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We have a $14 trillion economy. The idea that presidents can control it lies between an exaggeration and an illusion. Our presidential preferences ought to reflect judgments about candidates' character, values, competence, and their views on issues where what they think counts: foreign policy, health care, immigration, and long-term economic and social policy — how they would tax and spend. Forget the business cycle.

True, presidents try to manipulate it. In 1971, President Nixon imposed wage and price controls in part to prevent inflation from jeopardizing his re-election. The economy boomed in 1972. But the controls were a time-delayed disaster. When they were removed, inflation exploded to 12% in 1974. In 1980, the Carter administration adopted credit controls to squelch raging inflation. The result was a short recession — a complete surprise — that probably sealed Mr. Carter's defeat in November.

History's long view teaches the same lesson. No president tried harder, with good reason, to influence the business cycle than Franklin Roosevelt. When he took office in 1933, unemployment was roughly 25%. By executive order and congressional legislation, FDR effectively abandoned the gold standard, adopted deposit insurance, tried to prop up falling farm and factory prices, rescued many defaulting homeowners, regulated the stock market, and embarked on massive public works.

With what result? Well, leaving the gold standard aided recovery. But some economic research suggests that other New Deal measures may have frustrated revival. In any case, all of them together didn't end the Great Depression. World War II did that. In 1939, unemployment was still 17%.

No matter. When the economy is good, presidents claim credit; when it's not, their opponents blame them. Political phrase-making compounds the error by personalizing the process. Hence, "Reaganomics" and "Clintonomics." Among Republicans and Democrats alike, there is much myth-making.

To his worshippers, Ronald Reagan's great economic achievements were tax cuts and spending restraint. Not so. Reagan's singular feat was supporting Paul Volcker's Federal Reserve in suppressing double-digit inflation, which had destabilized the economy, four recessions between 1969 and 1982. Between 1980 and 1983, inflation dropped to 4%from 13%. This set the stage for the long expansions of both the 1980s and 1990s.

Reagan's cut in tax rates probably helped slightly, but the overall tax burden wasn't much reduced. In 1988, taxes were 18.2% of gross domestic product, slightly above the post-1950 average until then, 17.8% of GDP. With a military buildup, spending restraint was negligible. In 1988, federal outlays were 21.3% of GDP, only slightly lower than President Carter's last year, 21.7%.

Bill Clinton had little to do with the causes of the 1990s' economic expansion: low inflation, low oil prices, a computer and Internet boom, a stock market boom. The claim made for Clintonomics is that paring the federal budget deficit in 1993 provided the essential catalyst by reducing interest rates. But long-term rates in 1994 were actually higher than in 1993. Many forces affect rates aside from the budget deficit: inflation and inflationary expectations, saving behavior, Federal Reserve policy, overall credit demand.

President Clinton's contribution was self-restraint. Unlike Nixon and Mr. Carter, he didn't meddle with the Fed. He was a "conservative" in a pragmatic way. He knew when to leave well enough alone.

Of course, presidents do affect the economy. But their greatest influence often occurs after they've left office. FDR's enduring legacy was Social Security; Reagan's was low inflation.

Some policies that are initially popular turn out to be calamitous. Under John Kennedy and Lyndon Johnson, the government followed highly expansionary policies to reduce unemployment. Initially popular, they ultimately spawned high inflation. The converse is also true. The anti-inflationary policies of the early 1980s sent unemployment to 10.8%. Reagan's popularity plummeted.

Sensible voters should look beyond the cheery or dreary economy of the moment. They should recognize that, if presidents could control the business cycle, recessions would never occur, there would always be "full employment" and inflation would remain forever tame.

Instead of judging prospective presidents on what they can't do, voters ought to concentrate on what they can do. There are plenty of real differences among the remaining candidates. But Mr. Carville is probably right. For many, it will be the economy; and it will be stupid.

© 2008 The Washington Post Writers Group

Though Reagan spoke confidently of renewed economic optimism that would result from tax cuts, Volcker’s countenance was very dark, with frequent pronunciations about us not being so naïve as to assume “there are quick and painless solutions” to the economic problems we faced. To Volcker, there was no way we could “avoid a clash between monetary restraint….and the growth of economic activity;” this despite the truth that growing economies require more money, not less.

Given his skeptical views about the Reagan tax cuts, Volcker lobbied in secret against their passage owing to his view that they would lead to a massive revenue shortfall. While Fed Chairman Fred Schultz worked on House members, Volcker lobbied senators to vote against the cuts.

As George Schultz told William Greider in Secrets of the Temple, Volcker’s position was that, “We are in favor of a tax cut, but you must recognize that if you can’t accomplish this with much bigger budget cuts than you are contemplating, it’s going to put much more pressure on us and that means higher interest rates.” Shades of Robert Rubin.

Using his control of the interest rate lever as a weapon, Volcker kept money “tight” in order to prize tax increases out of the White House. More on monetary policy later, but bad dollar policy brought on the ’81-’82 recession, and remarkably led to a bill that increased taxes ahead of the 1982 elections. Unsurprisingly, the Republicans lost 26 House seats.

Even more galling, according to Paul Craig Roberts’ The Supply-Side Revolution, not a single Democrat voted for the tax increase. None needed to in that as Mark Shields wrote in the Washington Post at the time, Reagan’s advisors (including Volcker) did all of their dirty work for them in terms of attracting Republican votes in favor of tax increases. Thanks to economic advisors that did not share Reagan’s optimism about tax cuts, by 1983 the Reagan tax cuts of ’81 had disappeared in dollar terms. The marginal incentives of course remained, but due to powerful opposition on the part of Volcker, Alan Greenspan and others, Reagan’s tax program was severely compromised.

In his most recent column, George Will continued the false legend concerning Volcker, noting that he and President Reagan whipped the inflationary dragon with contractionary economic policy that resulted in double-digit unemployment. Will’s thinking resembles that of our present Fed Chairman who labors under the retro view that growth is the cause of, not the cure for inflation. The truth about Reagan vis-à-vis Volcker when it comes to inflation is a bit more nuanced.

A Carter appointee, Volcker’s attempts to use interest-rate increases to slay inflation in the late ‘70s were met with a great deal more inflation. By February of 1980, with the Fed funds rate at 14 percent, gold hit an all-time high of $875/ounce.

The dollar’s aforementioned fall was of course sped along by another major mistake carried out by Volcker just a few months prior. Correctly recognizing the futility of interest-rate targeting, Volcker shed the latter only to make a fateful decision that would drive the U.S. economy even further into the ditch. Put simply, in October of 1979 Volcker began a three year experiment with Milton Friedman’s monetarism.

Instead of targeting the Fed funds rate, Volcker attempted to target the quantity of money with disastrous consequences. Though inflation is surely a monetary phenomenon as Friedman long noted, with the majority of physical dollars outside these fifty states, attempts to control the quantity of dollars within these fifty states were bound to fail. To the extent that the Fed targeted various aggregates of U.S. money supply lower, this merely meant that dollars in other markets (eurodollars for instance) would fill the shortfall.

Worse, given the Fed’s efforts to control money quantity rather than rates, the Fed funds rate bounced around on a daily basis such that businesses faced an impossible task of raising capital owing to uncertainty about the rate at which they could raise capital. As Charles Kadlec and Arthur Laffer wrote at the time, “the Fed’s action reduced the viability and attractiveness of the dollar,” and as a result its policies “increased the prospects of inflation” in spite of the fact that monetarist targets “resulted in a slower growth in the measured quantity of money.” What the economy needed according to Laffer and Kadlec were “policies that lead to an excess demand for dollars relative to their supply.”

Those policies did materialize, but no thanks to Paul Volcker. Though the dollar hit what was until recently an all-time low under Volcker in February of 1980, positive electoral developments began to reveal themselves which succeeded in arresting the dollar’s fall.

In short, by the spring of 1980 the markets started to price in Ronald Reagan’s election. Reagan of course ran on a pro-growth platform of further de-regulation, tax cuts, and a return to a more stable and stronger dollar. And economic growth, if it has any effect, serves to soak up excess liquidity. With investors pricing in a brighter economic future, gold was down to $600/ounce by election day in 1980, and by the end of 1981, the yellow metal had fallen below $400.

Contrary to modern accounts of that period suggesting Volcker’s policies whipped inflation, the markets had as mentioned already “voted” on them with gold having reached an all-time high in his early years at the Fed. The weak dollar that gold signaled was itself inflation, not a cause of the latter, and with Reagan’s election and its policy aftermath having boosted the dollar, inflation was effectively contained.

Sadly, Volcker did not agree. Seeking to tighten further through futile attempts at managing the various monetary aggregates, his actions sent the economy into a major recession which led to the ’82 electoral rout, and which made Reagan’s 1984 re-election prospects increasingly dicey. Worse for the Reagan program, Alan Greenspan and Herbert Stein gave Volcker enhanced political cover given their view that the tax cuts themselves would be inflationary.

So rather than accommodating the Reagan tax cuts with increased liquidity, Volcker went in the opposite direction until a looming Mexican loan default threatened the worldwide banking system. The time was October of 1982, and on October 9th of that year Volcker finally abandoned the monetarist approach to Fed policy that had proven so disastrous.

The resulting expansion of dollar liquidity did not prove inflationary as so many (including Milton Friedman) assumed it would, because by 1983 the marginal tax cuts Reagan had championed fully kicked in. Contrary to suggestions today that say tax cuts are slow to impact the economy, a combination of lower rates and increased dollar liquidity Fed an economic boom that led to Ronald Reagan’s landslide re-election in 1984.

Still, the Reagan Revolution almost never was, and Paul Volcker’s 6’7” frame weighed on it like no other politician or government policy. If he should be given any credit for Ronald Reagan’s successes, it would have to do with his belated admission in 1982 that his policies were hammering the economy along with Reagan’s economic program. And it was the latter that whipped inflation, not Paul Volcker.

All this in mind, no one should be surprised by Volcker’s endorsement of Barack Obama. Despite the truth that Reagan’s visions elevated him to central-banker sainthood, he never agreed with the vision. As such, his embrace of the Illinois senator isn't newsworthy in the least.

Looked at mechanically, some argue that “home bias” explains commodity currency strength. Though commodities are priced in dollars, when the dollar is weak commodity countries take in copious amounts of dollars thanks to rising prices, but then sell those dollars for the home currency. Notably, when North Sea oil discoveries briefly made England a substantial petroleum player in the ‘70s, the late ‘70s spike in the oil price is said to have played into pound strength.

