Big One in 2008

This is from the latest issue of Forbes, and nicely encapsulates the upcoming debate in 2008; namely, which direction will the U.S. go? I have read other editorials which suggest, correctly I think, that the U.S. is in a generational battle between an FDR vision of the world and a Ronald Reagan vision of the world. These are fundamental questions that have huge implications for our future GDP growth rates, taxes, technological advances, and the types of policies we implement to try to solve big problems (Social Security, Medicare, healthcare, etc.)...

Big One in '08Steve Forbes 01.07.08, 12:00 AM ET
by Steve Forbes

The upcoming presidential election will be the most critical one since 1980. Back then Ronald Reagan decidedly defeated incumbent Jimmy Carter, ushering in radical new policies that would successfully set the course of this country for the next quarter-century. Unlike previous administrations, Reagan's dramatically cut taxes (the top income tax rate dropped from 70% to 28%). Reagan pushed government deregulation and reined in nondefense, nonentitlement spending. And, most important, he won the Cold War, an extraordinary victory that few experts had thought possible. We have been living off Reagan's dividends ever since.

What course will the country take now? Will we significantly simplify the tax code and cut tax rates, as Rudy Giuliani and some other GOP contenders advocate? Or will we raise taxes to stagnant, old-Europe levels, as all the Democratic presidential wannabes favor doing? Will we push for consumer control of health care or will we have a de facto socialized system, such as that Hillary Clinton is pushing? Will we turn Social Security from a liability into an asset by allowing people under the age of 50 to have personal accounts that are owned by them, not by Washington politicians--a system that will yield far greater returns than the current Social Security system could possibly do? Or will we go the Democratic way of heavier payroll taxes and reduced benefits?

Regarding foreign policy, will we take a broader, more vigorous approach to combating terrorism, deploying not only our military (which must be beefed up) but also a Reagan-like type of "soft diplomacy," such as far more effective use of radio and Internet broadcasts to troubled parts of the world? Will we push pro-growth economic policies that emphasize sound money, low taxes and property rights for developing countries or the detrimental high-tax, cheap-money policies of the current Treasury Department and the IMF?
Fundamental questions all.

While the mud will fly, there will also be a vigorous debate on where we go from here. How that debate is resolved will determine the course of our economy and the direction of the stock market. If the optimistic example of Ronald Reagan triumphs, we'll have sound, noninflationary growth, and we'll lead the world in technological innovation. The stock market will soar easily to new heights. But if the current Democratic platform wins, we are in for troubled times.
I am an optimist. I believe the spirit of Ronald Reagan still reigns in this land.

Who's Paying the Most Taxes?

Today's WSJ ran an editorial showing recently released IRS data for tax year 2005. Take a look:



This chart shows that more and more people in the U.S. are entering the ranks of the truly affluent. This represent upward mobility in a truly competitive and dynamic system.

The amount of capital gains taxes and dividend income declared has increased by 50% since the cap gains and dividend taxes were lowered to 15%.

Bullets and The Gun

Since the massive liqudity injection post-9/11, I have said (when rates were around 1.5%) that the Fed was going to need to reflate the economy by putting "bullets" back in the "gun". This has occurred over the last 24 months, and this is what needed to happen, since there has simply been too much liquidity in the system, and this has led to excessive risk taking, and low risk premiums. Historically, an environment with low risk premiums fares very poorly, and the recent credit crisis shows why.

So why did I think way back when that the Fed needed to put more bullets in the gun? Because those "bullets" represent Fed flexibililty in the face of another economic emergency. If we had been stuck in the 1.5% range, in the face of another Black Swan event, the Fed wouldn't have much wiggle room to move downward, and we certainly wouldn't want to end up in a Japan-style conundrum of a .5% rate environment. So by ratcheting up rates over the last 24 months, the Fed soaked up some liquidity, which is a good thing, since as Milton Friedman always said "inflation is everywhere and always a monetary phenomenon".

The Fed's decision to lower rates yesterday by .25% (Fed funds and discount rate) was seen as too little too late. The market already expected .25%, and "wanted" a reduction of .5%. Over the next year, the market expects rates to be lower by another 1%, which would greatly help out struggling financials and consumers. So while the Fed has wisely loaded it's Monetary Gun with additional bullets over the last couple of years, it needs to be able to pull the trigger! These gradual reductions will lead to more uncertainty and may lead us to the brink of a recession if not diligently handled.

Happy Thanksgiving

The image to the right shows what the Dow Jones Industrial Average has done over the last 3 months. This is not a pretty picture, and represents about a 9% slide in the stock market. This is all due to the recent credit "crisis", which is more appropriately a credit "loss of confidence", which started the cascading effect that we are still witnessing.

The silver lining is that we've had a recent upturn in the last 2 weeks, the Fed has signaled that it is in easing mode, and the big banks are starting to take huge (ultra-conservative) write-downs. Why is this important? Well, if the banks take a massive write-down now, each subsequent quarter these written-down loans are again marked to market. Eventually, there will be a market in these securities, and eventually these assets will be marked to market at higher prices than currently. At this point, maybe in 6-9 months, banks will stage a rally.