Today's Market Turbulence

Chronicle of the Conspiracy

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Tuesday, January 22, 2008

HE'S DOING IT AGAIN... Here's Paul Krugman, once again using the prestige brand of the New York Times to uncritically spread lies that he lifts from various blogs. Prestopundit has the story:

"I'm going to be honest: I know a lot less about economics than I do about military and foreign policy issues. I still need to be educated [about economics]". That was McCain speaking with Stephen Moore in Nov. of 2005, at the Senator's office in Washington, D.C. In the same interview McCain identifies former economics professor and U.S. Senator Phil Gramm as his leading economic adviser on economic issues. Here's the whole incident as recounted by Moore:

On a broader range of economic issues, though, Mr. McCain readily departs from Reaganomics. His philosophy is best described as a work in progress. He is refreshingly blunt when he tell me: "I'm going to be honest: I know a lot less about economics than I do about military and foreign policy issues. I still need to be educated." OK, so who does he turn to for advice? His answer is reassuring. His foremost economic guru is former Texas Sen. Phil Gramm (who would almost certainly be Treasury secretary in a McCain administration). He's also friendly with the godfather of supply-side economics, Arthur Laffer.

The always reliable "Huffington Post" re-writes history, and transforms this incident into a recent meeting with editorial board of The Wall Street Journal, one in which Sen. McCain is made to say he "doesn't really understand economics." A pure fabrication, and a rather nasty one at that. Here's the opening paragraph from Sam Stein's article "Short on Economic Understanding, McCain Brings Phil Gramm to Meeting" in the Huffington Post:

At a recent meeting with the Wall Street Journal editorial board, Republican presidential candidate John McCain admitted he "doesn't really understand economics" and then pointed to his adviser and former Senate colleague, Phil Gramm - whom he had brought with him to the meeting - as the expert he turns to on the subject, The Huffington Post has learned.

The incident was confirmed by a source familiar with the proceedings of the meeting.

Perhaps no surprise this -- Paul Krugman has picked up the fabrication and he's spreading it via the New York Times.

John McCain did in fact have a recent meeting with the editorial board of the Wall Street Journal -- but note well that Phil Gramm wasn't present, and John McCain didn't tell anyone that he "doesn't really understand economics".

Posted by Donald L. Luskin at 11:53 PM | link

THE PAULONOMICS FACTOR My column on Ron Paul from National Review Online today:Republican presidential hopeful Ron Paul sounds radical when he advocates the elimination of the individual income tax, a return to a gold standard, the wholesale downsizing of the federal government, and the abolition of the Internal Revenue Service and the Federal Reserve. The media and the other presidential candidates treat him as a nut. Indeed, Paul often enough opens himself up to that treatment in the flamboyant way he expresses himself. Sometimes he even seems to relish his image as a gadfly on the political fringe.

But it’s time to start taking the ten-term Texas congressman seriously. He tied for second-place (with John McCain) in Nevada on Saturday. He beat both Rudolph Giuliani and Fred Thompson in Michigan (he also beat Giuliani in Iowa and South Carolina and Thompson in New Hampshire). And Paul now holds the record for the most money raised — $6 million — on a single day in a primary season by any candidate in history. It would be a real mistake to think of Paul as the Dennis Kucinich of the right.

Nut or not, Paul isn’t going away. His message is combining intense opposition to the war in Iraq with a strong agenda for free-market capitalism. So it’s drawing grass-roots support from both parties. Even if it’s a bridge too far for him to capture the GOP nomination, he could mount an insurgent run for the presidency with cross-party appeal and fundraising power, probably as the nominee of the Libertarian party (on whose ticket he ran for president in 1988). He could end up shaping the coming election as H. Ross Perot did the 1992 race — denying either major-party candidate the mandate of a majority of the popular vote, and shifting the center of gravity on important issues.

For many conservatives, what makes Paul seem like a nut is his absolute opposition to the war in Iraq and his insistence on immediate withdrawal of U.S. troops from the Middle East and most of the rest of the world. On the other hand, his views on abortion are perfectly in line with mainstream conservative values (although this side of Paul never seems to get any attention).

