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Supply curves are upward sloping, meaning that as prices increase, quantity supplied increases. In the short term the supply curve for oil is almost vertical because oil has few close substitutes, long lead times and heavy capital expenditures. This means that any short term change in oil demand up or down will produce a large change in price rather than a large change in quantity supplied.

Food, like wheat, corn and rice, has a very different and much flatter supply curve because there are many close substitutes for different foods. Also food's production function, the time required to adjust output, is much shorter, typically one growing season, or at most, 12 to 18 months. In the medium term, these nearly horizontal supply curves mean that any change in food demand up or down will be mostly met with a change in quantity rather than a dramatic change in price.

Ethanol policy mandating that corn and oil become substitutes has forced these two very different supply curves to become one. The much larger global oil market expropriated the supply curve of the U.S. corn market. In short, oil markets now set food prices. This unintended consequence can be seen in global commodity markets.

From early 2007 to the peak in 2008 oil prices climbed from near $50 a barrel to over $145/barrel. Global food markets followed, as rice, corn and wheat prices more than kept pace with oil price increases. The recent offshore drilling debate along with expanded oil substitution and conservation has broken the price of oil and food markets in the short term. Recently oil has fallen by 25% and food stuffs by much more.

Correlations are never perfect, but one gets the point. High oil prices helped cause high food prices globally because U.S. ethanol policy forced both markets to act as substitutes sharing the same supply curve.

We should not be starving the poor people of the world by implementing a poor domestic ethanol policy. To solve the problem of high prices at the gas pump and the grocery store we should allow free markets to discover the right mix between offshore drilling, wind power, solar power and bio-fuels. We should never allow the government to tell markets what to do. If government gets out of the way, expect oil and food prices to continue their descent.

Was there ever a time when you were late on a bill because you just didn’t have the money? Most people can turn to family, friends or other resources to solve a temporary cash shortfall.

What would happen to you if a personal money problem grew into something so big that no one else could help you solve it? When things get that bad, bankruptcy becomes a rational choice to solve a problem that has no other solution.

Most of the people who can’t pay their debts aren’t flakey. Most can trace their problem to a divorce, the loss of a job, or a serious illness that caused them to stop working. These people didn’t choose that fate, and almost all of them incurred their debts during a time when they had the money to repay what they had borrowed. As we all find out, things in life can change. Very few of us are blessed with a secure lifetime job, perpetually good health, and a perfectly happy marriage. The loss of just one of these pillars frequently brings down the whole roof, financially speaking, and it leads many people down a path that eventually results in filing bankruptcy.

Filing bankruptcy usually brings people automatic relief. The pressure from bill collectors comes to an immediate stop, and in most cases, (called Chapter 7 bankruptcy) the court will actually order the elimination of most debts. In recent times, something like 1.5 to 2 million people each year have filed for bankruptcy protection. Read on, and you will see why most of them did so.

In the early stage of a debt crisis, people are usually in denial that they have any problem. They may buy themselves some time by borrowing from “Peter to pay Paul,” often transferring debt balances from one credit card to pay off another, because that keeps them “current” without actually making a payment that month. The problem with that strategy is that the debt never gets paid off; it just gets shifted to a different lender, often causing the debt balances to inch up ever higher with fees and transfer costs. In the later stage of a debt crisis, a person’s available credit may be all used up, they have no credit left for making further balance transfers, and the game becomes a miserable struggle of juggling overdue payments and dodging the phone calls from creditors.

Observing this end game is like watching the death struggle of a bunny being crushed by a python. Bill collectors can sense when a debtor is sinking fast, and they also sense that they are competing against each other to squeeze out whatever limited money a debtor has left before some other creditor can take it. The strong arm tactics exerted by many bill collectors often become downright vicious at this stage of the collection process.

Despite some weak laws banning hard ball collection tactics, the final collection assault is often a forceful combination punch that threatens the debtor with immediate fearsome legal consequences, (threats to garnish wages, seize bank accounts, car and other assets) combined with heaps of degrading personal abuse. There are very few people that can stand up to such pressure without an emotional meltdown, especially when the collector has you thoroughly frightened. You want to pay it back, but you just haven’t got the money. You feel helpless. You feel humiliated. This stage of the collection process leaves many a borrower holding their phone and weeping in tears of shame, fear and frustration.

That is the exact point when many debtors have simply had enough; they want the protection of personal bankruptcy, even if they don’t exactly know how it works or what it does. They just know that they need it.

Bankruptcy laws in the U.S. have evolved over time to provide a safe harbor where the “honest but unfortunate” debtor may be allowed to discharge most kinds of debts. The actual process entails a fairly complex legal inquiry that is conducted in a United States Bankruptcy Court. To describe this in very simple terms, the process takes place by demonstrating that one’s debts were incurred under honest good faith circumstances and that one is truly unable to pay back any of the money.

Debts that are owed for family support, taxes, and educational loans are generally not discharged and will usually remain owing. There is also a bankruptcy remedy, (called Chapter 13) that may allow someone to restructure most debts on new, better terms and often with no interest.

A complex new bankruptcy law took effect on October 17, 2005. The new law imposes a mechanical “means test” for deciding many of the bankruptcy cases, (instead of allowing a courtroom judge to decide) who is entitled to be forgiven of their debts, and who isn’t. The means test is a mathematical determination that starts by dividing everyone into two classes: those who earn above the median level of income in the state where they live, and those who earn below it.

For people with an income below the median income level of the state where they live, a bankruptcy case generally works out to produce a result that is pretty much the same as what it used to be, albeit with a great deal more legal work and expense than there ever used to be.

For those with a personal income above the median income in the state where they live, relief might still be granted but the bankruptcy calculus moves to a complex computation in which a combination of certain actual living expenses and certain hypothetical living expenses are subtracted from the debtor’s average income that was actually received during the previous six months. If the debtor shows a surplus of income under this formula, then the debtor may be required to give creditors all of their projected disposable income for the next 5 years in a bankruptcy case under Chapter 13.

On the surface, this process may look fair enough. Those who can pay something shouldn’t get a free ride. But in reality, the “means test” has some serious drawbacks as a gatekeeper for debt relief. For one thing, the eligibility process is anchored on a mathematical model of hypothetical living expenses. The use of hypotheticals and a mathematical model to decide the outcome of a law case does not uphold the principal of judging each case on an individual basis. Moreover, the hypothetical living expenses that the law imposes for conducting this “test” is actually the exact same standard that the IRS currently uses as a collection tool against delinquent tax payers.

In addition to using certain artificial living expenses as a measurement, the “means test” also artificially determines a person’s income. The test measures income that the debtor received over the previous six months, even if the debtor doesn’t have that income any more. A person who has suddenly lost a job or become disabled may be kept from filing what would have been a good faith bankruptcy case because the “means test” is imposed on their old income, not the income that they have now. Moreover, the variance in “means test” median income from one state to another can be huge.

Here is an astounding example: a person living in Connecticut can pass the means test and be allowed to file bankruptcy even though that same person earns about $20,000 more than someone who has failed the test and lives in Louisiana.

The median income cutoff to avoid the “means test” for a single person living in Louisiana is currently $33,391. The median income cutoff to avoid the “means test” for a single person living in Connecticut is currently $53,876.

To make matters more complicated, within any particular state these anomalies grow more pronounced. People within the same state having the same identical income can have a completely different outcome in their bankruptcy cases. For instance, under the means test property owners get to reduce their disposable income by deducting the full amount of their actual monthly mortgage expenses; renters fare worse, because they only get a limited standard rent deduction instead of using what they actually pay. A high income earner with a big monthly mortgage payment may be allowed to file, while a renter with the same income may be excluded.

The means test works that way because it was originally formulated by the IRS as a debt collection tool. Understandably, the IRS wants a tool to maximize the taking away of future income from delinquent tax payers who have wrongfully failed to pay their taxes. However, modern American bankruptcy law was created for the opposite purpose, which is to give people who have been “honest but unfortunate” a fresh start. That happens by allowing people to keep their future income free from the burden of insurmountable debt. In fact, modern consumer bankruptcy law is a process that normally helps to immunize an economy from the effects of a serious downturn, such as that which is now being brought on by the mortgage crisis.

Economists know that accessible bankruptcy laws actually create an escape valve that allows troubled consumers to stay in the economic mainstream as self-supporting taxpayers, (instead of dropping out under the pressure of never ending debt collection and wage garnishments). It also fosters entrepreneurship, (risk taking) which creates job formation in new small business enterprises and thus helps an economy to grow.

Writing off the debt that is now discharged in bankruptcy is not a loss to the economy, because most of it wouldn’t have been collected anyway, (you can’t get blood from a turnip.) When any society makes the cost of personal financial failure too great, (thru harsh or inaccessible bankruptcy laws), then those laws make entrepreneurs shun the risk of starting new businesses. Fewer entrepreneurs want to risk being saddled with permanent, inescapable debt. Thus, an economy stagnates.

The current bankruptcy law was enacted at the behest of Big Money, namely the collection departments of the credit card banks. Their idea was quite simple but brilliant: make a new law that is very hard to understand and difficult to administer, fewer people will use it, and bill collectors will have more time to collect more money from more people. Similar legislation was vetoed twice by President Clinton. In 2005, the Congress and the administration enacted this new law, effectively making bill collectors the fox in charge of the hen house.

Expert bankruptcy attorneys have been steadily learning how to guide their clients through the tangle of new rules, regulations and complex forms that are now required for even the simplest bankruptcy case. Debtors who try to brave this system without expert help are courting disaster. The best advice for people with a serious debt problem remains the most obvious; get the best legal representation that you can find. Filling out bankruptcy forms is a good example of something thing you should not try at home with a self-help book.

The current bankruptcy law is now two and a half years old. The law is a bill collector’s dream come true, but it isn’t much good for the consumers and the small business people that keep an economy robust. Foreclosures are raging, energy prices leap skyward, and the dollar has sunk. This is not the time to stifle entrepreneurial enthusiasm. Major economic ills can’t be fixed overnight, but a more rational bankruptcy law would be a modest step in the right direction. It would spur small business investment, foster new job creation, and rebuild consumer confidence.

This is a situation ripe for trouble, because one of these two diagnoses must be wrong. If the world’s central banks raise interest rates while the major problem is insufficient global demand, they might cause a depression. If they do not raise interest rates while the major problem is inflation, they might cause spikes in prices, rising inflationary expectations, and a stubborn wage-price spiral like that of the 1970’s that can be unwound only with a later, deeper depression.

I see the left as being correct — this time — in the global economy’s post-industrial North Atlantic core. Headline inflation numbers are the only indication that rising inflation is a problem, or even a reality. The American Employment Cost index and other indicators of developed-country nominal wage growth show no acceleration of change. And “core inflation” measures show no sign of accelerating inflation either.

The United States is experiencing a mortgage loss-driven financial meltdown that would, with an ordinary monetary policy, send it into a severe recession or a depression. In normal times, the Fed’s response — extremely monetary stimulus — would be highly inflationary. But these are not normal times. Indeed, the Fed’s monetary policy has not been sufficient to stave off a US recession, albeit one that remains so mild that many doubt whether it qualifies as the real animal.

The European Central Bank’s response has been analogous to the Fed’s, but less forceful, with monetary policy easier than the headline inflation rate would suggest is appropriate. And in Western Europe, too, GDP is now declining.

In brief, the major central banks on both sides of the Atlantic have responded to the financial crisis, but they have not overreacted. Even with their liquidity injections, the fallout from the financial crisis has eliminated the risk of a wage-price spiral that might otherwise have arisen.

Yet headline inflation is soaring, and, not surprisingly, gets the headlines. This reflects three developments. First, the world has, for the moment at least, reached its resource limits, and we are seeing a big shift in relative prices as the global economy responds appropriately by making labor and capital cheap and oil and other resources expensive. The result of this relative price shift is headline inflation.

Second, inside the US, the return of the dollar toward its equilibrium value is carrying with it import price inflation. Costs to US consumers are rising and making them feel poorer, not because they have become poorer, but because the previous pattern of global imbalances exaggerated their wealth. Global rebalancing is painful for American consumers, and shows itself as higher headline inflation. But to respond by fighting inflation inside the US would be grossly inappropriate – both much more painful for US consumers and pointless.

Finally, as the economists Adam Posen and Arvind Subramanian have argued, “China’s single-minded pursuit of mercantilist objectives produces inflation and overheating at home.” But “US efforts to get China to shed these objectives sound hypocritical when the United States seems to be opting for excess stimulus itself....[I]f the People’s Bank and the Fed tightened in coordination with most central banks, domestic [Chinese] concerns about competitive depreciation would be muted...”

China’s policy of export subsidies through currency manipulation was always bound to become unsustainable in the long run because it was bound to generate substantial domestic inflation. Now it is also generating substantial pain for other developing countries as China’s booming economy outbids them for resources. But it is politically impossible for the Chinese government to alter its exchange-rate policy under pressure without some “concession” from the US, and a tightening of US monetary policy could be sold as such a “concession.”

But this overlooks what ought to be at the center of the discussion: higher US unemployment right now is not an appropriate goal for stabilizing US output and offers few benefits, if any, for stabilizing US prices. Nor is a US that cuts back on import purchases more rapidly in the interest of any export-oriented developing economy – including China.

J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a former Assistant US Treasury Secretary.

To understand what’s at stake it’s important to consider not just how much money people earn, but how much in income taxes they now pay. We seem to have lost sight of how drastically this differs for households in different brackets. Simply put, at $250,000 in taxable annual income, a married couple filing taxes jointly would now pay about $62,000 in federal income taxes. By contrast, a couple earning $50,000 a year, which is about the median income in the U.S., would pay $6,750 in taxes. Although the $250,000 couple is in the 33 percent tax bracket (meaning every additional $1 in taxable income they would earn is taxed at 33 percent), the couple is actually paying about 25 percent of their total taxable income to the feds. At the same time, the median income couple pays about 13.5 percent of their income in taxes. In actual dollars, this translates into slightly less than 10 dollars in taxes from the higher income couple for every one collected from the median income family.

This ratio stays pretty much the same if one considers the impact of all federal taxes, not just the income tax, on these same households, according to the nonpartisan Congressional Budget Office. In its study Historical Effective Federal Tax Rates, the CBO noted that we actually pay a host of federal taxes in addition to the income levy, including the payroll tax, excise taxes and even corporate taxes, whose cost is borne ultimately by individuals. Figuring all federal taxes into the mix, as well as income from all sources, including government transfers, the CBO study suggests that the effective tax rate of a family with a taxable income in the range of $250,000 remains at slightly under double that of a couple earning $50,000.

Now Barack Obama and people who think like him would look at these numbers and argue that, after paying income taxes, the $250,000 family still has about $188,000 left to spend on other things (including paying other federal, state and local taxes, housing, food, etc.), while the $50,000 family has about $43,250 left. That’s too much of an imbalance so let’s raise taxes on the higher income family to finance cuts for middle income earners and programs that provide lower income families with assistance, says Obama. He calls this his attempt to create "a sense of balance fairness in our tax code." He personalizes it by adding that, "It is time for folks like me who make more than $250,000 to pay our fair share."

But looking at these numbers, the larger question for the economy is, at what point when we tax someone’s additional earnings in order to make our tax system ‘fairer’ does that person simply work less because government is taking so much more of the fruit of his effort (up to 39.6 percent under Obama’s plan, in addition to state taxes)? One could fill an entire library with economics dissertations on this subject, though it’s at least safe to say that the disincentive to work under Obama’s plan won’t be as great as it was when our top tax rate was 90 percent, but it will be greater than it is under today’s tax rates.

But the larger question is how much of an impact would it have on our economy if these folks did indeed work less? Can the rest of us simply pick up the slack if our most productive and innovative workers cut back, or do these folks add something that can’t easily be replaced? Judging by comments on some websites I’ve seen, many people view high income earners as little more than privileged exploiters, or slackers with good family connections, or people who just happened to be in the right place at the right time.

By contrast, it was Rand who recognized that this group also includes our most pioneering and inventive workers, the individuals “of the mind” whose innovations and ambitions drive the motor of the world and who are responsible over time for creating modern society, without which the rest of us would still be tilling ground in some pre-industrial world.

And so the debate about taxes is really a debate about the role that our biggest earners play in our economy. Increasingly, those who sit at the center of the Democratic Party seem to minimize that role. One theme of the Democratic convention last week was that government works, and that apparently applies especially to the economy. And so op-ed columnists now tell us that the real key to growth is the Democratic model of using government to drive the economy through vehicles like research dollars (although those research dollars come from taxes on private earnings). We seem likely headed, in other words, toward a period of rule by those who believe that it is government which is the motor of the world, and that it’s selfish to think about keeping too much of the fruits of your labor for yourself.

Will the rich, the productive, the inventive, buy it? Or will they see their ambition and learning and invention as unappreciated and overtaxed, and withdraw some of it, at great cost to society? It will be an interesting and revealing experiment.

Coming from the natural-resource rich state of Alaska, Palin is an experienced energy expert. She knows more about the economics of energy than senators McCain, Obama, or Biden. And in this year of the oil-shock economy, Palin’s role will be absolutely crucial.

"Obama is way off-base on all that. I think those politicians who don’t understand that we need more domestic supply of energy flowing into our hungry markets [are] living in la-la land. And we’re in a world of hurt if they’re agenda continues to be to lock up these safe, secure, domestic supplies of energy."

That’s what Palin told me in a CNBC interview in late June. I call it drill, drill, drill. But in fact it’s a full-throated America-first energy policy that will create millions of high-paying jobs with complete government deregulation and decontrol of the full menu of energy sources: oil, natural gas, nuclear, clean coal, shale, and the alternative fuels of wind, solar, and cellulosic.

Why aren’t all the candidates talking like Palin? How can this great country put its future growth and prosperity in the hands of enemies like Tsar Vladimir Putin, Ahmadinejad, and Hugo Chavez. Well, get ready for Sarah America to take on the fight against all comers.

The plain-talking governor is even tough on John McCain. The senator has said it’s too pristine to drill in ANWR. But Palin told me in June that "Sen. McCain is wrong on that issue. . . . We’re talking about a sliver of the coastal plain of Alaska being explored and drilled for oil. It’s about a footprint of a 2,000-acre plot of land. That’s smaller than the footprint of LAX."

Palin was pleased that McCain came around on the Outer Continental Shelf. But she intended to talk him into ANWR. Expect Mr. McCain to listen carefully. And she made this key point: The price of fuel will fall quickly in the expectation of more energy supplies, just as soon as Washington permits.

And when I interviewed her again in late July, she was justifiably furious that Congress was going on summer recess without a vote on rolling back its drilling moratorium. "Well," she said, "with all due respect to Congress, it’s pretty pathetic." Meanwhile, she was taking action: Palin had just gotten the Alaska legislature to agree to a new natural-gas pipeline that was 30 years in the works.

The U.S. Geological Survey estimates that there are nearly 100 billion barrels of oil in the Arctic, with roughly one-third under sovereign U.S. territory in Alaska. There are at least 10 billion (and perhaps close to 20 billion) barrels of oil in ANWR, while old estimates suggest between 800 billion and 2 trillion barrels of oil in the Rocky Mountain shale formations.

It’s also worth noting that 1.8 billion acres of the Outer Continental Shelf -- with roughly 100 billion barrels of recoverable oil and 400 trillion feet of natural gas -- are off-limits because of the congressional moratorium.