Still, when a currency’s direction is considered, the benchmark is usually the dollar itself. And there lies the misunderstanding. Like all currencies today the dollar is merely a paper concept. As such, currency strength relative to the dollar is very much a fluid idea. If the paper dollar is severely weakening as it has in recent years, strength relative to it could be masking actual weakness in the rising currency. Conversely, dollar strength from 1996 to 2001 made a lot of currencies seem weaker than they actually were.

To best understand the impact of commodity booms on commodity currencies requires measuring their direction against the commodity known to be most stable in real terms: gold. When the price of gold moves, the movement chiefly reflects changes in the value of the currency in which it’s priced. Sure enough, when we factor in the gold price of commodity currencies during times of commodity strength and weakness, a different story emerges.

Soon after President Nixon ended the Bretton Woods system of fixed exchange rates in August of 1971, the dollar’s value plummeted, and commodities, from oil to wheat to soybeans, rallied. Lacking the credibility that the gold link had previously lent it, the dollar predictably fell against all manner of currencies, including three commodity-country currencies: the Australian (AUD) and Canadian (CAD) dollar units, plus the Norwegian Krone (NOK).

From August of 1971 to December of 1974 the Krone and Aussie dollar respectively rose 32 and 17 percent against the dollar, while the Canadian dollar rose a less impressive 2 percent. But when we measure those same currencies against gold, what becomes apparent is that all three lost substantial value. While the dollar/gold price rose 330 percent during the time in question, the gold price in the Norwegian, Australian and Canadian currencies also rose 224, 270 and 320 percent.

In June of 1977, when Carter Treasury Secretary Michael Blumenthal communicated to the markets his displeasure with alleged yen weakness, the dollar went into freefall; thus sparking another boom in commodities. Interestingly, in the timeframe covered here (June ’77 – January ’80), there was no discernible strength among the commodity currencies - even against the dollar.

Measured in dollars, the Krone rose 7 percent versus .2 percent for the Aussie dollar, while the Canadian dollar actually fell 10 percent. In gold terms, while it rose 359 percent in dollars, as one might expect gold also rose 328 percent in Krones, 358 percent in Aussie dollars, and the gold price in “loonies” rose 402 percent.

Fast forward to the new millennium, the tragedy that was 9/11 combined with Sarbanes-Oxley, new tariff barriers against steel, lumber and shrimp, and a Bush Administration that has spoken with a forked tongue when it comes to currency strength, the dollar has entered yet another period of weakness. And as has always happened during bouts of dollar weakness, commodities have boomed.

Since June of 2001 the dollar price of gold has risen over 235 percent to all-time highs, and amidst the once mighty dollar’s fall, much has been made of the strength of other, non-dollar currencies. If we look at the commodity currencies covered in this piece, the Canadian dollar is up 51 percent, the Aussie dollar 73 percent, and the Krone tops them both with a 77 percent jump.

Despite the aforementioned strength relative to the dollar, all three currencies look less impressive once we bring gold into the equation. Indeed, since 2001 gold has appreciated 89 percent in Krone, 94 percent in Aussie dollars, and 122 percent in Canadian dollars. In short, when my Wainwright colleagues David Ranson and Penny Russell wrote in the Wall Street Journal last July that we were experiencing “another classic ‘run’ on paper currencies,” this included the very commodity currencies thought to weather inflationary outbreaks stateside.

The question then becomes one of why dollar inflation tends to be a world event. The answer seems to be a pretty simple one. While it’s true that “money is a veil” such that countries cannot generate more than fleeting trading advantages through devaluation, prices are sticky, and they’re particularly sticky in the United States. When the dollar weakens, monetary authorities around the world seek to maintain some semblance of currency parity so that their exporters are able to readily market their goods here.

Seeking to keep their currencies from rising too much relative to the dollar, monetary authorities sell the home currency for the dollar, and in the process inflate their own currencies; albeit not to the extent that the dollar inflates. This perhaps helps to explain why inflation in Euroland and the U.K. is hardly quiescent, not to mention December consumer price inflation of 3.7 percent in Australia combined with a 17 percent 12-month rise in fuel costs for a country that some dollar-watchers would say has a strong currency. Dollar weakness equates with world currency weakness.

All this raises the question of how dollar strength affects the same commodity currencies covered in periods of dollar weakness. Once again, the real truth is hidden by the tendency of currency-watchers to measure the health of non-dollar currencies against the dollar.

As is well known now, after monetary authorities stateside failed to accommodate the economic growth that resulted from capital gains tax cuts in 1996, the dollar experienced a great deal of strength from 1996 to 2001. Gold in dollars fell 31 percent, while the dollar rose 11 percent against the loonie, 31 percent against the Krone, and 36 percent versus the Aussie dollar. Due to dollar strength at the time, commodities across the board were weak with oil alone hitting a modern low of $10/barrel in 1998.

Conventional wisdom would have said that the aforementioned commodity currencies were weak due to falling commodity prices, but gold once again told a different story. It in fact depreciated 22 percent in the Canadian currency, was flat in Krone, and rose a mere 7 percent in Australian dollars. And just as worldwide monetary authorities inflate to slow the dollar’s fall amidst dollar weakness, they reverse course during periods of dollar strength through purchases of the home currency for dollars. Dollar disinflation is world disinflation, even for currencies whose countries are commodity-based.

If there’s a lesson here it is one telling us to pay little heed to currency commentary engaged in by mainstream media members. Oblivious to the truth that in a world of paper currencies there are no currency benchmarks, the wise men and women who report the news will continue to write about currency strength as though there’s a lot of information revealed in the interplay between two paper concepts. In truth, commodity booms are merely dollar routs, and to the extent that non-dollar currencies (commodity or otherwise) exhibit what many deem strength during the aforementioned booms, their seeming vitality is almost assuredly a money illusion masked by even greater dollar debasement.

Unfortunately, gyrating currency values wreck the crucial debtor/creditor relationship, all the while wreaking havoc on trade agreements whose values need to be hedged and re-hedged thanks to irresponsible management of the currency by central banks; the U.S. Treasury being the main miscreant as it were. So the broader lesson here is the simple truism which says that money itself is utterly insignificant except as a facilitator of the all-important beneficial exchange of goods. With the dollar’s status as reserve currency secure for now, we’ll see more wealth-enhancing trade once U.S. monetary authorities shed their mercantilist ways and get serious about providing the world with a stable unit of account.

Most economists ignore the fact that the sub-prime credit crisis, along with the extraordinary downturn in housing construction and home prices, is largely the result of the Fed’s massive tightening move that lifted the funds rate above 5 percent in the first place. Fed chair Ben Bernanke inherited this bucket of smelly molasses from his predecessor, Alan Greenspan. In straightening the situation out, Bernanke has opened the door to a rapid economic recovery. It’s a signal achievement for the former Princeton professor.

Bernanke has taken a lot of criticism in the last year, and I think much of it is undeserved. Wall Street claims that he’s an isolated academic, unaware of the real-world difficulties of sagging capital markets, slumping stock prices, and slowing growth. But he moved aggressively once he saw the credit problem develop last summer. And new information obtained under the Freedom of Information Act reveals how he has been meeting with leaders in business, finance, and government all along. He has talked with John Chambers, the CEO of Cisco Systems, Sam Palmisano, the head of IBM, JPMorgan’s chief Jamie Dimon, former Senate banking head Phil Gramm, and international central bankers Jean Claude Trichet and Mervyn King. The street was wrong about Bernanke. He’s been on top of the situation. He took remedial action and the economy will be the beneficiary faster than people think.

But here’s his next challenge. Bernanke needs to end the stop-and-go policies he inherited from his predecessor. Greenspan became a supreme monetary tinkerer in his final years, putting the Fed’s interest rate and monetary levers in constant overdrive. Go. Stop. Go. Stop. This Keynesian central-planning has damaged the Fed’s credibility. It has weakened the dollar. Entrepreneurs and investors can’t possibly plan ahead when interest rates bob up and down like yo-yos.

I suspect Charlie Prosser was referring to all this when he talked about the Fed’s credibility this week. If so, he’s right. So let’s say good-bye to Fed tinkering once and for all, and say hello to permanent enhancements to the economy’s incentive structure. How about lowering tax rates on corporations? How about lowering the corporate capital-gains tax rate? Why not abolish the individual capital-gains tax? Or the dividend tax? Or the estate tax? Why not eliminate the multiple-taxation of savings and investment?

At some point, the entire corporate tax structure should be thrown out, along with all the murky K-Street tax-earmark loopholes that litter the IRS code. We need to broaden the tax base and lower marginal rates. This is the key to maximizing future economic growth on the supply side. Without strong tax-reform measures to expand the production of goods and services, further Fed money injections are only demand-side “solutions” that will surely inflate prices and depreciate the currency.

Back in the 1970s, policymakers in Washington were obsessed with increasing aggregate demand, but they forgot about aggregate supply. Today’s short-term-stimulus rebate package is a throwback to that era. It’s not economic stimulus; it’s political stimulus. Congressmen up for reelection are trying to “do something” in response to primary-season exit polls that say Americans are totally unhappy with the economy. But these rebates are budget busters. And how will Congress attempt to pay down $400 billion in budget deficits? Higher tax rates, of course. And then we’ll really be back in the 1970s.

Out on the campaign trail, Sen. Hillary Clinton has a Nixonian idea to freeze interest rates on sub-prime mortgages. Exactly wrong. Doing so would cause financial havoc at home and abroad. Perhaps Sen. McCain, who is now campaigning as an heir to Ronald Reagan, will argue for strong, pro-growth tax reform to expand economic growth and a steady monetary policy to protect the dollar and reinforce domestic price stability. One can only hope.

But if Bernanke can officially put the yo-yo interest-rate days behind us, we’re halfway there.

Just think of Mr. McCain in a debate versus Hillary Clinton or Barack Obama. Remember Mr. McCain's zinger about Hillary's $1,000,000 earmark for a Woodstock Hall of Fame museum? He said he didn't know much about Woodstock because he was "tied up at the time." It was a killer line and we'll hear it again.

Mr. McCain is also good news for business and the stock market. He wants to cut the corporate tax and keep dividend and cap-gains tax rates low. He's tough as nails on restraining government spending and blowing up earmarks. On top of all this, he's a very strong free trader who knows America can compete with the rest of the world.

Stock market fears about a new wave of tax hikes should be put aside. It ain't gonna happen after Mr. McCain is sworn in. Neither will protectionism. So far as I can tell, high taxes and diminished free trade are the biggest worries for business and stocks. Investors can cast their fears aside.