On the economics front, Paul is a delightful paradox. If you crack the nut shell and look objectively at what Paul is really advocating, conservatives will find that Paulonomics looks an awful lot like Reaganomics. Paulonomics emerges as a refreshing return to conservative roots: small government, low taxes, deregulation, and sound money. If Paulonomics seems nutty, that may say more about the sad state of events today, with “big government conservatism” having become the new touchstone.

The core concept of Paulonomics is the reduction in the size and cost of the federal government. Irking many of today’s conservatives, Paul emphasizes how this should include scaling back what he calls American “militarism,” beginning with a pullout of Iraq.

But embracing a more classic fiscal conservatism, Paul would outright eliminate what he believes are wasteful and counterproductive federal programs, such as the departments of Education and Energy. Nutty? Most Republicans wouldn’t dare talk about eliminating the Department of Education in the age of “No Child Left Behind.” But Paul reminded me in a recent interview that it wasn’t so many election cycles ago that scrapping this department was an official plank of the GOP platform.

And if you mean it about cutting the cost of government, you’ve got to after the big-ticket items. As to the biggest-ticket items of all, Paul would decommission Social Security and Medicare by honoring obligations to those who are utterly dependent, but letting young people opt out of both systems entirely. Nutty? Let’s be honest: Most conservatives want to do exactly this, but are afraid to say so in a political environment where even mandatory personal accounts are vilified as a “risky scheme,” as Al Gore famously put it.

With all that and more gone from the federal budget, it’s not so nutty for Paul to talk about eliminating the individual income tax and the intrusive bureaucracy that administers it. Paul points out that today’s level of federal tax revenues, without the income tax, is sufficient to meet all the government’s expenses as they stood not so many years ago. The problem is that the size, scope, and cost of government has grown so much. Would it be such a nutty trade-off to roll back the clock on government expenditures if it meant eliminating income taxes for all Americans?

Paul deplores the federal deficit, but insists the only way “to solve that problem is to cut spending, not to raise taxes — or to not lower taxes when you get a chance.” As a first step he advocates the elimination of all taxes on capital — estates, capital gains, interest income, and dividends. He told me, “It’s capital that you need to make capitalism work.” He says the idea that most excites young voters is his proposal to eliminate income taxes on tips: “It’s a big deal if you’re a family struggling and if a second member of the family is working and trying to pay the bills.” Nothing nutty about any of that.

Paul may be the anti-Reagan when it comes to foreign affairs and the military. But he out-Reagans Reagan in his unwavering opposition to the government regulation of business. He may have seemed like a nut when he was one of only three congressmen to vote against the Sarbanes-Oxley Act in 2002. But weren’t the real nuts the conservative congressmen who got swept up in a witch-hunt against “corporate crooks,” and voted to impose the most sweeping, burdensome, anti-competitive, and costly financial regulation in a generation?

Paul is an advocate of free trade — to a fault. He believes deeply in unrestricted trade between people and nations. Yet he votes against free-trade agreements such as NAFTA and CAFTA because he believes that trade is a right, not a gift for Congress to bestow in certain circumstances. Without such agreements, the reality is that trade is probably less free than it is with them. Is Paul a nut for letting the perfect be the enemy of the good? Perhaps, but for Paul it’s a point of principle. He told me, “I don’t call them free-trade agreements; I call them managed trade agreements.” Instead, Paul would like to see a simple policy of “low and uniform” tariffs for all products from all nations.

Perhaps the most unusual element of Paulonomics is the idea of abolishing the Federal Reserve. For Paul, this is another way to eliminate government interference and to lower taxes — in this case to lower what he calls “the inflation tax.” Do we need the Fed to be a lender of last resort to aid in financial crises, such as the present sub-prime mess? Paul says no: “the lender of last resort is just the printer of last resort, the inflationist of last resort.”

Most politicians fall all over themselves in public adulation of the reigning Fed chairman. But Paul has had the courage to grill these unelected economic central planners when they come before his House committee. He asks the tough questions that others fear to ask, and they’re the same questions that are often asked by economic commentators on this website, including me. Most prominently, how is it the Fed continues to operate on the demonstrably false premise that rapid economic growth is, ipso facto, inflationary?