Palin grasps the strategic importance of all these domestic reserves. She’s also a governor who fully understands the energy- and foreign-policy designs of Mr. Putin, who sits right across the pond from her native Alaska.

Meanwhile, Obama railed against drilling in his Denver convention speech. He is opposed to ANWR. And shale. And nuclear power. He’s constantly bashing oil companies. And all he talks about is a windfall profits tax. That’s why he has no real economic recovery plan. He has no interest in reducing gasoline prices at the pump. He even sponsored legislation to prevent 3-D seismic technology and other research efforts to correctly measure our undersea oil deposits.

In other words, he just doesn’t get it.

That’s why the pro-life, tax-cutting, drill, drill, drill, family-centered, corruption reformer Sarah Palin will be a powerful weapon in this election. Don’t tell me she won’t make a difference this November.

Superficially, the conventional wisdom seems convincing. The Census Bureau found that median household income in 2007 was $50,233. Though up 1.3 percent from 2006, that was still less than the peak of $50,641 in 1999. (The median is the midpoint; all figures are in inflation-adjusted 2007 dollars.) Meanwhile, the share of people below the government's poverty line -- about $21,000 for a family of four -- was 12.5 percent, up from 11.3 percent in 2000. Finally, the ranks of the uninsured have increased in six of the past eight years. They're now about 15 percent of the population.

Case closed? Not exactly. Here are three reasons why (space precludes mentioning others):

First, comparisons are made to an artificially high benchmark -- the late 1990s "tech bubble."

Remember the dot-com binge. Wages rose sharply; bonuses and cash incentives mushroomed. Unemployment and poverty dropped. In 2000, the jobless rate among white men 20 and over was 2.8 percent. But all these gains reflected a boom that, though pleasurable, was temporary and unsustainable. Stocks are now trading below their 2000 highs. Using these years as the base for comparison makes later years look bad.

Picking 1997 -- the last pre-boom year -- is more realistic. From 1997 to 2007, median household income rose $2,600, roughly 5 percent. Though hardly spectacular, that's not stagnation. The poverty rate in 2007 was slightly lower than in 1997.

Second, immigration distorts commonly cited statistics.

Low-skilled immigrants, concentrated among Hispanics, outnumber the high-skilled. They drag down median incomes and raise poverty and the number of uninsured. One way to filter out the effect on income is to examine groups with few immigrants or their American-born children. Consider non-Hispanic white families. From 1997 to 2007, their median incomes rose about $6,000, to $69,937, a gain of about 9 percent. For black families, the increase was also about 9 percent, though only to $40,222. Again, not stagnation.

Immigration's effects on poverty and health insurance coverage are greater. Since 1990, Hispanics numerically account for all the increase in the number of officially poor. Similarly, immigrants represented 55 percent of the increase of the uninsured from 1994 to 2006, says the Employee Benefit Research Institute. Many unskilled workers can't get well-paid jobs with insurance.

Third, the census figures understate income gains by not counting fringe benefits.

Census counts only money income -- wages, salaries, dividends, interest payments. But compensation growth is increasingly channeled into fringes. From 2000 to 2007, only 53 percent of the increase in average compensation came from wages and salaries, says economist Gary Burtless of the Brookings Institution. The rest went to health insurance (21 percent), pension contributions (19 percent) and payroll taxes (6 percent). Americans understandably feel they're on a treadmill. They don't see fringe benefits in their paychecks, and small year-to-year cash gains barely register.

The real economic report card is both better and worse than imagined. The big advances of the rich (which occurred mostly in the 1980s and 1990s and reversed slightly last year) haven't prevented most Americans from achieving grudging gains. But a continuation of present trends would imperil future prosperity.

If health-care spending remains uncontrolled, Americans will see more of their compensation diverted from take-home pay into insurance that mainly benefits (as insurance should) a small proportion of very sick people. Similarly, if the immigration of low-skilled workers continues unabated -- whether they're legal or illegal -- the ranks of the poor will swell, as will the uninsured or the costs of providing government insurance.

Given the 2008 economy -- higher unemployment and inflation -- next year's census numbers will probably be worse than this year's. But it's the long-term threats that really matter. Obama and McCain don't confront them realistically because doing so would be unpopular and there's no strong public case for action. That's the biggest cost of misreading the economic report card.

Stocks were presumably booing a running-mate choice that will greatly aid Barack Obama’s election in November. Running against a candidate suddenly much less credible thanks to the Palin selection, Obama will now have much less reason to temper the liberal rhetoric that’s put him within striking distance of the White House.

Indeed, while various conservative columnists have excitedly written of disaffected Hillary Clinton voters that will be won over in concert with a now placated conservative base (the obvious paradox there remains unexplained), the fall in share prices perhaps speaks to the loss of economic libertarians (including this writer) and other conservatives who see McCain’s blatantly political move as evidence revealing how unserious and unprincipled he actually is.

Put simply, if he’ll suggest with a straight face that someone with a thin political resume about whom he knows very little is the most qualified person to replace him in the event of tragedy, wouldn’t he also talk up tax cuts with similar vigor despite a modern record showing hostility to same? For economic libertarians already skeptical about his pro-growth bona fides, McCain’s selection of an unknown when it comes to policy for the nation’s second highest office is evidence that he’ll say and do anything to get elected; his true views to be determined.

Seeking to make lemonade out of lemons, one pro-Palin op-ed noted a “maverick” Alaskan politician who risked “her political career by protesting ethics violations.” That sounds good at first glance until it’s recognized how very political were the “risks” Palin took.

Indeed, as the mayor of a town that until last Friday 99.9% of Americans had never heard of, it was politically astute for Palin to take on Alaska’s corrupt political establishment to clear her path to Juneau. In her coming-out speech Palin alerted voters to her opposition to the much reviled “Bridge to Nowhere,” but as a Washington Post story showed on Monday, her “opposition” to the Bridge was far more nuanced than she originally revealed. Further reports have shown Palin to have been far more open to earmarks, including those her running mate opposed.

In a Wall Street Journal op-ed, conservative commentator Fred Barnes lauded Palin’s selection for bringing “desperately needed diversity to the Republican ticket.” Put more bluntly, conservatives will now engage in gender politics without regard to actual merit or ideas in order to get elected. What’s that they say about what happens when a Democrat runs against a Democrat?

Worse, in another Wall Street Journal op-ed, McCain senior policy adviser Nancy Pfotenhauer ascribed chauvinism to those skeptical of Palin’s experience, all the while suggesting we should be impressed that Palin “has never shied away from challenging the influence of big oil companies.” It used to be that Republicans embraced oil companies for giving consumers what they wanted, but if conservatives can suddenly embrace gender rhetoric about “18 million new cracks” on the glass ceiling, why not the anti-business rhetoric that is also part of the opponent’s playbook?

But if Palin’s “toughness” when it comes to Big Oil is ignored, what’s gone unanswered is that if Palin was in possession of such a wise mind when it came to oil, and with oil a very large campaign issue, why up until now did McCain not actively seek Palin’s allegedly sage council on this most pressing of issues? Furthermore, why didn’t Palin have a senior position in the McCain camp all along to serve as his “energy czar”?

Since Palin was not part of McCain’s inner circle, we’re now asked to believe that someone he hardly knows is in his mind the most qualified person to potentially take the reins from a man who just turned 72. So while some may be giddy about a re-energized conservative base, what’s unknown is how many other Republicans and libertarians within the GOP bloc might sit on their hands in November rather than embrace the gender politics that led to the nomination of someone whose political leanings are mostly unknown, whose experience is charitably thin, and who possesses some of the anti-corporate views held by her perhaps future boss.

Time will tell, but market uncertainty since Palin’s nomination perhaps speaks to unhappiness among part of the electorate with the blatant, non-maverick, politics that led to her selection. To her credit, Palin is proud of her husband, but as the alleged party of economic growth, since when is it so that the Republican base would feel more in tune with Palin for her husband being a union member with a fancy for snowmobiling? Would she have not gotten the nod if her husband was an oil executive, investment banker or entrepreneur? Given their tight bond, would the whisperings of a non-union executive somehow hold less insight? Various commentators have waxed poetic about Palin’s down-home roots and an ability to talk on the same level as the “lunchbucket” (a more silly word would be hard to find) crowd, but if the base now embraces “glass ceiling” imagery, why not hit it with nonsensical talk rooted in class warfare?

If Palin’s experience or lack thereof for the nation’s highest office can be ignored in the way Obama partisans would like his similarly thin resume to be forgotten, the question when it comes to Palin becomes one of judgment. Both campaigns have done the politically correct thing in saying news of Bristol Palin’s pregnancy should be a private matter, but Palin’s non-mention of her 17-year old daughter’s pregnancy last Friday makes that an impossibility. That is so because the omission was political in nature.

Indeed, if they were in fact engaged before the news was leaked, why didn’t Palin trot out future son-in-law Levi Johnston, he of “I’m a f’in redneck” fame, when she introduced the rest of the family? Morality aside, is the shotgun announcement of marriage wrapped in the wonders of life’s sanctity not just another rank political act by Palin and the McCain campaign to save the former’s political skin? With adoption everywhere an option, is Palin showing good judgment in sanctioning marriage to a snowboard and dirt bike aficionado previously unmentionable who likes to “shoot some sh*t and just f’in chillin’ I guess”?

If with the vice presidency in mind Palin will countenance marriage by her daughter to someone who’s merely “in a relationship” but states flatly, “I don’t want kids,” how can we trust her to rationally choose a future Fed chairman, Treasury secretary, or with sound mind decide whether or not we should send troops to Georgia? If Palin will play politics with both her daughter’s and her grandchild’s lives, what other principles might she shed with political gain in mind?

Back when Bill Clinton got in trouble over Monica Lewinsky, while there was broad disagreement over what the affair said about his own morality, there existed somewhat of a consensus that he showed shocking disrespect for the Oval Office. Seemingly everyone agreed that the latter should be majestic and free of tawdry assignations.

In putting Sarah Palin potentially one heartbeat from the presidency, John McCain has for all his great service to this country shown an impressive disrespect for the same country’s highest office with this cynical gimmick. In doing so, he’s arguably handed the election to Barack Obama given the number of voters likely embarrassed by his choice.

Sadly for the economy and stock markets, McCain’s bad politics make clearer the path for a known redistributionist to win in November over a candidate whose true beliefs were made more opaque with this most shocking of selections.

Now, the prophets of doom enjoy their well deserved media attention. They were right; the sub- prime crisis wasn’t contained, Bear Stearns is a distant memory and the commodity bull turned out to be what it has always been - an indicator of inflation. The Fed rescue hasn’t worked and the losses at the banks and brokers turned out to be a lot worse than initially thought. According to the Nouriel Roubini crowd, there’s much more to come too. This won’t be over until we are mired in a deep recession or maybe even the Great Depression Part II. And by the way, there’s not a damn thing we can do about it.

And so, a mere nine months after the rejoicing of a new high in the stock market, we find ourselves mired in the depths of a bear market. Our worst fears seem to be well on their way to being realized. All the news is interpreted in negative fashion. Oil drops 25% and it is cited as only as confirmation of weak demand from a reeling world economy. The dollar rallies from the depths and it is seen as threatening our booming exports. The savings rate rises (finally!) and this is seen as reinforcing the recession because Americans will stop consuming. House prices drop and it is seen through the prism of the negative wealth effect where people feel poorer and thus spend less, prolonging the recession.

At the top of the market there was a delusion that all was well and the credit problem was being solved by the Fed. This delusion worked because in most investors’ lifetimes, the Fed has always ridden to the rescue with another dose of credit. Now that the myth of Fed power over the market has been revealed as a fraud, investors are moving to the other extreme of pessimistic delusion. Most of the economic news today could be interpreted in a positive light: Falling oil prices and a rising dollar are two sides of the same coin and the result is an increase in purchasing power for consumers; more savings should be welcomed as it is necessary for future growth; falling home prices will allow more people the opportunity to own a home; the credit crunch ensures that only those who are deserving and have acted responsibly with credit in the past will get a loan.

The optimistic view of the economy is a decidedly minority one. Googling “no recession” returns 728,000 results. Google “new depression” and you get 13,000,000 results. In other words, if you think the economy is bad right now and getting worse, you are the crowd. Think about how that worked out during the Internet bubble or the housing bubble. Considering that most of the newly prescient pundits have been bears for as long as anyone can remember, what are the chances they’ll be able to recognize good news when it really arrives? Will you?

Accepting the majority view of American economic decline is easy at this point. The press pushes the story every day. Prominent economists with gloomy outlooks get profiled in the New York Times. Pandering politicians promise economic nirvana if and only if they are elected and their recovery plans are put into action. Those who offer an optimistic outlook are ridiculed and dismissed. But good investing decisions are not made by hewing to the consensus view.

The seeds of a better economic future lay in the destruction of the last boom. Tighter credit in an economy recovering from a credit overdose is not a bad thing. Homes becoming more affordable is not a bad thing. Falling oil prices are not bad news. The dollar moving higher, not only against the euro but also gold, is not a bad thing. People saving more is not to be lamented. Markets are self correcting mechanisms. We may not like the adjustment process but it is necessary to ensure future growth. Nothing lasts forever, not even Presidential campaigns, and this period of economic malaise is no different. It is time to think, and act, like an optimist.

“With Pelosi and Reid pushing him,” said Welch, “there’s no limit to the taxes [Obama will] raise.” Mitch McConnell, who joined Welch on our show, was in full agreement: “You’ve got a prescription for turning America into France,” said the Senate minority leader, “which is exactly what the Democrats want to do if they get all three [houses.]”

I agree completely. A three-house Democratic sweep is a vital issue and McCain and Palin should be raising it. A three-house sweep is bad for the economy and the stock market. And will someone tell me exactly why the St. Paul Republican’s aren’t mentioning the economy?

As we head into the closing night in St. Paul, there has so far been no reference to the weak economy. There has been no economic-recovery message and no growth message. There has been no reference to the populist revolt against high gas prices at the pump, which is the main cause of the economic slump. There has been no reference to the 70 percent of Americans who are tired of high gas prices and want to drill for more oil as at least a short-run solution over the next 5 to 10 years. There is no one connecting with the economic woes of blue-collar type working folks who are getting creamed, who worry about falling jobs and rising unemployment, and who want someone to help with the oil shock. What’s going on here? What ever happened to the prosperity part of peace and prosperity?

I made many of these same points Wednesday night on The Corner, National Review Online’s political blog. To digest, Sarah Palin delivered a brilliant speech in St. Paul. So many good lines. She showed us all that she’s a superb communicator -- that she’s even Reagan-like. I personally loved her line about the difference between a hockey mom and a pit bull: lipstick. With a smile and a great quip, she signaled to her opponents that she is tough, serious, and purposeful -- that she has strong convictions and she’s not going to be intimidated. I asked last night if we’re not witnessing the Western frontier version of Margaret Thatcher. Sarah Palin is just what the Republican party needs. She connected really well with middle-class working folks, both in cultural and social terms, which is no small feat: Values matter and the Democrats are in trouble here -- big-time. The more they go after Palin culturally, as they have already, the more trouble they’ll fall into.

And Gov. Palin did mention oil and gas drilling, and she effectively connected her Alaskan natural-gas pipeline to Tsar Putin’s global aim of energy blackmail. She proved that she knows a bit more about high-table geopolitics than her critics think, and that Alaskans know a lot about Russian territorial ambitions, with Russia right across the pond.

But again, there were misses. Foremost, I do not think Palin connected with folks on the economic slump, nor did she present an economic-growth recovery plan. Rudy Giuliani made the first foray into that area in his speech when he talked about restoring economic growth through tax cuts and drilling. (Palin also fingered Obama as a tax-and-spend liberal. Good.) But he didn’t get to gas pump prices, or the oil-shock-driven consumer shortfall in real purchasing power, or the threat of more job losses and higher unemployment that are casting shadows over public confidence and the investor-class stock market.

That said, Palin did lay some important groundwork. In the weeks ahead, she can expand her oil-and-gas drill, drill, drill message to include gas prices and the economy. This is only a short stone’s throw away from her Wednesday-night speech. Wouldn’t it be great if she and McCain adopted a strong, pro-growth, tax-reform plan to reduce tax rates across-the-board, get rid of the corrupt loopholes and tax earmarks defended by the old order in Washington, and combine their ethical corruption cause with prosperity tax cuts as well as currency-reform to restore King Dollar?

At least Palin got us headed in the right direction last night with her America First energy-reform message. Watching her phenomenal communication skill, her disciplined yet positive style, I can’t help but be optimistic. I’m optimistic in part because Palin herself is clearly an optimist. I’m a sucker for optimism.

And tonight it’s McCain turn. What St. Paul needs is a good dose of economic reality. A drill, drill, drill message tied to gas prices and the economy along with supply-side tax cuts and King Dollar. And like Jack Welch said, why not make the Reid-Pelosi-Obama three-house link? A return to the Jimmy Carter ’70s is the last thing we need.

Happily, the above is really pretty irrelevant. As George Mason professor Donald Boudreaux reminds us in his essential book, Globalization, when we look at trade from an individual’s perspective (the only way to look at trade), said individual would be shockingly poor absent the ability to exchange the fruits of his labor for the surpluses of others.

The true mistake when we consider trade is to view it from a country or border perspective. In truth, it doesn’t matter where a good is made because rather than enervating, trade lifts us. Just as our exchanges with the local grocer free us from backbreaking farm work, so do imports from around the world move us even more toward the very economic specialization that enriches us.

That being the case, the best scenario for the average American would be for China’s economic growth to lift its citizens even higher, and at a much faster rate. If so, Americans and the rest of the world would be able to enjoy an even greater influx of cheap goods that would enhance our standard of living alongside more efficient deployment of our individual human capital.

Put simply, we must think of the Chinese and other rising economic locales in the way we think of computers. Computers arguably destroyed more jobs than any invention in history, but rather than impoverishing us, our embrace of them allowed many of us to more productively go about our existing jobs, and for others the productivity wrought by computers attracted capital that created new, higher paying employment.

Surprisingly, China’s economic rise has some prominent economists on edge. C. Fred Bergsten of the Peterson Institute says China is “challenging some of the fundamental tenets of the existing (global) economic system;” its alleged export-led economic growth “predatory” in nature.

Nothing could be further from the truth. That is so because there’s no such thing as “export-led growth,” let alone “predatory trade.” More realistically, as producers all, we trade products for products. Chinese producers are only able to export goods to the extent that the buyer on the other end is creating tradable goods that have similarly been exported; the country destination of those goods totally irrelevant.

Importantly, Chinese companies aren’t exporting out of love or benevolence. Instead, they make for the world saleable goods that will enable them to succeed at their main goal: imports. Indeed, whether a Shanghai-based firm is producing for customers in Beijing or Baltimore, in both instances this is done with the purchase of something else in mind.

What also has to be remembered is that imports into any country or region are the ultimate compliment; the imports a signal that the region or country in question has first made something the markets value such that there exists capital to import something else. Trade also can’t be predatory given the truth that it occurs between two consenting individuals who enter into an exchange arrangement with the desire to get something they value more.

Some would say that Chinese citizens often skip the “import” or buying part, and while the proliferation of cellphones, cars and Western-style houses over there certainly belies this assumption, even if true it would be unimportant. That is so because money saved hardly detracts from demand. Instead, money saved is merely lent out to businesses and individuals with near-term needs for employees and all manner of consumer goods.