This also happens to be a good time for the Republican to nominate someone who served bravely and courageously in the military. Mr. McCain is much more than a prisoner of war who somehow survived the Hanoi Hilton. He is a true military man. It flows through his veins, posing a whopper of a problem for Ms. Clinton or Mr. Obama. Guaranteed, there will be no chicken-hawk taunts.

And let's not forget that military leaders who know all about war, security, and defense are exactly the people who cherish peace the most. When John McCain talks about the global terror war and how to deal with it, and how to protect this country, and how to move toward peace, voters will listen. So will folks around the world. This is all part of Mr. McCain's character.

A short while back, I heard former Bush chief of staff, Andy Card, give an engaging talk at an Awakening conference in Sea Island Georgia. Mr. Card asked: What's the most important character trait for a successful president? And he answered: The courage to be lonely. In other words, the guts to make tough decisions. Not poll-driven, politically driven, or selfish decisions, but decisions made on the basis of what is right and what is wrong and what is best for America.

Mr. McCain is no flip-flopper. Just think about his stance against ethanol subsidies in Iowa and federal hurricane insurance in Florida. (And Florida's Governer Crist still supported him!) Think of his duty-honor-loyalty persona, to borrow from my friend Kim Strassel of the Wall Street Journal. Duty-honor-loyalty is part of the American military code of conduct. In this most important sense, Mr. McCain is a profoundly conservative man. When he makes a promise, he keeps it.

And don't forget his resiliency, consistency, and backbone. Here was a man moving around the country, without money and resources. He remained resolute on winning in Iraq, on the surge, and on the need to prevail abroad if we are to remain safe at home. Democrats were talking defeat. Republicans were hardly talking at all. But Mr. McCain soldiered on. Armed with courage, strength, and character, he kept his eyes on the prize. This may be the greatest political comeback in presidential history.

One of the troubles with American politics nowadays is that we don't appreciate our military men and women enough. We don't value their intelligence, their fitness, or their values. There was a time in American history — especially in the 19th century — when we held the military in great esteem. George Washington, of course, was one of our bravest generals, blessed with uncommon character and strength. Well, John McCain is a descendant of George Washington, and is a foot solder in his army. America yearns for exactly that kind of foot soldier. That's why he's going to win.

Fiscal policy is back. In the United States, intellectual and policy leaders have called for a heavy use to fiscal measures to counteract the coming economic slowdown in 2008. President George W. Bush drafted a plan committing resources for up to one percent of US GDP to transfers to households. The IMF joined with a call for a global fiscal expansion. As regards Europe, many observers actually expressed their concern about the constraints on fiscal policy in Europe due to the Stability and Growth Pact.

The new proposals mark an important shift in attitude. In fact, for several years a number of arguments have been feeding a diffuse scepticism on the mere effectiveness of fiscal policy as an instrument to stabilise the business cycle. This does not mean that fiscal policy was not heavily used (or abused). After the Clinton years, the new administration engineered an unprecedented reversal in the fiscal stance of the US. But it is difficult to find analyses celebrating the anti-cyclical merits of such a reversal.

In the past, fiscal scepticism has been fed by at least two leading arguments, stressing trade integration and financial globalisation. Are these arguments losing shine in the context of the much-feared 2008 global slowdown?
Globalisation and openness to trade

In conventional policy models, increasing openness to trade means that an increasing share of a given fiscal stimulus benefits employment and output abroad, rather than in the country sustaining the cost of the fiscal expansion. In the traditional jargon, the problem consists of the ‘leakages’ that reduce the additional output one can stimulate with a given amount of government spending or tax cut. The argument is not new: what is new is the extent to which the pace of globalisation has raised economic linkages. A large and increasing share of domestic consumption and investment fall on imported goods or indirectly on imported inputs.

With globalisation – the argument goes – fiscal policy may still be effective at the global level, if all governments expand at the same time. But from the vantage point of a single country, large fiscal programs may just translate into an increase in their trade deficit. Most importantly, there is little incentive to take fiscal initiatives, when by doing nothing a country can eventually benefit from fiscal expansions by its trade partners, on a cost-free basis. As is well understood, this generates a global deficit of expansionary policy.

In practice, budget expansion is comparatively more effective in the US than in countries that are smaller and more open to trade. While Europe would be comparable to the US in size and openness, not many people would attach a significant probability to a strong global expansion, given the constraint on fiscal policy in the euro area. Similar considerations apply to Japan, given the scant records of fiscal policy in that country.

A concern with an asymmetric strong expansion in the US is that, exactly because of demand leakages abroad, this is likely to interfere with the ongoing process of correction of global imbalances. This outcome cannot be welcomed by people who see excessive spending in the US as one of the main roots of the large US current account (see the exchange between Willem Buiter and Lawrence Summers in the Financial Times, January 6, 2008). Raising both the budget and the external deficits clearly magnifies the scale and therefore the costs of the macroeconomic correction to fix the current account imbalance down the road. It may also increase the likelihood of a much-feared disorderly adjustment, above and beyond the financial turmoil we have been experiencing so far.

Empirically, it is very hard to find evidence that the effect of a US fiscal expansion worsens the US current account by more than 20 cents to the dollar, if at all – a feature of the United States that can be attributed to the fact that it is a large and relatively closed economy (Corsetti and Mueller 2006). However, these average estimates may not provide good guidance in a situation where financial markets work quite differently than in the past (as argued below) and fiscal measures are designed to prevent a fall in consumption in response to a strong negative shock: the external effects of a budget expansion can be much stronger in the present circumstances, reinforcing concerns about external imbalances. Moreover, even if the external deficit response remains subdued, adjustment may involve a downturn in domestic investment, which is not necessarily good news regarding the ability of a country to service its external debt over time.

In conclusion, it seems that the reasons for ‘fiscal scepticism’ rooted in trade- or openness-related considerations remain quite strong. Unless one finds it plausible that we will experience strong setbacks in the process of trade liberalisation in the next few quarters, the reason for the ‘shift in attitude’ must lie with financial-market-related considerations.
Financial development and distress

Financial globalisation is a second powerful argument that has progressively strengthened doubts of the effectiveness of fiscal policy. The process of liberalisation and deregulation of financial markets – the argument goes – has relaxed credit constraints on households and firms. Because of the enhanced opportunities to smooth consumption vis-à-vis temporary fluctuations in income and diversify income risks, households demand is less and less dependent on current income, shaking the foundations of fiscal ‘multipliers’.

While there is a considerable controversy on how exactly fiscal policy works, econometric and quantitative studies provide some empirical backing to this view. An important instance is the work by Roberto Perotti (2005) documenting that the size of consumption multipliers appears to be declining since the 1980s. One could argue that the world after 1980 is different in exactly the two dimensions mentioned above: openness and financial liberalisation and deregulation.

In the current slowdown, however, it seems that this argument can be run in reverse. As the real estate crisis is propagating across the United States and other regions of the world, and the financial turmoil from August 2007 is still shaking money markets, the main fear is that credit and liquidity constraints on households and firms are now considerably tighter than they were just a few months ago. If the worst-case scenarios with diffuse distress in credit and financial markets materialise, many categories of households and firms will be cut off from the liquid and cheap financial markets characterising our economies through 2007. Hence, spending patterns would become much more dependent on current income.

Moreover, even ruling out the worst-case scenario, the correction of housing prices has obviously lowered the value of the collateral that households in the US and elsewhere can count on to borrow. The crisis has also meant that a number of financial arrangements that made real estate very much liquid in the past are now used with much more caution. At the time of the writing, the evidence on the US slowdown is still mixed, although signals are increasingly negative. Nonetheless markets appear to share a strong pessimistic feeling about the risk of a severe disruption.

So, it is the specific nature of the current slowdown – with financial market standards changing drastically from perhaps too lax in the recent past to excessively strict – that provides the ground for the current rediscovery of fiscal policy. Once again: fiscal policy must be more effective at times when credit and liquidity constraint are tighter, because firms and households spending decision are more dependent on current income – this is a good rationale for temporary fiscal measures of the kind recently proposed by Larry Summers or, proposed a few years ago (in a comparable situation) by Alan Blinder in the aftermath of 9-11.1 In normal times, these proposals would make very little sense, because only a tiny fraction of the transfer would concretely affect households’ behaviour.
Using fiscal policy wisely

But note that the above considerations simply re-affirm the effectiveness of fiscal policy as an instrument to stabilise the economy. They do not necessarily justify its use on a massive and indiscriminate scale. First, as is well understood, the problem of financial distress is not uniform across groups in the economy. The effect of income support may be vastly different across groups of households, depending on their initial debt level and their equity losses in the crisis. Moreover, as the uncertainty about future income has arguably become much higher in the current crisis, some groups may have even raised their propensity to save out of current income.

Consistently, fiscal support should be targeted to specific groups of households and firms that are more likely to suffer from the market distress. Concentrating income support may maximise its insurance value for the population, while at the same time guaranteeing a relative strong stimulus to the economy – creating more output for a given deterioration of the budget.

Fiscal policy does not come for free. Current benefits should be assessed against the future costs of a higher stock of public and arguably ‘twin’ foreign liabilities. The trade-off between these two may be quite sensitive to the size of the policy measure. A specific risk should in fact moderate the over-enthusiasm in the ‘rediscovery of fiscal policy’ at times of financial turmoil. In the last few years, credit spreads have been extremely low. Countries with vastly different ratios of debt and deficits to their GDP have been able to borrow at essentially the same interest rate. Would countries undertaking substantial fiscal expansion been granted the same treatment in the near future?

References

Corsetti, G. and Mueller, G. J.: 2006, Twin deficits: Squaring theory, evidence and common sense, Economic Policy 48, 598–638.
Perotti, R.: 2005, Estimating the Effects of Fiscal Policy in OECD Countries, CEPR Discussion Paper 4842.

Giancarlo Corsetti is the Pierre Werner Chair, joint professor at the Robert Schuman Centre for Advanced Studies and the Department of Economics at the European University Institute and CEPR Programme Director

In England, even though the pound has risen 37 percent against the dollar since 2001, the latest government inflation figures from January show that producer prices rose the most since 1995. The cost of raw materials rose 19 percent last year, the most since this number was first measured in 1986. The dirty little secret that explains U.K. inflation is that despite the pound’s strength relative to the dollar, it has been weakening steadily in real terms for several years; the gold price in pounds having registered a 151 percent rise since 2001.