Paul, however, can be his own worst enemy on this subject when, in debates, he seems to blame all our economic challenges on inflation, or when he buys into some of the conspiracy theories that have surrounded the Fed in various forms since its inception. In a recent grilling of Ben Bernanke, Paul made an issue of the discontinuation of M3 monetary aggregate statistics, as though the Fed had done this in order to hide something. Okay, that was nutty.

But as a first step toward eliminating the Fed, Paul advocates “legalizing competition — allow gold and silver to circulate with the dollar, and take off all the taxes on gold and silver money.”

Ah, gold! The mere mention of it in today’s modern economy brands you as a nut, or at least an economic hick. But remember, American money was linked to gold in one way or another for most of our history, until 1971 in fact. In his first year in office as president, Ronald Reagan established a blue-ribbon commission to investigate a possible return to gold. It went nowhere, but was Reagan a nut to ask the question? More fundamentally, is there anything nutty about money that would be, as Paul advocates, “convertible and redeemable in something of real value”?

For all his apparent extremism, there’s no other candidate who has managed to excite both Democrat and Republican voters by combining an anti-war message that irritates conservatives with a free-market message that irritates liberals. Nutty? Or brilliant?

If I’m right and Ron Paul doesn’t just fade away as the primary season progresses, he’ll make a real difference. His anti-war message would make life difficult for Hillary Clinton, by drawing away the most pacifist elements of the Democratic base. But it’s on the economics side where I think he could make the biggest impact. In an election year in which bigger government, higher taxes, and protectionism seem to have so much momentum, Paulonomics may be just what is needed to rebalance the debate in favor of growth.

‘Recession,’ Stocks & the Fed
What to think?

An NRO Symposium

Early Tuesday morning, as global stock markets plummeted on fears of a U.S. economic recession, the U.S. Federal Reserve made an unscheduled adjustment to the key federal funds interest rate, lowering it three-quarters of a point to 3.5 percent. The action, however, was not enough to calm equity markets, with the Dow Jones dropping more than 120 points on the day and closing below 12,000. Markets are volatile. Recession — though not in the data — is certainly in the air. What should investors think? National Review Online’s resident financial experts have some answers.


JERRY BOWYER
People who believed in the Bush boom and got into the markets when the president cut tax rates in 2003 have done very well. If you read NRO and have bought into the ideas of Larry Kudlow, Art Laffer, Steve Forbes, Rich Karlgaard, Brian Wesbury, Don Luskin, and yours truly, you made money. If you bought into the leftie doom-and-gloom scenario of Paul Krugman et al, you missed one of the great wealth-creation events in modern history. Bush proved, once again, that Reaganomics isn’t just theory — it really works. It works when Republicans like Calvin Coolidge use it. It works when Democrats like JFK and Bill Clinton use it. It even works when Russia and China use it.

But it doesn’t work when it’s not used, and that’s what’s happening to investors right now.

There’s been a great deal of discussion about whether or not the Bush tax cuts are going to expire at the end of 2010. But almost nobody has mentioned the fact that some of them have already begun to expire. The tax cut of 2003 extended a provision which changed the law (for fellow code-heads like myself, I’m talking about section 179) so that businesses could deduct durable-equipment expenses more quickly than had been allowed previously. Instead of forcing businesses to spread the tax deductions out over five or seven years, they were given greater leeway to deduct the purchases at the time they were made. That provision expired three weeks ago. No wonder investors are apprehensive about a slowing economy.

It’s not just the business-equipment deduction; it’s also the whole cluster of issues that buzz around the presidential election. Every caucus and primary election is a leading indicator of future tax and regulatory policy. Investors are just registering what they see. And they see that since Iowa, the pro-growth party has been in disarray while the anti-growth party has been the beneficiary.

If you don’t believe me, just look at the Intrade political-futures market for a Republican win overlaid with the Dow Jones Industrial Average. As the GOP prospects fall, so do the prospects of the investor class. Either a pro-growth candidate becomes a front-runner, or a front-runner becomes (persuasively) pro-growth. Otherwise investors will remain jittery. Do you blame them?

