-term tax-reform quest.) As a Harvard economics professor and president of the prestigious National Bureau of Economic Research, Feldstein's writings over the years have been terrific. Yet there is lingering suspicion that his work out-of-office is more reliable than in-office. Nowadays, when Fed chairmen testify on Capitol Hill, they are forced to talk at length about fiscal policy, especially budget deficits. Seldom do House or Senate members provide much ammunition to restrain spending. The conversation is almost always about raising taxes. Greenspan has generally done a good job in fending off tax-hike proposals that would curb economic growth and actually widen the deficit. As a rule this is poorly reported in the press. The maestro has also been a strong supporter of Bush's lower marginal tax rates on personal income, capital gains, and dividends. No one doubts that Glenn Hubbard would similarly defend pro-growth tax reform as Fed chairman. While Bush's top economic advisor, Hubbard was an unyielding proponent of the incentive power of lower tax rates to grow the economy. It was Hubbard who pressed harder than anyone in the White House for a reduction in the multiple taxation of investment. This made excellent sense. The stock market and business investment were hard hit by the recession Bush inherited. With the help of Hubbard, Vice President Cheney, and a number of economic advisors outside the administration, lower taxes on individual income, small business, investor dividends, and capital gains were embraced by the president and signed in the tax bill of June 2003. The results have been stellar. In a recent Wall Street Journal op-ed, Hubbard emphasized the positive results of lower marginal tax rates on work, saving, and risk-taking, linking lower "success taxes" to entrepreneurship and innovation. Once again, his steadfast and unyielding support of supply-side tax reform commends him strongly for the Fed job. As for the deficit problem, Hubbard agrees with Bush that the solution lies in maximizing economic growth, restraining discretionary domestic spending, and reforming major entitlement programs. While little is known about Hubbard’s monetary views, he certainly would not be tolerant of rising inflation. As a pro-market economist, Hubbard would probably make ample use of financial- and commodity-market price signals to guide his monetary strategy. According to people close to the White House, current CEA chairman Greg Mankiw will be returning to his teaching post at Harvard come January. This leaves a key slot open in the Bush economic high command. The president would be well served by appointing Art Laffer to that post. Formerly a close advisor to President Reagan, Laffer has been a senior advisor to businesses and financial institutions for more than three decades. His hands-on real-world experience would greatly benefit the White House staff as they tackle tough questions on tax and Social Security reform. Laffer would also serve as a key liaison to Wall Street, where he is highly regarded as a prescient forecaster and strong communicator. Washington insiders also believe that Treasuryman John Snow will remain in his post at least through mid-2005, and maybe longer. Snow was a senior member of Jack Kemp's tax-reform commission in the '90s and has detailed knowledge of the subject. He has long argued for lower tax burdens on saving and investment, thereby agreeing with Bush's view that the double-taxation of capital is just plain bad for economic growth and job creation. As a former railroad CEO, Snow would likely press for reform of the increasingly uncompetitive U.S. corporate tax code. With Hubbard, Laffer, and Snow in the mix, Bush's ambitious second-term economic agenda will have a much greater chance of success than most inside-the-Beltway pundits believe possible.
Posted at 12:07 PM, November 10, 2004 | Trackback | Print | #
November 8, 2004
To Have and Have Not
Class warfare doesn't work. Middle income voters do not sit around throwing darts at the faces of rich people. Nor do they necessarily vote for higher taxes on rich people. The Sunday New York Times printed a valuable demographic breakout of the presidential voting results. It turns out that the $50,000 to $75,000 income group, which comprised 23 percent of the electorate, went for Bush by a whopping 56 percent to 43 percent. Just below that group is the $30,000 to $50,000 income earners, comprising 22 percent of the electorate, and their results were basically a push: 50 percent Kerry, 49 percent Bush. The bottom two categories comprising less than $30,000 income earners did go for Kerry. But they don't pay any taxes. The earned income tax credit is refundable and it covers payroll taxes and then some. Basically no one at $30,000 or less pays any income taxes anymore. In broader brush, $50,000 and above, making up 55 percent of the electorate, went for Bush 56 percent to 43 percent. That group includes $100,000 earners, who are 18 percent of the electorate, and went for Bush 58 percent to 41 percent. It also includes the much-attacked $200,000 and over group, which comprised 3 percent of the voters, and went for Bush 63 percent to 35 percent. Democrats keep flogging the class warfare issue, and they keep losing on it. It has become a Democratic pathology; a veritable addiction that requires rigorous 12-step work if they are to be weaned off of this obsession/compulsion. That $50,000 to $75,000 category that went for Bush by 13 percentage points knows several important things about tax policy. They know that Democrats pledging to raise high income taxes are likely to raise middle income taxes also in order to finance big government social welfarism. They also know that rich people, so-called, have the investment resources to employ them. Or to provide the investment funding seed corn to start a new business or to hire a middle income worker as an independent contractor or consultant. The political moral of this story should be clear by now, but in all likelihood Dems will be right back with this nonsense in 2008. But the economic principle is even more important: you can't have capitalism without capital. You can't have jobs without businesses. You can't have businesses without investment funding. Therefore, connecting the dots, investment capital from rich people creates the wherewithal for middle income consumption. Folks in America who work, pay taxes, and vote know this full well. For them, the challenge is to climb the ladder of economic mobility, not destroy the upper rungs of the ladder itself. Over the next few years the trick for economic policy is to convert income into wealth for the middle class. Removing tax barriers all along the way should be policy priority number one. Flatter tax-rates, more tax free savings accounts, greater ownership, and an expansion of the investor class, will promote wealth for everyone, especially the non-rich who wish to become rich. If the Democrats ever figure this out, they will once again become a formidable political party.
Posted at 12:58 PM, November 8, 2004 | Trackback | Print | #