Last month in Euroland, government measures of inflation reached their highest levels in 14 years. This might seem odd when we consider the euro has risen 71 percent against the dollar since 2001, but as is always the case, the interplay between two paper currencies rarely reveals the real story when it comes to currency strength. Though the euro has slaughtered the dollar over the last several years, its price in gold since 2001 has risen 101 percent.

The Aussie dollar beats both the pound and euro when it comes to performance relative to the U.S. dollar; it having risen 73 percent against the greenback since 2001. Still, inflation Down Under is hardly quiescent as evidenced by the 94 percent appreciation of the gold price over the same timeframe, not to mention that the January CPI reading of 3.8 percent was the highest for Australia in 16 years.

When we look at dollar-linked currencies, the inflation story logically gets no better. In yesterday’s Wall Street Journal, Mary O’Grady noted that with El Salvador’s dollarization having effectively outsourced monetary policy to Ben Bernanke and the U.S. Fed, “Salvadorans left themselves vulnerable to Mr. Bernanke's weaknesses as a central banker.” Sure enough, 2007 inflation in El Salvador came in at almost 5 percent, and according to O’Grady, shows “no signs of retreating.”

Middle Eastern country Qatar currently links its riyal to the dollar, and its most recent measure of CPI inflation came in at 13 percent. China has most famously tied the value of its yuan to the dollar, and despite a more than 12 percent rise against the dollar since July of 2005, China announced its highest inflation reading (7 percent) in eleven years last December.

Given the historical correlation between falling currencies and inflation, it seems folly to assume that the United States has largely skirted the latter in recent years despite the dollar’s broad weakness. Inflation’s classical definition hasn’t changed, and from the North’s counterfeiting of the Confederate dollar (causing one of the greatest inflationary periods in U.S. history) downward during the Civil War to post-World War I Germany’s hyperinflation resulting from the falling Mark to the stagflation stateside in the 1970s, pricing pressures have always been monetary in nature and have resulted from currency weakness. For the Fed to assume that today is somehow different, that inflation will somehow moderate in the coming quarters, is for Bernanke et al to rewrite basic economic law.

It is said that low nominal rates of interest from 2003 to 2004 explain the weak dollar today, but the dollar’s fall began well before Fed funds hit 1 percent, and it continued alongside 425 basis points of rate increases from 2004 to 2006. The dollar has surely weakened since the Fed reversed course last fall, but to assume the dollar is weak due to lower nominal rates of interest is a bit of a misnomer.

The reality is that credible, stable currencies are low interest rate currencies. The dollar suffers today from a U.S. Treasury that regularly flaunts its lack of a currency policy, not to mention a Federal Reserve that seemingly ignores that which causes inflation, all the while frequently shifting its rate targets around given the Keynesian view that price stability will result from its “managing” the economy in such a way that it won’t grow or contract too much.

Perhaps owing to their desire to make the citizenry believe they’re actually helping us, politicians regularly tell us “there are no easy solutions.” Maybe so, but when it comes to the dollar the solution is simple: the Treasury and Fed must communicate to the markets their unhappiness with the dollar’s value, announce a rough gold price target at which they’d like it to stabilize, and make plain that if markets don’t reverse its fall, they’ll intervene and arrest its slide as monopoly issuers of the currency.

History, however, says once a non-inflationary dollar-price target is communicated, markets will do their work for them. If so, the inflation in our midst will quickly become yesterday’s news.

In January 2001, Russia introduced a fairly dramatic reform of its personal income tax, becoming the first large economy to adopt a flat tax. The Tax Code of 2001 replaced a conventional progressive rate structure with a flat tax rate of 13 percent. Over the next year after the reform, while the Russian economy grew at almost 5% in real terms, revenues from the personal income tax increased by over 25% in real terms. Besides this revenue yield performance, advocates also have credited the flat tax with beneficial changes in the real side of the economy. The Russian experience would appear to have been so successful that many other countries have followed suit with their own flat rate income tax reforms, and an increasing number of countries around the world are considering the adoption of a flat rate income tax.

What happened in Russia?

While Russia’s flat tax reform has created much excitement, little solid evidence on its impact on tax evasion or the real side of the economy has been provided thus far.1 In recent research (Gorodnichenko et al., 2008), we argue that the flat tax reform was instrumental in decreasing tax evasion in Russia, and that, to a certain extent, greater fiscal revenues in 2001 and several years beyond can be linked to increased voluntary tax compliance and reporting. We also find that the productivity effect on the real side of the economy was positive, although smaller than the tax evasion effect.

As income underreporting is not observable by definition, we use data on reported consumption and income to infer tax evasion. Under the permanent income hypothesis, current consumption should equal a share of permanent income. Assuming that consumption expenditures are fully reported, the discrepancy between consumption and income, which we call the consumption-income gap, indicates that households underreport a portion of their income. We perform a series of checks to verify that the consumption-income gap is an informative indicator of tax evasion and find that the behaviour of the consumption-income gap is consistent with common tax evasion determinants.

Since Russia’s reform decreased marginal tax rates for only some groups of people, we use the variation across time and taxpayers to identify and estimate the effects of the flat rate income tax reform. We find that, ceteris paribus, the consumption-income gap decreased by 9 to 12% more for those households that experienced a reduction in marginal tax rates. That is, the most significant reduction in tax evasion was for taxpayers that experienced a decrease in tax rates upon introduction of the flat tax. We also find that this decline in tax evasion was likely due to changes in voluntary compliance, as opposed to greater enforcement efforts by the tax administration authorities. In contrast, the productivity effect, measured by the relative increase in consumption for households that faced smaller tax rates after the reform, was zero at the threshold and about 4% for those taxpayers that experienced the decrease in tax rates over a four-year period.

This strong evidence of a positive relationship between (lower) tax rates and (lower) tax evasion stands out from previous studies of tax evasion that used cross-sectional data and provided only ambiguous results. Our method of using longitudinal household budget surveys to estimate the effects of significant changes in the tax structure might be used to revisit the topic. Given the data required, it may be possible to infer tax evasion and the effects of tax reform for a wide range of countries.

Policy implications

Our Russian results have several important policy implications. The adoption of a flat rate income tax is not generally expected to lead to significant increases in tax revenues because labour supplies are believed to be fairly inelastic. However, if an economy is plagued by ubiquitous tax evasion, as was the case in Russia, then a flat rate income tax reform may lead to substantial revenue gains via increased voluntary compliance. At the same time, a strong evasion response suggests that the efficiency gains from the Russian tax reform perhaps are smaller than previously thought. Using observable responses of consumption and income to tax changes, we find that the tax-evasion-adjusted deadweight loss from the personal income tax is at least 30% smaller than the loss implied by the standard method based on the response of reported income to tax changes. While a flat tax offers tangible efficiency gains, its reduction of tax evasion may be most important.

References

Feldstein, Martin, 1995. “The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the 1986 Tax Reform Act,” Journal of Political Economy 103(3): 551-572.
Gorodnichenko, Yuriy; Jorge Martinez-Vazquez; and Klara Sabirianova Peter, 2008. “Myth and Reality of Flat Tax Reform: Micro Estimates of Tax Evasion Response and Welfare Effects in Russia,” NBER WP 13719.
Ivanova, Anna; Michael Keen; and Alexander Klemm, 2005. “The Russian Flat Tax Reform,” Economic Policy 20(43): 397-444.
Martinez-Vazquez, Jorge; Mark Rider; Riatu Qibthiyyah; and Sally Wallace, 2006. “Who Bears the Burden of Taxes on Labor Income in Russia?” AYSPS International Studies Program Working Paper, No. 06/21.

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Footnote

1 Some recent papers (Ivanova et al., 2005 and Martinez-Vazquez et al., 2006) estimated the effect of the flat tax reform in Russia on earnings growth but they did not distinguish between tax evasion and real productivity effects.

This article may be reproduced with appropriate attribution. See Copyright (below).

A base real rate of return, and additional compensation for inflation, taxes, and risks.

In order to focus on how tax policies affect the equity discount rate, let us assume that equity investors want a 4% base real rate of return and the required compensation for inflation and risk is expected to be 0%. Let us evaluate how the tax policies for the two competing presidential candidates affect the stock market. The Republican Candidate advocates maintaining a 15% tax rate on capital gains and dividends, while the Democrat Candidate advocates moving the rate to 35%. What is the affect of each of these policies on stock market values? First let us determine the equity discount rate under these circumstances.

Equity Discount Rate:

The increase in investor tax rates will increase the equity discount rate by more than 30%. To put this into perspective, let us value a hypothetical company that is expected to generate $100 a year of cash flow into perpetuity. Under these circumstances, the values of this company under the policies of Republican and Democrat Candidates are $2127 and $1613, respectively. (Please note that these calculations did not require a premium for inflation or risk. Incorporating these factors into the discount rate, only serves to increase the final return demanded by investors and further reduce market values and economic growth.)

The higher the taxes on investment returns, the higher the rate of return investors will require for their investments and the less they will pay for a given investment. A natural extension of this concept is that if the tax rate on investment returns increases, the value of those investments in the economy will decrease. In the context of the stock market, moving from lower investment tax rates to higher investment tax rates will lead to a drop in market values, all other things equal.

Unfortunately, that is not the end of the story. As tax rates go up and increase the equity cost of capital, by definition there will be fewer investment opportunities that meet this new, higher required investment rate. As a result, companies, and entrepreneurs will find fewer acceptable investment opportunities. This results in fewer investments throughout the economy and subsequently slower growth. This insight was part of the genius behind the Reagan Revolution, which lowered taxes and freed more capital throughout the economy to empower wealth creation and economic expansion. It is ironic, that by pursuing a “tax the rich” agenda, politicians inadvertently punish the middle class and the poor by reducing the opportunities for the economy to create better jobs and finance new business ideas that serve to economically empower those who need it the most.

So while this may sound good in theory, is there any proof that the markets react to such tax information? After all, markets go up and down every day, allowing anyone to read almost anything they want into such movements in the same manner that Mark Twain said, “figures lie and liars figure”.

But one particular event comes to mind. During the Bush-Kerry election in 2004, each candidate staked out opposite positions on capital gains taxes. President Bush argued that the current 15% rate should be maintained and made permanent, while Senator Kerry advocated raising them on the top 2% of wage earners. An interesting thing happened during that election, as at approximately 2:30 PM EST on November 2nd, flawed polling data leaked to the press indicated that Kerry would win Florida and the entire election. Prior to the false news leaking, the Dow had increased as much as 125 points, or about 1.2% during the day. Afterward the market proceeded to fall 150 points (about 1.5%) from its peak. In other words the prospect of higher taxes immediately motivated investors to sell assets. As clear as the message the market sent about higher taxes was, it sent an even stronger and clearer message about keeping taxes low. Over the next 2 days, the Dow rallied approximately 3% or 280 points signaling its relief that taxes would remain low and capital would likely continue to flow into investments.