— Jerry Bowyer is the chief economist of Benchmark Financial Network.


VICTOR CANTO
During market downdrafts, investors get the urge to do something. However, this is one of the biggest mistakes they can make. When investors increase their cash exposure during short-run market corrections, they lock in losses and insure that they will not participate in the upside as markets recover. The U.S. experience during the last few financial crises bears this out. Looking back, I can point to Black Monday in 1987, the Mexican peso crisis (1994), the Asian Tigers crisis (1997), and the Russian default crisis (1998) as periods when a market tumble was made back in short order. The investors who held their positions were the ones who came out whole.

From a policy perspective, the current episode suggests that the Fed is ready to provide necessary liquidity while remaining vigilant of the underlying inflation rate. Looking back at prior market turbulence, the Resolution Trust Corp. episode of the early 1990s (an exception to the modern-day rule of quick market recoveries) shows that monetary policy alone may not overcome fiscal-policy mistakes. Recall that President George H.W. Bush raised tax rates around that time, and the economy went into a recession. The proper policy would have been a tax-rate cut. This would have increased after-tax cash flows and asset values, both of which would have accelerated the economic and financial recovery.

— Victor Canto, Ph.D., is the founder of La Jolla Economics, a research and consulting firm in La Jolla, California. He is the author, most recently, of Cocktail Economics.


LARRY KUDLOW
Stock market corrections and economic recessions come and go. It’s the nature of a free economy. Add to that Schumpeterian gales of creative destruction, as technological advances bring down old industries in favor of new ones. Turbulence is part of capitalism. But Tuesday’s turbulence should not dissuade investors from buying stocks for the long-run.

This strategy essentially argues for investing in America, which has produced the greatest prosperity in the history of history. I do not see this changing. Right now the stock markets have corrected by roughly 20 percent — the first time in about five years that we’ve had a true correction. To me this means there are a lot of bargains out there. In fact, the market averages at these levels represent good bargain prices.

I always recommend buying broad stock market indexes. For example, the Dow Jones Wilshire 5000 or the S&P 500. Owning international indexes also makes sense, including emerging-market indexes. A package like this gives investors good diversification, keeps it simple, and covers the world.

I don’t foresee the overthrow of free-market capitalism, and not even Senator Clinton will bring back state-run socialism. Folks who bought the market in late 1987 and held it for twenty years did extremely well. I don’t recommend timing the cycles, and certainly not trading on a daily or short-term basis. The idea is to stay long-term. Younger investors should be 100 percent in stocks. Middle-aged investors should be about 80 percent in stocks. And elderly investors should probably be about 50/50 between stocks and bonds.

Be invested. Be diversified. Use cheap exchange-traded fund indexes. And stay optimistic.

THE DAILY ECONOMIC NEWS

‘Recession,’ Stocks & the Fed
- NRO Symposium, National Review
Hillary and Say's Law
- George Melloan, Wall Street Journal
The Other Stimulus
- IBD Editorial
Washington Embraces Keynes, Investors Shrug
- John Tamny, RCM
A Freer World is a Better World
- John Stossel, Real Clear Politics
The Inconvenient Truth About Earmarks
- Samuel Loewenberg, the Politico
The Shape of the Stimulus Package
- Matthew Bandyk, US News
It’s the Partisan Economy, Stupid
- Michael Barone, American.com
Bernanke's Brain
- Amity Shlaes, New York Sun
What the Market Brought Us Between 1966 and 1996
- TJIC.com

Today's Market Turbulence

Stock market corrections and economic recessions come and go. It’s the nature of a free economy. Add to that Schumpeterian gales of creative destruction, as technological advances bring down old industries in favor of new ones. Turbulence is part of capitalism. But Tuesday’s turbulence should not dissuade investors from buying stocks for the long-run.

This strategy essentially argues for investing in America, which has produced the greatest prosperity in the history of history. I do not see this changing. Right now the stock markets have corrected by roughly 20 percent -- the first time in about five years that we’ve had a true correction. To me this means there are a lot of bargains out there. In fact, the market averages at these levels represent good bargain prices.