Economist Robert Samuelson fears that China’s rise will “destabilize the world economy” thanks to huge “financial imbalances” and “contentious competition for scarce raw materials.” Samuelson’s fears are similarly overdone because just as productivity in Duluth accrues to economic activity in Dallas, so will Chinese growth be ours, and ours theirs. This is the happy result of an integrated world economy. Whenever we think of trade with anyone anywhere, we must always think of the local grocer who enabled us to leave the farm.

Where “financial imbalances” are concerned, what Samuelson presumes cannot be. That is so because all trade by definition balances. In truth, it is a physical impossibility for the U.S. to have to finance its alleged deficits involving trade. Instead, to the extent that we’re productive, we’ll attract imports. Nothing is free.

When we consider competition for “scarce raw materials”, this too is a misnomer. Instead, individuals rather than countries will access what they need. To the extent that actual demand makes some resources dear, far from an inflationary event, this will merely foster substitutions, or more realistically drive the intrepid among us to find that which is in short supply.

What’s interesting about the above is that Samuelson decries currency manipulation; in particular Chinese manipulation of the yuan “at artificially low levels.” Samuelson gets it backward. It’s been the failure of U.S. monetary authorities (and other countries that have sadly followed our lead) to properly manipulate the dollar’s value with an eye toward stability that explains expensive raw materials mostly expensive today thanks to a weak dollar.

Importantly, the value of any currency is mostly immaterial. Currencies are in the end insignificant except as measuring rods that foster trade. So when we address competitive devaluations, the enemy is us. Had we not the left the currency stability that was the purpose and result of the post-WWII Bretton Woods monetary agreement, other countries would have had less reason to follow our lead down an inflationary path these last 37 years.

Looking ahead, it should be hoped that we and our trading partners ignore rhetoric suggesting free trade or China or both are somehow threatening. More threatening would be an inward turn against beneficial individual exchange imposed by governments that would lower personal standards of living worldwide, all the while forcing workers to use their talents in sub-optimal ways.

A country earns or loses that trust based on the policies it implements. A country with strong, stable pro-growth policies will garner trust from investors, thus creating demand for its currency and appreciating its currency value. Oppositely, a country with weak, volatile anti- growth policies will break any trust that the country will be able to honor its promises, thus creating less demand for its currency and depreciating its currency value.

These changes in currency value are measured in two ways. The first, and most common way, is to look at currency exchange rates. The problem with exchange rates is that they cannot tell you which country is gaining or losing trust. If the U.S. dollar rises against the Euro, as represented by the $Dollar/Euro exchange rate, is it because the U.S. implemented better policies and gained trust or because the Eurozone implemented worse policies and lost trust? To answer this question and be able to see a currency’s strength or weakness more clearly, one must measure a currency against some standard like gold, or another basket of "stuff."

A trusted currency neither inflates (falls in value) nor deflates (rises in value). Both are breaches in trust, and both cause "windfall" losses. In the case of inflation, the losses are to savers and lenders. In the case of deflation, the losses are to borrowers. The Fed plays a small but important part in making currency stable, but there is no Fed policy that can offset a massive drop in the demand for money caused by bad government policy.

We can now assess the recent dollar rally in terms of what it is telling us and why it is happening. The dollar index has risen nearly 10% since mid-July against a basket of nearly all currencies. Part of this short term move is likely due to the fact that investors are losing trust in Eurozone polices relative to the U.S. European economic growth continues to slow, and the ECB insists on fighting the wrong enemy of inflation instead of addressing the global deflation by cutting interest rates.

However, the dollar has also strengthened against gold by nearly 20%. This tells us that there may be a fundamental positive shift in U.S. policies. Energy policy is improving, as the reality of U.S. offshore drilling becomes more likely. Monetary policy is also improving, as falling commodity prices are evidence that the Fed and Treasury should stop worrying about the wrong problem, inflation. Lastly, we do not think it is a coincidence that the dollar bottom against other currencies and gold coincides with a huge increase in McCain's odds to be our next president. Since July 14th, McCain’s odds have surged in most national polls as well as in online political trading markets like www.intrade.com.

The dollar is reacting to the increasing possibility that the low tax, free trade, energy independent candidate will win, and it is beginning to regain investors’ trust. McCain’s pro-growth policies are mandatory for a sustained rally in the dollar. If we get those policies, the coinciding strong dollar will be joined by capital inflows to the U.S., employment growth and rising stock and bond markets

Unfortunately, for many years we have not had a stable dollar. Today, people are angry and afraid. The crumbling, gyrating dollar has created an economic crisis.

I was a judge for 25 years. I believe in law and order. The U.S. Constitution is the supreme law of the land. Article I, Section 8 of the Constitution provides that: “The Congress shall have Power…To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures…”

So, what has Congress been doing about the dollar? Nothing. Since 2001, Congress has stood idly by while the dollar has lost almost 70% of its value, whether measured against gold or retail gasoline.

When a currency begins to lose value, the effects show up first in the price of gold, followed quickly by other commodities, such as oil. However, eventually the inflation works its way through the entire economy, raising prices across the board. In the process, the hard-earned savings of Americans are devalued—or, the way I look at it, stolen.

Inflation creates turbulence in financial markets and provokes conflict between economic groups. People become angry because they feel that they are being robbed. They become afraid because they know that unchecked inflation can lead to economic collapse.

In 1913, Congress delegated its power over money to the Federal Reserve. Unfortunately, the Fed has been preoccupied with manipulating interest rates. Since 2001, the Fed has lowered its Fed Funds rate from 5.00% to 1.00%, raised it to 5.25% and then lowered it to 2.00%. Meanwhile, the value of the dollar has declined by nearly 70%.

Trying to regulate the value of the dollar by manipulating the Fed Funds rate makes no sense. The Fed Funds rate is the price of one type of capital. Because the Fed cannot supply capital (real resources) to the economy, it is not clear why it should be in the business of setting interest rates. Logically, interest rates should be set by the market—by the supply and demand for capital.

Unlike capital, the amount of money in the economy should not be limited by anything physical. It should be determined by the demand for money, which depends upon the transactions people want to do and how much money they want to hold.

What matters about money is not its quantity but its value. In this, dollars are no different than foot rulers. No one cares how many foot rulers there are in the world. What matters is that each one is the length prescribed by the U.S. Bureau of Standards.

My bill directs the Federal Reserve to bring the price of gold down to $500/oz and then to keep it there. The Fed would do this by announcing that its Open Market Desk was prepared to sell government bonds and contract the monetary base until the price of gold falls to $500/oz.

At last measure, the monetary base was about $872 billion. In December, 2005, which is the last time the price of gold was at $500, it was $827 billion. So, it is possible that the Fed might have to sell as much as $45 billion worth of bonds to implement the new policy. Because this is only about 0.8% of the total amount of bonds currently outstanding, this should not be a problem. However, I believe that the demand for the newly-stable dollar will be so great that the Fed will actually have to expand the monetary base to keep the gold price from falling below $500/oz.

Once the Fed implements its new directive from Congress, every dollar in the world will have the same market value as one five-hundredth of an ounce of gold. From then on, the monetary base will expand and contract automatically in response to market demand.

Why gold? My bill defines the value of the dollar in terms of gold because the financial markets want, and the American people deserve, a dollar that is “as good as gold”.

Why $500/oz? At $804/oz, the current market price of gold reflects the expectation (and fear) of future inflation. I believe that fixing the value of the dollar now in terms of gold at $500/oz will stop the current inflation without causing deflation. However, my bill also provides a powerful supply-side stimulus, in the form of first-year expensing of all capital investment, to ensure that economic growth accelerates at the same time that inflation is being stopped.

Bringing the dollar price of gold down to $500 will bring the price of gasoline down from its current $3.50/gallon to less than $2.50/gallon. It will strengthen the dollar against foreign currencies. Most important, it will prevent Americans’ incomes and savings from being stolen by inflation.

My bill will not put America on the gold standard, like we had in the early part of the 20th Century. Under the old gold standard, gold was money. Limiting the supply of money to the supply of gold was a huge mistake. It was the basic error that caused the Great Depression.

Under my bill, our money will be the same “legal tender” currency that we have now. There will be no limit on the number of dollars except market demand. The big difference will be that every dollar will always be worth the same as one five-hundredth of an ounce of gold.

When I became a Congressman, I took an oath to uphold the Constitution. The Constitution commands Congress to regulate the value of our money. My bill will do this. This is why it is essential that it become law.

Although their agendas are starkly different, both men make the same fundamental mistake. They declare that labor-force solutions, like higher wages or creating better jobs, will significantly reduce poverty America. But that won’t happen because the vast majority of the impoverished in America don’t work and wouldn’t even if we raised wages or created more jobs. They are in poverty because of social or physical problems or choices in life they’ve made which make it difficult or impossible for them to work. Some have simply chosen not to work. It’s not that our economy doesn’t work for most of the poor, but that most of the poor don’t work.

Obama and McCain can be excused for not addressing poverty’s real causes because rarely anyone else in public life ever does, including not only politicians but most reporters and editors who regularly cover the issue. When the Census Bureau released its latest figures on poverty in late August, on the day before Obama addressed the Democratic National Convention, the press’s reaction was superficial and predictable: “Poverty Rate Reflects Stalled Economy,” began a piece on National Public Radio, even though a close look at economic cycles over the last 35 years shows that poverty rates only change slightly when the economy turns up, or down.

But digging deeper into the layers of data that Census provided in its latest reports would be revealing—I would dare say startling—for the average American. For instance, what the latest data show is that of the 7.6 million families in poverty in America, more than 80 percent did not contain an adult who worked full time in the past year. In fact, in more than half of families in poverty the householder did not work at all in the last year. The problem was especially acute among single-parent families headed by women, which make up 19 percent of American families but 55 percent of all families in poverty. In only 17 percent of those impoverished families is the household head working full time. Still, even that is better than before welfare reform set time limits on public assistance in 1996. Back in the early 1990s, for instance, only 9 percent of all poor women who headed households worked.

It’s especially revealing to see why the poor don’t work. In this latest study, Census asked non-working impoverished adults between the ages of 16 and 64 why they are out of the workforce. Only 6 percent said it was because they could not find work. By contrast, 26 percent said they didn’t work because of family commitments, 27 percent said they were in school, 32 percent said they were ill, and 9 percent said they had retired. Whatever their individual problems or circumstances, in other words, a shrinking economy, or wage levels that are too low, or the decline of unions have little to do with the poverty of most of these people.

That the poor don’t work very much gets left out of all sorts of public policy debates, including those on the growing gap between the rich and the poor. A recent graph accompanying an Economic View column in the New York Times, for instance, showed that households in the lowest economic quintile make far greater income gains during Democratic administrations, while the top five percent of households do better under Republican presidents. The graph and accompanying commentary suggested that Democratic presidents are somehow producing more economic opportunity for those at the bottom of the economic scale, but as the Census numbers show, that’s just nonsense. According to the latest Census figures, 60 percent of families in the lowest quintile in America do not contain a single adult earner. When their income surges, it is often because Washington is increasing transfer payments to the poor, not because economic opportunity is rising.

By contrast, the members of America’s richest households are working like never before. About 76 percent of all families in the top 5 percent of household income contain two or more workers, Census data show, and the percentage of families with multiple workers increases as household income increases. As sociologist Dalton Conley recently wrote in the New York Times, “Today, the more we earn, the more we work.”

Until we address the causes of poverty frankly instead of resorting to demagogy about the rich and the poor, we won’t begin to make serious reductions in poverty. Social scientists, for instance, have understood for years now that one of the greatest problems we face in reducing poverty is the rise of single-parent households. As a 2006 paper published by the National Bureau of Economic Research noted, “Changes in family structure--notably a doubling of the percent of families headed by a single woman--can account for … more than the entire rise in the poverty rate” from 1980 to today.

And the problem is only getting worse. More than one-third of all births in America today are to unmarried women, and nearly half of them are already in poverty, meaning their children are being born directly into poverty themselves. Many of these women do not have a high school education, so the prospects that they can find anything but entry level work are grim. And given what social science now tells us about children raised without a father—that they are far more likely than kids raised in two-parent families to drop out of school, to wind up on welfare, and in the case of girls to become unwed mothers themselves— the likelihood of current levels of poverty persisting no matter how many new jobs we create is enormous.

Finding solutions to these problems is far more complicated and politically risky than offering palliatives about minimum wage hikes or tax cuts. To address the issue of the more than 80 percent of poor families where no one works full time requires figuring out how to dissuade poor girls without a high school education from having children by a man who won’t marry and support them. It also requires doing a much better job helping make ex-convicts--the 700,000 or so mostly men who leave prison each year--more employable. And it requires finding more successful ways of helping alcoholics and drug addicts—who make up a sizeable portion of those who say they can’t work because they are ill—get straight and stay clean.

These are difficult problems, but there are pockets of innovation going on around the country which offer hope. We rarely hear about them, however, because our candidates and the press are too busy telling us that our economy is somehow failing the poor.

The U.S. government currently owns about 215 million ounces of gold. At the current market price of gold ($752/oz), this is worth about $162 billion. If we emptied Fort Knox and converted all of our gold reserves to the gold coins that Ron Paul advocates, this would provide enough gold "dollars" to replace just under 19% of the paper dollars currently in circulation (i.e., the monetary base). If we took Ron Paul's proposal one step farther and went to 100% reserve banking, we would suddenly have less than one eighth as many "dollars" as we have now.

Of course, we wouldn't have to use today's market price of gold. At a higher gold price, the same amount of gold would allow us to make more "dollars" of gold coins. However, to replace all of our dollars of paper currency with our available gold would require a gold price of $4050/oz. The gold price would have to be pegged at $6500/oz to replace all of the "dollars" of M1, which is what we would have to do in order to implement 100% reserve banking.

Given that Ron Paul (correctly) points to today's $752/oz gold price as evidence of inflation, it is a strange idea that raising the price to $6500/oz would solve the problem.

In many of Ron Paul's writings, he advocates going to a gold coin standard and simply letting prices fall to make up the difference. Since Paul believes that it was a mistake to depart from the original $20.67/oz conversion price in 1933, let's look at what would happen if we went back to that.

After we replaced M1 with gold coins at $20.67/oz, the general price level would fall. Ron Paul points out that because all wages and prices would fall by the same percentage, this would not matter. However, take the case of a family with a $150,000 mortgage that watched its income fall from $100,000/year to $317/year. It's not clear that this family would believe that they were better off, even though they would now be receiving their pay in gold coins.

These calculations show that Ron Paul's gold coin standard fails for the same reason that the classic gold standard failed-there isn't enough gold in the world to prevent it from being wildly deflationary. Because all America has known for almost 70 years is inflation, many people have forgotten that deflation is much, much worse. The Great Depression was caused by deflation. People want stable money, but they aren't willing to starve to get it.

Fortunately, it is possible to stabilize the dollar and create an economic boom at the same time. Judge Poe's bill, H.R. 6690, would do this. It would require the Federal Reserve to use its Open Market operations to bring the COMEX price of gold down to $500/oz and keep it there. H.R. 6690 would also give the economy a powerful supply-side stimulus in the form of "first year expensing" of all capital investment.

H.R. 6690 defines the value of the dollar in terms of the market value of gold, but does not use gold as money. In this way, Judge Poe's bill would not create a new and potentially unlimited source of demand for a scarce commodity. This is the key difference between H.R. 6690 and both Ron Paul's approach and the classic gold standard.

Ron Paul believes that governments should not have the power to create money. However, the U.S. Constitution gives the Federal government exactly that power. Article I, Section 8 of the Constitution provides that: "The Congress shall have Power...To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures..."

Ron Paul argues that paper currency amounts to "bills of credit" and that the Constitution prohibits the Federal government from issuing these, and from making them "legal tender". However, the only place in the Constitution where these issues are mentioned is Article I, Section 10, which merely denies these powers to the States. Ron Paul believes that the Framers should have denied these powers to Congress as well, but they did not.

As it happens, it is a very good thing that Congress has the power to issue paper money. It would be impossible to "regulate" the dollar to a stable value if it were not possible to adjust the supply of dollars to meet market demand. The lack of this ability is the flaw in both Ron Paul's proposed gold coin standard and the classic gold standard.

The flaw in our current monetary regime is that Congress has abdicated its responsibility under the Constitution to "...regulate the Value..." of the dollar. H.R. 6690 corrects this problem by defining the value of the dollar as being equal to the market value of 1/500th of an ounce of gold. It also ensures that the Federal Reserve will supply the market with all of the paper dollars it wants at this price.

It is likely that the market demand for the stable "H.R. 6690 dollar" would be huge. The financial markets yearn for a single, stable, world currency, and the now-regulated dollar would quickly become this. Fortunately, H.R. 6690 places no limit on the number of dollars that the Fed can create. It merely requires that each dollar always be worth as much as 1/500th of an ounce of gold. The Fed would likely find itself in the position of having to buy up billions of dollars worth of Treasury bonds to meet the increased market demand for the U.S. monetary base, but this is something it can easily do.

In directing the Fed to maintain the real value of the dollar, H.R. 6690 will force the Fed to stop trying to control interest rates. This will be a good thing. Interest rates are the price of capital, which represents the right to control real resources for a period of time. Interest rates should be set by the market. That is to say, interest rates should be set by the interaction of savers, who supply real resources and investors, who put those resources to productive use.

The Fed cannot create real resources. All it can do is to print money and use that money to commandeer real resources. This process causes inflation, and it is therefore a good thing that H.R. 6690 will prevent the Fed from doing this.

Judge Poe's bill, H.R. 6690, takes the Constitution at face value and uses the powers granted to Congress to solve the biggest single problem facing the U.S. economy. Unlike Ron Paul's gold coin standard idea, H.R. 6690 would actually work.

And look at all these headlines. The Washington Post has "Palin Energizing
Women from All Walks of Life." In particular, white women with children at home give Palin a favorable rating of 80 percent.

Then there's this lead story in the Wall Street Journal: "Palin Lifts
McCain's Support." A WSJ/NBC poll now has the presidential race even, and
it's the Palin effect that explains the shift.

One-in-four Hillary Clinton voters now say the Palin pick makes them more
likely to vote for McCain. And traditional Republican states like Georgia,
Montana, North Carolina, and Alaska -- which Obama thought he'd fight for --
are now safely back in the McCain camp.

A Bloomberg news article is titled, "McCain Poll Surge, Fundraising Give
Democrats Election Jitters." It talks about how Democrats now worry they'll
lose the election. Rep. Arthur Davis, the Alabama Democrat who was Obama's
Harvard Law classmate, says the GOP just had its best week in four years.

And Obama & Co. are completely flummoxed as to what to do about the Palin
phenomenon. The normally unflappable Sen. Obama actually says, "You can put
lipstick on a pig, but it's still a pig." Whew. That one will add several
points to the McCain-Palin column. "Holy Sow!" reads the New York Post
headline, hammering home the mistake.

Even Camille Paglia, a strong Obama supporter, is waxing rhapsodic over
Sarah Palin. Paglia calls her "a new style of muscular American feminism"; a
"brash ambassador from America's pioneer past"; an "optimistic pragmatist
like Ronald Reagan." Following Palin's GOP convention speech, I compared the
governor to a Western pioneer version of Margaret Thatcher. I'm glad to see
Ms. Paglia pick up on that.