America faces a similar choice in 2008. Virtually every Republican has vowed to keep capital gains taxes constant or to reduce them further, while every Democrat has vowed to work to restore capital gains taxes for all (or at least the wealthiest taxpayers) back into the low 30% range. Because polls continue to indicate that no party has a clear path to the White House, the market most likely has not discounted the effect of potential tax changes on stock prices. However, should one side gain a clear advantage, prepare to make appropriate strategic changes in the composition of your portfolio.

Obrycki and Resendes are co-founders of The Applied Finance Group (AFG), a capital market research firm working with over 200 investment houses, corporations, and consultancies around the world. AFG’s clients rely on AFG’s Economic Margin™ research and tools to understand the performance expectations embedded in stock prices. To learn more about AFG’s research, visit www.economicmargin.com.

Outside of the whacko ultra-left Madison college population, which is even worse than the Ohio State population, Wisconsin is a lot like Ohio. And Ohio campuses will go for Obama. Think faculty voters, grimly determined for a left-wing takeover of America “from the bottom up,” to use the Saul Alinsky community-organizer phrase. As goes Wisconsin, so goes Ohio.

Not even Hillary’s last-minute bashing of business, free trade, and free-market capitalism — which was a complete repudiation of her husband’s presidency — could save her. Obama got there first, with a style and elegance that Hillary simply couldn’t match.

And it came out of nowhere. On the eve of the Wisconsin primary, Hillary did a hard-left imitation of John Edwards’s populist and demagogic soak-the-rich rhetoric. She trashed some of the greatest businesses in America — oil, credit-card, insurance, and pharmaceutical firms. Wall Street and lending firms. It all must have come as quite a shock to the alumni of the Bill Clinton White House who are working for her campaign.

Robert Rubin may have been too busy tending to Citigroup’s sub-prime collapse to keep Hillary on the reservation. But where were Wall Street’s Roger Altman and Washington’s Gene Sperling when Hillary discarded the pinstripes for the polyester lefty-union pantsuit?

Bashing business comes naturally to Obama. But for Hillary it was a complete failure. Exit polls from Wisconsin say the trade protectionists went with Obama. Union members? Obama. People who think the economy’s in trouble? Obama. Folks who don’t think it’s in trouble? Obama. People making less than $50,000 a year? Obama. More than $50,000 a year? Obama.

And it only gets worse.

Voters went with Obama on healthcare by 8 points, on the economy by 16 points, and on Iraq by 20 points. Churchgoers and non-churchgoers went with Obama. Most qualified to be commander-in-chief? Obama. College degree or no college degree? Obama. Democrats, Republicans, and independents went with Obama. So did blacks and whites.

White women did in fact lean toward Hillary, by a small 52 to 47 percent margin. But Hillary only got 31 percent of the male vote while tying the female vote. White males? They went with Obama by a full 29 points.

Obama won both married men and women, and he tied on unmarried women — a heretofore Hillary stronghold. Most likely to unite the country? Obama, by almost 30 points. Most interested in improving relations with the rest of the world? Obama, 56 to 40.

You think these trends are going to change in Texas, Ohio, and Pennsylvania? I don’t — no matter what last-gasp neutron-negativism tactics the Clinton team employs.

Bash Obama for plagiarizing Deval Patrick? That negativism backfired. Go after Michelle Obama’s incredible anti-American speech? Women are coming ’round to Obama, so try again. Go super-negative over the next two weeks? That’ll mean Obama beats Hillary by 35 points instead of 20. Lift the sanctions on the Michigan and Florida delegates? That’s an Obama trump card. Bribe or rent the super-delegates? Make my day, Obama is thinking.

If Hillary wants to preserve her career as a professional politician her best bet is to pull back in Texas and Ohio as a prelude to withdrawal. Bill will say no, ’cause his career is even deader than hers. But Hillary has more class than her husband. She also has some vague sense of reality — of the difference between right and wrong.

The Intrade pay-to-play prediction market showed Obama with a 10-point gain after Wisconsin, giving him an insurmountable 81 to 19 lead. It’s as if Hillary has suddenly become a steeply inverted yield curve, with a rapidly declining credit rating and a liquidity pool that’s quickly drying up. She won’t be able to raise two wooden nickels going forward. Not even Bill can raise enough money in Dubai to keep her out of bankruptcy.

The market has officially pulled the plug on Hillary, terminating her campaign. What’s left for her now is to muster some grace, humility, and character and begin the process of pulling out. To do otherwise will destroy the Democratic party, and what’s left of the Clintons’ badly tarred and tattered reputation.

The above helps the reader to understand the unimaginable poverty that would result from a life of economic isolation. Absent the cooperation he describes, rather than doing what we do best in exchange for the best offered by others, we as individuals would be wholly self-reliant, and tragically poor. That we’re mostly able to freely exchange our individual output with the world’s citizens means our lives get easier and cheaper every day. In short, as the world’s division of labor broadens, and as tariffs fall, we’re the beneficiaries of frequent non-monetary “raises” due to economic specialization that makes goods more plentiful, and as a result, cheaper.

Importantly, the book offers clear answers to the many objections raised to globalization over the years; from its impact on the environment, wages, job growth, deficits in trade, and with the rise of sovereign wealth funds, foreign investment. Those who emotionally support free trade but sometimes doubt its wonders will likely be won over by Boudreaux’s explanations. And for those violently opposed to the freedom he espouses, let’s just say this book will make them think.

On the wage front, Boudreaux notes the “high correlation between openness to foreign trade and people’s material prosperity.” The numbers provided within back him up. Between 1980 and 1998 citizens of countries most closed to trade had average annual per-capita incomes that were 13 percent of the wages earned by citizens in countries lacking heavy barriers to exchange. This shouldn’t surprise us when we consider labor is by definition finite, but potential jobs infinite.

When trade is free, workers are able to specialize at one task, while letting others achieve their own comparative advantage in other areas. Closed markets retard this process in that while the average New Yorker may be good with numbers, that same person may not be good with a sewing machine. Free trade solves this in that the Wall Street analyst is able to “produce” clothing thanks to numerical and industry-specific knowledge, whereas a haberdasher over in Hong Kong is able to produce a stock portfolio through a unique ability to design the clothes that Wall Street-types want.

And there lies the problem with tariffs. Beyond impinging on the individual freedom that allows us to purchase what we want from whom we want, tariffs redirect scarce resources of the human and mineral variety into “industries where, as a group, these resources produce less value than they would produce with free trade.” Owing to the sub-optimal allocation of resources that tariffs necessitate, according to Boudreaux, “the ability of American workers, in general, to earn higher wages is thwarted by protectionism.” Simply put, tariffs allow us and sometimes force us into professions that don’t maximize our talents. Markets and consumers sniff this out, and it’s reflected in our pay.

Do free trade and globalization lead to job growth? Boudreaux makes plain that the rise in the aggregate number of jobs is related to population, with limits to job growth mostly a function of government rules in regard to hiring. Rather than growth, Boudreaux shows that free trade leads to better jobs thanks to the oft-mentioned specialization of work effort that attracts investment, and with the latter, higher wages. Importantly, when market forces are enabled such that resources are allocated properly, a process begins whereby the lifestyle gap between the rich and poor shrinks as our productive endeavors are rewarded with imports that are sent to us in exchange for that same productivity. As Boudreaux points out, if our ancestors from the 18th century were to walk into Bill Gates’s home today, the lifestyle enhancements that would most fascinate them would be technological advancements that all Americans presently enjoy.

Regarding the environment, Boudreaux shows that on a country-by-country basis, rising incomes correlate with rising environmental performance. Call it the environmental Phillips Curve or, as Boudreaux writes, having “conquered the hunger, housing and disease challenges that still afflict people in poorer nations, Americans can now better afford to address harms that are less immediate and speculative.” Words of wisdom, and words politicians should remember the next time they seek environmental concessions from our poorer trading partners in exchange for trade agreements.

When it comes to deficits in trade, Boudreaux is forever amused with elite opinion suggesting a lower trade deficit is somehow bullish. Instead, he notes that the goods produced around the world for Americans in exchange for dollars are a certain signal that our trading partners want something in return from us. What they frequently want instead of American merchandize is shares in our innovative companies. The trade ultimately balances, though our export of shares as opposed to televisions explains a deficit in trade that merely reveals a preference among foreigners to invest in our economy rather than consume tangible items.

The above helps explain why Boudreaux is sanguine when it comes to foreign investment. He welcomes it for increasing the number of potential bidders who might have designs on our assets. The existence of foreign investors not only means we might sell what we own at a higher price, but it also means we’ll then have access to the knowledge of a broader range of investors who might have a better idea of how to get the most economic value out of the asset purchased. When foreigners buy our government debt, that just means they lower the interest costs on debt incurred in our name.

Boudreaux’s long-term outlook when it comes to globalization is positive. While it’s certainly possible that countries around the world could revert to the impoverishing economic isolation of the first half of the 20th century, he notes that socialism has happily been discredited, and at the same time the increasingly mobile nature of capital means a country’s citizens will quickly feel any negative shift away from economic freedom.

In concluding his excellent book, Boudreaux reminds us that prosperity results when we refuse “to let political boundaries define economic boundaries.” His words are simple and powerful at the same time. If we let others do for us what’s not in our economic interest so that we can achieve our individual work specialty, we’ll be better off. Easy words for an individual to live by. Now we just have to convince our politicians.

Nothing lasts forever. The fall of the dollar continues to strengthen the euro, while there are signs that financial turbulence will put the euro-zone under stress for some time to come. Given this, exit from the euro is now conceivable – if not very practical, as Barry Eichengreen has argued – especially where economic pressure meets a political climate for change, as in Italy. The closest match in history appears to be the exit of European economies from the gold-exchange standard in the wake of the Great Depression. Can a look back help us to assess the current risks for a break-up of the euro? Yes, it can help. But mind the gap. The euro is different and will be with us for a while.
1930s exits

In 1929, tightening monetary conditions in the US reduced capital outflows to the rest of the world and forced deficit countries to tackle their imbalances. This put countries on the gold-exchange standard between Scylla and Charybdis. On the one hand, adherence to the system – neither imposing capital controls nor devaluing the currency – implied a painful increase in real factor costs and reduced international competitiveness. On the other hand, unilateral steps towards devaluation or capital controls risked diminishing confidence in the stability of the national currency. And such confidence was highly valued in European countries that had just experienced a hyperinflation, had not yet established any track record of monetary policy, or just badly needed foreign capital for domestic development.

