Summary of a Theory

The President (George Bush Jr...remember him?) spoke today on the economy prior to the opening of a global meeting on the global economic crisis, which he is hosting.

On this one, he's a reluctant host. Sort of like the 9/11 Commission; first he was against such a meeting, now he's for it. What changed his mind? French President Zarcozy and the European Union President's visit of approximately one month ago. As word got around that Bush basically didn't want to do anything and wanted to let the next Administration handle the crisis (beyond what has already been done in terms of bailouts for U.S. financial institutions), the Europeans hopped on a plane for a 3 hour dinner meeting with Bush in Washington. In arrival remarks, Zarcozy publicly pointed out that a global meeting should be called by the U.S. in November. Shortly thereafter, Bush "changed" his mind (or whatever it is he calls a mind).

Today's Bush remarks, however, were an indication that he remains unconvinced of the magnitude of the changes the global community is likely to bring with them this weekend. He is still - true to the bitter end - a reluctant economic leader, preferring to wait for the invisible hand of long dead Adam Smith, to act via free markets with minimal, if any, oversight. And, Wall Street, which has largely grown to ignore him, responded accordingly (up 400+ points on the DOW), proofing that the markets follow the fundamentals when it suits them and are equally capable of ignoring them when they do not.

They may be temporarily clinging to faint hope. I believe that the type of capitalism that has ruled since Reagan is dead, which leads to the theory.

My theory is based on Eccles view on the causes of the Great Depression, wherein he noted that democratic capitalism depends in large measure on a more or less wide dispersion of wealth. If wealth becomes overly concentrated among a few, basically no one else has the money (or credit) to purchase things and the economy tanks.

I believe this is basically what is occurring today. The sub prime mortgage mess was merely "the trip wire" that began the unraveling of the "phony economy." If Eccles' observation is correct, falling or stagnate wages among the majority, with increasing concentration of wealth, was masked by easy credit and over-valued assets. Higher than normal foreclosures (virtually guaranteed by mortgage providers) led to falling real estate, which in turn has led to real estate investors to walk away from property worth less than their investment, leading to more foreclosures, etc., etc. [Note: the head of Bank America's mortgage loan division testified before Congress this week that the great bulk of those "walking away" from properties were not residents of the properties, but investors.]

All of this was further aggravated by an unregulated market, lousy risk management models, with a touch of greed, corruption and incompetence.

Considering that we are all in one segment of the "labor market" or another...be in on a GM assembly line or as manger of a trillion dollar hedge fund, I believe rebuilding the economy has to begin at the bottom. Pouring money into the financial institutions without substantial changes in those institutions will at best simply perpetuate the house of cards and add another layer; at worst it will do nothing more than add to the national debt, further undermining the house of cards.

Continuing with the theory expressed in earlier posts, I am coming to believe that between Reagan economics (or the Milton Friedman ideas upon which it was based -meaning totally free markets, minimal government interference, trickle down theories, etc.) and Keynesian economics, meaning government intervention, pump-priming via government spending and higher taxation, the economic "truth" lies somewhere in between, depending upon the times.

If times are stable the economic situation of the middle class sound (meaning a general increase in wages consistent with productivity and GDP growth), and sufficient oversight and regulation to ensure a minimal amount of fraud and thievery, then Reaganomics may be the best path.

However, it is largely a balancing act. If wages do not rise, through open borders or the exportation of good paying jobs, and the middle class begins to disappear, then government must step in and do for its citizens what the free markets could not accomplish...create jobs. Better paying jobs reduce welfare and put more people on the tax roles, thus spreading the tax burden.

At the moment, my impression is that no one really knows what to do. A government policy that forces a return to loose credit markets does not really resolve the problem; it merely continues it. Financial institutions are largely caught in the middle (not that they do not bear the burden of responsibility for the present mess). They are condemned for loss credit on one hand, but encouraged to provide it on the other.

I am not sure there is any "fix" without substantial more pain. It will take time to create meaningful jobs that cannot be easily moved overseas at lower labor costs. A tax increase for the wealthy of a few percentage points (say five on capital gains and upper income brackets) does not seem to be too harsh a "penalty" to impose on those basically responsible for the present mess (how many investors complained about ridiculous NINJA loans, but invested in them at the same time...it was as if the left hand didn't know what the right hand was doing). If used intelligently, nominal tax increases won't drive many into bankruptcy and may help to restore neglected infrastructure and create energy independence. The Republican clamor against tax increases strikes me as largely impractical for the times and largely ideologically based, to the degree of cutting off one's nose to spite their face.

In the recent Presidential campaign, Biden was chided for saying "paying taxes is patriotic." It is unbelievable that at a time of global economic crisis, record deficits and fighting two wars abroad that Republican pundits made fun of his statement, by arguing the exact opposite...i.e. along the lines of "we believe paying less taxes is patriotic!" Are these people crazy? Do they really understand what is going on? Did they think the country could pursue wars abroad and free markets without regulation and oversight, while lowering taxes, without a serious economic crisis?

Biden was right. Paying taxes in time of war is patriotic. Bush lowered taxes and skimped on our military.

While the Democrats are certainly not without blame (Fannie May; Freddie Mac; Wall Street connections; Bob Rubin, etc.), Republicans have been largely deluding themselves since 9/11 in abandoning fiscal discipline, ensuring genuinely free markets, and standing behind a foreign policy that suggested doubling or tripling military and homeland security outlays, rather than cutting taxes. If Democrats made the "Guns and Butter" mistake with LBJ and Vietnam, Republicans have now done the same.

Bluntly, cutting taxes in time of war is unpatriotic and very, very un-American.

[There is a book to be written on this subject and one might compare what we have tried to do in the middle east to the imperial wars of Great Britain, counting on a relatively small professional army, with superior weapons to "control" foreign colonies. One could argue that they, in fact, tried this on us, leading to our own revolution. Ironically, Mad King George was the British monarch at the time.]

Were it not for the McCain campaign, we could blame this on the abberation of George Bush. Yet McCain offered no substantial changes in either the Bush foreign or domestic policies. I do not recall him ever mentioning bringing war or foreign policy goals in line with financial resources. He seemed to think that if he could ban earmarks all would be well ($18B in annual earmarks versus some $150B in annual Iraqi and Afghan war costs).

Perhaps the major problem with the Republican hierarchy is that they drank the Kool Aid - i.e. began believing the sales pitch. And, as no less a conservative than David Frum has recently pointed out, until the party turns its attention to the middle class of America, they are doomed to failure. [Frum also noted that Joe the Plumber is probably not the answer...Republicans lost substantial vote among white, well educated males.]

The problems facing us today are often compared to the challenges Roosevelt faced in 1933. Obama's challenges may actually be greater. Roosevelt had an economic advantage in bringing the United States out of an economic crisis by mobilizing for war. Obama has to do the same economically, while extracting us from war. To accomplish both will not be easy for either a Democrat or Republican.

More next time on where I think Obama will take us and the need for a new Republican economic philosophy.