A story by Sen. Jim DeMint (R., S.C.) in the Wall Street Journal is titled,
"Yes, Palin Did Stop that Bridge." The senator says Palin may once have
supported the infamous Bridge to Nowhere, but she then killed it. And let's
not get into the flip-flop argument. Both Obama and McCain have flip-flopped
this year. And anyway, who cares if you flip-flop if you land in the right
place? Sen. DeMint notes that Palin cut nearly 10 percent of Alaska's
budget. And he should have reminded folks that Obama voted for the
pork-barrel farm bill -- chock full of earmarks and waste -- and then voted
again to overturn President Bush's veto of the bill.

A USA Today headline says "Palin Did Not Ban Books in Wasilla as Mayor."
After interviewing a bunch of local folks, the author simply could not
confirm the charge made by left-wing bloggers.

In "The Hunt for Sarah October," the Wall Street Journal's John Fund writes
about a 30-lawyer S.W.A.T. team of Obama Democrats descending on Alaska in
search of dirt related to "Palin's troopergate." They found nothing that
hasn't already aired about Palin's alcoholic ex-brother-in-law who tasered
his stepson.

Over in the Journal's Political Diary, Steve Moore says GOP House members
back from vacation are actually talking about picking up seats in November,
with a recent USA Today poll putting GOP members up four points on the
question: Who do you support, the Republican or the Democrat for Congress in
your district?

Even the financial pages are looking better. Oil is about to drop under $100
a barrel. Gold is plunging. And the greenback continues to rally in true
King Dollar fashion. Is there a Sarah Palin effect here, too?

On the campaign trail, Gov. Palin says, "We're going to drill now to make
this nation energy independent." And she adds that she's "ready to help John
McCain bring tax relief to all Americans." That's the disciplined Sarah on
message. She signaled this in St. Paul when she said the difference between
a hockey mom and a pitbull is lipstick. Obama picked up on the dark side of
that metaphor. But Palin's really saying: Don't tread on me. Don't try to
intimidate me. I am a strong, tough mom who is determined to succeed in
politics.

That's just what she's doing.

An investment bank really only has three things—working capital, smart finance guys and client trust.

Capital can be raised and American business schools educate lots of sharp minds. Trust is tougher to find.

In the world of mergers and acquisitions and initial stock/bond offerings, clients often navigate complicated, perilous transactions requiring complete confidence in the integrity of their investment bankers.

Mr. Fuld has tried to rescue Lehman from disaster one too many times. Only a foolish corporate executive would trust Lehman to handle their most prized assets. Hence, Lehman's investment banking business is not worth much in the hands of its current management.

Less its toxic real estate assets and investment management unit, Lehman’s only real value is its client relationships. Those must be transferred to a more trustworthy firm to have any value.

No other large firm should buy Lehman whole—its real estate and securities are too difficult to value. Only a fool would think he could fairly assess their value, unless they were given a value of zero.

Most of the major banks hold similar toxic assets. If another major bank finds its way into similar straights as Lehman, which is likely, the second fire sale would mandate an even lower book value for Lehman’s mortgage-backed securities than could be assigned now.

This explains why one of the solutions offered stalled Saturday—peeling off Lehman’s investment bank and investment management unit for sale, creating another bank holding with its toxic assets, and shoring up the latter with cash injections from other banks.

Most other banks need all the cash they have to cover their own bad securities, and any money they put into a crippled holding company would likely just be lost.

What’s more, Mr. Fuld likely has an outsized view of what Lehman is worth, less the bad assets, and he is likely seeking too much to compensate himself and his band of co-conspirators. We should never underestimate the hubris of a New York banker.

The Federal Reserve, which is propping up the banks and securities companies with huge loans, should require them to reveal their counterparty deals with Lehman and broker pairing of those deals to unwind transactions with Lehman. That would minimize the destabilizing impact on credit markets of closing Lehman. Then the Treasury can introduce Fuld to a good bankruptcy lawyer.

Lehman executives would find it difficult to replicate their compensation elsewhere, and the re-adjustment of banking compensation to more realistic levels and responsible schemes is necessary to return Wall Street to sanity.

Performance-based compensation that pays big bonuses when bankers bet right, but that only imposes losses on shareholders when bankers bet wrong has propagated the kind of toxic financial engineering that caused a mortgage-backed securities meltdown, a general credit crisis, and the near death experience of many Wall Street banks and securities dealers.

Paying bankers more reasonably is as necessary to restoring the operation of credit markets as the general deleveraging Ben Bernanke talks about.

Sadly, Vikram Pandit at Citigroup, John Thane at Merrill Lynch, and others can’t let go of the fantasy that their 35-year old MBAs are worth as much as Yankee shortstop Derek Jeter, and that they in turn are worth multiples of that.

All the shareholder value they have destroyed offers another conclusion.

It is time to toss in the towel on Lehman, unwind the counterparty trades and march it through Chapter 7. Unemployed brethren at Lehman may cause Pandit, Thane and others to finally see the need to genuinely reform compensation and business practices.

Weyerhaeuser can provide the rest--plywood and nails. Board up the windows and send the Lehman bankers home.

Income and wealth inequality are blamed on a tax code believed to be insufficiently progressive. Slow wage growth is blamed on greedy corporations and CEOs capturing all the gains for themselves. Job losses, especially in the manufacturing sector, are blamed on outsourcing, The market is also blamed for the other supposed difficulties facing our economy. a result of too much free trade. Expensive health care is blamed on greedy, callous insurance companies. For those who believe we’ve had too much of the free market, the answer is obvious – government must become more involved in directing the course of the economy and consumers need protection from the predators practicing lassez faire economics.

This narrative is believed, fervently in some cases, by those who see government as a benign entity – if it were only populated with more of the enlightened politicians of a particular party. Unfortunately for them, we do not live in the free market world they describe and the benign government they envision does not exist. Our problems have been caused not by too little government, but too much. The politicians that populate the halls of power, no matter their party affiliation, are not the idealistic individuals naïve voters conjure in their dreams of power.

The prescription offered by these idealistic, if misguided, individuals is a familiar refrain. Raise taxes on the rich to reduce inequality. Increase regulatory oversight in all areas of the economy. Increase government spending on infrastructure. Increase government directed investment in favored industries. Protect American jobs by raising tariffs against low wage countries. Increase union membership and raise the minimum wage through legislative action. Increase healthcare coverage through mandates and direct government spending. Increase taxes on “bad” industries and transfer the revenue to “good” industries or consumers.

These solutions may make us feel better about ourselves, but if we are to get this right, we need solutions that work. The solutions offered have already been tried, here and in other countries, and found lacking. After the collapse of twin stock and real estate bubbles (sound familiar?), the Japanese government propped up failing banks, raised taxes, increased government spending on infrastructure and ultimately reduced interest rates to 0%. The result is an economy that is still struggling and a stock market still less than half its peak value. They’ve only avoided high unemployment because of low growth of the labor force due to aging and low population growth. Furthermore, Japanese government debt is now 180% of GDP. Is this the example we want to emulate?

Increasing regulation raises the cost of doing business and reduces job growth. Raising taxes and increasing tax credits for the poor takes capital from those who will invest it in productive, job producing enterprises and transfers it to those more likely to consume. Raising wages for existing workers benefits those already employed at the expense of those who are not. Raising tariffs reduces the variety of consumer goods while limiting the potential markets of exporters. Investing tax dollars in infrastructure and alternative fuels merely diverts investment from productive private uses to inefficient public uses. Mandating health insurance coverage by private employers reduces wage growth.

One of the reasons that Americans increasingly reject free market principles is because they have been convinced that the free market reforms of the Reagan generation have failed. Those reforms - less regulation and lower taxes - are seen as the cause of our problems. Looking at today’s economy one is tempted to agree, but that simple analysis ignores the fact that the Reagan revolution failed in two important areas that are required for the very long term health of our economy: a balanced budget and a stable currency.

Since President Nixon removed the dollar’s last link to gold, monetary policy has been seen by our politicians as the first, and for many the last, tool of economic policy. The only exception is the first term of Ronald Reagan which saw dramatic tax cuts and deregulation of various industries. Those tax cuts and deregulation unleashed a wave of investment from which we still benefit today. Unfortunately, the gains of the Reagan revolution were limited by the lack of monetary reform. Since that time, every economic hiccup has been “solved” by an increase in credit from the Federal Reserve. Meanwhile the value of the dollar, however you define it, has gone through 5 major cycles. It fell after the end of Bretton Woods, rose during Reagan’s first term, fell through the first Bush administration, generally rose during the Clinton years and has fallen again during the second Bush administration.

At the same time, our government has become increasingly reckless with the public purse. From the end of WWII to the end of Bretton Woods, the federal budget quadrupled. That included two wars (Korea and Vietnam) and the budget alternated between minor deficits and minor surpluses. Since ending the last link to gold in 1971, the federal budget has expanded 12 fold and run deficits in all but two years.

The path to recovery for our economy is well worn and proven. Corporate taxes should be reduced dramatically or preferably eliminated. Individual taxes should not be raised and preferably reduced. Regulation should be limited and effective. Banking reform should include a gradual increase in capital requirements. Trade should be expanded, not limited through tariffs and stealthy “fair” trade laments. Most importantly, the Federal Reserve should be reformed and given one mission – a stable currency. Not a rising dollar, not a falling dollar, but a stable dollar. The best way to accomplish that mission is by stabilizing the price of gold. A stable currency, once again linked to gold, will eliminate inflation and limit government spending.

The policies that advocate more government are borne of fear. The policies of the free market are borne from optimism. America is not a place that was built on fear. Our choice is clear.

Last March, acting in conjunction with Fed head Ben Bernanke, Paulson safeguarded the banking system and the whole global financial structure by backstopping a JPMorgan-Chase deal to acquire the ailing Bear Stearns with $29 billion of loan guarantees. The action succeeded in stabilizing markets, but it put U.S. taxpayers on the hook big-time.

Then last week Paulson stepped into the breach again by backstopping mortgage lenders Fannie Mae and Freddie Mac. It was a necessary action. It stopped a global money meltdown. But it raised the stakes for taxpayers once more.

So this time around, as the Lehman stock headed for zero, Paulson said enough is enough.

Paulson’s view -- supported by Bernanke and former Clinton Treasury official Timothy Geithner (now the president of the New York Fed) -- is that the private sector has to take responsibility, including a consortium of private bank funds to assist the beleaguered AIG insurance company. We are now in for some Schumpeterian gales of creative destruction. But this is how it must be.

“Moral hazard,” said Paulson, “is something I don’t take lightly.” He’s saying bad financial behavior must be penalized, not rewarded. That’s the essence of the issue. The risk of failure is essential to an efficient economic system, and that includes financial risk.

In our capitalist system there are losers as well as winners. There are failures as well as successes. Harking back to the eminent economist Joseph Schumpeter, the old failures will be replaced by new enterprises.

The alternative, of course, is that the U.S. goes down the old European path of government domination of markets and the economy. But the moment the U.S. becomes bailout nation, that is the moment our economy and country heads irrevocably down the road of decline. However, Paulson set down a marker and said, “No we won’t.” As difficult as the next days may be, the primacy of economic freedom has been given a boost while the economic future of the U.S. looks brighter. Paulson’s decision was both momentous and transformative.

Obama is on the campaign trail predictably charging that a lack of regulations during the Bush era is responsible for the current mess. But he’s misreading history. As George Mason economist Tyler Cowen wrote in the New York Times, one of the problems with the U.S. financial system is not a lack of regulation, but a lack of smart and effective regulation.

During the Bush years, financial regulations increased exponentially, beginning with the misbegotten Sarbanes-Oxley act. That put accountants and lawyers in the driver’s seat rather than entrepreneurs. And it turns out that neither the Fed, the FDIC, the Comptroller of the Currency, nor the SEC properly supervised high-risk leveraged borrowings and the capital-adequacy ratios necessary to safeguard against losses. Accounting standards need reform, especially the notion of fair value. Economist David Malpass wants to throw out mark-to-market all together. He has a good point.

Then there’s Congress, led by Democrats in the last two years and Republicans before that, which mandated substandard lending to low-income groups. And as the high-risk loans mounted, this very same Congress -- under the gun of political contributions -- continued to promote the excesses of lenders, including Fannie Mae and Freddie Mac.

There are many more issues wound up in all this. But one thing’s for sure. Keeping tax rates low, holding back cheap-money inflation, strengthening the dollar, and building a more effective regulatory structure that does not stifle free enterprise is what will promote long-run economic prosperity. For optimists like myself, the plunge in oil and gas pump prices is already producing a sizable tax-cut effect, planting the seeds of recovery for mortgage-holding consumers and everyone else.

It’s easy to be overly pessimistic right now. But that negativism is not written in stone. Mr. Paulson talks about a housing and financial recovery in terms of months, not years. And I think he’s right. But his courageous action to put a stop to bailout fever will do as much as anything to move the nation toward recovery.

In a 2003 speech made while he was vice chairman at the Fed, Bernanke spoke about the possibility of future inflation; specifically that “the effective slack in the economy may be less than we now think, and inflationary pressures may emerge more quickly than we currently expect.” In July of 2005, in a Wall Street Journal op-ed written just months before his nomination as Fed chief, Bernanke asserted that there is a “highest level of employment that can be sustained without creating inflationary pressure.” And since taking over as Fed chairman in 2006, Bernanke has regularly characterized inflation as a function of too much growth. Now, with the dollar still at near historical lows versus gold and other foreign currencies, he says inflation will moderate in coming quarters given his view that slower growth ahead will be the fix for pricing pressures.

H.C. Wainwright research has of course shown the opposite; that if anything high historical rates of GDP growth occur alongside low rates of inflation. This commentary will marry the empirical with the anecdotal in arguing that Fed thinking is wrong. Economic growth can in no way be an inflation accelerant.

A globalizing labor market. Probably the best place to start is employment. Ben Bernanke has made it plain that if U.S. unemployment gets too low, inflationary pressure will be the result. At first glance this makes sense. If there’s a labor shortage, employers presumably have to offer higher wages and salaries to existing and prospective workers, and that might theoretically push prices up too.

But given a second pass, Bernanke’s assumptions don’t hold up. First off, the number of prospective workers is hardly static. If demand for workers is rising in such a way that there is wage pressure, workers on the sidelines will be more willing to offer up their services with knowledge that they’ll be compensated more handsomely.

Secondly, rising wage pressures that result from lack of labor supply are a positive market signal rather than a warning sign about inflation. Wage pressures merely tell the sidelined or underutilized worker to relocate to achieve wage gains. In the end, rising wages are moderated by rising labor supply to capture those same wages.

Taking this further, no doubt everyone is aware of the various talking-head economic scaremongers on TV. CNN’s Lou Dobbs, for example, for several years now has used his soapbox to criticize U.S.-based companies that have moved jobs overseas. But “offshoring” is a positive economic trend that allows for greater work specialization and production, and so long as U.S. companies continue to access the abundant supply of labor from around the world, there’s less need to worry about wage pressures here.

To offer up but one example, Beaverton (OR) based Nike has never manufactured any of the products it sells in the United States. When policymakers at the Fed suggest that falling unemployment in the states is inflationary they ignore the fact that U.S. companies employ the world’s labor force in carrying out their operations. That they do calls into question an inflation model that is heavily based on domestic job pressures, or the lack thereof.

We must also remember how Americans increasingly conduct their individual lives. Most no longer transact with a live human being when buying movie and airplane tickets, when filling their cars up with gasoline, or when they go to the bank to deposit or withdraw money. Big-box producers like Wal-Mart and smaller pharmacies such as CVS increasingly offer self-serve checkout lines involving no human contact while shopping.

Forgetting the migratory path of labor, not to mention the certain availability of foreign labor, markets continue to innovate around labor shortages. Unfortunately, when the Fed uses its interest rate mechanism to slow down the economy and wage pressures, it inhibits the process whereby economic actors innovate, and through innovation, enhance the very productivity that attracts more capital.

Economic “slack.” Moving to capacity utilization, or what Bernanke terms the “amount of slack in the economy,” various FOMC press releases since he took over in 2006 have had a variation of the following statement: “While the Fed expects inflation to moderate, a high level of resource utilization has the potential to sustain those [inflationary] pressures.” Fed thinking here is that if the economy really starts growing, there exists the possibility that producers will run out of manufacturing capacity due to excess demand such that prices will rise.

This too might seem reasonable at first in that the supply/demand function is certainly a factor in pricing. But capacity is hardly static either. Instead, it’s very dynamic in the sense that looming capacity shortages serve as a signal for producers that causes them to increase the very capacity that Fed models deem fixed. It’s also true that manufacturers regularly enhance their production techniques to get more out of their existing assets, thereby increasing capacity.

An easy example is to look at the quality of Ford Motor Company’s initial factories in the early 20th century compared to those in operation today. No one would credibly compare the two, and sure enough, one reason the U.S. auto sector presently struggles is that productivity enhancements have made contracts entered into with labor unions very dated in scope. The basic reality is that all manufacturers need less and less in the way of human inputs to create the goods we buy.

Oil refineries are another example. Much is made of the fact that regulations have made it not worth the hassle for oil companies to build more of them. While that’s true, the main reason the number of U.S.-based refineries continues to shrink has to do with more and more output being derived from the existing ones.

Furthermore, we once again can’t ignore that U.S.-based companies of all stripes continue to access world capacity in order to create the finished products that consumers and companies purchase. Boeing is presently building its 787 Dreamliner in six different countries around the world. And while Apple Computer’s iPods and iPhones were designed in the States, the manufacture of both occurs in Asia. When the Fed worries about capacity stateside being the source of inflationary pressures it assumes that our manufacturing capacity is limited to these fifty states. Happily it is not.

Is demand growth inflationary? The prevailing view at the Federal Reserve is that excess demand itself is inflationary. For background, in a 2007 speech at Stanford, Ben Bernanke questioned whether increased worldwide economic integration has actually driven prices lower. While strongly advocating globalization and free trade, Bernanke said “there seems to be little basis for concluding that globalization overall has significantly reduced inflation” and that “indeed, the opposite may be true.”

Bernanke specifically pointed to demand from China and other formerly dormant countries as major contributors to rising energy and commodity prices in recent years. He also cited a study that showed oil prices in 2005 would have been as much as 40 percent lower absent demand from those economically resurgent countries. That the price of oil since 2001 is up roughly 380 percent in dollars versus 160 percent in euros seemingly did not factor into his analysis, and sure enough, the Fed continues to ignore the dollar’s emasculation as a driver of the commodity market price boom.

Can excess demand or supply affect the general price level? No doubt a shortage of iPhones, flat-screen televisions or hotel rooms in New York City would drive up the price of all three and, to some, this would be inflationary. This theory breaks down because it assumes an increase in income. Without that, if demand for certain products is pushing prices up, demand in other areas must be falling, and in the process, driving other prices down.

Prices at the pump for the average individual have tripled in recent years. That means that the same individual would have a great deal less income to demand other products previously accessible. In sum, the net effect of demand-driven inflation is zero. Demand drives up relative (real) prices for specific items but not necessarily money (nominal) prices.

Is supply growth deflationary? Conversely, while still at the Fed, and in testimony before the Joint Economic Committee, Alan Greenspan said the addition of over 100 million educated workers to the global workforce from the former Soviet Union, China, and India would “double the overall supply of labor,” and that this growth in the number of workers would help “to contain inflation” in the future.