However, the pattern of exit from the gold-exchange standard in the 1930s was quite peculiar and suggests that more than that simple trade-off affected the monetary regime choices of European countries. Germany left gold in July 1931, soon followed by the Habsburg successors Hungary, Austria, Czechoslovakia and also Sweden in September 1931, only the latter two being net-capital exporters. In contrast, Italy left gold only in 1934, while (capital-rich) France in the west and (capital-poor) Poland in the east adhered to the gold-exchange standard until the bitter end in 1936. In recent research, I analyse exit probabilities using a large new set of monthly panel data for Europe over the period January 1928 through December 1936. Briefly, the key determinants were national institutions, cross-border economic integration, and the stability of the financial sector (Wolf 2008).
Why did they leave?

While every European country faced the same basic trade-off in the decision whether to exit the gold-exchange standard, those with a strong, independent central bank and stable democratic institutions were quicker to leave. They were less willing to suffer through a domestic-adjustment crisis as advocated by monetary orthodoxy because the extension of the franchise after 1918 gave a political voice to those who cared about unemployment. And they were better equipped to risk an independent monetary policy with a strong independent central bank that may have helped to limit the loss in credibility associated with exiting from gold. This mattered especially because adherence to the gold standard in the 1920s was not universally beneficial. For today, there is no question that all European governments are concerned with growth and the reduction of unemployment, but only few could claim that their national central banks have a track record good enough to replace the ECB. This suggests that good performance by the ECB over the next few years will significantly reduce the probability of a euro break up.

The analysis of the interwar experience also shows that neighbours matter: countries tended to follow their main economic partner in their monetary regime choice, ceteris paribus. For example, Sweden’s decision to exit in September 1931 was clearly driven by its commercial interest in trade with England, which had just announced its exit. But some neighbours were better liked than others. Poland was eager to tighten its economic and political links with France in order to distance itself from Germany, in stark contrast to Austria, Hungary, or Czechoslovakia in the early 1930s. The new Polish state that had re-emerged on the European map in 1918 needed France to limit its massive dependence on Germany and Austria, inherited from 123 years of occupation. In this respect, the euro is certainly different: all members of today’s euro area are part of one tightly integrated market for goods and capital (and increasingly also for labour and services), with the monetary union merely part of a multidimensional economic network. Leaving the euro to help competitiveness would not be a very promising strategy because of the large negative side effects, as argued in Eichengreen (2007). Among other things, an exit would imply political costs, such as possible exclusion from other EU-related decisions.

But what about the financial sector? The empirical evidence for the interwar years suggests that financial turbulence was an additional trigger for exit (as suggested in “third generation models of currency crises”). For Austria, Hungary and Germany, one can make the case that efforts to rescue struggling banks eventually made the exit from gold inevitable. Could a similar financial crisis force a country out of the euro? The answer is not that simple. Pan-European banks whose activities span several euro-countries are rapidly emerging, while financial market supervision remains largely national. If problems emerge in a large pan-European bank, the current institutional framework would not be suited to a timely and quick intervention. Financial turmoil has a growing potential to challenge the monetary system, and a European banking crisis could put existing European institutions, including the euro, under massive stress. Hence, the question is not so much whether any country could be forced to leave the euro in reaction to a banking crisis, but whether the euro could be weakened to such an extent that exit became an option again. The mismatch between a monetary union and national financial market supervision needs to be addressed.
A reassuring history lesson

The euro will be under pressure over the next years, but there is good reason to believe that it will prove more robust than the interwar gold-exchange standard. Every year of good performance relative to other key currencies and every further deepening of integration within the euro- area will increase its chances of living a long life.

Nikolaus Wolf, University of Warwick and CEPR Research Affiliate.

References

Barry Eichengreen (2007), The Breakup of the euro Area, NBER WP 13393.

Nikolaus Wolf (2008), Scylla and Charybdis. Explaining Europe’s Exit from Gold, January 1928-December 1936, CEPR DP 6685.

The world doesn't work like this at all. Just think of why borrowers and lenders get together in the first place. The borrower thinks: "If I borrow this money, then I can invest in an asset (or business) that, over time, will produce an effective return on capital greater than the rate of interest on the debt, and I'll make a profit." OK, that's a little technical, but the basic story is that the borrower sees an opportunity to put capital to use. The lender is thinking almost the same thing: "If I lend this money, I can enjoy a return on assets (the interest on the loan, minus credit risk) greater than the interest paid on my borrowing (which is the interest paid to depositors mostly), and thus enjoy a profit." In other words, it's a win-win situation, as it would have to be or nobody would do it voluntarily.

If such win-win situations exist, then the financial system will naturally tend to find a way to make it happen. For example, what if there was a borrower who had some great uses for capital, but had a hard time borrowing? They would look around for a lender, and be willing to pay a decent interest rate. They could look all over the world. They aren't limited to US lenders. (In 2006, I was making some loans to companies in China, while others in the firm were making loans to small companies in Mexico and Venezuela. They paid very well.) The entity that made this loan would probably do pretty well, also. The lender would thus be profitable. Capital chases the profit. Thus more capital would be directed at this sort of lending, and the banking system would expand.

To take a more specific example, what if there were lots of wonderful loan opportunities, but banks today are unable to take advantage of them because of impaired capital? Well, they could then raise some more capital, which is exactly what they are doing. "We need capital to take advantage of this wonderful situation. If you buy an equity stake in our bank, we are sure you will enjoy a wonderful return on equity." Investment floods into the sector. This has been happening in a big way in Eastern Europe, where Western European banks are investing hugely. This is also an argument behind the sovereign wealth funds' recent investments in big US banks. "Well, they're having a hard time now, but they have fantastic franchises and have proven to be very profitable in the past. We'll bet on a winning horse, and when the situation turns around and there are more lending opportunities, the bank will make good money again." Or something like that.

Or, a competitor could arise. "Bank A is flat on its back due to crappy lending in the past. Nobody wants to invest in Bank A because they are such losers. However, Bank A is missing all kinds of wonderful lending opportunities as a result. I'll step in and eat Bank A's lunch! And you can join me, just invest in my new bank." Warren Buffet is doing something like this by challenging the monoline insurers' core municipal bond insurance business. Thus the total capital of the system increases, in response to the excellent returns on capital provided by the abundance of win-win lending opportunities.

To summarize, lending is not driven by capital, rather capital is driven by opportunities in the lending business. Probably every businessman understands this, as it is true not only of banks but of practically any industry.

A good example of this appeared in Japan. In the 1990s, we were hearing the same baloney about how banks couldn't lend because they didn't have enough capital, and if there was more capital, then banks would lend more, and the economy would recover. There was a major failed bank called Long Term Credit Bank of Japan. The government thought it would use this bank as an experiment. They effectively nationalized the bank and sold it to some foreign (US mostly) investors, who effectively made a new bank out of it. (The new bank is called Shinsei Bank, which means "New Life". Poetic bank names were very popular in the 1990s in Japan.) Now there was a brand-new fully-capitalized bank without all the bad-loan difficulties of the other major banks. Plus, this brand-new bank had (supposedly) best-quality management, namely those New York sharpies who were going to show us all the most sophisticated pratices in the financial industry. This new bank would then make all the loans that the other banks "couldn't" make, because they were capital impaired. With more loans, the economy would recover.

Right?

Wrong. Actually, at the time, there was very little demand for borrowing, because of the poor economy. The poor economy was caused, in large part, by monetary instability in the form of horrible deflation, plus various tax hikes. Debt is very painful in a monetary deflation. Most of the healthier companies had all the debt they wanted, and more, and didn't see many expansion opportunities (requiring more borrowing) in the environment of unstable money and high taxes. Most of the weaker companies nobody wanted to lend to, nor did they want to borrow either, as they were spending all their time trying to figure out ways to escape the burden of their past debts. In fact, the existing large banks were, at the time, searching very hard for good lending opportunities, from which they could make the profit to pay for their losses on their existing bad debts, and not finding many. All of this was represented in very low interest rates (high prices), for both government and good-quality corporate debt, which shows an excess of buyers (lenders) compared to sellers (borrowers).

So, what happened to Shinsei Bank? For the first couple years, it didn't do a thing. The lending market was, in fact, very competitive, and virtually all the demand for debt was satisfied at very good prices for the borrower (low interest rates), and rather poor terms for the lender (narrow net interest margin and low profitability). Later on, as the monetary issue was resolved (reflation), investment opportunities arose again, and both banks and borrowers got together to take advantage of them.

The New York sharpies still made out very well, however, mostly because of cushy terms given to them from the government. So, in the end, the real opportunity was not in the wonderful lending opportunities. The real opportunity was the chance to get a very cushy deal from the Japanese government. And how did they get this cushy deal? Because of the idea that there would be some wonderful lending boom and economic recovery if the government gave them a cushy deal.

That is one reason why we see these arguments again and again during these "bad debt" events. The economists at the big brokerage houses blah blah about it constantly. Some of the economists are aware of the scam (a little bit), but most are just useful idiots. At the end of the day, they act like amoebas that swim toward a source of sugar. (If they weren't idiots, they wouldn't be useful.) The useful idiots understand, at some limbic level, that if they talk the blah blah, they keep getting paid. The journalists pick up on it and magnify it. (Most journalists have an inferiority complex, making them unwilling to challenge anyone who makes more than they do, which is about everybody, and amount to badly paid useful idiots.) After years and years of this blah blah, the politicians relent.

Probably the scammers themselves (in this case the foreign investors) believe the story. Why not? They aren't economists either, but they can smell a good deal, and if they can also Play an Important Part in the Revival of the Japanese Financial System, well, that's fine too, and maybe they'll get an honorary degree or something out of it.

And who is pushing this idea today? Why, it's the economists of Goldman Sachs! I am soooo surprised!

$2 trillion lending crunch seen Goldman Sachs economist says mounting credit losses could force banks to significantly scale back their lending.

Are we prepping the waters here for another cushy deal from the government? Maybe? It might be a different sort of cushy deal. More like a "save our asses by taking our bad debt off our hands, or lending will contract by $2 trillion!!!" cushy deal.

Bank of America Asks Congress for a $739 Billion Bank Bailout

Well, that's enough for this week. We are going to be talking about banks around here for a while longer, I can tell.