I always recommend buying broad stock market indexes. For example, the Dow Jones Wilshire 5000 or the S&P 500. Owning international indexes also makes sense, including emerging-market indexes. A package like this gives investors good diversification, keeps it simple, and covers the world.

I don’t foresee the overthrow of free-market capitalism, and not even Senator Clinton will bring back state-run socialism. Folks who bought the market in late 1987and held it for twenty years did extremely well. I don’t recommend timing the cycles, and certainly not trading on a daily or short-term basis. The idea is to stay long-term. Younger investors should be 100 percent in stocks. Middle-aged investors should be about 80 percent in stocks. And elderly investors should probably be about 50/50 between stocks and bonds.

Be invested. Be diversified. Use cheap exchange-traded fund indexes. And stay optimistic.

A Freer World is a Better World

By John Stossel

This week's newspapers are full of predictions of an impending recession, and maybe they're right. But the great untold story is the good news: the worldwide boom in economic growth.

"I think one of the best kept secrets is that the world is in the midst of an economic boom, and it is largely driven by increases in economic freedom," says economics professor James Gwartney, director of the Stavros Center for the Advancement of Free Enterprise and Economic Education at Florida State University. "The world has become more free, and, at the same time, growth is soaring to new highs. During 1995 to 2005, the growth rate of per capita GDP in 99 countries for which data are available has increased to 2.2 percent, nearly twice the rate of recent decades. Since 2000, the annual growth rate of per capita GDP has been even more rapid, 3.2 percent."

As the world gets freer, says Gwartney, it gets richer.

He should know. For years, Gwartney and Robert Lawson of Capital University have compiled an index showing the solid relationship between economic freedom and economic growth. The latest index, covering 2005, was recently published by the Economic Freedom Network, which comprises more than 70 policy institutes worldwide, from Albania to Zambia.

The story the index tells couldn't be clearer: Economic freedom produces high living standards.

This insight shouldn't come as news, but unfortunately it will because prejudice against the profit motive and property rights leads many to believe that government coercion is better than free markets at making life better.

What is economic freedom exactly? As the report puts it, "individuals have economic freedom when they are free to use, exchange, or give their property as long as their actions do not violate the identical rights of others."

The researchers ranked countries according to five criteria: size of government, security of property, access to sound money, freedom to trade internationally and level of regulation.

The top five freest countries in 2005 were Hong Kong, Singapore, New Zealand, Switzerland and the United States. That's a slight slip for the United States, which in 2004 came in third. We've never placed higher than second (in 2000).

The next five are the United Kingdom, Canada, Estonia, Ireland and Australia. The bottom five are Republic of the Congo, Angola, Democratic Republic of the Congo, Myanmar and Zimbabwe.

It's hard to miss the point: The freest countries are far more pleasant places in which to live. Countries with little or no economic freedom make life hellish for all but the politicians or dictators in charge (and even for some of them).

The good news, says Gwartney, is that economic freedom is increasing. "The average rating of the 99 countries for which data are available continuously since 1980 has increased from 5.5 in 1985 to 6.6 in 2005," he says. "The primary factors underlying this increase are lower top marginal tax rates, more stable monetary policy, lower tariffs and less regulation of international trade and some relaxation of restrictions on the movement of capital."

Gwartney's data also show the relationship between economic freedom and income. As countries get freer, per capita GDP rises. The least-free nations have a per-capita GDP of about $3,300. The next group up the freedom ladder has a per capita GDP of about $6,100; the next, $10,773. The freest group of nations comes in at more than $26,000.

Gwartney's data show that it's better to be poor in a more-free country than in a less-free country. In the freest countries, the poorest 10 percent earn on average more than $7,300 a year versus $905 in the least free countries. And, of course, in a free society, people often move out of the poorest groups.

Finally, the study also finds a strong correlation between economic freedom and environmental quality.

It is beyond dispute. Economic freedom leads to good things, while government coercion leads to poverty and oppression.