Initially, Greenspan’s reasoning perhaps made a lot of sense. Millions of new workers would certainly drive up supply, and that would put downward pressure on prices. But what Greenspan left out is that for the Indians and Chinese, just as for every worker in the world, what they supply becomes their demand.

Laborers trade products for products, so while the influx of new workers would obviously increase the world supply of goods, it would also yield a commensurate increase in the demand for goods. Newly freed workers in Russia, India and China aren’t creating products for us so that they can remain poor. Instead, they produce to enhance their lifestyles in hopes of eventually living like us.

Some might say that workers around the world save more than us, and that due to savings, their demand will not be commensurate with their supply. This makes the false assumption that savings detract from demand. In truth, banks don’t sit on money saved, but rather lend that money to businesses and entrepreneurs possessing labor and product demands themselves. Money saved is also lent out to individuals intent on spending the money immediately.

It’s also said that the influx of cheap goods from overseas has helped to contain U.S. inflation in recent years. While that may be true when we consider the false readings offered up by product-based government measures of inflation, this assumption doesn’t pass muster when it comes to the general price level. More realistically, if the U.S. is inundated with massive amounts of cheap goods from overseas, its consumers now have more money to demand other goods previously unattainable. Or, if they save money previously spent on essentials, that capital will fund the buying power of new labor entering the workforce. Taking nothing away from the life-enhancing wonder of free trade, its net inflationary or disinflationary effect is zero.

The counter-productive effect of Fed anti-inflation policy. Ultimately, Federal Reserve assumptions about the nature of inflation have a major monetary impact. To read FOMC statements about interest rates, the Fed does not raise rates with a stronger dollar specifically in mind, but to reduce “resource utilization” or, in normal parlance, to slow down employment and production so that the economy doesn’t hit its alleged limits. That being the case, Fed actions to cool economic growth work 100% against its efforts to reduce true inflation.

Indeed, even if we assume that capacity and labor utilization are high within the U.S., this, if anything, would put a damper on inflationary pressures. When businesses produce goods for sale, and when workers supply labor, they are implicitly demanding money. So we can say the total amount of goods and labor for sale on any given day constitutes demand for money. Hence, when the economy is growing, dollar liquidity is shrinking. Or, when the economy is losing steam, liquidity is expanding. If resource utilization is subsiding alongside rising unemployment, the signal is that the demand for money has shrunk, or that there’s too much liquidity.

That’s why inflation correlates so well with economic weakness. From 1970 to 1982, the U.S. economy experienced no fewer than four recessions, but the time in question is notable as a highly inflationary era.

Conversely, the economy grew almost without interruption from 1982 to 2000. If we relied on Fed models to divine inflationary pressures, we might have guessed that the ’80s and ’90s were a time of rising consumer prices, and surely skyrocketing commodities prices. Instead, the CPI measure of inflation was 2.7 percent by the end of the millennium (compared to 13 percent in 1979) while gold, the best monetary benchmark of them all, was trading at a modern low of $255/ounce.

The Fed’s Phillips Curve inflation models aren’t just wrong. They rob workers, manufacturers and investors of the necessary market signals that reveal when an economy is growing or contracting. When the Fed seeks to cool economic growth it does nothing to reduce the general price level, but workers sadly miss out on temporary or long-term wage increases that might result from a rising economy. Producers miss out on market signals telling them what to produce more or less of in the future. And investors are forced to make uncertain investment decisions given the knowledge that the Fed seeks to manage the economy rather than simply target the value of the dollar.

The Phillips Curve has zero predictive powers in the area of inflation, but as evidenced by a flat S&P 500 over the last ten years and an uncertain economy at present, continued reliance on this model will serve as a growth retardant.

Adherence to such a model will also further discredit our central bank. It can be hoped that as the Fed’s reputation plummets, the desire held by many for a price rule to stabilize the dollar will catch on. With that, the notion of limits to growth will be buried for good.

Why is this bailout happening in the world’s most avowedly capitalist country? Don’t venerable capitalist principles imply that anyone who believed in the real estate bubble and who invested in Fannie and Freddie must accept their losses? Is it fair that innocent taxpayers must now pay for their mistakes?

The answers to such questions would be obvious if the moral issues in the current financial crisis were clear-cut. But they are not.

Most importantly, it is not clear that the bailout will actually impose any net costs on US taxpayers, since it may prevent further systemic effects that bring down the financial sector and, with it, the world economy. Just because systemic effects are difficult to quantify does not mean that they are not real.

The bonds issued by Fannie and Freddie were widely thought to carry an implicit US government guarantee. Even though there was no official guarantee, the US government’s failure to come to the rescue could destroy confidence in government debt, and, by association, other financial paper as well.

The issues go far beyond the US economy. The global economy has been driven in recent years by remarkable speculative asset booms and busts, which bring into the equation questions of confidence and trust, as well as fairness. Similar housing booms in many other countries are now ending, and they may face the pain – and the moral dilemmas – that the US economy is now experiencing.

Moreover, housing markets are not the only issue. So are stock markets. The Shanghai Composite in China rose by a factor of five in real terms from 2005 to 2007, and then lost two-thirds of its real value. The Sensex in India rose by a factor of five in real terms over 2003 to 2007, and has since lost a third of its value. Similar stock market booms and busts have occurred in many other countries.

While they lasted, the booms that preceded these busts caused these economies to overheat. Now that the booms have been reversed, a decline in confidence could engulf the world economy, throwing it into recession. To prevent that, some selective bailouts will likely be needed, not to support the market but to deal with injustices.

There is no accurate science of confidence, no way of knowing how people will react to a failure to help when markets collapse. People’s reactions to these events depend on their emotions and their sense of justice.

The booms and busts have caused great redistributions of wealth. People who bought into the stock market or housing market did either well or poorly, depending on their timing. People will judge the fairness of these outcomes in terms of what they were told, and what kinds of implicit promises they inferred.

What were people in all these countries told about the markets in which they invested? Was it all really truthful? Unfortunately, there is no way to find out. Policymakers can provide only general responses, not deal with all cases individually.

We do know that recent economic growth in many countries has been spectacular. But were investments in their markets oversold? Did cynical salespeople in these and other countries lead people to believe that the boom times would produce wealth for everyone?

To be sure, while there may have been much ‘cheap talk’ – general advice with disclaimers – most of the losers in this game are not starving. But we cannot blithely conclude that all the losses should be allowed to stand in full force.

The gnawing problem is one of ‘good faith’. Economies prosper only on the perception that ‘good faith’ exists. The current situation, in which speculative booms have driven the world economy – and, having collapsed, are now driving it into recession – suggests that there may have been a lot of bad faith by people promoting certain investments.

Consider investors in Fannie and Freddie bonds. While the US government never officially promised to bail them out, it did create a special agency, the Office of Federal Housing Enterprise Oversight, which was to assess their strength in an annual report. But this agency never even acknowledged that there was a housing bubble. Government leaders gave no warnings.

So can we really say that investors must suffer the full consequences of any losses? How can this be fair?

The world is discovering capitalism and its power to transform economies. But capitalism relies on good faith. A perception of unfair treatment can be deadly to economic growth, because it means that people will lose trust in businesses, and hence be less willing to offer to them their precious capital and labor. Is that outcome morally superior to a bailout?

Robert Shiller is Professor of Economics at Yale, chief economist at MacroMarkets LLC and is the author of "Subprime Solution: How Today’s Global Financial Crisis Happened and What to Do About It".

Starting in the early 1980s, Wall Street entered into a period of unprecedented growth that has been interrupted by only a few short blips in the late 1980s and in the early part of the new century. The Street had foundered in the tumultuous 1970s when high interests rates helped discourage foreign investment in the U.S. and kept inflation-adjusted housing prices here at home flat (does anyone remember 14 percent fixed-rate mortgages?). But when the U.S. tamed inflation in the early 1980s, just as a generation of baby boomers were entering their prime earning, spending and investing years, Wall Street went on a long boom. During the first phase of that boom, the Dow Jones Industrial Average tripled from the opening of 1980 through the market’s peak in 1987, while securities industry employment in New York’s financial center, which had declined throughout the 1970s, more than doubled between 1980 and 1987.

Wall Street has proved remarkably good at re-inventing itself during this 25-to-30 year period, even when times seemed as bad as today. After the junk-bond market—whose rise had fueled a buyout binge that produced big investment banking profits—tanked in the late 1980s, Wall Street seemed headed for an enormous pullback. The decline of the high-yield market, accompanied by the infamous insider trading scandals, ultimately provoked the complete collapse of Drexel Burnham Lambert, which at its height was the nation’s fifth largest investment bank—employing some 11,000 people. A number of other venerable names also disappeared during those tumultuous years, including E.F. Hutton, weakened so that it had to seek a merger with Shearson Lehman.

But by the early 1990s, Wall Street was already on to new things, including an investment banking and public offering boom fueled by new technologies, and especially by this funny thing we called the information super-highway, or the Internet, for short. The technology-heavy NASDAQ composite index soared some ten-fold in the 1990s before peaking at above 5,000 in March of 2000, while employment on Wall Street increased 40 percent. By the end of the decade, the average annual pay on Wall Street was an exhilarating $250,000 per worker.

Although Wall Street’s profits, employment rolls and pay levels slumped following the bursting of the tech bubble in 2000 and then the attacks of 9-11, it didn’t take long for the firms to turn the low-interest rates of that period, and the housing boom they produced, into a profit-making machine in the form of mortgage-backed securities. What had once been a nice little business became the business of much of the Street in the last few years.

It was unexpected. After the tech bubble burst I remember an investment strategist for one of the big firms telling me that Wall Street had lost the confidence of its customers and it would be years before investment banks earned it back. His prediction sounded a lot like what critics of Wall Street envisaged after the junk-bond and insider trading scandals. But customers quickly returned to the firms in the very low-interest rate environment of post 9-11, snapping up collateralized debt obligations just as they had returned in the mid-1990s to snap up tech stocks. Even sophisticated institutional investors seemed unable to resist jumping into a risky but rising market, perhaps because they couldn’t afford to post investment returns that lagged behind their competitors by ignoring the hot new investment product.

But being burned for a third time may break the spell. With financial markets emerging around the world and new opportunities rising in developing countries, international investors who have been torched once too often may finally come to distrust what American investment banks peddle. The Wall Street firms that remain standing, moreover, may find their own balance sheets so weakened that it is years before they have the capital to make big, risky bets with their own money, which has been another source of profits on Wall Street. If that scenario plays out, Wall Street may find itself relying on the plain vanilla business of earning money on buying and selling stocks for customers—a low margin business—and arranging the occasional merger or public offering. Don’t look for the kind of hiring, bonuses or profits from that world that Wall Street has gotten used to.

Trying to predict the series of dominoes that would fall if investors around the world lose confidence in American finance is a speculative game that’s impossible to play accurately. Suffice it to say that the hundreds of billions of dollars that have already disappeared from portfolios worldwide are funds that are not going to be invested in American companies. The returns on a generation of IRAs and 401k accounts from baby boomers just starting to retire look ugly.

Meanwhile, governments which have expanded for years on the tax monies thrown off by Wall Street will face fiscal strains reminiscent of the 1970s. New York City, led by a mayor right off of Wall Street, has been spending money since 9-11 at twice the rate of inflation, so that the city’s surpluses of the last few years will provide only the briefest of cushions in a long downturn, while the subsidy that a thriving Wall Street has provided to the rest of a foundering New York State economy will disappear. Expect soon to hear calls from both the city and the state for federal help.

I can hear the optimists telling me that this is too bleak a scenario. The very fact that Wall Street has found its way out of previous crises is evidence it will come up with something novel and irresistible for a new generation of investors.

But I’m not so sure the world is waiting anymore to be wowed by Wall Street.

This is all relevant now given the events of the past week. Indeed, had anyone said just one year ago that alongside 5% unemployment Wall Street was on the verge of overseeing possibly $1 trillion of losses and the failure of three major investment banks, they would have been laughed out of the room. Reputation on Wall Street has once again told the tale in that both Merrill Lynch and Lehman Brothers were seen to varying degrees as too risky to re-capitalize or do serious business with as stand-alone entities.

Commentary since, including a RealClearMarkets piece, has touched on overpaid executives overseeing a business model that is broken. Wall Street has seen the enemy, and supposedly that enemy is Wall Street.

That’s true to a degree in that a uniquely American optimism often has those on and off the street of the view that trees DO grow to the sky. Maybe so, but investor optimism or "greed" does not explain what has and continues to unfold.

More realistically, strong markets never die of old age, but instead are grounded by policy failure. So as the markets crater, we're remarkably being told by both presidential candidates that the Washington that got us into this mess will somehow get us out. The political class's hubris is boundless.

As opposed to a broken business model, Wall Street (and the U.S. economy generally) suffers from a broken floating currency model; the gyrations of a dollar issued by our federal minders always foretelling pain in the future.

Think of it this way: while we could still build houses if the length of a foot changed with regularity, it’s a certainty that we’d build fewer homes while making far more mistakes in the process. Looked at in dollar terms, when the unit of account around which the world economy revolves is unstable, the potential for investment mistakes is magnified greatly.

Nearly ten years ago to the day, Lehman Brothers was similarly thought by some to be on the verge of collapse. The underlying miscreant then was a rising dollar that took out a major hedge fund in concert with broken foreign-currency pegs to the dollar around the world. Had the greenback been stable then, the distant memory of what is now termed the “Asia Crisis” would never have been.

Fast forward to this decade, the weak dollar policies of the Bush administration have led to similar investment errors. Von Mises used to say that when a currency weakens there’s a “flight to the real”, and sure enough the falling dollar drove all manner of investment into housing and mortgages such that a correction of some kind was inevitable.

It’s easy now to blame something opaque like Wall Street’s “business model,” but absent the illusions wrought by monetary debasement, it’s safe to say that investment would have been far more rational such that any mistakes would have been easily contained. Put simply, the answer to today’s problems does not lie in more regulation or taxpayer bailouts, but instead could be solved if Washington communicated to the markets a credible desire to stabilize the measuring rod of value that is the dollar. Rep. Ted Poe’s legislation to define the dollar as 1/500th of an ounce of gold would for now and in the future constitute the ultimate form of stimulus for ours and the world economy.

Lastly, when we contemplate the sad sight of various Lehman employees exiting the bankrupt firm’s headquarters with their belongings, there’s hopefully another lesson to be learned. While employment on Wall Street has long been seen as the easy path to riches, the risk required to create that wealth has at times been ignored. Needless to say, the banks over the years that have failed or been swallowed shows the flipside of big paychecks. High pay is merely the seen.

Far from overpaid individuals who’ve lucked into the earnings bonanza that is an investment bank, employees of the latter are to those who know them some of the hardest working people in the world. And when we consider that nearly every form of financing for businesses and mortgages has a Wall Street provenance, we should say that far from being overpaid, these people are heroes for constantly seeking to move capital to where it can be deployed most profitably.

So yes, banking types are handsomely compensated, but the harsh tradeoff is long hours doing the kind of work where mistakes of the individual or companywide variety can take one from a large paycheck one day to the rolls of the unemployed the next.

Looking ahead, readers should expect a great deal more knowing commentary about Wall Street yet again failing the good people of Main Street. This commentary will of course miss the point because an unstable dollar, not the actions of “greedy” bankers, explains the various investment mistakes that regularly harm companies and the good name of capitalism itself.

This week, Treasury secretary Hank Paulson said “no” to a government bailout of Lehman. Paulson and Ben Bernanke then took over AIG with an $85 billion bailout, with the Treasury issuing roughly $100 billion in new T-bills so the Fed has the cash to resuscitate AIG.

All this was necessary. A collapse of AIG would have been unfathomable -- it is simply too interconnected globally. But it turns out this rescue mission only elevated investor fears. Shareholders are asking: “Who’s next?”

The bears are now raiding Morgan Stanley and Goldman Sachs, two national treasures. Meanwhile, the Reserve Fund -- an original money-market fund launched by Bruce Bent, a hard-nosed friend of mine who for decades has supported conservative political causes -- has seen its net asset value drop from $1 to $0.97. That’s a shocker. And the reason? The fund’s holdings of Lehman commercial paper were unsupported by letters of credit.

Money-market funds are supposed to be safe havens for mom and pop -- for Mary and Joe in McKeesport, PA. But everybody now wants T-bills and gold.

Well, it’s time for some perspective. The world is not coming to an end. The stock market has tumbled, but it’s still over 10,000. In late 2002 it was 7,500 and in mid-1982 it was 750. Are things really that bad?

With home prices falling, foreclosures and defaults are at the root cause of the run against all manner of mortgage-related bonds held by the banks. But as investment guru Don Luskin points out, foreclosures today are less than 3 percent. During the 1930s they were 50 percent. Or how about the unemployment rate? Today it’s 6.1 percent. Back in 1982 it was near 11 percent and for most of the 1930s it was over 20 percent.

As the oil bubble pops the underlying inflation rate is somewhere between 2 and 3 percent -- quite unlike the double-digit hyperinflation of the 1970s. Home prices themselves have fallen between 10 and 20 percent, but they’re still about 50 percent higher than at the start of the decade.

And there are constructive policy measures that can help fix the market’s problems.

Investor Zachary Karabell writes persuasively in the Wall Street Journal that “mark-to-market accounting in the aftermath of the Enron scandal makes no sense at all.” Many banks have taken huge losses on mortgage-backed securities and their derivatives because the SEC insists on mark-to-market. But Karabell asks: Why knock down these bond values, sometimes by as much as 100 percent, when the underlying home values embedded in the mortgages have only dropped 10 to 20 percent? And in the long run, the housing market will recover, as it always does.

Bad accounting rules like this are sinking the financial system. And why hasn’t the SEC restored the up-tick rule to stem cascading share-price declines triggered by manic short-sellers? Short-sellers are an important part of the stock market, and they add liquidity at crucial junctures. But until July 2007, they could only short a stock after the share price rose, not while it was continuing to decline. The SEC also should restore the net-capital rule, which limits banks to a 12-to-1 leverage ratio governing their debt. Over-borrowing by Wall Street is what got many firms into deep trouble.

A gathering consensus also seems to be forming around a new version of the Resolution Trust Corporation, which effectively disposed of bad savings-and-loan assets in the early 1990s. A new RTC could purchase underwater assets that proliferate through the financial system and are clogging the credit and loan arteries of our banks.

We clearly are in an emergency moment. But the government should opt for smart regulatory action rather than broad-based interference that could stifle the free economy. On Thursday afternoon, as rumors spread that Paulson was talking President Bush into a new RTC, the stock market soared 400 points. That’s what I call an endorsement.

The pessimists are now talking about the end of capitalism or a permanent decline of America. I don’t believe that for one moment. Specific regulatory reforms can get us out of this fix. And most of all, policymakers must maintain the low-tax, low-inflation, open-trade formula that has propelled this nation’s economy and produced so much prosperity for so long.

I say, never sell America short.

The ratio between GDP and capital employed is higher during economic booms and lower during recessions. It was 40.1% during 1966, which was the peak year of the 1960s economic surge. It averaged nearly 38.0% 1997-1999, which was the height of the boom of the 1990s. The ratio of GDP to total capital employed was 31.2% during 1982, which was the pit of the worst post-war recession. Still, the year-to-year variation has been small. The bottom line is that GDP growth is caused by growth in total capital employed, which is driven by how much we invest each year.