Thanks to the Keynesian shape of the above policy, not to mention the failure of similar policies to resurrect post-World War II economies, the ideas of John Maynard Keynes are increasingly seen in a pejorative light. And well they should. Still, Keynes knew money, and he knew it well. To read his Tract on Monetary Reform is to believe that if he were alive today, he would clearly understand the negative sentiment that holds sway over the U.S. economy. Indeed, his Tract in many ways predicted what we’ve experienced amidst the dollar’s fall.

While there are varying views on the present health of the economy, polls show that Americans as a whole are unhappy and feel uncomfortable about the economic outlook. According to Keynes, economies “cannot work properly if the money, which they assume as a stable measuring-rod, is undependable.” Keynes went on to write that, “the precarious life of the worker, the disappointment of expectation, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer—all proceed, in large measure, from the instability of the standard of value.”

Be it a strong dollar or a weak dollar, changes in the value of money enervate the citizenry most by redistributing wealth. Keynes wrote that “when the value of money changes, it does not change equally for all persons or for all purposes.” Sure enough the falling dollar of recent years has enriched those long on land, precious objects and commodities all at the expense of the saver and to a high degree, the investor.

Stocks have certainly done well in stretches since the summer of 2001 (when the dollar began its decline), but the annualized total return on the S&P 500 since that time has been unimpressive to say the least. When we look at the dollar’s impressive fall versus currencies and gold over the same timeframe, we see that investors have actually lost quite a lot in real terms.

Keynes asked if the public could work around currency debasement and noted that “It has only one remedy, to change its habits in the use of money.” As he found, individuals eventually “discover that it is the holders of notes who suffer taxation,” so rather than hoarding currency that is declining “they spend this money on durable objects, jewelry or household goods.” And as we’ve seen in recent years, rich and poor alike have hedged their dollar wealth with purchases of homes, art (Sotheby’s shares are up over 100% since 2001) and jewels, and have borrowed against the commodity-like rise in the prices of their homes to fund all manner of improvements to same.

Keynes added that individuals “can reduce the amount of till-money and pocket-money that they keep and the average length of time for which they keep it,” and that of course helps to explain the heavy consumption versus saving that we’ve witnessed. Lastly, “they can employ foreign money in many transactions where it would have been more natural and convenient to use their own.” Supermodel Gisele Bundchen’s primary address is New York City, but in response to dollar weakness she’s asked that her modeling fees be paid in euros.

Currency weakness as mentioned benefits those who hold commodities such as homes, and as Keynes found, when money is losing value, “anyone who can borrow money and is not exceptionally unlucky must make a profit.” Rising prices often lead to expectations of further gains in these scenarios, so as Keynes noted, the “practice of borrowing from banks is extended beyond what is normal.” Much as we saw the rise of “day traders” during the strong-dollar driven equity boom of the late ‘90s, in more modern times we’ve seen the rise of part-time real-estate investors who rode the property boom of this decade.

And while broad measures of home prices such as the Ofheo Index continue to register yearly gains, the aforementioned property boom of recent years has seemingly ground to a halt. This likely wouldn’t have surprised Keynes given his view that the “increasing money value of the community’s capital goods obscures temporarily (my emphasis) a diminution in the real quantity of the stock.” Markets eventually adjusted to the money illusion driving up home prices, and with their continued appreciation not so certain, banks have understandably pulled back.

When it comes to conducting business, the changing value of money naturally affects commercial health, and as will become apparent, the reputation of businesses seeking profits. First, while there is some dispute as to the rising dollar’s role in the 2001-02 recession, it can safely be said that businesses holding debts found themselves paying back dollars that were more valuable than those they borrowed.

On declining money values, Keynes wrote that when “the value of money falls, it is evident that those persons who have engaged to pay fixed sums of money must benefit, since their fixed money outgoings will bear a smaller proportion than formerly to their money turnover.” That’s the good part, and stocks certainly showed strength (aided by timely cuts in dividend/capital gains taxes) for a time in the aftermath of the dollar’s decline that began earlier in this decade.

Where problems arise is that only monetary disturbance can change the broad price level, and with the dollar’s fall, profits, particularly those earned by companies that would more likely benefit from a falling currency, were called into question. Keynes witnessed this in the inflationary aftermath of World War I in England, and his insight was that falling money values not only discourage investment, but the money debasement “also discredits enterprise.”

His words ring true when we consider the reputational hit that U.S. oil companies have experienced alongside the dollar’s fall and oil’s rise. Just as they were forced to do in the ’70s when the dollar was weak, oil-company executives have twice been brought before Congress to explain their allegedly ill-gotten gains.

Keynes added that various remedies are thought up “to cure the evils of the day” wrought by cheap money, and he listed “subsidies, price and rent fixing, profiteer hunting, and excess profits duties.” Sure enough, Congress has passed the aforementioned stimulus package to subsidize the earnings of low-income Americans, the Treasury has foisted a “voluntary” rate freeze on “predatory” lenders, ExxonMobil executives remarkably seek to downplay the company’s profits, and Congress has resurrected the “windfall profits tax” from the failed policy playbooks of the 1970s.

And when we scrutinize the price of oil more closely, we ask why it is that producers don’t flood the markets with more oil to capture dollar profits while the price remains high. At first glance their actions (or lack thereof) may seem odd, but with the price of oil very much driven by the value of the dollar, we better understand why oil producers are reluctant. As Keynes wrote, “a general fear of falling prices may prohibit the productive process altogether.” Looked at in oil terms, producers are well aware that the dollar’s fall could eventually be arrested, and if so, they might hold oil that would have to be sold at a loss.

Keynes went on to write that “entrepreneurs will be reluctant to embark on lengthy productive processes involving a money outlay long in advance of money recoupment.” About oil we can say that the exploration process is long, very expensive, and the payoff from investment often occurs years down the line. U.S. politicians rail against OPEC and the major oil companies stateside for not bringing more oil to market, but as we’ve seen since 1971, periods of dollar weakness have frequently been followed by periods of dollar strength. With the dollar’s future value unknowable, should we be surprised in the least at the reluctance of oil producers to fix the supply side of the oil-price equation?

If Keynes were alive today, but unaware of the dollar’s direction, he might ask why President Bush suffers such low approval ratings, why Americans are so downcast about the economy, and why markets are so uncertain despite tax rates that are historically low, trade that is mostly free, and a war that, while unfortunate as all are, is being conducted continents away from us. His curiosity would be well placed, but easily explained by him once made aware of the falling dollar.

As Keynes so famously wrote, “There is no subtler, surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and it does it in a manner which not one man in a million is able to diagnose.” We know what ails us, and it’s the falling dollar. If we halt its decline, spirits will improve as they always do when we strengthen and stabilize the value of the money we earn.

The Patriot Employer Act

If the Patriot Employer Act proposal is anything to go by, we are in trouble if Obama wins. The legislation would provide a tax credit equal to one percent of taxable income to employers who fulfill the following conditions:
· First, employers must not decrease their ratio of full-time workers in the United States to full-time workers outside the United States and they must maintain corporate headquarters in the United States if the company has ever been headquartered there.
· Second, they must pay a minimum hourly wage sufficient to keep a family of three out of poverty: at least $7.80 per hour.
· Third, they must provide a defined benefit retirement plan or a defined contribution retirement plan that fully matches at least five percent of each worker’s contribution.
· Fourth, they must pay at least sixty percent of each worker’s health care premiums.
· Fifth, they must pay the difference between a worker’s regular salary and military salary and continue the health insurance for all National Guard and Reserve employees who are called for active duty.
· Sixth, they must maintain neutrality in employee organising campaigns.

Only the last of these conditions does not raise serious issues. In a free society, any worker should be able to join the union of his or her choice or not join.

The first restriction is distortionary. Companies ought to decide the location of their headquarters and their domestic and foreign employment levels without being subjected to fiscal incentives. It is also unenforceable. Foreign branches of domestic companies, whose workers count as employees of the parent, would be changed to subsidiaries, whose workers no longer count as employees of the parent. Companies ever headquartered in the United States would be sold to shell companies or shut down and immediately reopened with a different name and legal identity, headquartered abroad. Let Commerce Department lawyers try to use corporate DNA fingerprinting to determine the ancestry of these new corporations! Unfortunately, idiotic legislation that is unenforceable is not harmless – it breeds contempt for laws and institutions.

While requirement two is less damaging than raising the Federal minimum hourly wage (currently $5.85) to $7.80, Sen. Obama ought to realise that the natural response of firms to higher wages is to hire less labour and, even with a tax credit equal to one percent of taxable income, not every employer in the United States can provide these subsidies and still make enough of a profit to stay in business. The least skilled workers -- those who would be hired at a wage of, say, $6.50 an hour and who would be out of work when the wage is $7.80 -- are likely to find the passage of this act to be just another example of a (possibly) well-intentioned Democratic proposal unintentionally benefiting those not too badly off at the expense of the truly badly off.

The employers’ contributions to employee retirement plans, mentioned in the third requirement, are a cost of employment as much as wages are and the above discussion applies. Moreover, requirement three does little to correct problems associated with retirement plans. Any real solution must make the investment and management of retirement plans independent of the employer. This ensures portability and stops employers from raiding them. A demise of the corporate defined-benefit pension fund would be a small loss. Companies do not have the expected life span or employee base to run proper defined benefit pension funds; the government is the natural agent to do this, through the (unfunded) Social Security retirement scheme. In addition, defined benefit plans are not always required to be fully funded at all times and part of these costs can be deferred. This has led to such pension fund liabilities being ‘forgotten’, hidden, or not viewed as debt at all: consider the plans of the US automobile industry or the remnants of the US steel industry.

Similarly, employers’ contributions to employee health care costs are also a cost of employment. However, tax incentives, current or proposed, that link health insurance with being employed rather than with being alive, are distortionary and unfair. It discourages labour mobility and transfers income away from the self employed, the unemployed and the inactive.

Requirement five is a wonderful example of a policy that would end up hurting those it is intended to protect. It would create a strong incentive for companies not to hire any new employees who are National Guard or Reserve employees, and to fire any they already employ! If society deems it desirable that serving in the National Guard or Reserve not involve any loss of salary or benefits for the Guard member and his or her family, then society should pay for it, with general tax revenues.

Patriotism and Protectionism

The Patriot Employer Act is at least intended to help organised labour. Sen. Obama spends less time talking about those it will actively hurt. The cost will be borne by those who would not lose their jobs or see their US dollar wages fall in the face of foreign competition. These people – nurses, teachers, the unemployed and people living on social security, for example – lose out when restricting trade raises the price of consumer goods and cuts their real wages or the real value of their cash benefits.