It's stunning that some people still find the free market controversial.

Managing a Panic

Yesterday's emergency rate cut by the Federal Reserve seems to have stalled a global selloff in equity markets, and for that we can be grateful. We'd have preferred a narrower pledge of liquidity for all comers through the discount window, but then riding shotgun in a stampede can sometimes call for improvisation.

And such a panic is unfortunately what we have. The Fed explained its 75-basis-point move a week before its regular meeting "in view of a weakening of the economic outlook and increasing downside risks to growth." The central bankers are especially worried that struggling regional banks have stopped lending to small and medium-sized businesses, which are the U.S. economy's chief job creators. The job market has been the last bastion of growth amid the housing recession and credit crunch, so the Fed's concern is understandable.

The rate cut will reduce the cost of borrowing by lowering mortgage and other benchmark interest rates. In the best case, the lower cost of capital will give banks more confidence to lend, and in the process increase the demand for money, which might ease any inflationary pressures from monetary easing. As we say, this is the best case.

The worst part of yesterday's decision is that it looked like more Fed appeasement of banks and equity traders, suggesting even a hint of panic by the Fed itself. Chairman Ben Bernanke had already signaled that the Fed would cut rates sharply at its regular meeting next week, and in retrospect that candor only invited more Wall Street agitation to speed it up. Mr. Bernanke's interest in more Fed transparency is admirable, but we'd prefer if he saved his explanations for when he acts.

Yesterday's move might also have had more credibility if it had been coordinated with the European Central Bank. It speaks volumes that ECB President Jean-Claude Trichet has so far declined to follow the Fed's rate-cutting lead. Either Mr. Trichet doesn't think Europe's credit problems are all that serious, or perhaps he thinks the Fed's policy is misguided. This has given the Fed less protection against a further reduction in the dollar's value against the euro, and could yet inspire more trade tensions. Mr. Bernanke's dollar diplomacy could stand improvement.

The larger risk is that these rate cuts will contribute to a further flight from the dollar, along with more inflation down the road. Gold jumped yesterday, but on the other hand oil fell, perhaps on expectations of lower demand from slower global growth. Commodity prices and foreign-exchange markets bear watching in the coming weeks, and if they spike we'll know that investors expect the Fed will keep bowing to political pressure.

Futures markets are already pricing in further rate cuts deep into 2008. This is hardly a vote of confidence in the Fed, and our advice would be that if Mr. Bernanke wants to cut further he do so fast and be done with it. This would shift market expectations that still-lower borrowing costs aren't coming, and would itself help to revive lending.

Above all, Mr. Bernanke needs to be clear with everyone -- Congress, Wall Street, investors -- that easier money is not some magic elixir for the underlying problem of bank insolvency. The credit and real estate losses are real and have to be dealt with. This requires slow and steady workouts, raising new capital, and in some cases regulatory action to arrange mergers and rescue institutions whose failure could lead to problems in the larger banking system.

This is the advantage that the discount window provides, both providing liquidity to those in need and giving the Fed information about which institutions are in trouble and why. Unlike rate cuts, this is not glamorous work. But it is the best way to deal with insolvency while running the fewest systemic risks.

It would also help if President Bush and Congress both took a hint from the market selloff following their "stimulus" announcements late last week. Investors clearly view the tax rebates and new spending as useless in promoting growth. The White House signaled yesterday that Mr. Bush may be open to a larger package than his $150 billion proposal, but size isn't the issue. The problem is his reliance on "temporary" Keynesian nostrums that won't increase incentives to invest and take risks. Treasury Secretary Hank Paulson's defense of the package yesterday was, well, let's be kind and call it uninformed.

If Mr. Bush really wants to change the terms of the economic debate, he'd use his State of the Union address to make the case for a tax cut stimulus that is marginal, immediate and permanent. No doubt Members of Congress are saying that can't pass, and some in the White House want to be able to point to a legislative "stimulus" victory in an election year. But if the economy stays weak, Democrats will still blame the White House.

None of this is making life any easier for Mr. Bernanke. But sooner or later he has to make clear that managing a panic requires as much discipline as liquidity.