There is also a predictable relationship between the growth of “private business investment” (PBI) and total employment. It takes 5% growth in PBI (from that of the previous year) to produce 1% growth in total jobs. If PBI doesn’t grow, employment doesn’t grow. If total employment grows less than about 1% per year, the unemployment rate goes up. PBI would have to grow at a high rate for a long period of time to bring unemployment down and to provide jobs for the millions of people currently categorized as “discouraged workers”.

Note that for GDP and total employment to rise, it is private capital investment that must increase. Capital investment by government tends to either be wasted or, worse, to crowd out productive private investment. This is what happened in the U.S. in the 1930s, in Japan during the 1990s, and in all socialist nations at all times. If governments could invest efficiently and create good jobs, communism would have worked.

The level of private capital investment is a function of two factors: expected profitability and the availability of capital. Every major element of Obama’s economic plan would have the effect of reducing the profitability of private business investment and/or impeding the supply of capital to businesses.

Large corporations have access to the international capital markets. Accordingly, how much they invest—and where—is a function of the after-tax profitability of their projects and their cost of capital. By raising taxes on dividends and capital gains, Obama’s tax plan would raise the cost of capital and thereby reduce the level of investment. It would also tend to drive investment overseas, to nations that are more friendly to capital.

Obama has also vowed to abolish the secret ballot for unionization elections. His announced purpose for doing this is to promote unionization. Unfortunately, unionization raises costs and lowers profitability. This is why companies generally oppose it. While expanded union membership might increase the wages and benefits of workers lucky enough to have jobs, it will result lower capital investment, reduced output, and fewer jobs in the U.S.

Small businesses provide most of the new jobs in America. Unlike large corporations, small businesses must finance their growth via after-tax cash flow. Small businesses don’t have access to the public markets, and it is very difficult for them to raise outside capital, period.

Most small, privately-held companies pay their income taxes via the personal tax returns of their owners. Obama’s plan to raise the top personal income tax rate will directly reduce both the profitability of, and capital availability to, small businesses. His proposal to eliminate the salary “cap” on Social Security taxes will reduce savings and therefore the availability of capital. Worst of all, his proposal for a 45% death tax rate would have the effect of forcing many small businesses to liquidate upon the death of their owners.

For the government to take via taxation money that would otherwise be invested is economically insane. It takes capital that is producing a 36.1% return for the nation and uses it to pay off government debt that carries an interest rate of about 3%. Obama’s plan would simply increase the insanity.

Obama seems to believe that sending out “tax rebates” to people who do not now pay taxes will somehow offset the higher costs and taxes that he would impose on businesses, savings, and investment. This belief is based upon the Keynesian superstition that “demand” is what matters, and that government spending creates demand. The 2008 economic stimulus program was based upon this superstition. As the data has come in, it has become clear that the “stimulus” didn’t work. Obama’s tax rebates won’t work either.

Obama also seems to believe that the government can use the money he plans to divert from private investment to create good jobs, especially so-called “green jobs”. As noted earlier, this approach has never worked in the entire economic history of the world. However, what Obama also doesn’t seem to realize is how much capital it takes to create a good job.

If you divide the total assets of a company by the number of employees, you get the amount of capital it takes to create the average job at that company. On this basis, it cost more than $69,000 to create an average job at Wal-Mart. The comparable number for McDonalds is over $75,000.

Given that Democrats seem to consider jobs at Wal-Mart and McDonalds to be unworthy of Americans, let’s look at what it costs to create “good” jobs. Perhaps the “green jobs” that Obama envisions creating would be comparable to an average job at Apple Computer or General Electric. Each job at Apple has an average of more than $1.1 million in capital behind it. The comparable number for GE is more than $2.4 million.

The average job at Exxon-Mobil is supported by more than $2.2 million in capital. Assuming that the Federal government was able to invest capital and create good jobs as competently as Exxon-Mobil, each billion dollars that Obama invested in creating “green jobs” would create all of 442 jobs.

The U.S. employment numbers are typically rounded to the nearest 100,000. To create 100,000 “green jobs” comparable to the average position at Exxon-Mobil would require an investment of $226 billion.

The Obama economic plan is based upon fantasy and superstition. It would be a job and economic growth destroying disaster. Let the buyer beware.

In the United States, there were two key decisions. The first, in the 1970’s, deregulated commissions paid to stockbrokers. The second, in the 1990’s, removed the Glass-Steagall Act’s restrictions on mixing commercial and investment banking. In the days of fixed commissions, investment banks could make a comfortable living booking stock trades. Deregulation meant competition and thinner margins. Elimination of Glass-Steagall then allowed commercial banks to encroach on the investment banks’ other traditional preserves.

In response, investment banks branched into new businesses like originating and distributing complex derivative securities. They borrowed money and put it to work to sustain their profitability. This gave rise to the first causes of the crisis: the originate-and-distribute model of securitization and the extensive use of leverage.

It is important to note that these were unintended consequences of basically sensible policy decisions. Other things being equal, deregulation allowed small investors to trade stocks more cheaply, which made them better off. But other things were not equal. In particular, the fact that investment banks, which were propelled into riskier activities by these policy changes, were entirely outside the regulatory net was a recipe for disaster.

Similarly, eliminating Glass-Steagall was fundamentally sensible. Conglomerates allow financial institutions to diversify their business, and combining with commercial banks allows investment banks to fund their operations using relatively stable deposits instead of fickle money markets. This model has proven its viability in Europe over a period of centuries, and its advantages are evident in the US even now with Bank of America’s purchase of Merrill Lynch.

But conglomeratization takes time. In the short run, Merrill, like the other investment banks, was allowed to double up its bets. It remained entirely outside the purview of the regulators. As a stand-alone entity, it was then vulnerable to market swings. A crisis sufficient to threaten the entire financial system was required to precipitate the inevitable conglomeratization.

The other element in the crisis was the set of policies that gave rise to global imbalances. The Bush administration cut taxes. The Fed cut interest rates in response to the 2001 recession. Financial innovation, meanwhile, worked to make credit even cheaper and more widely available. This, of course, is just the story of subprime mortgages in another guise. The result was increased US spending and the descent of measured household savings into negative territory.

Of equal importance were the rise of China and the decline of investment in Asia following the 1997-1998 financial crisis. With China saving nearly 50% of its GNP, all that money had to go somewhere. Much of it went into US treasuries and the obligations of Fannie Mae and Freddie Mac. This propped up the dollar and reduced the cost of borrowing for US households, encouraging them to live beyond their means. It also created a more buoyant market for the securities of Freddie and Fannie, feeding the originate-and-distribute machine.

Again, these were not outright policy mistakes. Lifting a billion Chinese out of poverty is arguably the single most important event in our lifetimes. The fact that the Fed responded quickly prevented the 2001 recession from worsening. But there were unintended consequences. The failure of US regulators to tighten capital and lending standards when abundant capital inflows combined with loose Fed policies ignited a furious credit boom. The failure of China to move more quickly to encourage higher domestic spending commensurate with its higher incomes added fuel to the fire.

Now, a bloated financial sector is being forced to retrench. Some outcomes, like the marriage of Bank of America and Merrill Lynch, are happier than others, like the bankruptcy of Lehman Brothers. But, either way, there will be downsizing. Foreign central banks are suffering capital losses on their unthinking investments. As they absorb their losses on US treasury and agency securities, capital flows toward the US will diminish. The US current-account deficit and the Asian surplus will shrink. US households will have to start saving again.

The one anomaly is that the dollar has strengthened in recent weeks. With the US no longer viewed as a supplier of high-quality financial assets, one would expect the dollar to have weakened. The dollar’s strength reflects the knee-jerk reaction of investors rushing into US treasuries as a safe haven. It is worth remembering that the same thing happened in August 2007, when the sub-prime crisis erupted. But once investors realized the extent of US financial problems, the rush into treasuries subsided, and the dollar resumed its decline. Now, as investors recall the extent of US financial problems, we will again see the dollar resume its decline.

Emphasizing greed and corruption as causes of the crisis leads to a bleak prognosis. We are not going to change human nature. We cannot make investors less greedy. But an emphasis on policy decisions suggests a more optimistic outlook. Unintended consequences cannot always be prevented. Policy mistakes may not always be avoidable. But they at least can be corrected. That, however, requires first looking more deeply into the root causes of the problem.

Barry Eichengreen is Professor of Economics at the University of California, Berkeley.

Happily, stock markets are most useful for pricing in the future, and with Sarbox’s passage a near certainty, the S&P 500 proceeded to fall nearly 175 points over the next three weeks. The markets of course knew what the political class did not, that the “only insecurity which is altogether paralyzing to the active energies of producers is that arising from the government.” John Stuart Mill wrote the latter in the 19th century, and as John McCain and Barack Obama have seemingly found common ground when it comes to their dislike of Wall Street, they would be wise to heed Mill’s words.

Indeed, in the aftermath of the government’s nationalization of AIG last week, McCain and Obama each sought an easy target. Rich and greedy Wall Street predictably served as the punching bag for two candidates whose combined private-sector experience makes them impressively unqualified to comment on anything economic.

But comment they did, and their words were largely interchangeable. Obama said “Washington wasn’t minding the store” while “CEOs got greedy”, whereas McCain said, “We’re gonna fight, we’re gonna fight the greed and irresponsibility on Wall Street.” He added that he’ll “reform Wall Street and fix Washington” since he’s “taken on tougher guys than this before.”

So while there are doubtless many things factoring into the present stock-market malaise, it says here that it in no way helps market psychology that the two men seeking the presidency are in a bidding war over who can be “toughest” when it comes to the regulation of our financial system. Obama backers shouldn’t be surprised by his populist message, and when it comes to McCain partisans, suffice it to say, they were surely warned.

From here, it would be easy to bash government, and correctly point out that from its oversight of everything from the ‘80s S&Ls to Hurricane Katrina recovery to the nation’s budget to banks today, that it is massively unsuited to regulate anything. To state the obvious would be to shoot fish in a crowded barrel. Simply put, “government oversight” is as oxymoronic a term as “virtuous streetwalker.”

More realistically, we should say that government regulation isn’t so much bad for the under-qualified bureaucrats that would engage in such a fatal conceit, but for government possessing all the wrong incentives to do a creditable job. We could attempt to staff Washington’s regulatory bodies with the best and brightest, but even if we did, as government officials working without all-important market signals, they would necessarily do a poor job due to the lack of financial discipline that comes with working in an actual marketplace.

It should also be said that government is shackled with another major disincentive in that unlike private-sector businesses that are rewarded for solving problems and doing more with less, government officials put themselves out of work if they actually solve a problem. With government “success” largely a function of increasing one’s turf, budget and employees, there exist few incentives to make that which isn’t working, better.

So while McCain and Obama promise more regulation despite its impressive record of only discovering problems after the fact, the better answer would be for one or both to recognize that markets regularly do the regulating. Indeed, just as our federal minders were late to Enron and Worldcom, so were they late to the recent crises that some say have the financial world on the brink of collapse.

Markets and the bold people who trade in them discovered Bear Stearns and Lehman Brothers, and they’ll surely expose future mistakes by commercial entities. In short, governments will forever regulate yesterday’s problems in ways that will bring us harm. That is so because economic growth is always and everywhere the result of productive work effort. Taxes and regulation (think Sarbox where innovative CEOs were forced to act as accountants) merely put restraints on the latter, while bailouts will slow any economic recovery for assets not reaching market-clearing levels that will bring the intrepid, value-oriented investor out of the woodwork.

And if we ignore how regulation saps the productive energies of entrepreneurs, we have to also remember that it is the regulated that frequently fail in ways that require taxpayers to come to the rescue. To confirm the latter, ask yourself how many bailouts taxpayers have funded of mostly unregulated Silicon Valley firms versus heavily regulated banks. The contrast is stark, and with good reason.

Indeed, many of the regulatory bodies that exist today do so at the pleasure of established firms. It is regulations that many companies hide behind as “evidence” that they’re conducting business within the guidelines set by the very bureaucrats least qualified to impose rules. The existence of regulation simply allows firms to deploy investor capital in the most risky of ways allowable, and with the regulator ever eager to be seen doing something once problems arise, the existence of that same regulation makes bailouts more likely so that the government in power can save face.

J.S. Mill concluded that “laws cannot be said to afford protection to property,” but that “fear of exposure” will force companies to act in ways we like. In other words, markets will continue to expose economic miscreants as opposed to more regulation that merely insures more of the same.

Over the past few years there has been a lot of concern that the US has become less competitive in attracting listings by foreign firm (for example, see Zingales 2007). A popular explanation is that the Sarbanes-Oxley Act of 2002 (SOX) has made it more costly for foreign firms to have a US listing – so much so, it is argued, that fewer foreign firms now choose to cross-list in the US and firms already listed want to leave US equity markets.

Foreign firms that list on US exchanges, such as the NYSE and NASDAQ, have to register with the Securities and Exchange Commission and as a result, become subject to US securities laws. Since 2002, these firms have also been subject to Sarbanes-Oxley. Until recently, foreign firms could easily delist their shares from a US exchange, but they faced extremely tough obstacles in deregistering their shares and, without deregistration, were still subject to US securities laws.

All of this changed when Exchange Act Rule 12h-6 was unanimously adopted by the Securities and Exchange Commission on 21 March 2007. This rule makes it easier for foreign firms to deregister by means of a straightforward capital-markets test based on the extent of trading activity of their securities in US markets. Now, it is much more realistic for them to consider taking the step of deregistration. Indeed, within six months following the passage of Rule 12h-6, 59 foreign firms filed for deregistration for the first time from US equity markets.

Two competing theories

Why did these firms choose to deregister and what are the consequences for their shareholders? There are two competing theories.

The “loss of competitiveness” theory, advocated by the Committee on Capital Markets Regulation.

The “bonding theory” proposes that firms choose to leave because it is no longer in the best interests of their controlling stakeholders to stay, and they drove the decision to come in the first place.

Each of these theories has direct and distinct implications for which foreign firms choose to deregister from US markets and for the shareholder wealth consequences of such decisions.

Loss of competitiveness theory: Firms that deregister were adversely affected by the Sarbanes-Oxley Act so that a US listing became a burden rather than a benefit for them.

Shareholders of foreign firms, in general, and of deregistering firms, in particular, were hurt by Sarbanes-Oxley – abnormal stock-price reactions around Sarbanes-Oxley announcements should be negative.

Shareholders benefit from the introduction of Rule 12h-6 and from firms’ deregistration announcements – abnormal stock price reactions should be positive.

Firms that deregister have poor growth opportunities and have performed poorly.

Shareholders of firms that deregister are hurt by deregistration since it increases corporate insiders’ discretion to extract private benefits – abnormal stock price reactions should be negative.

Deregistration hurts shareholders more when firms have higher growth opportunities.

In a recent paper, we examined the 59 firms that deregistered in the six months after Rule 12h-6 was adopted.1 Our analysis shows that deregistering firms have poor growth opportunities and experienced poor stock return performance over a number of years before deregistration. Compared to other foreign firms cross-listed on US exchanges, deregistering firms also have a significantly lower “cross-listing premium”, the valuation difference between cross-listed firms and their home-market counterparts, and this lower cross-listing premium cannot be explained by an adverse impact of Sarbanes-Oxley.

When we examined the stock-price reactions of deregistering firms around major events surrounding the passage of Sarbanes-Oxley, we found no evidence that these firms were affected adversely by the legislation compared to other foreign firms cross-listed on US exchanges. In fact, there is no clear evidence to suggest that foreign firms with US exchange listings were affected adversely by Sarbanes-Oxley at all. The average stock-price reactions of deregistering firms to the announcements of Rule 12h-6 are insignificantly different from zero as is the average stock-price reaction to firms’ deregistration announcements. However, the average reaction to deregistration announcements is negative and the proportion of firms with a negative stock-price reaction is significantly greater than 50%. Finally, firms with better growth opportunities have a significantly worse stock-price reaction around the deregistration announcements.

So, then, why do they leave?

None of this evidence is directly supportive of the loss of competitiveness theory. There is no reliable evidence that firms with US exchange listings were hurt by Sarbanes-Oxley, that the legislation had a more adverse impact on deregistering firms, or that firms gain from deregistration.

Conversely, some of this evidence is supportive of the bonding theory. Deregistering firms have lower growth opportunities, worse return performance, and there is some (though admittedly weaker) evidence to support the view that shareholders lose when firms deregister, especially shareholders of firms with better growth opportunities.

Overall, the evidence supports the hypothesis that foreign firms list shares in the US in order to raise capital at the lowest possible cost to finance growth opportunities and that, when those opportunities disappear, a US listing becomes less valuable to corporate insiders, so such firms are more likely to deregister and go home.

Craig Doidge is Associate Professor of Finance at the Rotman School of Management, University of Toronto. George Andrew Karolyi is Professor of Finance at Ohio State University. René M. Stulz is Professor of Finance at the Ohio State University.

References
Zingales, Luigi, 2007, Is the US capital market losing its competitive edge? Journal of Economic Perspectives, forthcoming.

Footnotes
1 See Craig Doidge, G. Andrew Karolyi, and René M. Stulz, 2008, Why do foreign firms leave US equity markets? An analysis of deregistrations under SEC Exchange Act Rule 12h-6

This is similar to the RTC story twenty years ago, when Bill Seidman presided over similar asset sales from bankrupt S&Ls and wound up making money for Uncle Sam and his taxpayers. A long prosperity wave followed.

In fact, industry insiders tell me the Federal Reserve and the SEC may be moving toward a five-to-seven year amortization plan for the scoring of bank losses from the sale of this distressed paper. This is very constructive. Fed head Ben Bernanke also is talking about getting rid of mark-to-market accounting and moving towards “hold to maturity.” This is good.

But the credit arteries are now clogged with a terrible virus that can be removed by the Paulson rescue plan. And as the problem is solved, credit and loans will be made more available to Main Street homeowners, small businesses, and consumers of every type. Credit markets will gradually unfreeze. It can be done. A deep recession can be avoided.

And maybe along the way we can get a strong King Dollar to fight inflation and attract international investment. And perhaps, just perhaps, we can get more drilling to reduce gas prices at the pump -- a big recovery tonic. And, dare I hope, maybe we even can get corporate tax reform with lower tax rates, which along with energy deregulation will spur jobs and wage growth.

But after Tuesday’s Senate hearing I’m very concerned. The bells and whistles that would be attached to Paulson’s plan by our Democratic friends are anti-capitalist and anti-opportunity.

Capping compensation for both the selling and purchasing institutions? What? Salaries and bonuses are no business of the government. People go to work for profits. For opportunities. It’s at the heart of our free-market capitalist system.

Now, I can understand companies like AIG, Fannie, and Freddie, which effectively have been nationalized. That’s different. I don’t care if they all make $75,000 a year, just like the regulators. But to stretch this to the banks that are selling or buying the assets goes beyond the pale. It’s France. But it’s France heading toward the old Soviet Union, or at least Tsar Putin’s Russia.

And then there’s the ownership question. Some Democrats want Uncle Sam to take an ownership position in all the selling and purchasing banks. This is nuts. In America, this is nothing but property confiscation. It also will sharply curb buyers of the distressed assets.

You think Henry Kravis or Steve Schwarzman are gonna take a salary cap and lose an ownership share of the private-equity funds they themselves created and built? They shouldn’t and they won’t. And these funds are crucial to the new process. The only banks that will sell in this over-regulatory environment are the absolute, near-bankruptcy turkeys.