The Patriot Employer Act seeks to transfer wealth from the truly downtrodden of the world to a limited number of favoured US workers: mainly those in once dominant manufacturing industries that have lost their global competitive edge. It is breathtaking hypocrisy to object to the often appalling conditions of work and employment in developing countries and emerging markets, including sweatshops and child labour, while at the same time trying to prevent the operation of the normal and effective mechanisms for remedying these deplorable circumstances: foreign direct investment, outsourcing, off-shoring and all other manifestations of free trade.

Sen. Barack Obama’s proposal is reactionary, populist, xenophobic and just plain silly. It is time for him to stop pandering and to show the world that hope and reason are not mutually exclusive. Instead of increased protectionism, the United States might increase its competitiveness by sensible investments in infrastructure and education. Much of the US infrastructure is old and inadequate following decades of bipartisan neglect; it serves as an obstacle to the ability of the United States to respond and adapt to change. It should not take the collapse of more than one major bridge in a large US city to spur increased investment. The quality of primary and secondary education in the US has fallen behind the level provided by most other industrial countries and is even threatened to be eclipsed by levels in quite a number of emerging market nations. The best American universities are still the best in the world. But, in America they are islands of excellence in a sea of mediocrity. China, India, Vietnam, Brazil, Thailand, Bangladesh and Indonesia are a reality. The United States must adapt and invest or face extinction.

He intends to regulate the profits for drug companies, health insurers and energy firms. He wants to establish a mortgage-interest tax credit. He wants to double the number of workers receiving the earned income tax credit and triple the benefit for minimum-wage workers.

The Obama spend-o-meter is now up around $800 billion. And tax hikes on the rich won't pay for it. It's the middle class that will ultimately shoulder this fiscal burden in terms of higher taxes and lower growth. This isn't free enterprise. It's old-fashioned-liberal tax, and spend, and regulate. It's plain ol' big government. The only people who will benefit are the central planners in Washington.

Obama would like voters to believe that he's the second coming of JFK. But with his unbelievable spending and new-government-agency proposals, he's looking more like Jimmy Carter. His is a "Grow the Government Bureaucracy Plan," and it's totally at odds with investment and business.

Obama says he wants U.S. corporations to stop "shipping jobs overseas" and bring their cash back home. But if he really wanted U.S. companies to keep more of their profits in the states, he'd be calling for a reduction in the corporate tax rate. Why isn't he demanding an end to the double-taxation of corporate earnings? It's simple: He wants higher taxes, too.

The Wall Street Journal's Steve Moore has done the math on Obama's tax plan. He says it will add up to a 39.6% personal income tax, a 52.2% combined income and payroll tax, a 28% capital-gains tax, a 39.6% dividends tax and a 55% estate tax.

Not only is Obama the big-spending candidate, he's also the very-high-tax candidate. And what he wants to tax is capital.

Doesn't Obama understand the vital role of capital formation in creating businesses and jobs? Doesn't he understand that without capital, businesses can't expand their operations and hire more workers?

Dan Henninger, writing in last Thursday's Wall Street Journal, notes that Obama's is a profoundly pessimistic message. "Strip away the new coat of paint from the Obama message, and what you find is not only familiar," writes Henninger. "It's a downer."

Obama wants you to believe that America is in trouble, and that it can only be cured with a big lurch to the left. Take from the rich and give to the non-rich. Redistribute income and wealth. It's an age-old recipe for economic disaster. It completely ignores incentives for entrepreneurs, small family-owned businesses and investors.

You can't have capitalism without capital. But Obama would penalize capital, be it capital from corporations or investors. This will only harm, and not advance, opportunities for middle-class workers.

Obama believes he can use government, and not free markets, to drive the economy. But on taxes, trade and regulation, Obama's program is anti-growth. A President Obama would steer us in the social-market direction of Western Europe, which has produced only stagnant economies down through the years.

It would be quite an irony. While newly emerging nations in Eastern Europe and Asia are lowering the tax penalties on capital — and reaping the economic rewards — Obama would raise them. Low-rate flat-tax plans are proliferating around the world. Yet Obama completely ignores this. American competitiveness would suffer enormously under Obama, as would job opportunities, productivity and real wages.

Imitate the failures of Germany, Norway and Sweden? That's no way to run economic policy.

I have so far been soft on Obama this election season. In many respects, he is a breath of fresh air. He's an attractive candidate with an appealing approach to politics. Obama is likable, and sometimes he gets it — such as when he opposed Hillary Clinton's five-year rate freeze on mortgages.

But his message is pessimism, not hope. And behind the charm and charisma is a big-government bureaucrat who would take us down the wrong economic road.

The above is interesting on two levels. First off, dollar mismanagement by our own federal minders was the likely miscreant when we consider investment distortions that led to big losses for U.S. banks, and which necessitated foreign investment. Secondly, with those private banks ever striving to please fickle shareholders, it seems they would be most qualified to sniff out investment of a sinister nature. And if not, outside investment that proves enervating for one company merely creates the opportunity for another firm to fill the market void.

Down from the SWF article was the headline, “States Draw Fire for Pitching Citizens On Private Long-Term Care Insurance.” Last year California governor Arnold Schwarzenegger sent out six million letters to mid and lower income Californians in hopes of getting them to purchase insurance for the aged, and states from New York to Pennsylvania to Nebraska are doing much the same. Nebraska governor Dave Heineman went so far as to name last November “long-term care partnership awareness month.”

What the various healthcare-minded politicians didn't comment on was if something like this is so useful to the citizenry, why would government officials need to tell them about it? The answer is of course explained by the truth that government on the federal and state level has already heavily inserted itself into the delivery of healthcare. With states facing high future costs related to Medicaid, those same states “are now promoting long-term care policies under marketing partnerships with the insurance industry.”

If they were searching for a governmental trifecta on the Journal’s front page, readers noticed that federal prosecutors convicted five insurance executives for facilitating “fraudulent transactions between American International Group Inc. and General Re Corp.” Federal prosecutors say “they plan to ‘work up the ladder’ seeking more indictments,” and without commenting on the merits of the prosecution, it seems fair to ask if we need government officials to eradicate fraud? At first glance many would say yes, but then the aforementioned verdict stems from “one of the highest-profile fraud cases to emerge from the accounting investigations that rocked Wall Street following the collapses of Enron Corp. and WorldCom Inc.” About the latter, it should be remembered that investors, as opposed to government regulators, revealed the fraud, not to mention that investors are surely compensated for malfeasance in the executive suite through stock risk premiums that lower the costs of shares purchased.

Turning to A2, readers were met with the headline, “FDIC to Add Staff as Bank Failures Loom.” The Federal Deposit Insurance Corp. (FDIC) of course insures depositors against bank failures, which in layman’s terms means it privatizes bank successes, all the while socializing bank failures. To shore up staff, the governmental body will add former employees that helped handle the S&L implosions of the ‘80s and ‘90s.

Former FDIC chairman William Isaac was quoted in the article, and without irony he said that bringing back those employees who weathered the last S&L debacle is “very smart.” What he deems smart is something the electorate should be wary of. Taxpayers will now be on the hook to insure the mistakes of the very bureaucrats who enabled the last S&L crash.

Moving to A3, there was a headline stating, “Deal Nears to Curb Home-Appraisal Abuse.” One might assume such a deal would have been reached between private economic interests eager to achieve more accurate price discovery when it comes to housing. The assumption would be wrong. Instead, government-sponsored mortgage giants Fannie Mae and Freddie Mac are near a deal with New York attorney general Andrew Cuomo “to make changes meant to discourage inflated appraisals.”

The above activities would surely be anathema to libertarian-minded people in our midst, but then the both the housing and mortgage industries are very much the supplicants of the federal government through tax-deductible interest payments on loans, preferential capital-gains treatment on home sales, and of course, Fannie Mae and Freddie Mac; two entities implicitly backed by taxpayers and who are supposedly necessary to maintain a liquid mortgage market. So rather than allowing private markets to solve any problems related to home appraisal, the deal means “two government-sponsored companies” will “require lenders they work with nationwide to change their appraisal practices.”

Down from the above-mentioned article, but on the same page was the headline, “Food Companies Become Frustrated With Meat Recall.” The companies included Wal-Mart, Costco, Burger King and McDonald’s. Rational minds might think that owing to the desire of each company to maintain a customer base that accesses its foods with a high degree of regularity, there would be no need for government oversight here. Wrong again. Instead, the USDA is forcing each private concern to recall meat that internal analysis suggests is safe. The USDA is not budging on its recall, which means its implacable stance “could cost food makers hundreds of millions of dollars and result in some small meat companies going out of business.”

On to page A12, there was a related headline, “Rice and U.S. Beef Lobbyist Offer Reassurance in Seoul.” Within the article readers learned that the “largest food recall in U.S. history is reverberating abroad, and the White House is helping the meat industry counter the fallout in an important Asian market.” Secretary of State Condoleezza Rice and her entourage will seek to revive the U.S.-South Korea free-trade pact, though the unseen here is how protectionist interests in Washington had previously created the barriers to trade that would make such a pact necessary.

All of which led to page A17, the one that precedes the Journal’s editorial section; a section that happily decries government involvement in private commerce on a daily basis. It is on the preceding page that readers saw a small article in which they learned that Fed Governor Frederic Mishkin would like policy makers to “focus on core inflation that excludes food and energy prices when the economy faces an oil-price shock.” Despite the certainty that private interests are much better suited to price market goods, Americans accept without protest a federal body intent on using its rate mechanism to target the prices of that which we buy.

But what’s even more remarkable here is that a Fed governor would talk about oil shocks without noting the certain truth that every single “shock” since 1971 has been the result of a declining dollar. Indeed, as evidenced by the previous examples, we see that the federal government seeks to insert itself into all manner of commerce, but when it comes to the dollar, a currency that is monopoly issued by the Federal Reserve, the latter regularly shirks its duties when it comes to issuing a currency that is stable in value.

In writing about the paralyzing nature of government, J.S. Mill went on to say that it is when those in power seek to relieve the "population from much of the former insecurity" wrought by freedom that formerly productive people become “enervated and impoverished." If Mills were alive today, and if he were to have picked up the February 26th Wall Street Journal, it’s fair to assume that he would have been shocked by the high level of government involvement when it comes to commercial matters, and that the latter would have led him to reiterate his views on what the encroachment’s impact would mean for our future economic health.