Meanwhile, Sen. McCain apparently has proposed that the buying and selling banks have comp-levels no higher than the top paycheck in the U.S. government, which I guess is the president’s at around $400,000 a year. Hey, I’ve got an idea. Let’s raise the chief executive’s pay to $50 million. He probably earns it anyway.

It’s these congressional bells and whistles that really trouble me. And they also trouble the stock market. Stocks absolutely roared last Thursday and Friday when they got wind of Paulson’s program. But Monday and Tuesday, as the new details leaked out and various Democratic senators put their ideas on the table, shares plunged big time. What does that tell you?

I can understand legitimate concerns about a big-government intervention and a giant $700 billion number. There’s a shock effect here. But once in a while the financial center of capitalism goes into panic mode and something has to be done.

Actually, it’s a marvel that we permit government to infrequently come to the rescue of our credit system. It doesn’t happen everyday. But it has been necessary going all the way back to Alexander Hamilton’s original rescue of our failing debt system in the 1790s.

Understanding this history, conservatives should not panic or walk away from the Paulson assistance plan. It would be great to avoid either a deep credit-driven recession or a global banking meltdown -- or both. Paulson has always viewed his rescue plan as an economic-growth tool. I think he’s right.

RealClearMarkets: Can you draw parallels between the 1930s and now?

Amity Shlaes: The underdiscussed parallel is the international component. Back then the world seemed to be falling apart, and then, the U.S. as well. Now, not only do we have our domestic challenge but also China has just about stopped growing. Europe is feeling pretty smug these days but their entitlement obligations mean that can’t last, Brits excepted. A simultaneous downturn world over will worsen the trouble.

RCM: What else?

AS: In his book, Allan Meltzer went back and looked at banking policy in the 1920s and 1930s. He concluded that one of the problems was the so-called “real bills doctrine.” Others have also written about this --- Thomas Hall and J. David Ferguson in The Great Depression.

Real bills said lending on anything other than good commercial paper was inflationary. If no one came to borrow, the Fed should remain idle. Real bills also implied that if the Fed bought government securities, inflation would follow because they are not real bills. The effect was to help banks that are healthy and not help those that weren't.

The doctrine was perverse because it was “procyclical” – when you were in trouble was when you weren’t helped. Nowadays we believe in “countercyclical” policy, which says “loosen” when the country or the banks are in trouble.

The “mark to market” accounting rules of today are similar: procyclical when we need countercyclical measures. Just when you do want to sell, your balance sheet suddenly looks worse. That’s because you have to account for an asset by its price at the moment. Both the real bills doctrine and mark to market can be Catch 22s for financial markets.

But what if presently there is no market for the asset, of what if the market is thin? The analogy would be a town where only one house has sold, say a shack. The government then comes along and says that the mansion on the other side of town needs to be priced like the shack because the market had signaled that the shack price was the value for houses.

RCM: Beyond the parallels, do you see Washington making similar mistakes that prolonged the downturn in the '30s, and that will prolong any pain today?

AS: What mattered was not the 1929 Crash, or even the many aftershocks and the bank runs of the early 1930s. What mattered was the duration of the Depression, from 1929 to World War II. Imagine if the Dow did not come back to its highs of, say, October 2007 until 2032. That is what happened then – the Dow didn’t reach its 1929 levels until the mid-1950s. “Everybody a Millionaire Era Ended Quarter Century Ago in Plunge that Still Chills” was the New York Times headline in October 1954 when the Dow finally hit that 381 baseline.

What can cause such a long duration? Monetary policy and banking policy for sure, but also a government either a) overly involved in commerce or b) hostile to commerce.

A) Involved in Commerce: What the Paulson Treasury bailout reminds me of is the National Recovery Administration. The NRA gave wide license to industry to self-police and manage recovery. The NRA was all about deals – picking winners and losers. That’s the element of the Treasury proposal that is hard to like.

B) Hostility to Commerce: The New Dealers blamed the street, and so did Hoover before them. They also drove labor prices up too high relative to productivity, as Lee Ohanian of UCLA has shown.

Our equivalent scenario would be: raising taxes, ignoring Latin America, conducting “Pelosi Hearings” in the place of the Pecora Commission hearings of yore. In The Forgotten Man there’s a chapter called “A Year of Prosecution,” about 1934. When the New Deal didn’t bring complete recovery, the New Dealers tried to prosecute their way to economic success. That impulse is extremely destructive. The story this past weekend about President Uribe of Colombia visiting America seemed separate from the Treasury bailout story. But the two are related. Cutting back protectionism increases chances of saving Latin America politically. But it is also good for our economy.

RCM: Andrew Mellon is heroic in The Forgotten Man for his elevation of business and lower taxes, but ultimately he gave in to President Hoover's desire to raise the success penalty. What about being on the gold standard then required him to do that, and what do you think the impact would be today if the next president seeks to pass tax increases?

Under a gold standard, there needs to be gold in the bank for the economy to expand. Under a gold standard, too, countries compete for that gold. The gold goes to the countries in the best budgetary shape. If you are running a deficit, you are more of a credit risk than a country in surplus. In order to grow and get dollars, America needed good credit. Therefore it needed to balance the budget and increase federal revenues. Hence the tax hike of 1932.

This comes clear in the testimony of the men at Treasury, who were reluctant to hike taxes but felt they had to. “You cannot restore the credit structure of the country by increasing the public debt,” said Treasury Undersecretary Ogden Mills in 1932. The Treasury also put forward new car taxes, radio taxes, taxes on malt syrup and brewers, even an estate tax. This must have driven Andrew Mellon nuts since he disliked death taxes, especially. He’d seen the tax eat away at his friend Henry Clay Frick’s estate.

The gold standard was less forgiving than the current system. Under our post-Bretton-Woods arrangement, the case for lower rates to get higher revenues is more compelling.

As I have observed before, mortgage fraud soared in the run-up to this mess, and believe it or not, it’s continuing to rise. The FBI says that reports of suspicious mortgage activity increased by 10-fold from 2001 through 2007, and rose another 42 percent in the first quarter of 2008. As more and more mortgages have gone bad, researchers have looked into troubled portfolios and found startling rates of deception. BasePoint Analytics, a research firm, has estimated, for instance, that 70 percent of subprime loans that default before they reset (exactly the kind that trouble the market right now) contain some kind of misrepresentation by the borrower, lender or broker, or some combination of the three.

One big category of deception has been so-called ‘no-doc’ loans, where a borrower agrees to pay a slightly higher interest rate in exchange for not documenting his income. Originally designed for the growing number of self-employed workers in America who don’t have ready documentation from an employer, these mortgages became known as ‘liar loans’ because many people without sufficient income used them to qualify for financing they otherwise couldn’t get. One lender that compared what 100 applicants claimed as income on no-doc loans to what they reported to the IRS on their tax returns found that in 60 percent of cases borrowers were exaggerating their income by as much as half (or lying to the IRS).

Speculators are also part of the problem. As the housing market rose, more people got into the game of betting on higher prices by purchasing homes which they intended to flip quickly without ever occupying. As this became a popular form of investing, applicants starting lying about their intentions. They were trying to fool developers who grew wary of selling too many homes in new developments to people who would never occupy them, since these are the buyers most likely to walk away from a mortgage when the market turns down. BasePoint Analytics has estimated that this form of misrepresentation accounts for 20 percent of mortgage fraud.

Whether they were cheating or not, speculators clearly played a big part in the mortgage mess. According to a report earlier this month by researchers at the Mortgage Bankers Association, the vast majority of delinquent mortgages and homes in foreclosure continue to be in a handful of states where the housing bubble was largest and where speculation was common, led by California and Florida, which together accounted for a whopping 58 percent of all subprime adjustable rate mortgages that went into foreclosure in the second quarter of this year. In fact, so concentrated are the problems that only eight states have foreclosure rates that are above the national average. And while the rate of new foreclosures for subprime ARMs in the quarter was a whopping 6.63 percent, for traditional fixed-rate mortgages, it was only 0.34 percent. “For the quarter, a majority of states saw relatively little change” in their foreclosure numbers, the MBA researchers noted.

Against this background, fraud is not only growing but continues to be concentrated in states where the market meltdown has taken place—again led by Florida and California. In those states, moreover, the fraud reports are most common on properties near the coastlines, that is, in places where there is an enormous amount of speculation and where many purchases are for investment purposes.

The FBI is not so surprised by the trend. It warns that a sinking market is ripe for new types of fraud, as individuals try to get out of a fiscal mess using further misrepresentations, or as scam artists perpetrate fraud under the guise of helping consumers stuck in bad loans escape their troubles. Given that we seem to have had a generation of mortgage borrowers who at the least didn’t understand the types of loans they were taking out, and at the worst were committing fraud themselves, the FBI’s latest warning suggests we won’t see the end of the bad mortgage crisis anytime soon.

On the bright side, there won’t be a lot of investment banks packaging these new bad loans into toxic securities that threaten the world financial system.

As it turns out, the century that ensued was very much England’s when it came to economic prominence. Though the loom did destroy jobs, the capital that was freed up of the human and financial variety found new, economy enriching wants, and England grew. This was a happy result that has always revealed itself within mostly free economies.

Had the Luddites succeeded in blocking out economic realities back then, history today would be very different given the basic truth that England would have regressed. Instead, England embraced economic progress to the massive benefit of its citizens, not to mention the citizens of the world who benefitted from the investment that flowed from the world’s richest country.

All of which brings us to the SEC’s decision last week to ban the short sale of shares issued by 799 companies. As one would expect, the number as of this writing has risen to 900 firms whose shares can no longer be sold short. In what is America’s “everyone gets a trophy” economy, if firms don’t like the opinion of certain investors, they can go to the government and have those bears banned.

The absurdity of the SEC’s ruling would be hard to overstate. While there are many logical equivalents to this most ridiculous new rule, let’s just say that if the SEC can ban bears, than it can in theory ban bulls in a more optimistic market for ignoring certain companies in the midst of their buying lust. That, or investors who might miss out on a future bull market could lobby for rules against long buys as a way of enabling their purchase of shares at a discount to their actual value.

Put simply, if the SEC possesses the power to theoretically block out negative information, it can also impose rules that would retard the process by which positive information would reach the markets through heavy buying.

The logical response to the above is that no regulatory body would ever do such a thing. Maybe so, but it says here that any efforts to ban negative sentiment from seeping into share prices is a huge market negative; one that by definition is a ban on positive news.

That is so because to the extent that short sales drive down the prices of certain stocks, this is wonderful information that insures the process whereby capital is taken from the firms thought to be misusing it, and invested in those thought to be taking better care. The basic reality is that today’s market winners won’t necessarily be tomorrow’s, so if short sales are banned to the alleged benefit of certain companies, there will be other, potentially more vibrant companies of the future that will miss out on the capital that would reach them in a free market.

Think of it in terms of market laggards such as GM, Blockbuster and Circuit City. Absent the ability of short sellers to influence a fall in their respective share prices, existing shareholders would have very little reason to sell all three and place the capital with better management. To the extent that short sellers have impacted the decline of all three firms, it’s been all to the good for capital being moved in the direction of management less likely to destroy it.

More important, it’s quite simply not true that heavily shorted companies don’t benefit from the actions of short sellers. Much as a restaurant might change its menu if customers were few, so are short sellers a welcome message to company management that they’re misusing the capital entrusted to them. Just as the U.S. economy would be a mess absent price signals, so will the economy be much worse off if investors are blocked from communicating their displeasure through share prices to management.

On the positive front, any efforts to ban short sales will ultimately fail. Sure enough, early Monday morning the SEC partially reversed its ruling for market makers of stocks that are engaged in hedging activity. Indeed, it would be very risky for a firm to write derivative contracts on shares absent the ability to short. And if the ban hadn’t been lifted, other, more rational stock exchanges the world over would have gladly take business driven away by silly regulation: think Sarbanes-Oxley and the resulting globalization of IPOs.

What’s in the end most sad about the SEC’s ban is that it serves as yet another signal of what an unserious country we’ve become. The Luddites would be impressed. Rather than acting as economic leaders should in terms of elevating free trade, market discipline and price signals, we’ve shown amid a decline largely caused by our federal minders that we merely talk a good game about free markets.

Because when it comes to actually allowing markets to prevail, our leaders engage in rank hypocrisy of the kind which says, “Do as we say, not as we do.”

Would something like this happen? It could, and Pimco's Bill Gross argued in today's Post that it might, but there are several reasons it might not.

First, we don't know what price the government would pay for the mortgage-backed securities. There are conflicting goals. On the one hand, the government wants to minimize the bailout's costs to taxpayers; that would favor paying the lowest possible price. In my example, the profit would be greater if the government paid only $40 million. On the other hand, the whole idea of the bailout is to help banks and other financial institutions get rid of risky assets and replace them with cash that would encourage a resumption of normal lending and investing. That favors a higher price. If the government paid $80 million instead of $40 million, say, it would lose money.

Second, we don't know how a weakening economy will affect future mortgage repayments. The worse the economy gets, the more homeowners will default. At the end of June, about 2.75 percent of home mortgages were in foreclosure, and an additional 6.4 percent were at least 30 days behind in their payments. The unemployment rate was 6.1 percent in August. If it rose to 7 percent or higher, defaults and delinquencies would climb. In my example, if only 25 percent of borrowers repaid their mortgages, the government would lose money.

No wonder members of Congress -- and the public -- are confused. My simple example captures the main unknowns, but in practice there are many more. What bonds and securities would Treasury buy? Would the government hold them to maturity or later try to resell them to private investors? To all questions, Paulson has said in effect: Trust us.

Mark Zandi of Moody's Economy.com has crudely estimated that the ultimate cost of Paulson's plan and all the other rescues (of the mortgage giants Fannie Mae and Freddie Mac, the investment bank Bear Stearns, and the insurer AIG) won't exceed $250 billion. That's a lot, but consider that the annual federal budget runs at about $3 trillion. Compounding the confusion is this: For budget purposes, the Paulson rescue would probably be "scored" under the Federal Credit Reform Act. This law sets budget spending at the proposal's ultimate cost -- not the annual cash flows. For now, the Congressional Budget Office says there are so many unknowns that it can't make an estimate.

But the biggest unknown lies elsewhere. What happens if Congress doesn't approve the plan, or something like it? Zandi, a supporter, argues that the economy will get much weaker, that many more banks and financial institutions will fail, and that the rise of joblessness will be greater, as will the fall in tax revenue and the increase in unemployment insurance and other government payments. Is this scare talk or a realistic threat? The true cost of Paulson's plan hangs on the answer, and if the danger is real and imminent, then the cost of doing nothing would be far greater.

All of these people in the tin market—all around the world—are nothing more than counterparty traders—to use the faddish term. If a supplier goes broke, it affects actors all over the world; similarly, if a consumer can’t deliver on a contract to buy tin, it affects those same actors all over the world.

Hayek showed that far from being alarmed by counterparty trading, it is something we should welcome. Counterparty trading is nothing more than the interconnectedness of the market which ties the various actors together and incorporates their decisions into the price of a product. This interconnectedness is not something to be feared, but rather embraced.

Hayek made another profound (and humbling) point in information theory. The point was that every individual knows more about his own situation than anyone else in the world; in this sense every individual is a worldwide expert in at least one respect. The importance of this observation can’t be overstated when it comes to central planning. Each individual knows his own likes and dislikes better than anyone else. These likes and dislikes are what constitute a person’s preferences.

A central planner would need to have communicated to him all of these preferences from individuals in the economy. An individual similarly knows his endowments—what he owns and doesn’t own—better than almost anyone in the world. Both an individual’s preferences and endowments would need to be communicated to a central planner, as opposed to a decentralized system allows individuals to use this information directly by purchasing and producing without approval of a central authority.

This second point about individuals’ store of knowledge is relevant to counterparty trading. A significant part of an individual’s economic situation is the viability of his trading partners. Before an individual or firm is extended credit, for instance, they usually must fill out credit applications, financial statements, sometimes tax returns, etc. Due diligence performed on a trading partner is not always perfect, but an individual or firm has every incentive to assess the credit of its trading partners accurately. If General Motors or Ford went bankrupt, their suppliers, as in their counterparty traders, might also go bankrupt, but those suppliers had every incentive to make the right decision about trading with General Motors.

The recent American Spectator article by John Berlau points out that the 2001 bankruptcy of Enron—the seventh largest public company in the United States—did not keep the economy from growing in 2002 and 2003. Berlau points out that Enron traded heavily in derivatives with counterparties such as Morgan Stanley and Citigroup that were heavily exposed to losses from Enron. Despite that, the economy kept growing.

Counterparty traders have every incentive to limit their exposure to those unable to perform, and did so to an extent when it came to Enron's implosion was not an economy breaker. There is no reason to think that the current financial situation is any different.

But let us suppose that the financial community’s counterparty losses were large enough to force a downturn in the growth of the economy. Should we then step in to save a firm and its counterparty traders from extinction? I would again answer no—no more than we should have stepped in to bail out Chrysler and those exposed to it.

It is sometimes suggested that the government actually made money on the Chrysler bailout and that this somehow justifies the government intervention. This argument misses the distinction between ex post and ex ante justification. Ex post, after the fact, we can say that the government was fortunate and made money. This does not justify the decision ex ante, or beforehand. Ex ante, no other private parties would lend the money to Chrysler on the terms set by the government and so the decision was not economically justified at the relevant point in time.

Similarly, the current proposed bailout will not be justified if the government ultimately makes money. Given that the last mortgage security package sold for only 22% of its face value, and that only 1 in 416 houses are in foreclosure nationwide, it would not surprise me if there was a profit on the government investment. But this would still not be a justification for the bailout.

If the mortgages are bought from the government by a private equity firm or a hedge fund, they'll not be subject to the same regulations that the current holders are. Indeed, the present requirement to mark securities to market value forces a public firm to write down the value of an existing performing mortgage portfolio merely because another firm had to sell its portfolio at a reduced price. If a new bidder such as a private equity firm—unhampered by the mark-to- market regulation—buys the mortgages, it will not be required to mark to market.

This same result of freeing a new buyer from mark-to-market regulation could also have been achieved by allowing these new bidders to have bid in a bankruptcy court for the mortgage securities. This would have been a much better way to free up the system and fix new prices for these securities, rather than having the government buy them ahead of an auction.

Let’s walk through this hypothetical for a moment. Through a market-driven auction, the Treasury will purchase some dollar amount — say $100 billion — of loans that banks will sell. The Treasury will then buy those loans at the prices that fill the auction, starting with the lowest prices and working up. Now, the Treasury will hold those bonds either to maturity or for a sale in the open market if rising prices in the market make that sale attractive. In other words, suppose the Treasury buys a bond package at 20 cents on the dollar. They hold it for a while, and if market conditions improve, they sell it for 50 cents on the dollar to some buyer (e.g., an investment fund, a private-equity fund, a hedgie). The Treasury will make the sale at the higher price in order to gain a profit for taxpayers.

In the meantime, as the Treasury holds the loans, the government will get monthly cash-flows coming in on the mortgages, or on any other loans that it owns. So it is win-win for taxpayers. First, taxpayers get the cash flow generated by the assets. (Something like a 10 percent interest rate.) Second, if the loan is sold for profit, the taxpayers will own that profit. And the new law must of course stipulate that all the cash flows and/or profits go for debt-reduction to protect taxpayers.

I don’t think a lot of folks understand this win-win scenario. Let me repeat: The taxpayers own the bonds the Treasury buys; the taxpayers own the cash flows generated by the bonds; the taxpayers own the profits when the bonds are sold; and the taxpayers benefit when the profits and cash flows are used to pay-down government debt.

Actually, for taxpayers, it’s a win-win-win-win.

Think about this. The troubled assets purchased by the Treasury right now are likely to be very under-priced because of the chaotic and frozen market conditions. But over time, through monthly cash-flow payments or through loan sales, taxpayers will get all their money back and in great likelihood a handsome profit.

I have been in conversation with leading House Republicans all day. And they understand these key points. Unfortunately, this understanding did not materialize in their original meeting with Mr. Paulson a few days ago. But now the actual reality is sinking in.

Another point: Republican leader Eric Cantor has an excellent idea for a federal bond insurance guarantee for straight mortgage-backed paper, financed by private-sector insurance premiums. That will improve investor confidence in mortgage bonds and will make those bonds highly marketable. Importantly, senior Treasury officials have told me that Mr. Paulson will accept the insurance idea as an option in the final bill, alongside the ability of the Treasury to purchase distressed assets.

Sources also tell me that other conditions will be necessary to bring the House GOP along. First, the ACORN slush fund must be removed. Second, the so-called union proxy to run a slate of corporate directors is a big problem. Third, all profits from the Treasury rescue mission must be used to reduce the national debt — 100 percent. Fourth, Republican members are opposed to bankruptcy judges setting mortgage terms and interest rates (Sen. Obama also is opposed). Fifth, the so-called government equity ownership of banks is distasteful because it effectively creates a corporate tax increase on banks at a time when they are struggling. And last, the Treasury secretary’s request for $700 billion is regarded as way too high.

Essentially, House Republican leaders want a slimmer, cleaner Paulson plan supplemented by Mr. Cantor’s mortgage-bond insurance program. I think it’s a good package that would be great news for stock and bond markets that are now ailing badly. It would set the stage for a gradual return to normalcy on the part of bank lenders, including loans to small businesses, consumers, and homeowners. It would be a pro-growth package at a time when the economy desperately needs a prosperity tonic.

The word that best epitomizes mainstream "macroeconomics" (the study of the entire economy, not individual markets) is demand. If weak demand left the economy in a slump, government could rectify the situation by stimulating more demand through tax cuts, higher spending or lower interest rates. If excess demand created inflation, government could suppress it by cutting demand through more taxes, less spending or higher interest rates.

Economists of this tradition watch consumer and business behavior. Are car sales soft? How much are companies raising prices? What about profits? The $152 billion "stimulus" program earlier this year was a classic exercise in "demand management." It didn't work well mainly because this crisis originated in frightened financial markets. Massive losses on mortgage-related securities caused some financial institutions to fail. As fear spread, financial institutions grew wary of dealing with each other because no one knew who was solvent and who wasn't.

To Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, this financial breakdown now threatens the real economy. Companies depend on bank borrowings and sales of commercial paper (in effect, short-term bonds) to conduct everyday business -- to buy inventories, to pay suppliers and workers before cash arrives from sales. Credit markets were freezing, Paulson and Bernanke decided. Panicky investors were shifting from commercial paper to Treasury bills; banks weren't lending to each other. If it continued, consumers and firms wouldn't get essential credit.

If you reject that conclusion, then the whole crisis has been a contrived farce. Some economists do; they note that downturns always involve losses and disruptions. This one isn't so different. But many economists agree with Paulson and Bernanke. "If we can't calm down short-term credit markets, we're looking at a pretty severe recession," says Michael Mussa of the Peterson Institute for International Economics. "If businesses can't roll over their short-term debt, [they] ask where can we cut back" -- firing workers, reducing spending -- "to avoid bankruptcy."

Unfortunately, we lack experience with stabilizing financial markets, and the issue has been at the fringes of economics. Mostly, markets should operate freely. When is intervention justified? How?

Of course, economists recognized that the Federal Reserve should act as a "lender of last resort" and that permitting two-fifths of banks to fail in the 1930s aggravated the Depression. But the creation in 1933 of deposit insurance (now up to $100,000) was thought to prevent most bank runs, and the "lender of last resort" role never anticipated a worldwide financial system that mediated credit not just through banks but also through hedge funds, private equity funds, investment banks and many other channels. In congressional testimony last week, Bernanke admitted the Fed has been "shocked" at how elastic the "lender of last resort" role has become.

The resulting intellectual vacuum has spawned political chaos. Unpleasant and untested ideas invite opposition. Paulson's plan to buy up to $700 billion of impaired securities is wildly unpopular. It may not work and raises many problems. If the government pays too little for the securities, financial failures may mount; if it pays too much, it may create windfall profits for some investors and losses for taxpayers. But Paulson's plan has better prospects for restoring confidence by removing suspect securities from balance sheets than suggested alternatives would. Selective injections of capital into banks, for instance, might involve favoritism and operate too slowly to improve confidence. Psychology matters.

The economy will get worse. Mussa thinks unemployment (now 6.1 percent) could peak near 7 percent; other projections are higher. The harder question is whether financial turmoil heralds an era of instability. Our leaders are making up their responses from day to day because old ideas of how the economy works have failed them. These ideas were not necessarily wrong, but they're grievously inadequate at the moment.

There is, however, a shortage of capital for companies that have acted irresponsibly with investor capital in the recent past. For some reason, our political leaders believe this is a failure of the market, but isn’t this what should be expected from rational investors? Given a choice, why would a rational investor allocate limited capital to the losers rather than the winners? If capital is really as scarce as it seems, isn’t it better for our economy if we make sure that it is allocated wisely?

The biggest bank failure in the history of the United States happened last Thursday night and by Friday morning, it was business as usual. The only difference was the name on the door and the losses suffered by those unfortunate enough to invest in Washington Mutual bonds or stock. The taxpayers didn’t lose anything and depositors didn’t lose anything, only investors. That is how capitalism works in case everyone has forgotten.

The “crisis” we face today is not a creation of the market. Government intervention over many years (but especially the last year) is what brought us to the point where we’ve placed our hopes for economic recovery on the good intentions of a Congress facing re-election in a few weeks. There has been much commentary recently about the role of Fannie Mae and Freddie Mac in the creation and expansion of the sub-prime mortgage market which many believe to be the cause of this mess. That criticism is certainly warranted, but little attention has been paid to the real culprit – the Federal Reserve. Furthermore, what attention there has been is concentrated on the role of Alan Greenspan rather than Ben Bernanke. While Alan Greenspan deserves his share of the blame, Bernanke’s contribution to this mess should not be minimized or excused.

Bernanke obviously does not trust the market to sort the winners from the losers. When this erupted last year, the Fed lowered interest rates, including the discount rate, which is the rate charged by the Fed to lend directly to banks. There has always been a stigma attached to borrowing directly from the Fed and for good reason. If a bank can’t get other banks to lend it money, that tells the market something about the condition of the bank in question. Last August, Bernanke convinced three large banks to borrow at the discount window in an effort to remove that stigma. When that didn’t work, he concocted a scheme to allow banks to borrow from the Fed in anonymity via a mechanism he called the Term Auction Facility. When Bear Stearns blew up, he added the Term Securities Lending Facility for investment banks. By removing the stigma of borrowing from the Fed and hiding the identity of the borrowers, Bernanke removed important information from the market.

Now we face a situation where banks are not willing to lend to each other and have therefore become dependent on the Fed for daily liquidity. This is a direct result of the Fed’s actions. Banks will not lend to each other because they don’t know which ones are really in trouble. The rise in inter-bank lending rates is a rational market response to a lack of information. Furthermore, why pay those inter-bank rates when the Fed or ECB is offering easier terms?

These opaque lending facilities are just part of the problem created by the Fed and Treasury. The Bear Stearns intervention started the process by raising expectations that the government would step in and broker deals that would normally be left to the private sector. By providing favorable terms to JP Morgan in the deal, private actors came to see an advantage in waiting to see if the Fed would provide similar terms again. The worry at the time was that a Bear Stearns failure would cause a collapse of the system, but after watching Lehman Brothers file bankruptcy one has to wonder if that worry was based on fear or facts. Lehman filed bankruptcy on a Sunday night and the market opened the next day and functioned as it should. Would a Bear bankruptcy have been different? We will never know, but I have my doubts.

Now markets are waiting on pins and needles as the politicians haggle over the details of the latest bailout attempt by the Fed and Treasury. This has introduced another roadblock to the re-capitalization and reorganization of the financial industry. Companies that are in need of capital are waiting to see if the plan will bail them out of their difficulties. If Hank Paulson is willing to pay an above market price for their bad loans, why should they dilute their equity now? Why not wait until they can offload the bad paper on the taxpayer and raise capital at a better price? Why take Tony Soprano terms when Uncle Sam is willing to let the taxpayer take the hit for you?

If this bailout goes ahead in its current form and the Treasury pays a high enough price to recapitalize the troubled banks, what has been accomplished? The plan may be enough to induce the banking sector to start lending again, although frankly, I don’t know why we would want institutions who have shown such poor judgment in the past to stay in that business. This plan short circuits the capitalist model which would allow the stronger, well-run institutions to gain market share and/or expand profit margins. The long-term effect will be to lower the overall return on capital in the financial services industry. The government apparently believes that the key to economic recovery is to allocate limited resources in an inefficient manner. Does that make sense?

Paulson and Bernanke have testified to Congress that the market for the mortgage paper rotting on the balance sheets of bad banks is not working. They have not offered an explanation of why that market is not functioning except to blame the complicated nature of some of the securities. That explanation begs the question of how exactly the Treasury believes it will be any better at deciphering the mortgage market. A more logical explanation is not a lack of willing buyers, but a lack of willing sellers. The Fed has allowed institutions to use collateral of ever falling quality to secure loans from the Fed. If a bank can finance its activities through the Fed and keep the bad loans on the balance sheet, what incentive does it have to sell? Selling will reveal the true condition of the company and will also force other institutions to do the same under mark- to-market accounting. The Fed is the one keeping the market from functioning. The Treasury does not need to enter the market for it to start functioning; the Fed needs to leave the market.

Paulson has said that the cause of the current problems is the housing deflation, but that ignores the elephant in the living room. The housing bubble, which was concentrated in a relatively small number of states, was caused by the reckless actions of the Greenspan Fed. The consequences of that bubble have been exacerbated by the Bernanke Fed. The market is functioning as it should. It is the Fed that is not functioning correctly. There is no reason we had to go through either the bubble or the aftermath. We got into this mess because we tried to avoid the consequences of the Internet bubble. We will only make things worse by trying to avoid the consequences of the housing bubble.

We are not on the verge of a new depression. The housing bubble collapse in California, Florida and a few other states is not enough to bring down the entire banking system. Investors who made mistakes in these markets should be held responsible and those who navigated the Fed-distorted market should be rewarded for their wisdom and prudence. Enacting the Paulson plan will not allow that to happen and our economy will suffer for it in the long run. The Japanese tried to prop up failed banks in the aftermath of the bursting of their twin bubbles and the result was 15 years of stagnation. Why are we emulating a strategy that is a demonstrable failure? A better alternative would be to allow capitalism to work as it should and stop the interventions of the Fed in the money market. Trust capitalism. It works.

So while the House's failure yesterday to pass the financial rescue package perhaps lends short-term firepower to the arguments of those who support passage, it should be calmly remembered that for nearly a year the markets have been buckling; stocks having fallen more and more with each governmental attempt to arrest the natural workings of markets. As scary as the here and now might be, there's something to be said for more debate.

And when we consider the nature of laws passed amid past crises (think Sarbanes-Oxley), probably the best long-term tonic for markets would be the passage of a law mandating that no major economic decisions be voted on until after a three-month "cooling off" period. This would be hard for many to countenance now, but then the alternative is the acceptance of even greater state involvement in the economy passed by legislators eager to be seen doing something, as opposed to doing that which will be best for our economy over the long haul.

Even though Goldman Sachs and Morgan Stanley both conducted costly, but oversubscribed $10B financings last week, many in Washington believe that without help from the very government that has caused every economic calamity going back to the nation’s founding, recession is a near certainty. Republican Rep. John Boehner tells us the Paulson plan is necessary to “avert the crisis”, while Democrat Barney Frank argues that “If we don’t pass this bill, serious harm will occur.”

The comments of Boehner and Frank follow those of President George W. Bush last Wednesday night. Apparently the Reagan Era is over as so many on the left have made plain because while Reagan frequently said that the ten scariest words in the English language are “I’m from the government, and I’m here to help you”, the alleged heir to Reagan conservatism further distanced himself from anything Reagan given his proclamation that the markets aren’t “functioning properly” such that the federal government is “responding decisively.” Reagan Era, R.I.P.

So rather than allow non-governmental solutions to fix that which ails us, our leaders in Washington would like to take money from the private sector only to put it back in the private sector. We’re told of course that the investments made by Leviathan will probably make money, but if we ignore the kind of investment certainty not exhibited by even the best of money managers, there’s a bit of a problem here.

Indeed, during the 2005 debates about private Social Security accounts when markets were presumably functioning “properly,” many politicians told Americans who might want to opt out of the federal government’s pension plan that the markets were too risky for such activity. Now it seems markets that are “frozen” and function-free aren’t too risky for taxpayer dollars. Put simply, many in the political class are telling us that markets only work when Washington is at the controls.

Worse, our leaders on the Potomac ignore market solutions that wouldn’t require the very “rescue” that continues to roil markets. Last Friday Fox Business’s David Asman referenced the desire of private equity funds to buy the toxic securities that currently trouble banks but for the fear of bidding against Treasury and its presumably unlimited balance sheet. Whereas many market-oriented thinkers used to decry Japan’s unwillingness to let that which isn’t working fail, some of those same thinkers accept a government role when it comes to us.

What’s not being asked enough is if government is presently the problem when it comes to the health of the banking system. Indeed, with some sort of government rescue a near certainty regardless of what happened yesterday, isn’t it logical that this would drive the bidding of private interests to the sidelines? And with so many politicians seeking to bolster homeowners as part of the rescue (lenders are predatory, while borrowers are sacred victims), hasn’t the presumption of aid made mortgage-delinquents even more delinquent given the belief that Main Street’s role will be whitewashed? Some say the presumption of a rescue is what keeps markets afloat, but those same people are the ones who’ve suggested that markets are frozen despite expectations of same.

It’s probably naive to ask this considering the basic governmental incentive to grow, but if Washington won’t countenance the market-clearing and cleansing process that would be a path to recovery, why not at least minimize the government’s role through basic industrial policy? We always hear about how tax cuts “cost” the Treasury versus “stimulus” and $700B in spending that will allegedly aid the economy at a profit, but if bank balance sheets really are a mess, why not zero out capital gains treatment on the purchase of toxic securities to foster a private rescue?

Additionally, are there any small-government Republicans in our midst willing to use the rescue as a chance to shrink the role of government? Another free solution would involve the suspension of anti-trust and other bank-holding company rules so that private-equity interests presently flush might buy the struggling banks whose poor health has the economy on the brink.

It is said that politicians don’t “do the dollar”, but with the federal government the greenback’s monopoly issuer, has the positive impact of a stronger and more stable dollar even been considered? When we consider that mortgage-backed securities pay out dollars, a stronger unit of account would quickly make that which supposedly isn’t saleable more marketable, not to mention that those struggling to pay off mortgages would receive a raise that would keep on giving. The raise would result from commodities such as oil and gas falling in nominal terms, plus a stable greenback would propel capital back into the entrepreneurial economy such that wages for all Americans would get a needed boost.

Unfortunately, the nature of government means that any rescue will entail a truly remarkable process whereby money will be taken from the private sector, make a roundtrip through Washington, after which it will be used to supposedly prevent Armageddon. The wariness of voters about such a plan is well founded, and yesterday's House vote revealed voter concerns.

But such a plan is what we'll most likely get, and it will haunt us for some time. In the end, economic growth is always the result of productive work effort. Sadly, the federal government’s solution insures future regulations that will hamper work effort, not to mention a delaying of the necessary market-cleansing process whose very delay will push true recovery back even further.

So as painful as yesterday was for all investors, it's important to think longer term. While no bill will satisfy everyone, it can be hoped that further debate will at least lead to a plan that is less statist, and as such, less harmful over the long-term.

Personally, if this scenario plays out, I would probably withdraw my support for the rescue mission and switch to plan B, which would center on the FDIC and its bank-recapitalization powers. The bank-ownership issue, in particular, could lead to heavy nationalization of America’s financial system with a three-house Democratic sweep in November.

I’m not forecasting, because I don’t know the next bill’s content. And while McCain’s polls are heading south, he could still win. But a three-house Dem sweep to implement some off the very onerous provisions being talked about could set up the end of the U.S. financial system as we know it.

I’m gonna wait and see. Obviously, the financial markets are in total collapse today. And the economic outlook is suffering.

Tough day. One of the worst I can remember.

Concern about the financial system is fully justified. But excessive gloom is not. In the most recent quarter, GDP rose 2.1% year over year, 3.1% excluding housing. Hardly a depression. So let's not talk ourselves into one.

We, too, have qualms about the rescue effort. Washington under Democrat-led Congresses wrote the rules that made this mess possible, and we have little confidence in their ability to get us out of it.

We have even less confidence after watching Democrats try to insert things in the plan — from money for the radical community group ACORN to new taxes on Wall Street — that made no sense at all. We're glad Republicans opposed these and made the bill better.

But now it's time for all to hold their noses and vote as soon as possible on a compromise. Both the public and the investment community need to be reassured their leaders aren't dropping the ball.

Failure won't just cost billions; it will cost trillions — in lost output, a shrunken job market, smaller retirements and lost productivity. Is this the future we'll choose for ourselves? We hope not.

Republicans who voted against the bill did so for legitimate reasons. They don't like government getting too involved in the economy, and this package permits just that. But they also don't want to be blamed, as the minority party, if the deal turns sour.

That's already happening. Yes, more than 60% of Republicans voted against the rescue bill, but so did 40% of Democrats. That said, it's time for Republicans to take a deep breath, pull up their pants and help pass a bill. The nation's confidence is riding on it.

Americans must be made to realize it's not Wall Street that's being "bailed out," as the media keep putting it. It's Main Street.

The reason President Bush and Treasury Secretary Paulson moved so quickly and boldly is they fear a "seizing up" of financial markets. That means banks will stop lending to one another. It means companies that finance in the money markets — as many medium- and large-size businesses do — will be frozen out.

No lending, no business. Here's where Main Street comes in. Thousands and maybe millions will be laid off as commerce grinds to a halt. That's a real threat. Republicans will never get a perfect bill out of this Congress; compromises must be made by both sides.

We hope the $700 billion requested of Congress is enough to cover the problem. But we also note that on Monday, without Congress' interference, the Fed made $630 billion available to world financial markets. That brings this rescue to $1.4 trillion.

The ability of the nation's and the world's financial markets to finance this shouldn't be questioned. As the nonpartisan Congressional Budget Office noted Monday, the cost of any eventual rescue plan would likely be "substantially smaller" than $700 billion because of asset resales. And, around the world, there's some $70 trillion or so in investment capital, according to estimates.

We're not short on capital, as we said, but on confidence. Passing a bill, even if flawed, would go a long way to restoring the latter.